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Choosing an accounting basis at your nonprofit organization

How to Choose the Right Basis of Accounting for Nonprofits

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Being successful as a nonprofit means that everything needs to fall into place when and where it needs to fall into place. Knowing this, there are many different considerations and moving parts that you can control in order to gain additional visibility, save time, and improve outcomes.

While we discussed some of these factors, including the shift to outcome metrics and things to understand before selecting or changing from a calendar year to a fiscal one, today, we would like to turn our attention to another important consideration: How to choose a basis of accounting.

A recent AICPA article explored the basics on selecting a basis, and how to decide on whether a cash basis, accrual basis, modified cash basis, or tax basis is the proper way to look at the numbers, comparing these options and offering tips on how to select the one that makes the most sense to your nonprofit.

Different Bases of Accounting for Nonprofit Organizations

Whether cash, accrual, modified, or tax year, each basis of accounting listed below poses opportunities and challenges in measurement, disclosure, and reporting.

Cash Basis

If a nonprofit organization uses the cash method of preparing its accounting records and statements, it recognizes income and expenses when they occur. In other words, the nonprofit would record income when it received the funds and not when it is actually earned. It would also record expenses at the time it paid the bill rather than when it incurred the expense.

Example

This is a common approach for smaller nonprofits, as it mirrors a personal “checkbook accounting,” entering debits or credits as they are completed. For example, under a cash basis, if you receive a $10,000 pledge today, you do not record the $10,000 until the money is in the bank.

Pros and Cons

Pros and cons of the cash basis are as follows:

  • Pro: Easier to use on a day-to-day basis as it only requires one entry per transaction.
  • Pro: Due to its straightforward nature, cash basis requires less work and less stress when working with slow-paying funding sources (as opposed to accrual accounting, where money would be booked but the bank accounts could be barren)
  • Con: Must put a disclaimer on year-end reports that you use a cash basis.
  • Con: Presents challenges in visibility, especially for larger nonprofits.

Accrual Basis

Using the accrual method of accounting, a nonprofit recognizes income when they earn it, rather than when they receive it. It would also recognize expenses when they were incurred instead of when the organization paid the bill. For example, using the accrual method a nonprofit would recognize a pledge as income. That would hold true even if it had not yet received all the money, or even any amount of the donation pledged.

Example

Under the accrual method, nonprofits would record revenue and expenses when the transaction takes place, regardless of whether the cash has changed hands. For example, a $10,000 pledge would be recorded immediately and would create a receivables account for outstanding cash.

Pros and Cons

  • Pro: Offers a more complete view for monthly and quarterly financial statements, allowing you to get a more complete picture of your organization’s financial condition.
  • Con: More work—two entries per transaction and necessary cash flow statements.
  • Con: Requires more time and effort to keep books on a pure accrual basis.

Fund Accounting

Funds accounting is a form of accrual accounting that is specific to nonprofits. As a nonprofit grows, its funding sources can become more diversified. It may receive multiple grants, a government contract, personal donations of cash and goods and donations of time. With the funds basis of accrual accounting, each income stream is given its own accounting code. For example, your Department of Education grant would have its own code. Beyond that, you would be able to assign codes within a category so that you could break up DOE funds between general revenue, service revenue and administrative.

Modified Cash Basis

Modified cash basis statements combine elements of cash basis and accrual accounting. Certain transactions are reported on an accrual basis and others on a cash basis (for example, liabilities may be presented, but fixed assets may not).

The modified cash basis establishes a position part way between the cash and accrual methods. The modified basis has the following features:

  • Records short-term items when cash levels change (the cash basis). This means that nearly all elements of the income statement are recorded using the cash basis, and that accounts receivable and inventory are not recorded in the balance sheet.
  • Records longer-term balance sheet items with accruals (the accrual basis). This means that fixed assets and long-term debt are recorded on the balance sheet, and depreciation and amortization in the income statement.

