Accounting for nonprofit organizations holds key differences in comparison to for-profit accounting. From the tax status, to the accounting requirements, as well as the essential financial statements. Nonprofit accountants must focus on the planning, recording, and reporting of the organization's finances rather than centering around profitability.
Tax-exemption
For starters, nonprofit organizations can become tax-exempt as long as they adhere to the following rules shown in 501(c)3. One rule that the establishment must comply with is that they cannot operate for the benefit of any private interest. There cannot be any deviation from the nonprofits mission, and majority of the earnings must go towards the organization's mission. Establishments that meet the requirements of 502(c)3 will be exempt from income tax and the donations received are tax-deductible for the donor. Furthermore, nonprofits are required to provide the public with their annual IRS returns because of how the organization receives their funding.
Fund Accounting
For-profit businesses focus on maintaining their profitability, while nonprofits focus on accounting for the funds they receive. To account for these funds, accountants use fund accounting. Fund accounting is used to distinguish a general fund from a special-purpose fund. General funds are items such as general office expenses and employee wages. The purpose of establishing a separation between special-purpose funds from general funds is to ensure an organization is using its funding for its intended purpose. Many financial contributions are donated with restrictions from the donor that specify where the funds should be allocated. To keep track of the restrictions, the assets are divided into three sections: temporarily restricted, permanently restricted, and unrestricted assets.
However, the FASB has since put out new standards to account for the restricted assets. Instead of three categories, there are now only two: with owner restriction and without owner restriction. According to the National Council of Nonprofits, If the funds are being moved from “with donor restriction” to the “without donor restriction” category, that is referred to as “releasing (funds) from restriction”. However, the accountant is still expected to have a detailed breakdown of the fund’s restrictions in the notes to the audited financial statements. The two new categories are simply there to make it easier for the reader to understand, but does not necessarily provide less work for the accountant. Moreover, we will “often see a line item called ‘Revenue Released from Restriction’ ‘Net Assets Released from Restriction’, which means that cash with a donor restriction has been used for its specified purpose or within the designated period (“Understanding the New FASB Accounting Standards”).
Key Financial Statements
Much like a balance sheet, nonprofits use the statement of financial position. Like the name entails, the statement reflects the organization's financial position. The statement includes the nonprofit’s assets and liabilities, but does not include equity. In addition, instead of a profit and loss statement, nonprofits use the statement of activities to exhibit revenue and expenses in a specific time period. The last two financial statements that I will be mentioning are the statement of cash flow and the statement of functional expense. The statement of cash flow demonstrates the inflow and outflow of cash and takes into account the amount received from outside investments. The statement of functional expense shows incurred expense during the recording period. These financial statements are necessary to exhibit the positive or negative changes in funding and the cost of operating services or programs.
Resources:
https://onlinedegrees.und.edu/blog/accounting-for-nonprofit-organizations/
https://www.accountingedu.org/fund-accountancy/
HTH & Accounting Associates help organizations and business owners with accounting and/or financial consulting services. For Help with the accounting cycle or Bookkeeping contact us at accounting@thaddeus.org or call us at 909-599-2111
Thank you for reading,
Vivianna De La Torre
I am Vivianna De La Torre, and I work at Thaddeus as an Accounting Intern. I am currently a student at the University of La Verne majoring in Accounting. I aspire to become an Accountant one day and pass the CPA exam.
