Why Should You Use Accrual Basis Accounting? Accrual Basis vs. Cash Basis Accounting
By Sara Lassila, Sara Lassila, CPA, Inc.
The Methods by Definition:
In accrual basis accounting, income is reported in the fiscal period it is earned, regardless of when it is received, and expenses are deducted in the fiscal period they are incurred, whether they are paid or not. In other words, using accrual basis accounting, you record both revenues and expenses when they occur.
In cash basis accounting, revenues are recorded when cash is actually received and expenses are recorded when they are actually paid (no matter when they were actually invoiced).
So the primary difference between the two types of accounting is when revenues and expenses are recorded.
Why is Cash Basis Accounting a problem?
All you see in your financial reports is the cash balance.
You do not know what amounts are owed to the Association by unit owners and others. There is no assessments or accounts receivable amount reported on the balance sheet, nor is there a supporting schedule of the individual balances of the amounts owed to the Association.
You do not know what amounts are owed to vendors. There is no accounts payable amount reported on the balance sheet, nor is there a supporting schedule that lists who the Association still owes for any products or services.
Cash basis accounting can leave you guessing whether there is money available or not to meet the needs of your Association.
Why is Accrual Basis Important?
The accrual basis of accounting method is the method used by most businesses because the combination of the information on the balance sheet and the statement of income or loss provides them an accurate financial picture required to make good business decisions.
Your Association is a small business, so accrual basis of accounting will give you better financial reporting to be able to manage cash resources to meet the expenses and plan for the future, short term and long term.
As Board members and professional managers you will be able to avoid over obligating the cash resources of the Association.
Accrual basis allows for ease in tracking individual homeowners’ receivable amounts. Individual amounts are required by Minnesota State law to be disclosed in a resale disclosure. In addition assessments receivable must be disclosed in the Association’s annual report.
Accrual basis accounting is required for Association year end reporting under the Minnesota Common Interest Ownership Act section 515B.3-121(c), Accounting Controls. If your Association is maintaining its monthly financial reporting on the cash basis of accounting, your CPA will need to convert your financial information to accrual basis accounting at year-end.
Accrual basis accounting avoids the attitude that "since there is still money in the check book, we can spend it;” it forces you to plan for expenses that need to be paid based on the cash that is on hand, plus assessments receivable (cash that is not yet received but will be), less any cash that is already obligated for payment of prior Association expenses.
And finally, using accrual basis accounting will make your CPA who prepares your year end audit or review HAPPY!
Should you have questions or want more information about accrual accounting please contact Sara Lassila at 952.474.1631.