Nonprofits can use either cash or accrual accounting for their day-to-day books and IRS filings, but accrual is required for GAAP-compliant financial statements and becomes effectively mandatory once an independent audit, federal grant, or state charitable registration enters the picture. The IRS itself accepts cash, accrual, or a hybrid on Form 990 as long as the method matches how you regularly keep your books.1Internal Revenue Service. Instructions for Form 990 The pressure to move to accrual almost always comes from auditors, grantmakers, and state regulators rather than from the IRS.
When Cash Basis Works
Cash basis records revenue when the money hits the bank and expenses when a payment goes out. Nothing tracks pledges, invoices, or obligations that haven’t yet been paid. For a board, it reads like a personal checking account: this is what we have right now.
Small nonprofits with simple finances usually stay on cash basis because it takes minimal bookkeeping expertise. Community groups, small foundations, and organizations with annual gross receipts of $50,000 or less often operate this way, sometimes filing only the Form 990-N e-Postcard to satisfy their federal reporting requirement.2Internal Revenue Service. Annual Electronic Filing Requirement for Small Exempt Organizations Form 990-N (e-Postcard) The method holds up as long as the organization doesn’t carry significant receivables, long-term pledges, or grant obligations that span multiple fiscal years.
The trade-off is visibility. A large grant deposited in December but earmarked for next year’s programs shows up as a surplus that isn’t really free cash. Bills already incurred but unpaid don’t appear anywhere. Once operations grow past the basics, those blind spots start to matter.
When Accrual Is Required
Accrual records revenue when it’s earned or pledged and expenses when the obligation is incurred, regardless of when cash moves. A grant award letter triggers revenue recognition before the check arrives; a signed service contract creates an expense before the invoice is paid. That timing shift is what makes accrual useful for understanding financial position, and it’s what several outside authorities require.
GAAP and Independent Audits
GAAP requires the accrual method for nonprofit financial statements. The Financial Accounting Standards Board governs nonprofit reporting through ASC Topic 958, updated by ASU 2016-14, which reorganized net assets into two classes: with donor restrictions and without donor restrictions.3Financial Accounting Standards Board (FASB). Accounting Standards Update No. 2016-14 Not-for-Profit Entities (Topic 958) If your organization goes through an independent audit, your auditor will expect accrual-basis statements built on these classifications.
Federal Single Audit Threshold
Nonprofits that spend $1,000,000 or more in federal awards during a fiscal year must undergo a single audit under the Uniform Guidance.4eCFR. 2 CFR Part 200 Subpart F – Audit Requirements Organizations below that threshold aren’t required to have a federal single audit, though their records must remain available for review. Any organization spending enough federal money to trigger a single audit will need accrual statements to get through it.
State Charitable Registration
Many states require nonprofits above certain revenue thresholds to submit independently audited financial statements as part of their charitable solicitation registration. Those audits follow GAAP, which means accrual. If you fundraise across state lines, check the requirements in each state, because audit thresholds and filing fees vary widely.
Unrelated Business Income Above the IRC 448 Threshold
The IRS generally doesn’t dictate an accounting method for Form 990 reporting, with one important exception. Under Section 448 of the Internal Revenue Code, a tax-exempt trust with unrelated business income is treated like a C corporation for that income, and the cash method is prohibited once the organization’s average annual gross receipts over the prior three tax years exceed the inflation-adjusted threshold.5Office of the Law Revision Counsel. 26 U.S. Code 448 – Limitation on Use of Cash Method of Accounting For tax years beginning in 2025, that threshold is $31,000,000, and it adjusts annually for inflation.6Internal Revenue Service. Revenue Procedure 2024-40 Most nonprofits will never reach this number, but organizations with substantial commercial activities alongside their exempt purpose should track their three-year rolling average and be ready to switch methods for the unrelated business income if they cross it.
What Accrual Actually Requires You to Track
Pledge accounting is one of the main reasons larger nonprofits need accrual. Under GAAP, an unconditional promise to give is recognized as revenue in the period it’s received, not when the donor sends the money. A donor who signs a pledge card in November committing $50,000 over three years puts the full present value of that pledge on the books in November.7Financial Accounting Standards Board (FASB). Accounting Standards Update No. 2018-08 Not-for-Profit Entities (Topic 958) Clarifying the Scope and Accounting Guidance for Contributions Received and Contributions Made
Conditional pledges follow different timing. A contribution is conditional when it contains both a barrier the organization must overcome and a right of return if the barrier isn’t met. A grant that requires the nonprofit to raise matching funds before receiving any money stays off the books until the match is secured.7Financial Accounting Standards Board (FASB). Accounting Standards Update No. 2018-08 Not-for-Profit Entities (Topic 958) Clarifying the Scope and Accounting Guidance for Contributions Received and Contributions Made Getting this distinction wrong can dramatically overstate or understate revenue in a given year, which is where cash-basis organizations sometimes stumble when grants start rolling in.
Donated services are another accrual-only entry. GAAP recognizes in-kind services as revenue only when the person donating the service has specialized skills and either creates or enhances a nonfinancial asset or performs a service the organization would otherwise have purchased. A CPA donating audit preparation work qualifies. A volunteer stuffing envelopes doesn’t, however valuable the help. Organizations receiving significant pro bono professional services need accrual records to capture these contributions accurately.
The Hybrid Middle Ground
Some nonprofits blend the two methods. A common version keeps routine operating expenses like payroll and utilities on cash basis while using accrual entries for multi-year pledges, depreciation on fixed assets, and outstanding loan obligations. A small finance team can handle daily bookkeeping without specialized software and still capture the larger obligations that a pure cash system would miss. The IRS allows an “other” method on Form 990, which covers these arrangements.
Hybrid works well during a growth phase. A nonprofit that has always run on cash but starts receiving multi-year grants or building an endowment doesn’t have to overhaul its system overnight. Layering accrual entries for the significant items on top of a cash ledger buys time. The limit is that hybrid books won’t satisfy an auditor preparing GAAP-compliant statements. Once an audit is required or expected by funders, full accrual is the destination.
Reporting Your Method on Form 990 and Changing It
Every nonprofit filing Form 990 must indicate its accounting method on Part XII, line 1, choosing among cash, accrual, or other. The IRS expects the method on the return to match the one you regularly use for your books.1Internal Revenue Service. Instructions for Form 990 Organizations filing Form 990-EZ report the same information on line G.
Once you adopt a method, you’re generally expected to stick with it. Switching from cash to accrual, or the other way, requires filing Form 3115, Application for Change in Accounting Method.8Internal Revenue Service. About Form 3115, Application for Change in Accounting Method This applies even in years when the organization generates only tax-exempt income.1Internal Revenue Service. Instructions for Form 990 The filing requires a Section 481(a) adjustment so that no income or expenses get counted twice or skipped during the transition. A nonprofit moving from cash to accrual has to account for pledges receivable and accounts payable that existed at the changeover date but were never recorded under the old method. Most organizations bring in an accountant familiar with the process, since errors here can trigger IRS inquiries.
Choosing the Method That Fits
The decision usually comes down to size and outside expectations. A neighborhood association running a few thousand dollars through a checking account has no reason to move to accrual. A nonprofit receiving federal grants, managing an endowment, or carrying multi-year pledge commitments needs accrual to satisfy auditors and funders. The IRS won’t penalize you for using cash basis on Form 990, but your grantmakers and state regulators may insist on audited accrual-basis statements regardless of what the IRS accepts. Start with who’s looking at your financials, and let that answer choose the method.