Nonprofit Accounting Standards: Your Questions Answered
The particulars of the nonprofit world do not stop with the 501c3 application. Once your nonprofit is up and running you join the wide world of 501c3 accounting!
So, we gathered the brightest minds to break the nonprofit accounting basics into digestible pieces for you. Although nonprofit accounting courses are available, this article will give you a good head start on how funds are recorded and handled within your nonprofit organization.
Here’s what we will go over:
- What Are (And Who Makes) The Nonprofit Accounting Standards?
- Why Do We Have Accounting Standards?
- What Are Accounting Standards Used For?
- What Information is Needed to Be Compliant With the Standards?
What Are (And Who Makes) The Nonprofit Accounting Standards?
In the United States, the accounting standards are set by the financial accounting standards board (or FASB). The standards themselves are known as the Generally Accepted Accounting Principles (or GAAP). As the name itself suggests, these are the accounting standards generally accepted by most sectors. Note that FASB provides regular amendments and new guidance along with effective dates, restrictions, and requirements on its website.
These GAAP accounting standards are applicable to for-profit businesses and nonprofits alike; however, the standards between sectors, and even within the nonprofit sector, may vary. This can lead to perfectly understandable confusion among nonprofit leaders about what needs to be done, and why.
Why Do We Have Accounting Standards?
Because of the important and amazing work that many nonprofits do, they are entitled to certain privileges. Not paying taxes is one example. To avoid unscrupulous organizations taking advantage of these privileges, and to ensure protection and proper use of the public’s money, nonprofits are required to adhere to certain accounting policies.
Why do we have accounting standards? Corinne is pondering!
Please note that the information required to meet these standards, typically GAAP standards, may vary across different kinds of nonprofits. For instance, accounting standards for nonprofits are structured in such a way as to make information visible that is specifically of interest to donors, members, creditors, and other interested parties.
This sort of information is likely very different from the kind of information that would be of interest to the stakeholders and investors of a traditional company and having an accountant for your nonprofit organization can certainly help!
What Are Accounting Standards Used For?
These standards, and associated accrual accounting basics, are used by nonprofit leaders as a guide for how they should record information such as transactions, donations, grants, and other contributions and receivables. The nonprofit’s leadership team is ultimately responsible for overseeing and ensuring that this guidance is implemented.
Strict adherence is imperative. If standards and nonprofit cash handling procedures are not followed, your organization may be subjected to certain repercussions. The kind of consequences depends on which standards were not met, and the extent to which they were ignored. One important negative byproduct, however, is the loss of your organization’s tax-exempt status.
Pro Tip: It is also recommended that the leadership schedules an annual audit by a third party accounting firm. The auditors’ goals are to ensure that management is following the proper accounting standards and making all necessary disclosures. Their job is to test the reasonableness of controls put in place by management to record all financial transactions and comment on any departure from best financial practices for nonprofit organizations they may find. This leads to greater transparency and can be used as an update report to the board for any recommendations to improve processes and controls.
What Information is Needed to Be Compliant With the Standards?
There are several documents that your nonprofit should prepare and maintain from the moment it begins operations to ensure that you keep your books in the necessary order to comply with GAAP for nonprofits. Maintaining financial statements and related documents will not only make certain that you have all the information needed for GAAP but in addition, means that you’re always equipped with a clear overview of the financials for your entity.
Sam is compiling all the documents he needs to be compliant!
These documents, which are common nonprofit accounting terms, are:
The nonprofit budget is a planning document created by the finance or leadership team to project expenses and allocate direct and indirect expenses for the organization. This is the form that your management team is most likely to be familiar with.
This document is typically created for an annual accounting and is made up of two main pieces. These include:
Expected Revenue. This number is calculated using two different calculations on historical figures. The cutoff method multiplies each revenue stream by the probability that you’ll secure that funding. As an example, if you determine that your organization has a 90% chance of receiving a certain grant, you’d multiply the amount of the grant by 0.9.
The discount method is when you take your expected total revenue and factor it by the probability of receiving it. If your educational nonprofit expects to receive a million dollars in revenue, however, they believe there is an 80% chance of collecting that amount, $800,000 would be entered into the budget.
Expense Budget. This divides your organization’s expenditures into as many categories as your leadership determines. This can include categories such as programs, fundraising, administration, events, government affairs, those required for proper fund accounting for nonprofits, and any number of others. Fund accounting is just one of many potential nonprofit accounting methods you could use.
Statement of Financial Position
Also known as a balance sheet, the Statement of Financial Position gives a complete overview of both assets and liabilities for your organization. It calculates your net assets: a number that is determined by subtracting your liabilities from your assets. This gives your leadership a good idea of your overall financial health.
The balance sheet also has the information needed to determine the organization’s liquidity ratio. This financial ratio provides potential lenders information on how likely your organization is to be able to pay off its short-term debt obligations.
Statement of Activities
Put in simpler terms, this is your organization’s income statement. It categorizes and displays your nonprofit’s various sources of revenue and expenses. Not only can it be used for reporting, but it can also be helpful in reviewing changes from the start of your fiscal year to year-end.
Statement of Functional Expense
This document takes your organization’s expenditures and lumps them into one of three main categories. This separates your expenses into an operational function, either Program Expenses, Fundraising Activities Expenses, or Administrative Expenses.
A new standard (added in 2017) requires that in this report you must also further break it down into the nature of the activities that are listed. For example, a program expense may further be categorized as "education", "fundraising", "membership", or "government affairs".
David is loving learning all about nonprofit accounting!
This categorization will help your finance department (or bookkeeper, depending on the size of your organization), keep the books orderly and organized. Which is useful any way you look at it.
Statement of Cash Flows
This report is designed as a way to view and understand how cash moves (or "flows") through your organization. It lists and breaks down cash received from all the various revenue streams (grants, membership fees, and donations). It helps your finance team to determine how much money is available at any time to pay organizational expenses, as it is a continuing account of your current cash status.
Form 990 is an essential form to file for nonprofit accounting. It’s the tax form that is required annually from any 501(3) tax-exempt organization to be compliant with IRS requirements and regulations.
Form 990 is essentially proof that your organization is legitimate and transparent in its dealings. It records yearly revenue as well as expenses and shows how the finances have been used throughout the fiscal year. All of the documents listed are important to have, but Form 990 is one that must absolutely be filed without fail to avoid consequences.
While all of this may seem overwhelming at first glance, realize that setting up these reports will actually help you keep things straight in the long run. Have your financial professional set up some solid spreadsheets that can be filled automatically and half your battle is won. Once the systems are in place, they aren’t difficult to keep up with.
Pro Tip: You can also find examples or templates online of each document. These samples can help you to better visualize exactly what to include and how to present it. You may also help build your bank of nonprofit accounting resources by reaching out to Facebook groups such as the Nonprofit Management Circle.