The Differences Between GAAP, Cash Basis, and Modified Cash Basis of Accounting
Generally Accepted Accounting Principles in the U.S. (GAAP) are just that – generally accepted. However, it’s not the only choice of accounting basis available to not-for-profit organizations, and many organizations select another basis of accounting. There could be many reasons for presenting a different basis, one being that it may be more in line with how the organization reviews financial reports for budgeting purposes. But bankers and various funding sources typically understand GAAP basis financial statements and may even require it. So what are the benefits of reporting financial information in accordance with GAAP? Here are a few:
- GAAP basis requires accruals. Recording receivables and accrued expenses in the period in which they were incurred supports the matching concept (matching revenues and expenses in the same period).
- The modified cash basis allows you to decide where you are going to modify the pure cash basis. For example, maybe you only modify to record fixed assets and long term debt. Because you decide in which areas you want to modify, that means that there are no definite “rules” about when to record or recognize
certain financial statement items. Thus, it is difficult to do any sort of comparison with the financial statements of another organization.
- This ability to decide on where the modifications will be can lead to confusion when an unusual type of transaction comes up that you haven’t dealt with before. It forces you to decide- are you also going to modify the cash basis to record this particular item in a certain way? Again, there are no clear rules relating to this.
- If you do not modify the cash basis to record accounts payable, you are easily able to manipulate your net earnings amount for the year simply by delaying payment of expenses relating to that year.
- Because GAAP basis has definite “rules” about how and when to record transactions, financial statements prepared on this basis can be compared to financial statements of other organizations on GAAP basis.
Some nonprofit organizations maintain their monthly financial records on a modified cash basis internally for budgeting purposes, and then convert to the accrual basis at year-end so that their fiscal year-end financial statements are in accordance with GAAP.