Why Would a Nonprofit Need to Convert from Cash Basis to Accrual Basis Accounting?

A nonprofit organization may need to convert from cash basis to accrual basis accounting for a variety of reasons. One common reason is that as the nonprofit grows and becomes more complex, it may need more sophisticated financial reporting. Accrual basis accounting provides a more accurate picture of the organization’s financial position and performance by recognizing revenue and expenses when they are earned or incurred, regardless of when they are received or paid.

Accrual basis accounting is also required for nonprofits that exceed certain annual revenue thresholds, as determined by the Internal Revenue Service (IRS). For example, if a nonprofit organization has average annual gross receipts of more than $250,000 over a three-year period, it must use accrual basis accounting for tax reporting purposes.

Another reason a nonprofit may need to convert to accrual basis accounting is if it receives grants or other funding that require it to report financial information on an accrual basis. In addition, many donors and grant-making organizations require nonprofits to use accrual basis accounting to provide a more accurate and transparent view of their finances.

For more about cash basis vs. accrual basis, watch this video:

Video explaining cash vs. accrual basis accounting.

What is the Process for Converting from Cash Basis to Accrual Basis?

The process for converting from cash basis to accrual basis accounting for a nonprofit organization typically involves the following steps:

  1. Determine the date for the conversion: The nonprofit organization needs to choose the date from which it will start using the accrual basis of accounting. This could be the start of the fiscal year or the start of a new accounting period.
  2. Identify all accounts that will be affected: The nonprofit organization needs to identify all accounts that will be affected by the conversion, including cash, accounts receivable, accounts payable, and any other assets, liabilities, revenues, or expenses.
  3. Record adjusting entries: Adjusting entries need to be recorded to bring the cash basis accounts up to the accrual basis. For example, accounts receivable and accounts payable balances need to be adjusted to reflect the amounts owed at the end of the period.
  4. Create new accrual basis accounts: New accrual basis accounts need to be created, such as accounts for prepaid expenses, depreciation, and accrued revenues and expenses.
  5. Prepare financial statements: Once all adjusting entries have been made and new accounts have been created, the nonprofit organization can prepare financial statements using the accrual basis of accounting.
  6. Communicate the changes: The nonprofit organization needs to communicate the changes to its stakeholders, including its board of directors, donors, and grantors, to ensure they understand the new financial statements and the impact on the organization’s financial position.
  7. Monitor and review: Finally, the nonprofit organization needs to monitor and review its financial statements regularly to ensure they accurately reflect the organization’s financial position and performance.

Overall, converting from cash basis to accrual basis accounting can help a nonprofit organization to better understand and manage its finances, meet regulatory and reporting requirements, and improve its ability to secure funding and support from donors and stakeholders.

Caroline Grimm

Caroline Grimm is an accounting educator and a small business enthusiast. She holds Masters and Bachelor degrees in Business Administration. She is the author of 13 books and the creator of Accounting How To YouTube channel and blog. For more information visit: https://accountinghowto.com/about/

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