Non profit accounting

What Is Non profit accounting?

Non profit accounting refers to the specialized accounting practices and principles utilized by organizations that operate for purposes other than generating profit for owners or shareholders. This distinct field within accounting principles focuses on accountability to donors, grantors, and the public, rather than profitability. Unlike commercial entities, non profit organizations typically derive their financial resources from donations, grants, and program service fees, rather than sales of goods or services for profit. The primary goal of non profit accounting is to demonstrate how resources are used to fulfill the organization's mission and to ensure compliance with specific regulations, which often grant a tax-exempt status. Key components include managing restricted and unrestricted funds, careful revenue recognition, and detailed expense classification. Non profit accounting requires adherence to Generally Accepted Accounting Principles (GAAP) but with particular nuances that reflect the unique nature of their operations.

History and Origin

The evolution of non profit accounting standards has largely been driven by the need for greater transparency and accountability as the non-profit sector grew. Historically, accounting for non-profit organizations was less standardized than for commercial entities. A significant development in the United States occurred with the issuance of Statement of Financial Accounting Standards (SFAS) No. 116, "Accounting for Contributions Received and Contributions Made," and SFAS No. 117, "Financial Statements of Not-for-Profit Organizations," by the Financial Accounting Standards Board (FASB) in 1993. These standards, effective for fiscal years beginning after December 15, 1994, fundamentally changed how non-profits recognized contributions and presented their financial statements⁵. Further updates, such as Accounting Standards Update (ASU) 2016-14, issued in August 2016 and effective for fiscal years beginning after December 15, 2017, aimed to simplify and improve the presentation of financial statements for non-profit entities, particularly regarding liquidity and functional expense reporting⁴. These ongoing revisions reflect the sector's growth and the increasing demand for clear, comprehensive financial reporting from donors, regulators, and the public.

Key Takeaways

• Non profit accounting focuses on accountability for resource use to fulfill a mission, rather than on profit generation.
• It adheres to specialized GAAP requirements, distinct from those for for-profit entities, especially concerning revenue and net assets.
• Organizations must classify net assets as "without donor restrictions" or "with donor restrictions."
• Financial statements emphasize the organization's ability to provide services and meet obligations.
• Transparency and compliance with regulatory bodies like the IRS are paramount.

Formula and Calculation

Non profit accounting does not rely on a single, overarching formula like those found in business valuation or investment analysis. Instead, it involves the application of accounting equations and principles to track financial activity. The fundamental accounting equation remains:

Here:

• Assets represent what the non-profit owns.
• Liabilities represent what the non-profit owes.
• Net Assets (formerly referred to as fund balances or equity in some contexts) represent the residual value, or the amount by which assets exceed liabilities. In non profit accounting, net assets are typically classified based on the existence or absence of donor-imposed restrictions. This differs from a typical balance sheet for a for-profit entity, which shows owner's equity.

The calculation of changes in net assets over a period is reflected in the statement of activities, which is analogous to an income statement for a for-profit entity. This statement measures the change in net assets without donor restrictions, with donor restrictions, and the total change in net assets.

Interpreting Non profit accounting

Interpreting non profit accounting involves understanding how an organization manages and utilizes its financial resources to achieve its mission. Unlike for-profit businesses where success is often measured by profitability, non-profits are evaluated on their programmatic impact and financial stewardship. Users of non-profit financial statements, such as donors and grantors, look for indicators of financial health, efficiency in program delivery, and adherence to donor restrictions.

A key aspect of interpretation is analyzing the "Statement of Activities" (similar to an income statement), which details revenues and expenses and the change in net assets. Another critical component is the "Statement of Financial Position" (the balance sheet), showing assets, liabilities, and net assets at a specific point in time. Additionally, the "Statement of Cash Flows" provides insights into the organization's liquidity and operational efficiency cash flow statement. The presence of robust internal controls and regular auditing further enhances the credibility of the financial reports, assuring stakeholders of proper financial management.

Hypothetical Example

Consider "Hopeful Horizons," a fictional non-profit organization dedicated to providing educational programs for underprivileged youth.

