In order to fully understand nonprofit accounting, you must be able to answer key basic questions. Answers to these questions form the foundation for understanding the difference between nonprofit and for-profit accounting.
Nonprofit Accounting Key Questions
Nonprofit fund accounting is unique to nonprofit organizations. Most readers of commercial financial statements are not familiar with this type of accounting. As a result, fund accounting tends to be very confusing. In the simplest terms, funds in a nonprofit help to define how a nonprofit can use the revenue that comes into an organization.
Other specialized fund groupings are used by organizations reflecting either donor restrictions or board designations, but they all fall under one of the four fund categories mentioned above. Even though there are only four classifications of funds, some organizations will set up their books with only one fund, some will set up their books with many more funds.
What are net assets?
The difference between the total assets and total liabilities is called net assets.
Net asset fund classifications:
- Net assets without restrictions. There are no restrictions placed on the resources of this fund and the organization can use the amounts in the fund as it chooses.
- Net assets with restrictions: These funds are resources that are given to the organization as part of their normal activities, but only for specific purposes.
- Restricted Endowment Fund: These funds contain resources donated to the organization with the stipulation that only the income earned by these assets can be used, while the original gift is kept intact forever, or a stipulated period of time.
- Fixed Asset Fund: A separate fund for the cost of fixed assets, buildings, land, etc. The purpose of this fund is to separate these assets from the unrestricted fund, so the unrestricted fund represents the current activity of the organization.
What is fund accounting?
The purpose of using fund accounting is it allows a nonprofit to manage the diverse streams of revenue that they receive and to monitor the restrictions often attached to that revenue. By breaking up an entity’s finances into appropriate funds, fund accounting enables organizations to keep the revenues that it receives in the proper categories and prevents those revenues from being spent on inappropriate expenses. Each fund will have its own revenue and expense report, its own excess or deficiency calculation and its own balance sheet.
The purpose of using fund accounting is it allows a nonprofit to manage the diverse streams of revenue that they receive and to monitor the restrictions often attached to that revenue.
If a nonprofit wants to be compliant with GAAP and FASB 116/117, all of their funds must be grouped into three categories of net assets: unrestricted, temporarily restricted or permanently restricted. So a nonprofit should only have three funds in their financial statements presented to the public to be GAAP compliant and to report on the breakdown of net assets on IRS form 990.
What is the statement of financial position?
One of the key differences between for profit and 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.
The statement of financial position provides an overview of what the nonprofit organization is worth. The net asset section of your statement of financial position will have unrestricted net assets, or funds that can be used for the general benefit of the organization and restricted net assets, which are funds that must be used in compliance with the restrictions placed on the revenue by the donor.
Common mistakes in fund accounting
One of the major errors that nonprofit organizations make using fund accounting is the segregation of their assets by fund. For example, separate bank accounts do not need to be maintained for the cash attributable to a fund, especially when all of the organization’s cash is in a single bank account. All this does is create extra work for the accounting staff.
Another major mistake made by some nonprofit organizations is to create a fund for every program, grant, mission, project, or other activity that they operate. Churches and religious ministries carry the separate fund principle to the extreme. I’ve seen churches and ministries set up separate funds for every ministry, i.e., women’s, men’s, children’s, alter guild, flowers, refreshments and bible study, etc. Also some nonprofits set up separate funds for each of their grants. The reason is nonprofit management thinks they need these for both internal and external reporting. They have perverted the use of funds in fund accounting.
What is the purpose of nonprofit accounting?
All of those activities should not be classified as funds in your accounting system. The better way to track all of this activity is the use of program or functional codes within a fund. With the proper set up, a program classification within a fund can properly track the designated revenue and associated expenses for a specific activity. These separate program areas are referred to as functional areas and fall under three categories, management and general, program and fundraising.
The principle of nonprofit accounting provides organizations with a method to measure how they are meeting their goals. It helps identify the sources of an organization’s revenue, and it shows how efficiently the organization is using those revenues for their designated purpose. The use of fund accounting highlights areas of strength and weakness, and it provides transparency for external audiences.
Nonprofits just need to get past the idea that everything they do should be classified as a separate fund. If a nonprofit sets up their financial records with the appropriate net asset fund classes and tracks revenue and expenses within the funds using program codes, they can provide proper stewardship to their donors and funding sources.
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