In order for nonprofit organizations to maintain their 501(c)(3) status they must demonstrate compliance with government regulations.
Accounting Practices for Nonprofit Compliance
Although a nonprofit may have been founded out of a passion to carry out its mission, the nonprofit is not owned by anyone. Rather, it is a public trust directed by a board, staff, and Executive Director. Since it is not a public, for-profit corporation, there are differences in the financial management of a nonprofit.
Nonprofit organizations and board members must understand these differences to avoid jeopardizing their 501(c)(3) status. These practices are essential to prepare the required Form 990 and demonstrate compliance.
Best Accounting Practices for Compliance
There are key differences in financial management between a for-profit business and a nonprofit organization. We’ll focus on some of the best nonprofit accounting practices for nonprofit compliance.
- Accounting for income and expenses are different. A for-profit business tracks revenue typically made from the sale of a product or service. This can be recorded in a general ledger under the appropriate chart of accounts, and will balance itself with a single transaction.
A nonprofit organization typically doesn’t sell a product or service for their revenue. Rather, they mainly operate on donations and grants that require special categorization to determine if the revenue is designated as restricted for its use, or is unrestricted. Some nonprofits do sell a product or service, such as arts organizations, museums, or health care clinics, but even their revenue must be properly categorized to track the source of the revenue.
Advice for Tracking Nonprofit Revenue
Besides tracking the funding stream has either as restricted or unrestricted, the nonprofit must classify the revenue to specific program areas that reflect the organization’s mission. So, if the money is restricted, the nonprofit organization can not legally take money earmarked for a program and spend it on any other area within the organization.
Therefore, each fund must be tracked separately, and expenses are tracked back to a single point of origin, or segments within the chart of accounts using fund accounting.
- A nonprofit uses a Statement of Financial Position. A for-profit business uses a balance sheet, which is a snapshot of the company’s assets and liabilities. Additionally, the balance sheet will show the owner’s equity, or net worth. This is extremely important to shareholders and investors.
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Financial Statements Unique to Nonprofits
Nonprofits do not have shareholders. They are a public trust essentially owned by the public for public benefit. As a result, nonprofits are required to generate financial statements and Form 990 that demonstrate compliance for maintaining 501(c)(3) status.
One such report is the statement of financial position (SOP). Like a balance sheet, the SOP shows assets and liabilities. The difference lies in the balance once you subtract liabilities from the assets. Since there are no owners, it won’t show “owner’s equity”; instead the balance is called net assets. The net assets are then divided into two categories: With Donor Desginations and Without Donor Designations (Restrictions).
The net assets circle back to their point of origin, or the grant or donation it was tied to.
- A nonprofit organization accounts for a statement of activities. While a for-profit company uses a profit and loss statement showing the profits made from the products and services sold, and reports that profit to shareholders, a nonprofit must use a statement of activities.
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Bottom Line
Revenue and expenses can overlap into various categories, and it is important for the financial management of the nonprofit organization that all revenue and expenses are tracked back to the origin of the program it is associated with. A nonprofit organization’s budget should the segregation of revenue and expenses by funding source and program. This provides the nonprofit with financial data that reflects whether or not there is enough resources for the nonprofit to fulfill each program’s mission.
By using a segmented chart of accounts that reflects the organization’s structure, the statement of will provide a nonprofit organization with the information needed to measure the resources available for their mission and helps management make more informed decisions. Following principles of accounting for nonprofits will ensure the mission doesn’t become endangered from poor financial management practices.
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