One of the key differences between for profit vs nonprofit accounting is the presentation of net assets on the balance sheet. In the nonprofit world, it is not called a balance sheet. It is called a Statement of Financial Position.
Presentation of Net Assets and Liabilities
The presentation of assets and liabilities is the same for both for-profit and nonprofit businesses, except for the balance sheet. For-profit businesses show owner’s equity, which is made up of retained earnings and stock. Nonprofits do not have owners, therefore, there is no owner’ equity. The difference between the total assets and total liabilities is called net assets.
Net assets in nonprofit accounting are what your organization has, what is owed, what is invested and what is deposited. Liabilities are what your organization owes to others or holds on behalf of others.
The calculation of retained earnings and net assets is essentially the same. It is the cumulative difference between revenue and expenses. For nonprofits, revenue must be assigned as either net assets without donor restrictions, or net assets with donor restrictions.
Net assets represent the net worth of the organization and can be either fixed, liquid (cash), long term, tangible and intangible.
Explanation of Nonprofit Net Assets
As of 2018, there are now only two new classes required for nonprofit financial statements. The two new classes replace the older classes of: unrestricted funds, temporarily restricted funds and permanently restricted funds
Net assets with donor restrictions combine the temporarily restricted and permanently restricted classes. Net assets without donor restrictions replace the unrestricted funds class. The new classes are determined by donors at the time of their donations. Donor imposed restrictions are classified as without donor restrictions. The nonprofit can use the donation for whatever purpose it needs to fulfill its mission. Donor imposed restrictions are classified as with donor restrictions and must be used for a designated purpose.
When a donor does not specify restrictions on their contribution, the donation is recorded as an asset and revenue. This type of revenue will result in an increase in the total net assets without donor restrictions.
When a donor imposes restrictions on their donation, the revenue is recorded as donor restricted contribution revenue. This results in an increase in net assets with donor restrictions.
New Classes Simplify Reporting
The new classes simplify the treatment of assets in the Statement of Financial Position. It now focuses on the existence or absence of donor imposed restrictions instead of the types of restrictions.
The new treatment of assets in accounting have improved reporting in the following ways:
- Reduces complexity in net asset grouping
- Clarifies of information regarding liquidity and availability of resources
- Demonstrates transparency in reporting of financial performance
- Shows consistency in reporting expenses
- Utilizes the statement of cash flows
Since nonprofits exist to fulfill its mission, they are required to issue a Statement of Activities report. This replaces the income statement issued by for-profit businesses. It now presents revenue and expenses according to the two classes of net assets.
If a donation has no restrictions, it is classified as without donor restrictions. The nonprofit can use the donation for whatever purpose it needs to fulfill its mission. If a donation has restrictions, it is classified as with donor restrictions and must be used for a designated purpose.
Why Is This Important?
Recognizing net assets with donor restrictions on financial statements help decision makers be aware of obligations in the future. Changes in net assets without donor restrictions shows whether an organization operated with a gain or a loss. This provides a birds eye view the nonprofit’s cash flow.
The debt to equity ratio measures liquidity and shows how much debt versus net assets is being used. The new financial statement presentation of net assets provides improved information for donors, grant makers and other funding sources. It also reduces the complexities and costs of financial reporting.
Accountings for nonprofits will continue to track assets and comply with restrictions imposed by donors. However, they are no longer required to distinguish between temporarily and permanently restricted net assets. Nonprofit leaders need to communicate and understand these calculations over time to gain insight into their financial trends.
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