Nonprofit accounting definition
/What is Nonprofit Accounting?
Nonprofit accounting is the process of recording and reporting a nonprofit organization's financial activities. Unlike for-profit accounting, the focus is not on generating profit, but rather on tracking how funds are received and used to support the mission. Key components include fund accounting, which separates resources by purpose (e.g., restricted vs. unrestricted funds), and producing specialized reports like the Statement of Financial Position and Statement of Activities. Accurate accounting by the nonprofit accountant helps to ensure an organization’s financial sustainability and public confidence.
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Nonprofit Accounting Key Concepts
Nonprofit accounting employs the following concepts that differ from the accounting by a for-profit entity:
Programs. A nonprofit exists in order to provide some kind of service, which is called a program. A nonprofit may operate a number of different programs, each of which is accounted for separately. By doing so, one can view the revenues and expenses associated with each program.
Management and administration. Costs may be assigned to the management and administration classification, which refers to the general overhead structure of a nonprofit. Donors want this figure to be as low as possible, which implies that the bulk of their contributions are going straight to programs.
Fund raising. Costs may be assigned to the fund raising classification, which refers to the sales and marketing activities of a nonprofit, such as solicitations, fund raising events, and writing grant proposals. There is some pressure to keep these reported costs as low as possible, so that donors will think that the organization is being efficient in directing most of their funds toward programs.
Nonprofit Budgeting
A budget is an essential component of the accounting for a nonprofit business. This is because a nonprofit typically has quite limited revenue sources, and so must maintain tight control over its expenditures at all times. Consequently, its budget must be rigorously developed based on reasonable revenue expectations, with all cost variances being promptly investigated. The budget model should contain a summary of all expected revenue sources by quarter, such as the one stated in the following exhibit, so that managers can spot any situations in which revenues are falling below expectations.
In addition, the budget should itemize the planned expenditures for all fundraising, administration, and program activities, so that managers can track actual expenditures against expectations in all areas of a nonprofit’s operations. A sample expenditure budget (for fundraising activities) appears in the following exhibit.
Net Assets
A net asset is the equivalent of retained earnings in the financial statements of a for-profit business. When contributing assets, a donor may impose restrictions on their use. The result is two types of net assets, which are classified as net assets with donor restrictions and net assets without donor restrictions. The accounting for these types of net assets varies, as noted below:
Net assets without donor restrictions. When a donor imposes no restriction on a contribution made to a nonprofit, the nonprofit records the contribution as an asset and as contribution revenue with no donor restrictions. These funds are used to pay for the general operations of a nonprofit. The fundraising staff strongly encourages donors to make unrestricted donations, since these funds can be put to the broadest possible range of uses. Since this contribution revenue also creates a profit, the profit appears in the statement of financial position as an increase in net assets without donor restrictions.
Net assets with donor restrictions. When a donor imposes a restriction on a contribution made to a nonprofit, the nonprofit records the contribution as contribution revenue with donor restrictions. Only the donor can change this designation; a nonprofit’s board of directors is not allowed to do so.
The totals of each of these classifications are reported within the net assets section of the statement of financial position, along with a grand total for all net assets.
A final thought regarding net assets is that they do not refer to assets. An asset is an item of economic value that is expected to yield a benefit in future periods. A net asset is more like a separate project, for which a separate set of financial statements can be generated.
Nonprofit Financial Statements
There are a number of individuals and other entities that want to view a nonprofit organization’s financial condition and ability to provide services. This information is provided through the financial statements, which use a standardized format to describe the financial results, financial position, and cash flows of an organization. A nonprofit issues financial statements that are somewhat different in name and structure from those used by for-profit entities. The following exhibit compares the financial statements used by these two types of organizations:
The Statement of Activities
The primary intent of a nonprofit is (as the name implies) something other than earning a profit. Consequently, a nonprofit does not issue an income statement, as does a for-profit business. Instead, a nonprofit issues an alternative called a statement of activities. This statement quantifies the revenue and expenses of a nonprofit for a reporting period. These revenues and expenses are broken down into the “without donor restrictions” and “with donor restrictions” classifications, and which are divided into separate columns across the statement. The rows in the statement reveal revenues and expenses. A sample statement of activities appears in the following exhibit.
The Statement of Financial Position
A nonprofit needs to report the state of its assets and liabilities as of the end of each reporting period, as well as provide an indication of its ability to meet its financial obligations. In a for-profit business, the financial statement used to report this information is the balance sheet. A nonprofit entity reports similar information in the statement of financial position. The main difference between a balance sheet and a nonprofit’s statement of financial position is that the balance sheet contains a shareholders’ equity section, which is replaced by a net assets section in the statement of financial position. A sample statement of financial position appears in the following exhibit.
The Statement of Cash Flows
The statement of cash flows contains information about the flows of cash into and out of a nonprofit; in particular, it shows the extent of those nonprofit activities that generate and use cash. This information is useful for donors, who may want to know how their contributed funds are used. A sample statement of cash flows appears in the following exhibit.
Reporting of Expenses by Nature and Function
It can be useful for a nonprofit to report its expenses by nature and function. This presentation is used to show how expenses are incurred for each functional area of the business. Information reported by nature means that a line item is presented that contains expense results, such as for salaries, rent, electricity, supplies, interest expense, and so forth. A sample presentation of this report appears in the following exhibit.
