An effective bookkeeping system is crucial to the success of a nonprofit organization. Under the Generally Accepted Accounting Principles, the bookkeeping method for nonprofits involves a unique way of planning, recording, and reporting its finances. Unlike for-profit organizations, the goal of bookkeeping for nonprofits is to prove how an organization is spending its funds.
Learning how to tackle nonprofit accounting and understanding the statements required, which are needed as supporting evidence to this unique angle of spending, is crucial for anyone who wants to run a successful nonprofit organization. Since most nonprofit organizations have a tax exempt status with the IRS, they have to make sure they follow the correct guidelines to maintain that status.
Here, we will cover what a nonprofit organization is, how nonprofits operate, how the funding source of a nonprofit is different from that of a for-profit business, and some of the best practices for nonprofit accounting so that you can better manage the financial health of your organization.
What is nonprofit accounting?
While most companies focus on making a profit by selling a good or a service, nonprofit organizations have their money come in from donors and contributors who are supporting an important social cause in society. Therefore, nonprofits put more focus on the accountability of the accounting process. Nonprofit organizations follow a certain set of guidelines and procedures that keep them accountable to contributors and donors who want their money to go to certain projects and programs.
What accounting method do nonprofit organizations use?
Since donors can set restrictions on how funds are spent, nonprofits use a different method of bookkeeping that better cater to their business structure.
Fund accounting principles
Fund accounting allows nonprofits to allocate money into different groups to keep them better organized and ensure that the funds go toward the designated requests.
a. Fund accounting groups
Funds are typically divided up into the following groups:
- Restricted funds: Restricted funds are spent on specific projects.
- Temporarily restricted funds: Temporarily restricted funds are spent on specific projects during a specified time period.
- Unrestricted funds: Unrestricted funds are spent in areas with the greatest need. There are no restrictions in place as to what the funds can be spent on.
These groups are just one way of keeping nonprofit organizations on track with their finances.
b. Nondistribution constraint
Bookkeeping for nonprofits also helps organizations stay accountable through non-distribution constraint. This means that nonprofits are not allowed to distribute any net earnings to nonprofit leaders such as board members and executives.
What are some basic bookkeeping tips and best practices for nonprofit accounting?
Nonprofit bookkeeping involves several key tasks if you want to establish an efficient and effective accounting system.
1. Determine how transactions will be recorded
Whatever nonprofit friendly bookkeeping solution you choose for recording transactions, you’ll need to make sure it’s an efficient method for recording and organizing receipts, recording disbursements, and keeping track of petty cash.
The following are some of the options for recording your organization’s financial transactions:
- Recording the financial data in a ledger
- Enter the data into a non-profit friendly accounting software
- Add data to an Excel spreadsheet
- Use accounting nonprofit professionals such as bookkeeping services or certified public accountants
2. Implement fund accounting principles
Fund accounting is unique to nonprofit organizations. With fund accounting, instead of putting all of the funds into one cash account, the money is distributed into different “buckets” or groups. Nonprofits usually have specific rules about how the funds are spent.
3. Open separate bank accounts
Never use your own personal bank account for funds that belong in the nonprofit organization. Make sure you have a dedicated bank account for your nonprofit’s transactions.
4. Reconcile your bank accounts
Once you’ve established your designated bank account for your nonprofit, you’ll need to make sure that the data on your bank statements align with the data in your bookkeeping system. To do that, you’ll compare each transaction on your bank statement with the corresponding transaction in your books to make sure they line up.
Monthly bank reconciliations will help you track cash flow, prevent fraud, detect human and bank errors, and ensure that your books are up-to-date and that you have accurate financial records.
5. Use purchase orders
Since nonprofits have strict rules and guidelines on how their money is spent, it’s important to have an organized system in place to ensure that the financial process is handled properly. Purchase orders are a great way to record and have a record of agreements between the nonprofit and all vendors.
6. Record in kind donations
With nonprofit bookkeeping, how would you record the gift of volunteer hours? You would do this by having a separate income account for in kind donations and then enter the donation based on the fair market value of comparable services or goods.
7. Establish a budget
It’s essential that a nonprofit operate on an annual operating budget. This budget includes all of the expected income sources and expected expenses.
The budget is created by determining what your nonprofit wants to achieve, calculating estimates on how much is needed to achieve those goals, determining what your income sources will be, and altering the budget at times to line up with reality. This way you can track to see how your income and expenses compare to the goals of your budget.
8. Create and analyze financial statements
Financial statements are created to let the nonprofit and its donors know how much money the organization has, where the money is, and how it got there. The three main types of nonprofit accounting financial statements include the statement of financial position, the statement of activities, and the statement of cash flow.
a. Statement of financial position
The statement of financial position is similar to a balance sheet. The statement of financial position gives a screenshot of the organization’s financial health during a specific point in time. It reflects what you owe, what you own, and the balance between the two.
