Nonprofit accounting is the process of recording, managing, and preparing compliant financial statements for 501(c)(3) organizations. This includes everything from tracking income and expenses to tax returns to generating financial reports necessary for maintaining tax exempt status.
Table of contents
- What is Nonprofit Accounting?
- What are the differences between profit vs nonprofit accounting?
- What are nonprofit accounting requirements?
- What are nonprofit financial statements?
- Bank Reconciliation for Nonprofits
- Nonprofit Tax Exempt Status
- What are the benefits of accounting for nonprofits?
- Accounting Training
- Accounting for Nonprofit Software
- Bottom Line
What is Nonprofit Accounting?
This specialized type of accounting helps nonprofits keep track of their finances. Most importantly, they can make informed decisions about how to allocate resources and manage risk and report performance transparently.
Main goals include:
- Compliance with legal requirements, efficient management of resources
- Financial stability over time and fundraising effectiveness.
What are the basics of nonprofit accounting?
The basics focus on understanding the financial statements and how to prepare them. Nonprofit organizations must file annual reports with state authorities. These reports evaluate a nonprofit’s performance.
What are the differences between profit vs nonprofit accounting?
The difference centers around the bottom line. A for-profit company makes a profit for its owners. A nonprofit has two bottom lines. The first goal fulfills its stated mission. The second one provides the necessary funding to support your mission in the present time and the future.
Nonprofit organizations, known as public benefit corporations, receive revenue from a combination of:
- Donations or grant income
- Donated facilities and equipment
- Low paid or volunteer staffs
Measurement of success:
- Financial Goals
- Accounting Software
The infographic below illustrates the measurement of success. For nonprofits, the accounting methods differ in terms of accountability and compliance.
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What are nonprofit accounting requirements?
It is important for nonprofits to be aware of their legal obligations.
- Taxes (income tax, social security tax)
- 501(c)(3) status (if applicable)
- Ensuring compliance with all relevant regulations (both federal & state)
Nonprofits must file annual taxes as part of their federal tax filing requirements. Some don’t have to file audited financial statements with the IRS.
Tax requirements include:
- Assessed real estate or sales tax.
- IRS Form 990. Filing the IRS Form 990 ensures that charitable organizations are accountable to funding sources.
Accounting Methods for Nonprofits
Accounting for nonprofits uses fund accounting. Fund accounting focuses on accountability and donor stewardship. Nonprofits separate resources into various accounts, which identify where those resources come from and their usage. Organizations must keep detailed bookkeeping records. This helps maintain them maintain their tax-exempt status.
This type of accounting system is typically a series of general ledgers, or funds, which enables the organization to track revenue and expenses to a single point of origin. Theoretically, each fund has a separate budget, and this separation in the books ensures the nonprofit is using grants and donations solely for permitted purposes. FASB117 and FIN46 are the IRS resources that outline a nonprofit accounting system’s needs.
What are the reporting requirements for nonprofit organizations?
GAAP for Nonprofits
To be clear, Generally Accepted Accounting Principles (GAAP) provide accounting definitions for nonprofit organizations. Most importantly, it ensures that organizations present their financial statements in a transparent way to the public.
IRS Form 990 includes information about the organization’s annual and quarterly tax returns, financial statements, and the organization’s plans for the future.
A budget represents what your nonprofit expects to spend (expected expenses) and earn (expected revenue) over a specified time period.
What are nonprofit financial statements?
Financial statements for nonprofits are a set of reports that demonstrate how well a nonprofit is doing financially. They show how much money the organization has, how it spends its money, and what its assets and liabilities are. It includes information about the organization’s income and expenses. Nonprofits prepare financial statements quarterly or annually. Therefore, choosing accounting software designed specifically for nonprofits make preparing and generating financial reports much easier.
For-Profit vs Nonprofit Reports
For-profit businesses use a balance sheet which reflects the assets the corporation owns. These assets become retained earnings distributed to shareholders. A nonprofit generates a statement of financial position. It reflects assets on hand for furthering the mission of the organization. A for-profit tracks net income. A nonprofit tracks the excess of revenues over expenditures.
Understanding these major accounting differences between for-profits and nonprofits can help you avoid surprises and can ensure that your organization meets its financial accountability and transparency requirements under state and federal law.
The main purpose of preparing financial statements is to help organizations understand their performance and make decisions based on that information. Financial statement information is useful for understanding whether a nonprofit is meeting its goals, raising enough money to continue operating, and deciding whether to invest resources into the organization.
Preparation of Financial Statements for Nonprofits
Nonprofits prepare financial statements that meet the reporting and accounting standards required for nonprofits. The statement of financial position details assets and liabilities. A nonprofit accountant can determine the size of the nonprofit by reviewing its net assets.
There are four types of financial statements that nonprofits must submit to ensure federal, state and local compliance. These statements form a complete picture of the organization. These include:
- Statement of Activities – Profit or Loss/Income Statement
- Statement of Changes in Net Assets – Profit or Loss by Functional Area combined with changes in Net Asset
- Statement of Financial Position – Balance Sheet
- Statement of Functional Expenses – List of expenses summarized by functional area
- Statement of Cash Flow
1. Statement of Activities – Income Statement
Statement of retained earnings calculates revenue earned by subtracting expenses incurred.
- Revenue minus Expenses = Excess or Deficiency
This change results in an excess or deficiency net asset balance.
The Statement of Activities gives you a sense for how well the nonprofit is operating.
