This guide teaches nonprofit organizations about accounting standards, rules and how to handle common issues. Accounting experts share concepts, formulas, sample financial statements and a free getting started guide.
- Accounting standards
- Sample chart of accounts for nonprofits
- Getting started with nonprofit accounting
- Nonprofit accounting expert advice
Accounting for Nonprofit Organizations
A nonprofit organization is a company whose primary goal is to further a mission, rather than earning revenue to benefit stakeholders. Goals can be charitable, religious, scientific or educational, and many nonprofits are exempt from paying federal taxes.
With no ownership interests, a board or voting members govern a nonprofit. To keep the nonprofit status, companies must comply with specific regulations. For example, they keep records as per the Internal Revenue Service’s (IRS) coded requirements, are financially transparent and ensure that their financial records show a direct line to their charitable purpose. People or companies contribute to a nonprofit with no expectation of return. There are 27 types of nonprofit organizations, and each has specified rules that govern their eligibility, elections, tax-deductible contributions and how they lobby.
“Of course nonprofits need to earn money! It is for the sake of their own sustainability,” she says. “Even though the nonprofit class is tax-exempt in profits, it is crucial that they do earn profits for things like a rainy-day fund or to expand their programs and services.”
What Is Nonprofit Accounting?
Nonprofit accounting is the financial recording and reporting system that nonprofits use. Often called fund accounting, it requires balanced accounts based on provider-imposed restrictions. Nonprofit accounting tracks how a company spends money to achieve its goals.
The funds that nonprofits account for are from contributions, programmatic revenues, fundraising, investments and dues. Some of their financial recordings are unique compared to those of for-profit businesses.
Nonprofit donors want to see their contributions go directly to the programs the organizations support. Donors also want to see low overhead costs because many mistakenly believe it is a measure of organizational success. The chart below lists other categories where nonprofits differ from for-profit companies.
For more information about nonprofit, tax-exempt status, review Internal Revenue Service Publication 557, “Tax-Exempt Status for Your Organization”.
Nonprofit Chart of Accounts for Organizations
A nonprofit chart of accounts is a list of each account that receives or sends out money. An organization will create a unique chart of accounts, listing each account under one of the major categories of assets, liabilities, equity, income and expenses.
Standard number ranges exist for each category. The business decides where each sub-category falls within that range and assigns it a number. The number categories are:
- Assets: 1000 – 1999
- Liabilities: 2000 – 2999
- Net Assets: 3000 – 3999
- Revenue: 4000 – 4999
- Expenses: 5000+
Sample Chart of Accounts for a Nonprofit Organization
Set up a nonprofit organization’s chart of accounts (COAs) by compiling a list of the business’s necessary accounts and organizing it into five categories. Then, create subcategories from the list of accounts, titling each account in an understandable way. Delete unused accounts yearly.
Several large nonprofit organizations created the Unified Chart of Accounts (UCOA) as a standardized chart of accounts for nonprofit use. The UCOA aligns with the IRS Form 990, where nonprofits record their activities. However, many opponents of the UCOA complain that it is too complicated for most nonprofits, and each organization should develop a chart based on its needs and unique attributes.
Companies use the chart of accounts to list how they set up their funds. The table below is a sample that companies can use for reference.
Nonprofit Accrual Accounting
When a nonprofit uses the accrual method of accounting, it recognizes expenses when it incurs them, not when it pays for them, and it recognizes income when people pledge a donation, not when the nonprofit receives the money. Pledges go into a receivables account for outstanding cash in that period.
Fund accounting is a form of accrual accounting specific to nonprofits. The practice leads to a more realistic operating picture that a nonprofit can use to be successful. To learn more about accrual accounting, see “How to Use Accrual Accounting in Your Growing Business”.
Accounting Standards for Nonprofit Organizations
Accounting standards help nonprofit organizations manage and account for funds properly. Standards provide easy comparisons between different organizations giving auditors and those with interest in the company the ability to understand its activities and relative success.
Nonprofits report their financial statements using the Generally Accepted Accounting Principles (GAAP) from the American Institute of Certified Public Accountants (AICPA) and the Financial Accounting Standards Board (FASB). FASB is the primary standard body in the U.S. These groups publish principles for nonprofits to help prevent errors and discrepancies in financial statements.
The International Accounting Standards Boards (IASB) sets international standards in accounting for nonprofits with the International Financial Reporting Standards (IFRS). IASB and FASB hope to converge their standards to minimize their differences eventually.
