Introduction to Nonprofit Accounting
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If you're starting a new nonprofit organization or are only familiar with for-profit accounting, you'll need to understand the basics of nonprofit accounting to ensure you follow the rules. So what are the big differences between for-profit and nonprofit accounting?
In addition to the ways for-profit businesses generate revenue, like selling goods and services and investment income, nonprofit organizations can produce revenue through other channels. Nonprofits can raise funds through donations, be awarded grants, and collect membership fees.
Nonprofits must track revenue from different sources for financial accounting purposes. Donations, for example, are tax deductible for the donor. And nonprofit organizations must provide a receipt for any donation. Nonprofits can raise unlimited earned revenue as long as the revenue is tied to its mission. But if the nonprofit generates revenue that is not related to its mission, that revenue is considered unrelated business income and will be taxed.
For-profit businesses track their expenses along natural categories. Natural categories explain what an expense is. Payroll, rent, or printing are examples of natural categories. In addition to tracking expenses with natural categories, nonprofit organizations have to track their expenses along functional categories. Functional categories explain why an expense was incurred. The three functional categories that nonprofits must use are Fundraising, Management and General, and Programs. You can create additional functional categories and subcategories, but those three are required.
MonkeyPod makes tracking expenses easy by providing built-in safeguards to ensure you follow nonprofit accounting rules. MonkeyPod uses Accounts to track natural categories (what did we spend money on?) and classes to track functional categories (why did spend that money?). Read more about Accounts and Classes.
Tracking Net Assets
In for-profit accounting a balance sheet must show that Assets = Liabilities + Equity. But because nonprofits do not have owners, there is no equity. Instead, for nonprofits, the difference between assets and liabilities is called net assets. On their Statement of Financial Position, nonprofits must show that Assets = Liabilities + Net Assets.
Net assets must be assigned as either net assets with donor restriction, or net assets without donor restriction. When net assets have restrictions, nonprofits must track the release of those restrictions prior to spending.
Let's look at an example to see how this works.
If a donor makes a donation to your nonprofit and specifies that she only wants her donation to be used for your artist residency program, her donation must be recorded as a net asset with restriction. In order to spend that donation on the artist residency program, the nonprofit must show in their books that those funds were first released from restriction, and then spent on an appropriate expense.
MonkeyPod makes it easy to track net assets by automatically recording when they are released from restriction. You can also record a fund release in advance.
For-profit businesses and nonprofit organizations must produce annual financial statements. And while there are some similarities between the reports, the terminology is very different. For-profit businesses produce balance sheets and income statements (or P&L statements). Nonprofit organizations produce a Statement of Financial Position, Statement of Activities, and Statement of Functional Expenses.
Because nonprofits are exempt from income tax, they must submit to the IRS Form 990, "Return of Organization Exempt From Income Tax." Tax-exempt organizations, nonexempt charitable trusts, and section 527 political organizations all have to file Form 990. A nonprofit organization's 990 can be viewed publicly and includes important financial information about the organization.
|Revenue Sources|| Donations
Sales (Tickets, Merchandise)
| Sales of Goods
Sales of Services
|Reporting Expenses By Function|| Fundraising
Management and General
|Tracking Net Assets|| Net assets with restriction
Net assets without restriction
|Main Financial Statements|| Statement of Financial Position
Statement of Activities
Statement of Functional Expenses
| Balance Sheet
|Annual Reporting||IRS Form 990||IRS Form 1120|
|Tax Status||Exempt from Income Taxes||Must Pay Income Taxes|