Hidden Gems About Accounting for Nonprofits Revealed
Compared to for-profit accounting, accounting for nonprofits focuses on demonstrating accountability and fulfilling its mission as a measurement of success.
What is Accounting for Nonprofits?
While many aspects of for-profit and nonprofit accounting are similar, such debit, credits, tracking and reporting of income and expenses, assets and liabilities, there are significant differences that make nonprofit accounting much more complicated.
Unlike for profit businesses that exist to generate profits for their owners, nonprofits exist to pursue a mission that addresses specific needs of society. So the bottom line for a for-profit businesses is making sure that revenue exceeds expenses to make a profit. Whereas the bottom line for a nonprofit is fulfilling its mission. Because of these fundamental differences and the rules set in place by Accounting Standards Organizations the focus for nonprofits is not profitability but accountability.
What are Functional Expenses
These differences come down to measuring how a nonprofit fulfills its mission. In terms of financial management, nonprofits are required to itemize expenses across management (general and administrative), fundraising and program areas. These are called “functional expenses” and the IRS requires that they be reported.
The requirement for nonprofits to report functional expenses also highlights the importance of a direct cost allocation plan. This defines how you allocate expenses across various functional areas and specific programs.
Nonprofit Accounting Standards
Nonprofit Accounting Standards are set in the United States by the Financial Accounting Standards Board. Their last major statement was issued back in the 90s (FASB 116 / 117) that addressed how a nonprofit must classify the revenue it receives and whether or not the revenue has certain restrictions placed on it by the donor.
Nonprofit revenue recognition incorporates two classes of revenue: net assets with donor restrictions and net assets without donor restrictions.
These restrictions are the fundamental difference between for profit and nonprofit accounting. A nonprofit must follow the wishes of the donor as to the use of their funds if the donor designates the donation for a specific purpose. But in the for profit world, for goods that are sold and services provided, once the customer receives the goods or services, the company can choose to do whatever it wants with the revenue.
Classification of Nonprofit Expenses
Another key component of nonprofit accounting is the classification of expenses. All businesses have expenses for salaries, payroll taxes, rent, utilities and supplies, but a nonprofit must classify those expenses into three functional areas — management and general and fund raising which are called support services and program which is how much money is actually spent on their mission.
This breakdown is required for financial statement presentation to the general public and on the nonprofit’s annual IRS 990 report. Functional expense reporting is another important financial measurement for the nonprofit. It provides information on how much of their resources are dedicated to their mission.
Nonprofit Accounting Financial Statements
While the underlying principles of financial statement preparation are the same for for-profit and nonprofits, the presentation is different.
A for profit generates an income statement listing all revenue and expenses and the profit or loss. A nonprofit generates a statement of activities with an emphasis on revenue restrictions and grouping of expenses by functional area. There is no profit or loss for a nonprofit, but the difference between revenue and expenses is show as a change in net assets to reflect how the organization is using its funds to fulfill its mission.
A for profit’s balance sheet lists the company’s assets, liabilities and the owner’s equity. But a nonprofit generates a statement of financial position with assets, liabilities and a breakdown of net assets by their donor imposed restrictions.
Nonprofit Financial Goals
The goal of all commercial enterprises is to make a profit.
The goal or mission of a nonprofit organization is to perform a service or fulfill a mission that benefits the community.
A nonprofit usually operates at breakeven or deficit levels of spending on purpose. The reason for this is because it must spend the money granted to them or it will jeopardize future donations and grants.
For example, a grantor gives a nonprofit organization a $250,000 grant to operate a youth crime prevention program. If the organization only spends $210,000, technically and legally it must return the remaining $40,000 to the grantor.
It’s because of these differences that nonprofit organizations must use the right accounting software tools that help them generate proper financial statements that measure their effectiveness, provide proper accountability and transparency.
Want to read more? Check out these insightful articles:
- Key Difference Between Nonprofits and For Profits and Why It Matters
- What Every Nonprofit Must Know About Functional Accounting
- Nonprofit Financial Statements: How To Generate Compliant Reports
- How to Read Your Nonprofit Statement of Activities Report
- Why A For-Profit Strategy Can Boost Nonprofit Revenue
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