Pros and Cons

  • Pro: Makes accounting for small transactions easier while allowing for a more accurate position when looking at fixed assets or large transactions.
  • Pro: Does not need disclaimer on year-end forms.
  • Pro/Con: Very conservative method of recording income and expenses. In this method, you only report cash which has been received, but include expenses whether or not they have been paid.

Tax Basis

While rare in the nonprofit world, there may be some cases for a tax basis for accounting. The tax method of accounting would ensure the financial statements match the organization’s Form 990.

Factors to Consider When Deciding on an Accounting Basis

AICPA author Marc Kotsonas, CPA, Officer- Mahoney Ulbrich Christiansen Russ shared the following six factors in choosing a basis of accounting.

  • Simplicity. The cash method may be the easiest to maintain and understand. Either the money came in or it went out. There are no accruals or allocations to compute. Cash basis financial statements are most common with very small not-for-profits.
  • Savings. Cash basis financial statements may provide administrative savings. With no accruals or allocations to consider, less time is required for accounting. In addition, if the organization has a financial statement audit, there are fewer statements for an auditor to test and issue an opinion on. This would generally reduce the cost of an audit.
  • Regulatory Requirements. Do you have to use a particular basis of accounting? For example, in Minnesota, the Attorney General’s office requires not-for-profits with more than $750,000 in revenue to have audited financial statements under GAAP. The IRS also addresses accounting method in its Form 990 Instructions, so be sure to consider the tax compliance implications of your choice.
  • Organizational Documents. Like regulatory requirements, a not-for-profit’s by-laws may specify the basis of accounting the organization must use. Consider reviewing your organization’s by-laws before undergoing extensive research to make sure you have the flexibility to choose a basis of accounting.
  • Understanding of Financial Position. Financial statements prepared under GAAP typically give readers a better understanding of the financial position of the organization at year-end. GAAP-based financial statements will show payables and other outstanding obligations, as well as any committed receivables or pledges. Cash basis statements often provide limited information. For instance, a not-for-profit that receives donated supplies and materials used in its programs would not capture their value or impact to the organization using cash basis statements.
  • Established Framework. Financial statements prepared using GAAP are based on a familiar framework. Since GAAP is commonly used, it also allows for financial statement comparability. Modified cash basis financials can be presented in any format management chooses, so they may not be comparable with the statements of other organizations.

Learn More: Nonprofit Success with rinehimerbaker

At rinehimerbaker, we are committed to helping you succeed. This is why we have written a series of helpful articles on running the finances at a nonprofit organization. We invite you to learn more by reading our articles on Outcome measures,  improving reporting, and increasing efficiency. Learn even more by reading these two nonprofit success stories from our friends at Sage Intacct, and contact us for more details.

five challenges nonprofits face

Five Top Pain Points for Nonprofit Financial Teams

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Now that you’ve filed Form 990, it’s time to get back to the daily grind of accounting. Was this year more challenging than last? Will next year be even more challenging? As your nonprofit organization grows, you face additional challenges that come with said growth—often facing more stakeholders, stricter requirements, and smaller budgets than a comparable for-profit organization. Needless to say, you face some unique challenges. Today, we would like to look at five of the biggest challenges that financial leaders at nonprofits face, and how to address them as you grow.

Five Top Challenges Nonprofits Face Day in and Day Out

Challenge 1: Complexity in Nonprofit Accounting

For nonprofit organizations, the daily tasks of accounting and financial management are driven by a broad array of complexities. Nonprofits have to work with different documents than their for-profit counterparts, including statements of activities, statements of financial position, statements of cash flow, and the Form 990.

With different cash flows and income streams come different challenges, as well. Grants, donations, break-even product sales, for-profit subsidiaries, and more mean that you have a lot of different questions to answer—all while trying to focus on the mission.

It’s a complex environment with a lot of stakeholders, and nonprofit organizations need to be able to answer questions quickly and accurately.

