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Wednesday, October 14, 2015

What Your Board Needs to Know About Nonprofit Accounting


The reality is that nonprofit accounting is distinctly different than that of the for-profit world where many board members come from. Even board members with solid experience in business struggle to wrap their for-profit minds around nonprofit concepts. That’s why we’re outlining the top 8 things every nonprofit board member should know if they’re joining your board from the for-profit sector.

1. Nonprofits don’t have owners. Board members have a stewardship function rather than an ownership function. They are legally obligated to watch after the money—including ensuring that revenues are greater than expenses so that the organization’s programs, services, and operations can be maintained.

Because of this key difference, nonprofits use a unique set of financial statements:

  • Statement of Financial Position: Similar to a balance sheet for a for-profit business, this report shows assets and liabilities, but shows net assets instead of equity, with net assets divided into three categories (unrestricted, temporarily restricted, permanently restricted).
  • Statement of Activities: Similar to an income statement in a for-profit environment, this shows a nonprofit’s activities (i.e., how funds are being used), but does not necessarily show operating results.
  • Statement of Cash Flows: Same as a for-profit business, this shows cash at the beginning of the year, what came in and what went out, what it was used for and how much is left at year-end.

2. Revenue comes from different sources. With a for-profit entity, revenue is generated primarily from the sale of goods and services. With a nonprofit, the money comes from a variety of sources:

  • Donor Contributions              
  • Membership Dues
  • Program Fees                         
  • Fundraising Events
  • Grants                                    
  • Investment Income
  • Donated services, assets and use-of-assets

3. Expenses are reported by function. Most nonprofits report their expenses by their functional expense classifications:

  • Program
  • Management and General
  • Fundraising

Because many activities and expenses are applicable to more than one function, allocation of those joint costs is one of the unique aspects of nonprofit accounting.

4. Funds are subject to restrictions. The single biggest differentiator between for-profits and nonprofits is the binding restrictions that can be placed on funds by the donor.

  • Temporarily Restricted Net Assets: Limits are placed on the use of the funds (e.g., must be used for a particular project or during a certain period of time).
  • Permanently Restricted Net Assets: Funds are not expendable by the nonprofit (e.g., an endowment fund).
  • Unrestricted Net Assets: Can be used for any legitimate purpose of the nonprofit in fulfilling its mission.

The board cannot specifically restrict net assets—only the donor can. When the board sets aside funds for a specific purpose, it is considered a designation (not a restriction).

5.  Restricted funds must be released from restriction before they are spent. These restrictions appear on a nonprofit’s statement of activities and balance sheet, which show net assets under the three categories. Funds are released from one category and spent in another (basically, funds are transferred from one category to another).

6. Nonprofits have net assets, not equity. Because a nonprofit doesn’t have owners, its statement of financial position reflects net assets rather than owner's equity or stockholders' equity. (Total assets minus total liabilities equals net assets.)

7. Promises to give are treated as an asset. Pledges are unique to the nonprofit world. These promises to give are treated as an asset and shown on the books as follows:

  • Unconditional: Recorded as an asset when the promise is made.
  • Conditional: Recorded as an asset when the donor conditions are substantially met.
  • Intention: A mere statement of an intention to give is not recorded. For instance, being named in a will, when that will is revocable at any time, is only an intention to give.

8. The public is watching. Most nonprofits (churches are exempt) are required to file IRS Form 990 each year. This publicly available document provides an unflinching look at the organization's activities, governance and detailed financial information. Form 990 also includes a section for the organization to outline its accomplishments over the previous year to justify maintaining its tax-exempt status. A nonprofit is specifically asked on Form 990 whether its board of directors has reviewed the information before it is submitted.

For help in understanding what your current financials are saying about your organization’s fiscal health, reach out to our nonprofit team.

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