- Broken down by Fund – According to proper nonprofit reporting standards, the Statement of Activities must separate your revenue and expenses by Net Asset Class:
- Net Assets Without Donor Restrictions
- Net Assets With Donor Restrictions
- Broken down by functional area within each Fund: Management & General, Programs, Fundraising
Revenue Released from Restrictions, a line item, replaces Temporarily Restricted Expense.
- Excess or deficiency increases or decreases the Net Asset balance
Restrictions on revenue are based on timing. First, money must be spent on its designated purpose. Second, money becomes recognized as revenue after it is used for its designated purpose.
2. Statement of Activities and Changes to Net Assets
The primary purpose of the Statement of Activities and Changes in Net Assets is to provide relevant information about the sources of and uses of income and the effect of those transactions on specific net asset classes.
Net asset classes include:
- Net Assets Without Donor Restrictions
- Net Assets With Donor Restrictions (grants, program revenue, donations, earned revenue)
This statement focuses on the organization as a whole and reports the amount of the change in net assets for the period.
- Assesses service efforts and ability to provide services
- Assesses whether managers have conducted their stewardship responsibilities
- Lists revenue by line item. Similar to Statement of Activities
- Revenue summarized by Functional Area or Program
- Includes the Changes in Net Assets by Fund
- Provides relevant information to evaluate the performance of an organization and the ability to continue in these efforts
3. Statement of Financial Position – Balance Sheet
- Summarizes all assets and liabilities
- Net Assets listed by net asset class
- Reflects financial position at a fixed point
- Computes net worth or net loss
Assets and liabilities included:
- Assets – cash accounts, receivables, prepaid expenses, security deposits, and fixed assets
- Liabilities – accounts payable, accrued expenses, payroll tax liabilities and loans payable.
- Net Assets – organization’s net worth at a specific period of time. The calculation of net assets is your Assets minus your Liabilities.
Net Asset Balance breaks down by Net Asset Class, similar to the Statement of Activities.
4. Statement of Functional Expenses
The statement of functional expenses tracks real costs by categorizing expenses by functional area: mission-based programs and support services such as administration and fundraising.
- Used to show how expenses are incurred for each functional area of a nonprofit entity.
- Functional areas typically include programs, fundraising, and management and administration.
- Each functional area is displayed in separate columns, with a list of all expenses incurred, with totals for each area.
- Is necessary in a nonprofit’s audited financial statements
5. Statement of Cash Flow
As a nonprofit, your biggest challenge is likely to be managing your accounting cash flow. More importantly, cash flow is necessary to pay bills and other expenses. The Cash Flow Statement includes total cash received minus total cash spent.
The purpose of managing your cash flow is to make sure that you have enough cash to pay current bills. The Cash Flow Statement includes total cash received minus total cash spent.
Using Cash or accrual based accounting determines when to record revenue and expenses.
Reports the change in its cash and cash equivalents in three sections:
- Net cash from operating activities
- Net cash from investing activities
- Net cash from financing activities
Bank Reconciliation for Nonprofits
Bank reconciliation is necessary to keep your nonprofit running smoothly. The bank reconciliation supports findings in financial reports. It verifies that reported values match what is found in the reconciliation. Furthermore, reconciling your bank statements monthly ensures account balances from records match a bank statement. Most importantly, bank reconciliations help prevent fraud.
Nonprofit Tax Exempt Status
Tax-exempt status under IRS 501(c)(3) refers to a nonprofit which states it must be an organization and operated exclusively for exempt purposes. None of its earnings may be for private or individual use. The IRS is responsible for determining the tax-exempt status of the organization.
What are the benefits of accounting for nonprofits?
The benefits include increased transparency, compliance, and accountability.
- Transparency: Nonprofits require more transparency. This makes it easier to track financial performance and make informed decisions about resources.
- Compliance: Accurate records help ensure compliance with tax laws and regulations.
- Accountability: A proper accounting system provides information used for individuals or organizations accountable for their actions. This increases the likelihood that they will act ethically and responsibly in the future.
Finance employees and volunteers must receive specific training. Start with a solid understanding of nonprofit financial accounting principles.
Having the proper accounting training for nonprofits will help you prepare meaningful financial statements. Other aspects of nonprofit financial management include:
- Preparation of grant proposals for programs
- Preparation of financial statements for the board
- Reconciliation of bank statements
- Cost projection by program for the next year
- Preparation of year-end processing
These tasks require an understanding of financial management. By taking a nonprofit accounting course, your finance team will understand the important building blocks necessary to make informed decisions. Some of the core topics they need to know include:
- Creating budgets
- Managing cash
- Reconciling accounts
- Proper recording and classification of revenue and expenses
- Preparing and generating compliant financial statements
Accounting for Nonprofit Software
Keeping good accounting records ensures accurate nonprofit audits or financial statements. FastFund Nonprofit Accounting software helps you automate many parts of your nonprofit organization’s finance operation- making it easier for you to record transactions accurately, manage your data and generate compliant financial statements.
For-profit businesses use off-the-shelf accounting software, a one-size-fits-all solution. This does not meet the nonprofit requirements for fund and functional accounting. You will need to take an extra step to export all your data into a spreadsheet to generate financials.
Make sure your nonprofit financial software provides the accounting tools for the unique requirements of nonprofit organizations. This is how you can become more accountable, cultivate better relationships with your donors, raise more funds and help your nonprofit fulfill its mission.
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