Challenge 2: Internal Controls

Most for-profit corporations create their internal controls, reporting, and financial monitoring by products, divisions, geographies, and entities. Nonprofits have remarkably similar needs, seeking to manage their monies by grants / donors, programs, geographies, and other dimensions.

For national nonprofits—especially ones looking to improve engagement by decentralizing and localizing operations with a chapter structure, this creates a set of complexities akin to major franchises or other multi-location businesses. Yet in this kind of environment, the central office still needs to take control of these decentralized locations, rolling up all of the information and ensuring that all are operating within the standards of the national.

Challenge 3: Complexities in Grant and Fund Management

While a for-profit business may have to answer to a few external requests for information, a nonprofit has to answer to each grantor and funder differently. Every funder wants to see how his or her investment is going, and this means reporting to a great deal of people with different expectations.

Without automation, these reports could takes days or weeks to complete, and still not provide all of the expected information. In terms of grantors, their expectations, while just as high, also require your nonprofit organization to report on general vs. restricted funds, adding even more complexity and challenge in reporting.

Challenge 4: Meeting Stringent Reporting Requirements

In a challenging economy, agencies, social-service organizations, charities, and other nonprofits are under tremendous pressure to acquire, secure, and maintain funding sources to ensure their continued operation. Transparency is an essential strategy for securing and keeping those donors and sponsors on board.

Communicating the effectiveness of your initiatives can be one way to secure more funding and to maintain your status in the eyes of the government requires accuracy and transparency. Add on top of this internal reporting requirements, and you have even more challenges that can’t be addressed with manual reporting.

Challenge 5: Handling the Needs of a Growing Nonprofit without Growing IT Budgets

Even while struggling to address all of these challenges, you have to do so with a much more stringent budget than your for-profit counterparts. One of these strict budgets is IT—it’s likely you don’t have the people or capital to allocate huge amounts of money on a software solution.

Nonprofits need to be able to do all of this reporting while still increasing their contribution to the mission, and one of the most common ways they are doing this is through cloud financials.

Download the Nonprofit CFO Survival Guide

Is your nonprofit or not-for-profit organization struggling to keep up with increasing needs with the same limited resources? Nonprofit CFOs are under the gun to achieve so much: to automate processes, improve productivity, create greater levels of transparency and visibility, enhance the governance of the organization, and strengthen the team’s decision-making and strategic focus.

If you feel that your organization is being held back by manual operations, primitive tools, and paper-based processes, we would like to share with you an immensely helpful whitepaper for finance leaders at nonprofits looking to take control of their operations and move toward their mission.

Titled The Nonprofit CFO’s Survival Guide—A Mini Field Manual, this whitepaper explores the aforementioned challenges in depth and how to address them. Download the Nonprofit CFO Survival Guide here.

rinehimerbaker, llc is proud to serve the unique needs of nonprofit organizations across the state of Florida. From outsourced accounting to software selection assistance, we have worked with nonprofits before and would love to help you. Learn more about Intacct for nonprofit organizations, compare it to other solutions like Abila and QuickBooks, and contact us for more details.

IRS Form 990 for Nonprofits

IRS Form 990: What Nonprofits Need to Know

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For nonprofits who follow a January 1-December 31 calendar, one of the most important dates of the year is coming up: Form 990 filing day. Just as March 15 for corporations and April 15 for individuals, May 15 holds a great deal of importance for tax-exempt organizations, nonexempt charitable trusts, and section 527 political organizations who have to file this form to provide the IRS with the information required by section 6033.

Used by the government to determine whether you can retain tax exempt status for the year and charity evaluation organizations who determine if donor money is being used properly. As the date rapidly approaches, it’s important to have your house in order so as to avoid any kind of last-minute issues or crunches that could pop up if you wait.

Why You Need to File Your Form 990

If you’ve been operating for a while, it’s likely you know why it’s so important to file a Form 990—providing the public with information about your financials so that possible donors know your funding sources and so that you can prove that their money is going toward your mission. It’s also important so that you can keep your tax exempt status—failure to file for three years in a row means automatic revocation of tax exempt status.

