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October 06, 2021

Basics of Nonprofit Accounting

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Nonprofit organization

An organization is considered nonprofit if two conditions are met:

  • its purpose is not to make a profit. As a rule, it sets before itself socially useful tasks: social, charitable, cultural, educational, scientific, and many others;
  • the received profit is not distributed among shareholders. It should be spent for its intended purpose: for the operation of the organization or the implementation of the goals it set before itself.

Most often, nonprofits are public or religious organizations, charitable foundations, trade unions, and other similar associations. To be able to achieve its amazing goals, it is not enough to just have good wishes. Nonprofit accounting is just as important for successful nonprofit activity as it is for an ability to legally maintain the nonprofit status.

Basics of Nonprofit Accounting

Nonprofit accounting

The goal of nonprofit accounting is to not just be able to answer where the money is coming from and where it is going, but also tell if it was spent on the purpose it was intended for. It focuses on transparency and assisting in accomplishing the goals and mission or purpose that the nonprofit has originally declared, rather than profitability.

So, where does a nonprofit get the money? The main sources that come to mind are donations and fundraises. However, nonprofits are not limited to just these cash inflow sources. They can be doing regular business and selling something, but instead of generating this money for the business owner, the nonprofit earns profits to make it possible to reach its goals, expand the range or scope of its activity.

When a nonprofit receives the money, it has an obligation to spend that money appropriately, which should be reflected in the accounting records with all the details included. This allows the organization to be able to respond to any request, whether from the entity that donated the money or the government bodies that check on whether the business deserves to hold its nonprofit status and all the advantages associated with it.

Key differences

When it comes to nonprofits, it should be pointed out that the key difference between accounting for a business that is created to make a profit for its owners and nonprofit accounting is that the funds the organization receives are placed in different categories.

  • Restricted. These are funds that a donor puts limitations on the purpose and timing of their use. For instance, the person who gave the money might want it to be spent only to help dogs in honor of the lost dog and not to be spent on other animals or other activities of the organization. In other cases, a business might donate a big amount, but it does not want to be used all at once. Instead, the organization promises to spend only a specific portion of the money every year.
  • Unrestricted. As the name says, the nonprofit organization is free to use the money it received from outside for any of its needs as long as the money is used to achieve the goals and mission of the nonprofit and within the legal framework. For example, it can choose to help 1,000 individuals in need instead of 100 or provide additional services that it wanted to provide before but did not have the financial means for.

This difference in income sources and their spending also translates into slightly different accounting reports. First of all, you will see that the financial statements themselves are named differently, although you can trace many elements to the standard accounting reports you would see in a for-profit organization.

When it comes to the Balance sheet or rather the Statement of financial position, you will notice right away that it is missing the Shareholder’s equity section. Instead, this document will present information on the Net assets, subdivided them into restricted and unrestricted. In a way, you can think of these as the funds invested by other parties, but in a nonprofit organization these entities are not waiting for anything in return.

The Income statement or Statement of activities as it is called in nonprofit accounting, also slightly differs. First of all, the bottom line is referred to as Net assets (which you see on the Balance sheet) instead of Profit. Once again, the Revenue sources are categorized as restricted and unrestricted. For convenience, the user will also see a total for each line. Under Revenues, you will obviously see many account names that are not typical for for-profit organizations, such as foundation grants, individual donations, and in-kind donations (e.g. food, goods, or services).

For the reasons stated earlier, you will not be preparing a Statement of shareholder’s equity for a nonprofit. Instead, you will see one report that is not typical for a regular business. This would be a Statement of functional expense. This document will list all the expenses the organization had during the period and break down the numbers based on the different activities of the nonprofit.

You will see separate columns for each service offered and columns for supporting functions, such as management and fundraising. You will also have the totals for each line and each category. Given the various restrictions and government requirements the nonprofits are obliged to stay in compliance with, this report makes it easier for all the parties to see if everything is done as supposed to be done.

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Author: Charles Lutwidge

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