Best Way To Understand Nonprofit Accounting

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A nonprofit, or non-business entity, is an organization which does not operate for the purpose of making a profit. After business expenses are covered, all revenues are used to further the nonprofit’s cause. Nonprofits include advocacy groups, religious organizations, charities, foundations, and professional/trade organizations. When preparing federal income taxes, it is important to note that a nonprofit organization has different goals and taxing requirements than a for-profit company.

While the primary purpose of a for-profit company is to earn profits, the purpose of a nonprofit is to aid members of a community. For-profits strive for revenues to exceed expenses for the sustenance and growth of the company, but nonprofits seek to maximize revenues for the advancement of their cause. For-profits earn revenues through selling merchandise or services and through investments. Nonprofits primarily earn revenues through donations, fundraising events, federal and local grants, and membership dues.

While a for-profit company must issue balance sheets, nonprofits instead issue what is called a statement of financial position. This statement reports revenues such as donations, grants, membership dues, and earnings from fundraising events. Expenses such as fundraising events, management costs, and costs of programs are reported. Finally, alterations in net assets as a result of increases and decreases in revenues and expenses are listed.

The net assets segment can be broken down into three sections: unrestricted, temporary restricted, and permanently restricted net assets. When these three sections are combined, the amount is referred to as net assets or total net assets.

Unrestricted net assets, as the name implies, have no restrictions and can be used for any purpose by the organization. When an unrestricted net asset is acquired, the amount should be listed as an unrestricted contribution revenue as well as an asset.

Temporarily restricted net assets are assets received by an organization which come with certain stipulations until the funds are used up generally within a year. For example, if a donor contributes funds with the stipulation that it be used towards a fundraiser, it cannot be used for any other purpose. When a temporarily restricted asset is acquired, the amount should be listed as temporarily restricted contribution revenue and an asset.

Permanently restricted net assets are assets received by an organization which come with certain restrictions and cannot be used up, except at the donor’s discretion. For example, a donor could contribute pieces of real estate with restrictions on how the land is used. When a permanently restricted asset is acquired, the amount should be listed as permanently restricted contribution revenues as well as assets.

While a for-profit business must issue an income statement, nonprofits instead issue a statement of activities, which details revenues, expenses, and positive/negative changes in net assets during an accounting period. Revenues include donations, grants, funds raised from fundraising events, and gains on investments. Expenses include the costs of running the main programs of the nonprofit, such as aid to the homeless, raising awareness for a disease, etc. Nonprofits also incur auxiliary expenses necessary for the running of day-to-day operations, such as paying rent or utilities, compensating members of management or staff, and fundraising costs. Using the accrual method of accounting, revenues and expenses are recorded when they are earned or incurred, as opposed to when they are received.

Nonprofits must maintain transactions within a general ledger, just as for-profits do. Statements within should note asset, liability, and net asset accounts, and statements of revenues/gains and expenses/losses.

A nonprofit’s statement of cash flows contains the same information present in a for-profit’s statement of cash flows. It is composed of three sections, detailing net cash flow from: operating activities, investing activities, and financing activities. The operating section includes cash from contributions, such as permanently restricted, temporarily restricted, and unrestricted net assets. Also included is payments to employees, grants earned, and dividends received. The investing section details purchases of investments and assets. The financing section details borrowed funds and any long-term debt issued.

The statement of functional expenses is a financial document which breaks expenses down by function. Sections include expenses incurred from programs related to the nonprofit’s mission, expenses from day-to-day management, and expenses from fundraising activities. Expenses are further broken down by the type of expense incurred. The detail included in a statement of functional expenses varies by nonprofit, while some may not be required to create one.

At the end of financial statements should be notes included which provide some context to the information within. To understand the full financial position of a nonprofit, notes or footnotes should be prepared explaining business activities.

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