In a given fiscal year, Hopeful Horizons receives:

• Unrestricted donations: $200,000
• Restricted grant for a new literacy program: $100,000 (to be spent only on books and tutors)
• Program service fees (e.g., from after-school classes): $50,000

Their expenses for the year are:

• Salaries (unrestricted): $120,000
• Rent and utilities (unrestricted): $30,000
• Books and tutors for literacy program (restricted): $70,000

Under non profit accounting, Hopeful Horizons would record:

• Revenues:
  • Contributions Without Donor Restrictions: $200,000
  • Contributions With Donor Restrictions: $100,000
  • Program Service Fees: $50,000
  • Total Revenue: $350,000
• Expenses:
  • Program Expenses (Literacy Program): $70,000 (from restricted funds)
  • Management and General Expenses (Salaries, Rent): $150,000 (from unrestricted funds)
  • Total Expenses: $220,000

Change in Net Assets:

• Change in Net Assets Without Donor Restrictions: $200,000 (Unrestricted Contributions) + $50,000 (Program Fees) - $150,000 (Management & General Expenses) = $100,000 increase.
• Change in Net Assets With Donor Restrictions: $100,000 (Restricted Grant) - $70,000 (Literacy Program Expenses) = $30,000 increase.
• Total Change in Net Assets: $100,000 + $30,000 = $130,000 increase.

This example illustrates how non profit accounting tracks funds separately based on restrictions and how different types of income and expenditures impact the organization's overall financial statements and net asset classifications.

Practical Applications

Non profit accounting is essential for the effective operation and oversight of a wide range of organizations, including charities, educational institutions, healthcare providers, religious organizations, and cultural institutions. Its practical applications are numerous:

• Fund Management: It enables organizations to accurately track and report on restricted funds, ensuring that donor intentions are honored. This is a core aspect of fund accounting, which is crucial for non-profits.
• Grant Reporting: Non-profits often receive grants with strict reporting requirements. Proper non profit accounting practices ensure compliance, which is vital for securing future funding.
• Public Accountability: Detailed financial statements prepared using non profit accounting standards provide transparency to donors, beneficiaries, and the general public, demonstrating how resources are being utilized to advance the organization's mission.
• Regulatory Compliance: Non-profit organizations in the United States must comply with Internal Revenue Service (IRS) regulations, particularly for maintaining their tax-exempt status under sections like 501(c)(3) of the Internal Revenue Code³. This includes filing annual information returns, such as Form 990, which provides public insight into the organization's finances and governance.
• Strategic Budgeting: It provides the necessary data for effective financial planning and strategic decision-making, helping organizations allocate resources efficiently to achieve their programmatic goals.

Limitations and Criticisms

While non profit accounting is designed to provide transparency and accountability, it faces certain limitations and criticisms. A primary challenge is the potential for a lack of complete transparency. Unlike for-profit companies, which are driven by profit motives and subject to market scrutiny, non-profits' effectiveness is harder to quantify financially. Concerns sometimes arise regarding the allocation of funds between program services and administrative or fundraising costs, leading to calls for clearer and more consistent reporting.

Another criticism can stem from the complexity of GAAP as applied to non-profits, particularly for smaller organizations with limited resources and expertise. This can make it challenging to maintain accurate and up-to-date financial records². Furthermore, the emphasis on reporting expenses by function (program, administrative, fundraising) can sometimes be ambiguous, allowing for varied interpretations that may not always present the clearest picture of an organization's efficiency. While the framework aims for accountability, a truly balanced view requires examining not just financial reports but also programmatic outcomes and governance practices.

Non profit accounting vs. For-profit accounting

Non profit accounting and for-profit accounting share fundamental principles of financial record-keeping, such as the use of double-entry bookkeeping and the preparation of financial statements based on accrual accounting. However, their objectives and reporting emphasis differ significantly.

The core distinction lies in the financial motive. For-profit entities aim to maximize wealth for owners, reflected in profit and loss statements. Non-profits, conversely, manage resources to serve a public or community purpose, with financial reports demonstrating stewardship and the utilization of funds toward specific, often restricted, objectives. The Financial Accounting Standards Board (FASB) provides accounting standards for both, but with specific sections tailored to each sector¹.

FAQs

What are the main financial statements in non profit accounting?

The main financial statements for non-profits include the Statement of Financial Position (balance sheet), Statement of Activities (income statement equivalent), Statement of Cash Flows, and the Statement of Functional Expenses.

How do non-profits handle restricted donations?

Restricted donations are recognized as "net assets with donor restrictions" upon receipt. These funds are then released from restriction and reclassified as "net assets without donor restrictions" as the organization fulfills the donor-imposed conditions, such as spending the money for a specific purpose or during a particular time period.

Is GAAP used in non profit accounting?

Yes, Generally Accepted Accounting Principles (GAAP) are used in non profit accounting. However, there are specific GAAP standards and pronouncements issued by the Financial Accounting Standards Board (FASB) that are tailored to the unique nature of non-profit organizations, such as the classification of net assets and the reporting of contributions.