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Accounting for a nonprofit organization can be complex. This guide will help you stay on top of your nonprofit accounting responsibilities.
If you have a nonprofit organization, working toward making the world a better place is likely your top priority. However, nonprofits receive generous tax breaks and must be accountable to their donors. So, it’s also of the utmost importance to ensure you properly account for and report your incoming and outgoing money.
Nonprofit accounting provides financial transparency that makes donors feel comfortable and assured that the organization is spending money wisely to further its goals. Additionally, sloppy or inaccurate accounting can lead to problems with the IRS, like possibly losing nonprofit status, receiving hefty fines and even being hit with criminal charges. This guide will help nonprofits improve their accounting skills, learn how to handle accounting challenges unique to accounting for nonprofits and remain compliant.
Nonprofit accounting is a system of financial management, recordkeeping and reporting for not-for-profit groups. Nonprofits are organizations that:
Nonprofit accounting uses specific language and designations to note funded activities and create reports to show donors how their money is being used. Under FASB Accounting Standards Update (ASU) 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities, organizations must classify net assets into two primary categories:
Nonprofit accounting uses specific language and designations to note funded activities and create reports to show donors how their money is being used. Here are a few examples:
According to Eileen Gwaltney, a certified public accountant with over 20 years of experience in the field, one of the biggest accounting mistakes nonprofit organizations can make is improperly allocating administration expenses. Good nonprofit financial management should ensure that the organization can function and grow. However, donors might hesitate to give if your functional expenses become too large.
“With donors focused on making the most of their contribution, it is important for nonprofits to allocate costs correctly,” Gwaltney explained.
Nonprofit organizations rely on bookkeeping and accounting best practices to maintain compliance. While these terms are often used interchangeably, they encompass distinct functions within financial management.
Nonprofit accounting differs in several ways from traditional small business accounting. Both nonprofit and for-profit organizations must produce regular reports detailing their financial activities and use many of the same accounting principles. However, their different goals result in significant differences in these reports. See how accounting for nonprofits compares to accounting for for-profit enterprises in the chart below:
Aspect | Nonprofit | For-Profit |
---|---|---|
Primary organizational focus | Mission achievement and stewardship | Profit generation and shareholder value |
Net assets classification | With/without donor restrictions | Owner’s equity and retained earnings |
Revenue recognition | Contributions vs. exchange transactions | Sales and service revenue |
Functional expense reporting | Program, administration, fundraising | Cost of goods sold, operating expenses |
Tax status | Tax-exempt under 501(c)(3) | Subject to corporate income tax |
Financial statements | Statement of financial position, activities, cash flows, functional expenses | Balance sheet, income statement, cash flows |
Though the terminology differs, nonprofits and for-profits use the same accounting principles. Business development strategist Maggie Tallman told us that many nonprofits would be better off following for-profit practices of sharing data on the relationship between income (donations, in this case) and outcomes (their programs and services).
“Real-time insight into program, operational and financial metrics is imperative in today’s environment,” explained Tallman, who has worked closely with nonprofits to streamline their accounting practices and business operations. “Those nonprofit organizations that understand how to manage their data, and the insights and results derived from that data, are the ones that will leapfrog everyone else in donor and constituent engagement and organizational sustainability.”
Nonprofit accounting requires maintaining detailed records to ensure financial transparency, compliance with regulations and informed decision-making. Here’s a breakdown of the essential documents nonprofits must maintain:
Supporting documentation:
Additional supporting documentation that nonprofits must monitor and maintain:
The tax code for nonprofits can be confusing, and tax reforms can affect everything from how you report income to how you manage volunteers. Nonprofits should pay close attention to the following areas:
Form 990 — a comprehensive document that provides the IRS and the public with financial and operational information about the nonprofit — is due by the 15th day of the 5th month after the organization’s fiscal year ends. For nonprofits operating on a calendar year (January-December), this means the Form 990 must be filed by May 15 of the following year.
The form includes:
Tax-exempt organizations that need additional time to file beyond the May 15 deadline can request a six-month automatic extension by filing Form 8868, Application for Extension of Time to File an Exempt Organization Return. Form 8868 must be filed by the original deadline to receive the extension.
If a charitable nonprofit fails to file its Form 990 for three consecutive years, its tax-exempt status will be automatically revoked. This revocation occurs on the filing due date of the third consecutively missed year.
Some of a nonprofit’s income can be taxable if not reported or managed correctly. Whenever new tax laws pass, the rules outlining how nonprofits must handle and report income change.
“Under the 2017 Tax Cuts and Jobs Act, a nonprofit can no longer aggregate the profits and losses from various trades and businesses in computing their unrelated business taxable income,” warned Julie Treppa, a tax attorney and partner at Farella Braun + Martel LLP. “[Nonprofits must] be sure to segregate income and expenses from each trade or business in which it engages … UBTI is now computed separately with respect to each trade or business.”