FASB Nonprofit Accounting
FASB is a private nonprofit organization that oversees the accounting standards for nonprofit accounting. FASB developed accounting standards for the presentation of audits related to restricted and unrestricted net assets, liquidity disclosures and functional expenses. These standards went into effect after December 2017 for nonprofit organizations.
Nonprofit accounting operates under two primary standards from FASB, both introduced in June 1993. These are the Statement of Financial Accounting Standards No. 116 (SFAS 116) and the Statement of Financial Accounting Standards No. 117 (SFAS 117). SFAS 116 covers recording and reporting of contributed revenue and pledges, and SFAS 117 requires nonprofits to report using specified financial statements:
- Statements of financial position
- Statements of cash flows
- Statements of activities
- Statements of functional expenses (for some organizations)
The December 2017 updates apply to nonprofit organizations that need independent auditing or certified financial statements prepared annually. The state and some funding sources determine whether a company needs this auditing. For those that fall under this requirement, the changes are:
In July 2019, the president signed one additional change into law: the H.R. 3151, the Taxpayer First Act. This law requires all tax-exempt organizations to file the Form 990 series electronically. The act also covers some issues regarding cybersecurity and identity theft, as well as making data machine-readable.
Getting Started With Nonprofit Accounting
Nonprofit accounting has unique challenges. The first step in nonprofit accounting is to apply for a tax-exemption. To apply for federal tax-exempt status, the organization must register with its state as a nonprofit using one of the three applications:
Applicable to charitable, religious and educational establishments, for exemption under Section 501(c)(3).
Applicable to social welfare organizations, for exemption under Section 501(c)(4).
Applicable to other nonprofit or tax-exempt organizations, for exemption under Section 501(a).
You’ll also need to learn about the tax responsibilities, the necessary financial statements and open a dedicated bank account. Choose an accounting method, a chart of accounts structure and a system to record accounting transactions.
Nonprofit Accounting Cheat Sheet
Use this free cheat sheet to get your company started with nonprofit accounting.
The options for recording transactions include paper ledgers, nonprofit-friendly software or a bookkeeping service. Accountants should be able to record transactions such as in-kind donations using fair market value, whether they are for money, goods or services. They should also be able to create purchase orders for procuring goods and services from businesses.
Start making budgets for the nonprofit. Budgets are the financial plan for the expected income sources and expenses. Income may include contributions, donations, fundraising, grants and revenue. Expenses include payroll, fundraising expenses and other overhead. Group these based on your chart of accounts. To create a budget:
- Decide what the nonprofit will accomplish in the coming year. These goals may come from the founder and management or as a part of a company quality process.
- Develop realistic costs to achieve the goals.
- Estimate the income for the coming year.
- Align the expected costs with the projected income.
Nonprofit Financial Statements
Nonprofit financial statements are different from those at for-profit businesses, although both report the same items generally. All companies report a balance sheet, income statement and statement of cash flows. In addition, nonprofits report their statement of functional expenses.
Foley explains the names of the financial statements for nonprofits:
“The balance sheet is called the statement of financial position. The income statement is the statement of activities. And there is a new accounting requirement that nonprofits are supposed to use called the statement of functional expenses. This statement breaks the financials out by whether they are a program, management or fundraising. Its inclusion is meant to give the readers more clarity and more information on how the company used funds.”
The statement of financial position, usually called a balance sheet, is slightly different in a nonprofit. Since a nonprofit does not have an owner, it reports its net assets, which is the same as equity in a for-profit company.
Net Assets Formula
Net assets are what remains once the company takes out its liabilities:
There are two types of net assets: restricted and unrestricted assets. Restricted net assets are the funds from donors that have rules or conditions attached. These donations require special accounting procedures, and accountants usually report them separately from other net assets. Unrestricted net assets are the donations or funds that don’t have any conditions attached to them, such as cash donations.
According to Foley, “For net assets in a nonprofit, funds can be donor-restricted or without donor restrictions. The IRS requires the organization to show how the company dealt with these funds, whether it was for a period- or purpose-restriction. The IRS also requires nonprofits to record unconditional promises to give when the donor makes the promise — not necessarily when the organization receives the gift, even if it’s over several years (and accounting periods).
“For example, the organization records a $10,000 per year donation for 10 years promise as $100,000 in the year the donor promised it, booking the full amount. This revenue recognition would not be spread out over 10 years.” There can be many inputs on the statement of financial position, but each falls into one of the three categories: assets, net assets and liabilities. Use the net assets formula slightly differently on the statement of financial position:
Statement of Activities
The statement of activities in a nonprofit, also called the operating statement, is similar to a for-profit business’s income statement. This statement focuses on the whole company, not just its funds. Report the revenues, expenses and changes to net assets in the period on the operating statement.
