Government and Nonprofit Accounting: Our Guide to the Key Differences
The activities of governments and nonprofits are frequently conflated because neither are driven by profit. However, despite their similarities, nonprofit accounting does differ from government accounting in some ways.
It is vital that you know these differences so that you can prepare your nonprofit financials correctly. We are sure your head is probably already swimming with important information on nonprofit accounting basics and nonprofit accounting terms. Do not worry — we are here to add to this information with an easy-to-understand overview.
- Why Government and Nonprofit Accounting Are Similar
- What Is Fund Accounting?
- Government vs. Nonprofit Accounting
- Final Thoughts
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Why Government and Nonprofit Accounting Are Similar
Governments and nonprofits have similar characteristics because neither are in it for the money. They use tax or contribution money to render valuable services to those they serve. Because of this, there is a greater need for transparency in both forms of accounting, as constituents and donors want to know where their money is going.
Both types of accounting must ensure adherence to the generally accepted accounting principles (GAAP). United States law requires governments, businesses, and nonprofits to follow GAAP guidelines.
One of GAAP’s primary objectives is to make sure that financial data is organized, reported, and backed with supporting records. Using accrual accounting basics, nonprofits and governments can ensure this.
Finally, both government and nonprofit accounting have a similar goal of ensuring that annual expenditures end up very close to annual revenue in a given year.
What Is Fund Accounting?
As previously mentioned, government agencies and nonprofit organizations are not driven by making money, so they both utilize a system of accounting known as fund accounting. Organizations that receive funding for a designated purpose have to use this accounting system. This is because it helps maintain transparency when it comes to how these funds get allocated within an organization’s budget.
Hmm...what is fund accounting? Sadie is about to find out!
There are three classifications of funds in a government:
Governmental funds: funds that relate to the functions of the government
Proprietary funds: funds that are set aside to provide goods and services to the public
Fiduciary funds: funds that are held in the interest of a third party, such as pension funds
There are also three types of funds for nonprofit fund accounting, with two of them having prerequisites for how they can be used:
Restricted funds: money designated for a specific purpose
Unrestricted funds: money that can be used for any purpose
Temporarily restricted funds: money that is for a specific purpose to be used within a specific timeframe
Keep in mind that each fund gets accounted for separately for reporting and organization purposes.
Fund accounting is important because it helps:
Keep tight control of where your funding goes
Honor your restricted funds
Ensure that you have the necessary funds for continued operation
Assure stakeholders that your nonprofit is not fraudulent
Pro Tip: You will need to keep these various types of funds in mind as you are creating the budget for your nonprofit. You will also use these funds to compile financial statements, such as your nonprofit's chart of accounts.
Government vs. Nonprofit Accounting
Now that you know how government accounting is similar to nonprofit accounting, let's look at how they differ. There are three major differences between these accounting processes.
Government agencies and nonprofit organizations use three main financial statements for their reporting. Two of the statements are the exact same — the statement of activities and the statement of cash flows.
The statement of activities reports revenue and expenses over a specified period. The statement of cash flows tracks an organization's cash handling procedure in terms of cash inflow and outflow over a certain period.
The third document is the statement of net position for government agencies and the statement of financial position for nonprofit organizations. Both of these statements provide the same information, looking similar to a balance sheet. They summarize liabilities and assets, which helps in assessing the financial health of the entity.
So how does the statement of net position and the statement of financial position differ? Mainly, these statements show how the assets affect certain individuals. For governments, these individuals would be the taxpayers. For nonprofits, they would be the beneficiaries of the goods or services. For example, say an organization connects students at universities with instructors that can be their mentors. The beneficiaries would be the students — and maybe the instructors, depending on whether they value being a mentor.
Every year, government agencies are required to put together a comprehensive annual financial report (CAFR). The CAFR examines the financial status of a government body. This report is compiled using the GAAP and the Governmental Accounting Standards Board regulations. (More on GASB below)
For a brief overview, a CAFR analyzes the financial data for a given period, which is usually the financial year. This data includes the following components:
Revenue accumulations from the year prior
Consolidated financial statements
Comparison of the budget vs. the actual spending
The CAFR can include government-wide financial statements that provide an understanding of an agency’s financial position as a whole. On the other hand, the CAFR can include fund financial statements that show financial data for specific governmental funds. The latter of the two formats provides a more detailed assessment of the financial objectives, expenditures, credits, and more.
Anthony has never thought of all the differences between nonprofit and government accounting!
Nonprofit organizations are not required to compile CAFRs. However, they still have to compile financial reports for their board of directors, investors, members, donors, grantors, and other stakeholders. This compilation is typically known as the report of consolidated financial statements. It includes the financial statements we mentioned in the previous section. With that data, stakeholders can track key nonprofit metrics, such as fundraising efficiency.
Pro Tip: We recommend compiling your report of consolidated financial statements using fund accounting software. This type of program typically comes with templates for making this financial analysis report. It also gives you access to a nonprofit financial dashboard that illustrates your organization’s transparency.
While they both follow GAAP, government entities and nonprofit organizations also have their own accounting standards that reach beyond GAAP. The GASB and FASB are both independent, private sector organizations that enforce GAAP accounting standards. However, government accounting adheres to GASB standards, while nonprofit accounting follows FASB ones.
GASB stands for the Governmental Accounting Standards Board. It establishes accounting and financial reporting standards for state and local governments in the United States that follow GAAP.
The GASB uses 97 standards to guide and educate the public on financial reporting and government accounting. Keep in mind that these standards are constantly under review.
For governments to be compliant under the GASB, they have to consider:
Fund type limitations
Asset and liability reporting
FASB stands for the Financial Accounting Standards Board. It establishes accounting and financial reporting standards for public and private companies in addition to nonprofit organizations that follow GAAP. As with the GASB, the FASB uses transparent standards that are constantly changing.
Pro Tip: If you can find room for it in your budget, hire an accountant for your nonprofit organization. If you choose someone who specializes in nonprofit accounting, they will have the knowledge of basic and nonprofit accounting standards and financial practices. Plus, they will be able to compile and review your organization’s financial documents for you.
Government accounting and nonprofit accounting are largely similar. However, knowing their three key differences can make for a less stressful bookkeeping experience; and what nonprofit — or any entity, for that matter — does not want that?
As you begin to learn more about the knitty-gritty details of running a nonprofit, use us as a resource! Our Springly blog page has a host of online content just waiting to be discovered!
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💡How is government accounting similar to nonprofit accounting?
Government accounting is similar to nonprofit accounting because they both use fund accounting principles. Find out more.
🔑 What are the differences between government accounting and nonprofit accounting?
The three main differences between government and nonprofit accounting relate to financial statements, financial reporting, and accounting standards. Find out more.
📝 Why is government and nonprofit accounting different from for-profit accounting?
They differ because their reason for existence is not the same. A for-profit company’s purpose is to make a profit, whereas government agencies and nonprofit organizations provide services without focusing on turning a profit. Find out more.