Accounting for non-profit organizations

Non-profit organizations are formed to pursue a goal, not for profit or for any of the proceeds to go to its members or leaders. These organizations don’t have commercial owners and must rely on funds from contributions, membership fees, events, and investment income among other things. The money made is spent solely on the organization’s aims (and running costs…) to make sure it achieves what it set out to do.

Non-profits issue a 'statement of activities' instead of the usual income statement that regular businesses need to take care of. Non-profit organizations don’t have owners and so there is no owner’s equity, stockholders’ equity, and no distributions to owners.

It’s falsely presumed that these organizations can’t earn profits, but this is a must for non-profits in case of unforeseen circumstances, unexpected expenses, decrease in revenues, increase in staff, equipment replacement, etc.

Non-profit accounting is simpler than accounting for for-profit organizations since there are fewer forms to fill in. Our article on non-profit accounting will explain the process better, as well as which forms need to be filed. We will conclude with detailing what you should look for in non-profit accounting software programs should you choose to use one.

Tax-exempt status

In order to be exempt from paying federal income taxes, these organizations must contact the Internal Revenue Service (IRS). Non-profits can file Form 990 or Form 990-EZ along with Schedule A if their gross receipts are $25,000 or less. Form 990 is an 'information return' and needs to be filed under the provisions of Internal Revenue Code Section 6033 although religious organizations are exempt and don’t need to fill out this form. Form 990-EZ should be filled in by businesses that have less than $100,000 in gross receipts and less than $250,000 in total assets at the end of the tax year. A Schedule A form is for reporting information that isn’t disclosed to the public. It needs to be attached to Form 990 or Form 990-EZ but if the organization isn’t required to fill out one of these two forms, then the Schedule A form also doesn’t need to be filled out.

There have been discrepancies about whether a donor can use their contribution as a charitable deduction on their income tax return. This is definitely the case with schools and churches, for example. This may seem relatively straight forward, but there are non-profit companies that don’t have to pay taxes, however, contributions from donors don’t qualify as charitable deductions. Examples include college fraternities, amateur sports clubs, social organizations, etc.

Statements required by US GAAP

The principal financial statements required by U.S. generally accepted accounting principles (US GAAP) for non-profit organizations are:

  • Statement of financial position
  • Statement of activities
  • Statement of cash flows
  • Statement of functional expenses (for some organizations)
  • Notes to financial statements

The statement of financial position

The statement of financial position is another name for a balance sheet. The purpose of this statement is to list the organization’s resources, obligations, and ownership details of a company on a specific day.

A non-profit organization doesn’t have owners so instead of one part of the statement being owner’s equity or stockholders’ equity, it’s known as 'net assets', which is where this equation comes in:

Assets     =        Liabilities   +   Net Assets

The equation should always remain in balance due to double-entry bookkeeping so if the organization receives $1,000 from a donor, the net assets should be the same amount:                                                                                      

Assets       =          Liabilities   +   Net Assets

+ $1,000                                   +$1,000

The balance rule also applies if some of the donation is used straight away for equipment or fees, for example:

Assets     =          Liabilities   +   Net Assets

- $100                                      - $100

The statement of activities

This report is also known as the income statement or the profit and loss statement. The statement reports the revenue, expenses, gains, and loss of an NFP for a specified period, usually one year. This statement is mandatory since the aim of a non-profit organization is to provide for society. It must declare which programs it provides. The statement of activities is like the income statement that profit-making businesses issue.

The summarized transaction amounts are declared in the revenues and expenses part of the statement. Membership fees, program fees, fundraising events, grants and contributions all count as revenues that should be reported in the accounting period that they were earned, not when they were received (if this differs).

Expenses can be divided into two categories: program expenses and supporting services expenses. The former refers to the amounts directly incurred by the non-profit while carrying out its programs. If the company has four programs, then each one will be listed separately as well as the expenses for each one. The latter has two subgroups: management, general, and fundraising. The amount reported for each of the subgroups depends on how much time each employee spends performing these activities.

The statement of cash flows

This statement (also known as cash flow statement) is similar to that of a for-profit organization since it reports the business’ change in its cash and cash equivalents during the accounting period. The three different sections are:

  1. Net cash from operating activities (which reports the changes in cash aside from those reported in the investing and financing sections).
  2. Net cash from investing activities (which reports the amounts spent purchasing long-term assets such as equipment, vehicles, and long-term investments).
  3. Net cash from financing activities (which reports the amounts received from anything that was borrowed or any repayments).

The statement of functional expenses

The statement of functional expenses reports the expenses by their function (programs, management and general, fundraising) as well as the type of expense (rent, salaries). Statements of functional expenses aren’t compulsory, but you are recommended to issue one.

Notes to financial statements

These notes are an essential part of the statement of financial position, the statement of activities, and the statement of cash flows. They consist of several pages of information explaining the nature of the organization’s activities and also a summary of the significant accounting policies

General ledger accounts

The general ledger is where the organization’s transactions are recorded. The accounts are organized like this:

  • Statement of financial position accounts
    • Asset accounts
    • Liability accounts
    • Net asset accounts
  • Statement of activities accounts
    • Revenue and gains
    • Expenses and losses

The number of accounts in a company’s general ledger depends on the number of programs the non-profit has, the kind of revenue it earns, and the amount of detail that’s required for planning and controlling the organization. It’s normal for a non-profit organization to have a separate general ledger account for each of its bank accounts. There might be hundreds of accounts in the general ledger, but all the balances will be summarized in the financial statements.

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Non-profit accounting software, what to look for?

Dealing with non-profit accounting can prove tricky so if you don’t want to go it alone, you can count on the numerous software available on the market. Many small businesses don’t have the budget for pricey software, but luckily there are lots of free or affordable options out there.

The software needs to be able to deal with contributions from donors, grants, investments, and fund raising events as accurately as possible. It should also make it easier for you to collect information to submit your IRS Form 990 (mentioned above in this article).

Non-profit organizations are always hoping to attract new people and software can help you out with this task. Readable reports for funding sources are necessary so that others can see where their contributions have gone/are going. Non-profit accounting software can also help you plan future initiatives.

It is especially helpful if this software can predict cash flow so you know what to expect financially and can be more prepared for how unpredictable funding can be. It is of utmost importance that non-profit organizations organize their spending since there’s always the risk of unforeseen circumstances and the more prepared you are, the less disruptive this will be.

The software program needs to be easy to use and flexible since many different users will be operating it. Non-profits are often staffed by volunteers, who might not necessarily have non-profit accounting training so it helps if the software is uncomplicated and doesn’t need much familiarization time.

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