Nonprofit Accounting Standards

Nonprofit organization accounting is a specific approach to accounting for nonprofit organizations with a rigorous set of guidelines. For-profits primarily focus on earning a profit, but nonprofit organizations focus more on accountability. They keep detailed financial statements in order to report these figures to their donors and contributors at the end of each tax year.

This allows donors to make more informed decisions about where to give their money and make sure the money is used for the intended cause.

Compared to their for-profit counterparts, nonprofits are required to follow a stricter set of rules that ensure they're being transparent with their finances.

In this article, we'll cover the basics and best practices that nonprofit organization professionals should know about accounting standards and financial statements. Knowing the ins and outs of financial management will help you better manage your organization's programs in a way that maximizes value from the bottom line.

What Makes Accounting Standards Unique For Nonprofit Organizations?

Nonprofits need to prove they're good stewards of the money they receive from grants, donations, fundraisers, and membership dues. That's where nonprofit accounting comes in. It's an entirely different set of accounting standards and procedures than for-profit businesses use.

Donations with donor restrictions for the way nonprofits must spend their money can be frustrating, but they are important for maintaining responsible financial practices. Nonprofits break down their funds without donor restrictions into different groups in order to keep their finances organized and ensure that spending is on target.

Funds without donor restrictions can be spent on practically anything, but those with restrictions are known as earmarked funds on financial statements by most accounting standards. These are funds that have been specifically allocated for a certain project, activity, or program at your organization. These funds should be spent on certain projects and activities at your nonprofit until a certain time period. After that time, they either get returned to the donor or become unrestricted funds.

The unrestricted fund is used to pay for all the general operating expenses of your organization. This means the money you collect from people to support your organization can be spent on whatever aspect of your organization needs the most attention.

Financial Statements And Reports For Nonprofits

Businesses are subject to strict accounting regulations. Accountants must adhere to Generally Accepted Accounting Principles (GAAP) set by the Financial Accounting Standards Board (FASB). These regulations apply to all sectors, and they are applied by independent accountants and large accounting organizations alike.

The following are different types of documentation that your finance department should know and understand. It's extremely important to have a comprehensive, efficient, and secure recordkeeping system for financial statements in nonprofit organizations—especially in the event of an audit by the Financial Accounting Standards Board.

Statement Of Activities

You may hear your nonprofit's financial report referred to as the Statement of Activities. It's also called a Statement of Functional Expenses, a Functional Expense Statement, or an Income Statement. If you want to show your financial performance over a period of time, then use an Income Statement.

An Income Statement will show you how much money you brought in and how much money you spent over a period of time. If you want to show your operating performance over a period of time, then use a Statement of Cash Flows. The Statement of Cash Flows is less common but can be very important for understanding cash flow in your nonprofit organization.

Financial statements are your double-entry accounting system. If you're doing your own books, you need to have a good grasp of the Balance Sheet and the Income Statement. The Balance Sheet shows you where your business is at financially by listing your assets, liabilities, and net worth.

Statement Of Financial Position

The Statement of Financial Position, more commonly known as the Balance Sheet, reflects a nonprofit's financial health. The Balance Sheet shows you where your organization is financially at any given time by listing your assets, liabilities, and equity. In the nonprofit space, equity is usually referred to as "Net Assets" or "Fund Balances." In other words, the Balance Sheets shows:

Your Assets - Your Liabilities = Your Equity (a.k.a. Fund Balances or Net Assets)

The Balance Sheet lists the various types of assets and liabilities for nonprofits, such as cash on hand, marketable securities, and prepaid expenses. By understanding how to read this document, you'll have a better idea of the general financial health of your organization. Viewing the Equity section, you'll see how much money your organization has in assets minus how much it owes, broken down by each fund you maintain.

A positive figure is good because it indicates that your organization has more money than it owes in debt; a negative figure shows that your organization owes more than it has, which probably means you have some reprioritizing to do.

Statement Of Functional Expense

Your nonprofit's Functional Expense Statement breaks down your expenditures into three general categories: program expenses, administrative expenses, and fundraising activity expenses.

The categories are important because they help define the purpose of each expenditure: program expenses help carry out the organization's mission, administrative expenses support the organization's day-to-day functions, and fundraising activities support the organization by bringing in outside income. This statement also considers whether funds are subject to donor restrictions.

Managing A Budget And Net Assets

From setting up your budget to calculating your expected revenue, you'll need to become an expert in your nonprofit organization's finances. Expected revenue, also known as predicted income, can be calculated in two ways: the cutoff method and the discount method.

The cutoff method is used to calculate expected revenue by dividing your total expected revenue by the number of periods for your discount period.

The discount method is used to calculate expected revenue by multiplying the current period's expected revenue by the number of periods in the discount period and subtracting that product from your total expected revenue.

Your expense budget will be divided into different categories for financial reporting purposes, including fundraising expenses, administrative expenses, and program expenses (though you can make up your own categories if you choose).

Other Accounting Standards And Best Practices For Nonprofit Organizations

The ASC Not-For-Profit Entities Topic 958 is primarily the responsibility of the accounting department. However, successful implementation requires support from across a nonprofit organization. Most notably, this means seeking assistance from IT, legal, or procurement departments—especially when an organization has a large real estate portfolio or embedded leases.

This may mean donning the hat of a business analyst and partnering with the Chief Information Officer. Soliciting executive sponsors to champion implementation efforts and solicit resources can also be highly beneficial.

One of the biggest problems for nonprofits is having all of their information in one place. When a charity has leases across departments, or even internationally, if the organization has international operations, compiling terms and data can be daunting. However, for organizations that have yet to build out these structures, there are off-the-shelf and purpose-built technology solutions available to help streamline and automate contract management processes.

This article is not intended to be a substitute for professional services. Always consult a CPA or trusted professional when seeking tax or accounting advice.