According to Cullinane Law Group, since 2011, more than 500,000 nonprofits across the country automatically lost their tax-exempt status for this reason. Additionally, the IRS has no appeal process for automatic revocations due to failure to file an appropriate Form 990 for three years. Without this status, your organization could be subject to paying income taxes. Additionally, you can avoid paying user fees and filing additional documents with the IRS by submitting your Form 990 each and every year.

Different Variants of Form 990

Depending on your size and organizational focus, there are three variants in addition to traditional Form 990: 990-EZ, 990-N (e-Postcard), and 990-PF.

  • Form 990-N (e-Postcard): For organizations with gross receipts normally under $50,000, this is the easy way to satisfy reporting requirements. There are only eight things to file, and can be done in minutes. For more information, click here.
  • Form 990-EZ: For organizations ranging from $50,000 to $200,000, and Total Assets less than $500,000, Form 990-EZ is the short version of Form 990. Consisting of six parts and four pages, 990-EZ instructions can be found here, and the form can be found here.
  • Form 990: For organizations whose gross receipts exceed $200,000 or total assets equal or exceed $500,000, Form 990 is the traditional form, consisting of twelve parts on twelve pages. Additional schedules may need to be filed for both 990 and 990-EZ.
  • Form 990-PF (Private Foundations): For Private Foundations who need to report all grants, trustees, officers, and more, they need to file a Form 990-PF. Foundation Center shares an interesting article, Demystifying the 990-PF.

Schedules for 990-EZ, 990, and 990-PF

Additionally, those filing a Form 990 may need to complete additional Schedules in order to communicate their funding and status, listed below:

Public Charity Status and Public Support (Schedule A), Schedule of Contributors (Schedule B), Political Campaign and Lobbying Activities (Schedule C), Supplemental Financial Statements (Schedule D), Schools (Schedule E), Statement of Activities Outside the United States (Schedule F), Supplemental Information Regarding Fundraising or Gaming Activities (Schedule G), Hospitals (Schedule H), Grants and Other Assistance to Organizations, Governments, and Individuals in the United States (Schedule I), Compensation Information (Schedule J), Supplemental Information on Tax-Exempt Bonds (Schedule K), Transactions With Interested Persons (Schedule L), Noncash Contributions (Schedule M), Liquidation, Termination, Dissolution, or Significant Disposition of Assets (Schedule N), Supplemental Information to Form 990 (Schedule O), Related Organizations and Unrelated Partnerships (Schedule R).

Companies Exempt from Filing Form 990

Not all nonprofits have to file annual returns. Generally, the following do not have to file Form 990:

  • Most faith-based organizations, religious schools, missions or missionary organizations
  • Subsidiaries of other nonprofits – those that may be covered under a group return filed by the parent organization
  • Many government corporations
  • State institutions that provide essential services.

The Form 990 is Necessary and Important

Much like a 10-K for publicly traded organizations and their potential investors, Form 990 will be seen by the public. However, your organization relies on donations, volunteers, and grants, so making sure the form is accurate, that overhead is minimized, and that you can prove yourself as a viable mission-focused organization can be the difference between growth and collapse.

For many nonprofits, using spreadsheets and hope is not a strategy that can lead to high ratings. With spreadsheets and other manual financial processes so error prone, they could be forcing your organization to hire additional accounting professionals or worse, putting you at risk for audits.

Our friends at Intacct recently presented an on-demand webinar on strengthening accountability and preparing for the precipice of an audit. Learn more about how you can improve reporting, accuracy, and your ability to remain compliant by watching the webinar, Strengthening Nonprofit Accountability through Audit-Ready Financials, or by reading The Nonprofit CFO’s Survival Guide: A Mini “Field Manual”

Learn more about Intacct for Nonprofits and how rinehimerbaker can help you implement it for success in future years as it grows with you.