Accounting for Nonprofit Organization

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A nonprofit organization is an organization dedicated to serving charitable, educational, religious or scientific purposes. The aim of such an organization is to fill society's needs and make our communities more livable places. Unlike normal businesses, that operates to generate profit for owners and stakeholder, non-profit organizations do not operate for profits. They do generate revenue, but that is put back into non-profit missions. Nonprofits do not have commercial owners and that’s why they rely on funds from contributions, membership dues, program revenues, fundraising events, public and private grants, and investment income.

Accounting responsibilities of a non-profit organization are different than those of for-profit businesses. Tax payments, financial statements, and recordkeeping are handled differently than other businesses. Many nonprofit organizations receive tax-exempt status. An organization qualified for tax-exempt status (501(c)(3) organizations) is not required to pay federal business income taxes. However, they still need to pay state and local income taxes.

The most common types of non-profits are:

Charities:

Charitable organizations rely on contributions, donations, and grants, etc. The IRS defines a charitable organization in Publication 557 as one that “is organized and operated for purposes that are beneficial to the public interest.” Despite their tax-exempt status, the organization has to file with IRS every year and pay the related employment and business tax.

Charity organizations can be:

  • Religious
  • Educational
  • Environmental
  • Research-related
  • Health-oriented
  • Social Services organizations
  • Sports Clubs
  • Arts Clubs
  • Disaster relief organizations
  • International development initiatives
  • Child sponsorship programs
  • Animal welfare programs
  • Human rights’ initiatives

Private Foundation:

A private foundation is a 501(c)(3) organization, established for the purpose of granting money to charitable causes. They do not fund their own programs. The source of income of a private foundation is the individual or business that started the foundation, the money is then invested and the returns on that investment become donations for charities. Private foundations serve as philanthropic partners of charities and contribute to the success of charitable programs.

Private Operating Foundation:

The private foundations that use their income to provide charitable services or to run charitable programs of their own are called private operating foundations. This is a hybrid between a public charity and a foundation. Private Operating Foundations funds their own activities and programs. For instance, the Clinton Foundation is actually a charity that anyone can donate to. However, the Clinton Family Foundation is a foundation that accepts no donations and is funded by Clintons. The foundation determines and funds the organizations that are in need.

Due to the tax-exempt status, the process of accounting is different for non-profits. Hence, non-profit organizations’ focus is on keeping overhead low so that more money can be injected into the programs or services they offer.

Nonprofit businesses use similar financial statements as used by for-profit businesses, like income statements, balance sheets, and cash flow statements, but they have different names and are organized differently. Nonprofit accounting relies on using the statement of financial position (balance sheet), statement of activities (income statement), and cash flow statement.

The balance sheet of a non-profit organization is referred to as Statement of Financial Position (SOP) as it do not have owners. Synonymous to the balance sheet of a for-profit entity, the SOP shows the assets and liabilities of a non-profit organization. When liabilities are subtracted from assets, we are left with net assets, representing the organization’s net worth. Unlike the balance sheet of a for-profit entity, the nonprofit version substitutes net assets for equity. Net assets plus liabilities must equal the organization’s assets on the statement of financial position. Net assets of the non-profit organizations are categorized as unrestricted, temporarily restricted, and permanently restricted assets.

One of the main financial statements of a nonprofit organization is the statement of activities. As the statement of financial position, you must report revenues with or without donor restrictions. The statement of activities focuses on the total organization instead of focusing only on funds within the organization and reports the following:

a.Revenues such as contributions, program fees, membership dues, grants, investment income, and amounts released from restrictions.

b.Expenses reported in categories such as major programs, fundraising, and management and general.

c.The change in net assets resulting from revenues and expenses.

Like any business, nonprofits need a healthy cash flow to operate. They need to have enough money to pay for their employee salaries, unexpected expenses, bills, rent, etc. Though the non-profit organization does not sell any products they may have a variety of sources of revenue. They need to record all incoming revenue and outgoing expenses and payments with a well-sorted accounting system.

Cash accounting or accrual accounting method is used by a non-profit organization for recording its income and expenses. Cash-basis accounting is a system where you record expenses or income when you actually pay or receive them, not when the transaction takes place. An accrual accounting method records the amounts when a transaction occurs. It is generally believed that an accrual method of accounting gives a more accurate picture of a company’s finances.

The statement of financial position gives a non-profit organization a screenshot of the financial health of the organization during a period of time. The statement shows assets, liabilities, and net assets. Unlike the balance sheet, the nonprofit version substitutes net assets for equity. Your net assets plus liabilities must equal your assets on the statement of financial position.

Accounting for nonprofit organizations is tricky. There are lots of affordable accounting solutions available for nonprofit organizations to cater to their accounting needs. The accounting software used by non-profit organizations should have the capability to deal with grants, investments and fundraising, etc., as accurately as possible and should make collection of information easier to submit IRS Form 990. An easy to use software will help the staff of a non-profit organization, mostly volunteers, to quickly familiarize to it as they might not have no