This single-page document tells the business how profitable it was over the period. The statement shows details about how the company finances the services it provides and how the business finances any differences in expenses versus revenues.
Statement of Cash Flows
The statement of cash flows is the summary of the change in cash and cash equivalents for a period. This nonprofit financial statement reports the net cash organized as coming from operating, investing and financing activities.
Accountants calculate the statement of cash flows by subtracting the beginning balance from the ending balance on the statement of financial position. They separate the restricted net assets and report them separately from the statement of cash flows, as per GAAP requirements.
Taxes for Nonprofits
Often exempt from paying federal taxes, nonprofits often still must file an informational tax return with the IRS. Section 501 of the tax code specifies the organizations exempt from paying federal taxes, although the state determines which companies it considers nonprofit. Some companies tax-exempt under Section 501 must still file Form 990. This form reports the nonprofit’s revenues, expenses and changes to net assets.
Nonprofit Accounting Best Practices
Using nonprofit accounting best practices means that businesses will have better compliance with federal and state tax laws. Some states put out a checklist of best practices based on the business sector, but companies should always start with developing internal policies and controls.
The IRS and state officials look favorably upon companies that engage in fraud prevention. Since every business has some degree of fraud risk, other best practices for prevention include:
- Developing a Business Code of Ethics:
This code reminds officials, board members and staff of the organization’s intent.
- Assigning Different Financial Tasks to Different People:
Accounting discrepancies are easier to identify when there is more than one person cross-checking work and providing oversight.
- Using Accounting Software for Nonprofits:
Look into using specialized software developed for a nonprofit’s unique rules. This can help mitigate errors, especially when there are large, disparate data sets. See how Kiva deals with this issue.
- Creating an Annual Operations Budget:
A realistic budget, approved by the board, ensures transparency and buy-in when budget flexing needs to occur.
- Having Realistic Expenses for Operations:
Foley says, “Once you have a realistic, balanced budget and a strong governing board, look for what is trending in salaries for executives and programmatic percentages. You should analyze these benchmarks and trends to keep expenses optimized.”
- Understanding Nonprofit Tax Laws and Regulations:
GAAP provides recommended accounting practices, and the IRS lays out requirements to follow. State and federal entities can penalize nonprofits that do not follow these regulations and laws.
- Conducting Future Planning:
Match your business’ strategic plan with financial planning. Support company growth by determining what fundraising or actions need to happen to make the next strategic plan’s goals a reality.
- Developing Relationships:
It is logical for some organizations to work together on common or even similar goals. For example, a health department and the parks department could both be working towards getting their community to get outside more. Working together and sharing resources saves money and staff time and yields better results.
- Ensuring the Governing Board Is Independent:
A board without a vested interest in the company ensures that they will vote for what is best for the organization.
- Fundraising Strategically:
Realistic fundraising goals, set using either historical or industry-specific data, can protect your company from overspend on fundraising expenses or poorly-planned programs.
Which Is Better: Nonprofit Accounting Solution or Journal Systems?
Nonprofits have choices in how they process their accounting that ranges from completely manual to completely automated. Nonprofit organizations, while clear on their mission, have complex accounting practices. These organizations often receive revenue and have oversight from multiple sources.
With complicated budgets, a variety of funding sources and internal operational support needs, many nonprofit companies use some level of automation, especially if they want to be able to scale their organization, like Rise Against Hunger. Journal systems can become quickly overwhelmed and require more personnel to keep them coherent, putting payroll higher than necessary. Regardless of which a company chooses to use, any solution must include the ability to:
- Organize and record receipts.
- Record disbursements.
- Track petty cash, payroll, accounts receivable and accounts payable.
- Perform basic fund accounting.
Streamline Accounting and Fundraising Efforts With NetSuite for Nonprofit Organizations
Nonprofit organizations have a myriad of accounting rules and regulations they need to follow. Using a cloud-based solution specifically designed for the needs of nonprofits can help them improve operations and grow their mission. NetSuite for Nonprofit Organizations is an integrated cloud application that provides real-time financial management for nonprofits. Easily manage constituent relationships and fundraising. Gain efficiencies with a powerful nonprofit financial management and accounting system, and have visibility into all spending. Use the financial planning tools for budgeting and forecasting to ensure stability while growing and achieving your mission. Powerful e-commerce tools help you make the most of online fundraising.
Learn more about NetSuite for Nonprofit Organizations.