The statement of financial position has net assets instead of equity. Net assets are equivalent to the subtraction of liabilities from assets. Net assets can be broken down into restricted net assets and unrestricted net assets.
b. Statement of activities
The statement of activities is similar to an income statement. It indicates how profitable the organization was during a given time period. It’s basically a financial statement that shows revenue minus losses and expenses.
A nonprofit’s revenue usually includes program fees, membership dues, donations, sales income, proceeds from fundraising events, and investment income. Expenses incurred typically include travel, postage, salaries, rent, fundraising expenses, and financial services.
The statement of activities reflects the shift in net assets instead of net profit. The statement of activities is divided into two sections: restricted net assets and unrestricted net assets.
c. Statement of cash flow
The statement of cash flow tracks the organization’s cash. It lists the cash generated from financing, investing, and operations.
What are the tax obligations for nonprofit organizations?
The final step in nonprofit bookkeeping is taking care of your tax obligations. Most nonprofits can apply to the IRS for a tax exempt status, which means that the nonprofit would be exempt from federal taxes under Section 501.
Even if a nonprofit status ends up being tax exempt, it doesn’t mean that there are no taxes owed. There are still obligations to employment taxes and possibly other taxes such as real estate taxes and sales tax.
Most nonprofits are still required to file Form 990. This form shows expenses, revenue, and any changes to net assets. There are certain organizations that are exempt from filing Form 990, such as foreign, political, and religious organizations. It’s important to stay on top of a nonprofit’s tax obligations because nonprofit organizations are subject to audits just like for-profits.
How is nonprofit accounting different from for-profit accounting?
Nonprofits must focus more on the accountability of their finances. The reason for this is because those who fund grants and make donations want to make sure their money is being spent on the agreed-upon projects and programs. Contributors can set restrictions on how their money is spent.
Due to this different angle with nonprofits, the financial statements differ between bookkeeping for nonprofits and for-profit accounting. A nonprofit’s bookkeeping financial statements include the statement of financial position, statement of activities, and statement of cash flows. For-profit financial statements include the balance sheet, income statement, and statement of cash flows.
Nonprofits don’t usually have owners. Unlike nonprofits, for-profits do typically have owners. Therefore, the statement of financial position has net assets, and the balance sheet has equity. Net assets include restricted assets and unrestricted assets while there are no restrictions on for-profit funds.
Another major difference is between the statement of activities and the income statement. The statement of activities calculates the changes in net assets, and the income statement calculates net profit.
Cash flow statements, while similar, also have some differences. For-profit cash flow statements will include items such as investment income, service fees, and sales. Nonprofit cash flow statements will list items such as fundraising proceeds, program fees, membership dues, and donor contributions.
Finally, the tax status will more than likely differ between nonprofits and for-profits. Nonprofits, if approved by the IRS, will be exempt from taxes. For-profits will be subject to income taxes.
Frequently asked questions
Nonprofit accounting responsibilities entail organizing and tracking expenses and donations while remaining compliant with the Generally Accepted Accounting Principles established by the Financial Accounting Standards Board. They are responsible for implementing an accurate bookkeeping system that will reflect the financial transparency of the organization.
Look for accounting software that helps you track donations, automate recurring tithes, manage grants, manage donors, and generate financial statements automatically. Accounting software makes nonprofit accounting a much simpler process and usually results in a more accurate bookkeeping system.
QuickBooks for nonprofit bookkeeping is a great way to organize your expenses, donations, and financial information. It allows you to track your invoicing, billing, expenses, donations, and create detailed financial statements.
Nonprofit bookkeeping involves the implementation of fund accounting where funds can be distributed into different groups since donors can set restrictions on what the money is used for.
Nonprofit bookkeeping focuses more on the accountability of a company’s finances rather than on profits. Nonprofit is also based on non-distribution constraint which means that none of the earnings are distributed to the organization’s leaders. Nonprofits are also taxed differently than for profit organizations.
Nonprofit organizations are essential to our communities because their mission is to support social causes that benefit society. Like for-profit organizations, nonprofits need to establish an efficient bookkeeping system to bring the most value to our communities.
While there are some similarities between the two bookkeeping systems, there also are some major differences. One of the biggest differences is each one’s approach to its bookkeeping method. Nonprofits approach bookkeeping by focusing more on the accountability aspect when it comes to their bookkeeping method and process.
Caryl Ramsey has years of experience assisting in different aspects of bookkeeping, taxes, and customer service. She uses a variety of accounting software for setting up client information, reconciling accounts, coding expenses, running financial reports, and preparing tax returns. She is also experienced in setting up corporations with the State Corporation Commission and the IRS.
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