Frequently Asked Questions

Question

What is the difference between cash basis and accrual basis accounting?

Answer

Example of Cash-Basis Balance Sheet
Example of Accrual-Basis Balance Sheet

Cash-basis and accrual-basis accounting use different criteria for determining when to recognize and record revenue and expenses in your financial records. On a cash-basis revenues are recognized when cash is received and deposited. Expenses are recorded in the accounting period when bills are paid. In accrual-basis accounting, income is realized in the accounting period in which it is earned (e.g., once contracted services are provided, grant provisions are met, etc.), regardless of when the cash from these fees and donations is received. Expenses are recorded as they are owed (e.g. when supplies are ordered, the printer finishes your brochure, employees actually perform the work, etc.), instead of when they are paid.

To illustrate, let's take a simple example. At the end of a summer camp's fiscal year, it has recorded the following deposits and expenditures (left hand statement) from its checkbook. A balance sheet has also been prepared to show the camp's assets, liabilities and fund balance.

Example of Cash-Basis Balance Sheet

Since the information was taken from activity in the checkbook, we know these statements were produced on a cash basis. However, some pertinent information has not been recorded. For example,

• A foundation has given the camp a grant of $10,000 to provide scholarships for low-income children. The children did attend the camp, but the foundation has not yet sent in the check.
• Because cash is tight, the camp has not paid the final installment to their printer for this year's brochure. They owe her $1,500.
• The insurance premium was paid in December, and covers the period December through November. So, it is good for another three months.

To take these three factors into consideration on the financial statements, revenues and expenses need to be recorded on an accrual basis. Several line items need to be added to the balance sheet in order to update the financial statements. These are:

• Accounts Receivable
  Reports revenues which have been earned, but not yet received. For example, a payment from a government grant which has been vouchered, but not yet received is an account receivable. In this case, the camp has a grant receivable of $10,000, since the children have already attended the camp and the camp has therefore "earned" the scholarship money from the foundation.

  IMPACT:
  Increase grant income by $10,000 to $13,000
  Increase grants receivable to $10,000

• Accounts Payable
  Reports expenses which are owed to others. The money owed to the printer for completing the brochure is a $1,500 account payable.

  IMPACT:
  Increase printing expenses by $1500 to $5000
  Increase accounts payable to $1500

• Prepaid Expenses
  Reports expenses which have already been paid, but are for a future period. In this example, three months of insurance is considered a prepaid, rather than a current, expense.

  IMPACT:
  Decrease insurance expense by $1,050 ([$4,200/12 months] x 3 months) to $3,150
  Increase prepaid expense to $1,050

Reported on an accrual basis, using the categories described above, the camp's financial statements now look as follows:

Example of Accrual-Basis Balance Sheet

This example illustrates how preparing financial statements on an accrual basis, using these categories, will give a much more accurate and complete picture of an organization's financial condition. However, cash-basis accounting is easier to use on a day-to-day basis since there are fewer transactions to track. For this reason, many nonprofits, especially those with smaller budgets, choose to keep their books on a modified cash-basis. This means they do one or more of the following:

• Keep the books on a cash basis and prepare reports on an accrual basis. One way to accomplish this is by making accrual adjustments for receivables, payables, etc. on a worksheet and incorporating this information into the financial statements, without formally entering it into the books.
• Record small transactions (e.g., under $100) on a cash basis, but larger transactions and withheld payroll taxes are recorded on an accrual basis.
• Record income on a cash basis and expenses on an accrual basis. This is the most conservative method for recording income and expenses, since you only report cash which has actually been received, but you include expenses whether or not they have been paid.

Many organizations do not have the resources or need to keep their books on an accrual basis. Factors to consider when deciding which basis your organization should use include:

• The extent to which your organization has payables, receivables, etc. on an ongoing basis. If you have few unpaid bills or outstanding grants or fees throughout the year, cash-basis accounting will give essentially the same financial picture of your organization as accrual-basis, and will be easier to use.
• The expertise and time constraints of your bookkeeping staff.
• The cash flow position of your organization. If cash flow is an ongoing concern you will want to keep close track of accounts payable and receivable.
• The size of your organization's budget. Many small or new nonprofits do not have many payables or receivables, nor do they have the ability to keep track of accruals on an ongoing basis. These organizations will use cash-basis accounting. On the other hand, as their budgets grow, and with them the number of financial transactions, it may become more important to keep track of all activity. They will then switch to using a modified cash or accrual system.

No matter which system you use throughout the year, financial reports must be prepared on an accrual basis according to generally accepted accounting principles.

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