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 a number of concepts that differ from the accounting by a for-profit entity. These concepts encompass programs, management and administration, fundraising activities, budgeting, net assets, and a different set of financial statements. We address these topics below.
Nonprofit Programs
The reason why a nonprofit exists is to provide some kind of service, which is called a program. Examples of programs are providing meals to the elderly, offering free training classes, and distributing printed materials about safety hazards. Whatever the program may be, the accounting system should be designed to accumulate information about program revenues and expenses, so that management can determine how resources are being allocated to fulfill a nonprofit’s mission. It is particularly important to separate revenues and expenses for programs from the other activities of a nonprofit, especially the fundraising area and the management and administration area. When a sophisticated donor wants to see how well a nonprofit is managing its resources, it will likely want to see a breakdown of results that separates each individual program, and which separately shows fundraising expenses and management and administration expenses. Doing so reveals the relative proportions of resources being spent on the core mission of the entity.
Nonprofit Fundraising Activities
Fundraising is the sales and marketing component of a nonprofit, tasked with raising funds via a variety of methods to support the expenditure level of the organization. The activities of this group may include any of the following:
Grant proposals
Direct solicitation of individuals and businesses for contributions
E-mail solicitations through a mailing list of donors
Passive solicitation via a nonprofit’s website
Seminars regarding estate planning
Fundraising events, such as charity balls and art auctions
Contacting employers regarding matching contributions
A key component of fundraising is its associated marketing activities. Nonprofit marketing involves creating an image of the entity that makes it an attractive target for donors. Marketing can involve advertising, printed materials, hands-on contact with donors, interviews on the radio or television, local presentations, the creation of an attractive website, and so forth.
A key accounting consideration in the fundraising area is to track fundraising expenses at the level of the individual fundraising activity. By doing so, you can determine whether the amount of funds generated exceeds the associated fundraising cost. Without this level of detail, it is quite likely that the development director will continue to spend time and money on fundraising activities that do not generate an adequate return.
Nonprofit Management and Administration
Those activities not directly related to fundraising or programs are considered to fall within the management and administration classification. This classification provides operational support to the entire organization, and ensures that other activities run as smoothly as possible. The main activity areas provided by it include:
Accounting and finance services
Facility maintenance
Human resources services
Information technology maintenance
Risk management and legal services
Strategic planning and budgeting
The proportion of expenditures assigned to this classification is of deep concern to donors, who do not want to see their contributions “squandered” on areas outside of the core programs offered by a nonprofit. For this reason, the executive directors of nonprofits pay considerable attention to paring back management and administration expenses.
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.
Nonprofit 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.