Nonprofits must also be careful to record and report the valuation of specific employee benefits, which can count as taxable income if not reported properly. “A nonprofit’s UBTI includes any qualified transportation fringe benefits and on-premises athletic facilities provided to employees,” Treppa noted.
However, she added, proper reporting can save you from paying taxes on these benefits: “The organization can avoid the addition of these items as UBTI if it includes the cost of the benefits on its employees’ Form W-2.”
Beyond federal requirements, nonprofits must comply with state-level regulations that vary significantly by jurisdiction. Most states have basic nonprofit incorporation and annual reporting requirements. In addition, the majority of states require charitable nonprofits engaged in soliciting donations to register with the state. Specifically, 40 states and Washington, D.C., require charitable solicitation registration, according to the National Council of Nonprofits.
Common nonprofit activities that demand registration include soliciting donations from state residents, holding charitable assets within the state or receiving grants from in-state foundations. Most states require organizations receiving over $25,000 annually to register.
Annual state filing deadlines vary by jurisdiction. For example:
Many states will accept the IRS Form 990, but each state has its own requirements.
Nonprofit organizations must juggle impactful missions with the need for responsible financial tracking and management. Here are some key best practices all nonprofits should follow:
A robust system of internal controls is vital for any nonprofit organization to safeguard valuable resources and foster trust with donors and stakeholders. Consider:
Generally accepted accounting principles (GAAP) are a set of accounting procedures and standards issued by the FASB. Many nonprofits follow GAAP standards when preparing their financial statements, which creates transparency for donors and grant-makers and helps the government monitor whether an organization should retain its tax-exempt status.
Specific rules for nonprofits include:
No matter who does your books, choosing the right accounting software for your nonprofit is crucial. You’ll need an accounting program to track everything and be prepared when tax season rolls around. Nonprofits should look for highly rated accounting software that covers not only general bookkeeping and accounting but also specific not-for-profit needs, including donor management, FASB compliance and grant management.
Several accounting software programs are designed specifically for nonprofits, including the following:
In addition to nonprofit-specific accounting solutions, other leading accounting software applications have functionality for for-profit and nonprofit organizations alike. Consider the following:
Regardless of which software you choose, the most important part of nonprofit accounting may be communication. Tiffany Couch, a CPA and the CEO of forensic accounting firm Acuity Forensics, recommends keeping your staff and board members updated on what your accountants do and discover.
“Make sure you have a CPA who will walk you through all of your numbers — ensuring that you understand the profit-and-loss statement, the balance sheet and your cash flow statement,” Couch advised. “The more knowledgeable you become, the more empowered you become to make financial decisions that will lead to your success.”
Couch said this communication between accountants and decision-makers is essential to creating a sustainable nonprofit. “If you don’t have a CPA assisting you in this understanding, find one who will.”
Below are examples of real-world scenarios nonprofits may encounter as they manage their accounting.
If a donor contributes $25,000 specifically for youth programming, you would need to record it as temporarily restricted revenue when received, track expenses separately for youth programs and release the restriction as youth program expenses are incurred.
For donated office supplies worth $5,000, you would record contribution revenue at fair market value, record the corresponding expense or asset, and obtain written acknowledgment from the donor.
While volunteer services generally cannot be recorded as contributions under GAAP, they should be tracked for management purposes and Form 990 reporting.
According to Tab Burkhalter, a CPA and tax attorney for Burkhalter & Associates PC, “The market value of the donated services are reportable on [tax form] 990 as program service revenue and can reduce the percentage of administrative and management costs that is directly paid for by the organization’s cash contributions.”
Like any organization that handles cash flow and pays taxes, nonprofits should invest in a professional accounting and finance team. However, many nonprofit organizations don’t allocate resources for a professional accountant to manage their finances. Instead, they assign the task to an untrained staff member or volunteer. Couch says this is one of the biggest mistakes not-for-profit organizations make.
Couch explained that nonprofits risk fraudulent activity if they don’t carefully manage bookkeeping and accounting. Mistakes are often unintentional, arising from a lack of oversight or experience. Volunteers often comprise a significant part of a nonprofit’s staff and may leave an organization with short notice, which can cause recordkeeping gaps. That’s why nonprofits shouldn’t hesitate to seek professional accounting guidance.
“Don’t have a mindset of scarcity when it comes to ensuring you have appropriate resources in terms of handling your money,” Couch advised. “There are plenty of CPAs who would be willing to provide a discount or pro bono services.”
The most crucial element of nonprofit accounting is, well, accountability. Unlike small for-profit companies that answer only to a handful of owners (or one owner), nonprofits have many stakeholders with varying interests, including the following:
By handling your nonprofit’s accounting responsibly, you’ll earn the trust of donors and foundations — and more easily accomplish your organizational goals.
Mike Berner contributed to this article. Source interviews were conducted for a previous version of this article.