For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. He is the sole author of all the materials on AccountingCoach.com.
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Introduction
From churches to youth organizations to the local chambers of commerce, nonprofit organizations make our communities more livable places. Unlike for-profit businesses that exist to generate profits for their owners, nonprofit organizations exist to pursue missions that address the needs of society. Nonprofit organizations serve in a variety of sectors, such as religious, education, health, social services, commerce, amateur sports clubs, and the arts.
Nonprofits do not have commercial owners and must rely on funds from contributions, membership dues, program revenues, fundraising events, public and private grants, and investment income.
Our intent is to merely introduce some of the basic concepts that are unique to nonprofit accounting and reporting that are required by the Financial Accounting Standards Board (FASB).
We will not discuss the accounting which is similar to that used by for-profit businesses. If you are not familiar with accounting for businesses or you need a refresher, you will find explanations, practice quizzes, Q&A, and more by visiting our course outline.
Accountants often refer to businesses as for-profit entities and to nonprofit organizations as not-for-profit entities, or NFPs. We will be using the more common term nonprofit instead of not-for-profit.
Again, this is a very brief introduction to nonprofit accounting. There are many different types of nonprofits, including governmental nonprofits, which we will not address.
Note: We developed seven business forms to assist you in preparing the financial statements of a nonprofit organization. You can find additional information at AccountingCoach PRO.
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Mission and Ownership, Tax-Exempt Status
Mission and Ownership
While businesses are organized to generate profits, nonprofits are organized to address needs in society. As a result, nonprofits will issue a statement of activities instead of the income statement issued by for-profit businesses.
Since nonprofits do not have owners, there is no owner’s equity or stockholders’ equity and there cannot be distributions to owners.
Some people mistakenly assume that if an organization is designated as a nonprofit, it cannot legally earn profits. In fact, having more revenues than expenses is almost a necessity for a nonprofit if it hopes to withstand such things as:
unexpected expenses
uneven flows of revenues
a decrease in revenues
rising costs due to inflation
an increase in staffing needs
an increase in the need for its services
a purchase or replacement of needed equipment
other needs since a nonprofit cannot issue shares of stock
Tax-Exempt Status
Nonprofit organizations may apply to the Internal Revenue Service in order to be exempt from federal income taxes.
A second issue is whether a donor’s contribution to a nonprofit organization will qualify as a charitable deduction on the donor’s income tax return. For example, churches, schools, and Red Cross chapters are some of the nonprofits that will qualify as tax-exempt and their donors’ contributions will also qualify as charitable deductions on the donors’ income tax returns.
However, there are nonprofits that qualify as tax-exempt but their donors’ contributions do not qualify as charitable deductions (although they may qualify as business expenses). Examples of these nonprofits include social organizations, chambers of commerce, college fraternities and sororities, amateur sports clubs, employee organizations, and more.
You can learn more about the tax-exempt status for a nonprofit, the deductibility of contributions by donors, and the taxability of activities not directly related to a nonprofit’s exempt purpose in the Internal Revenue Service Publication 557, Tax-Exempt Status for Your Organization, which is available at no cost on IRS.gov.
Even if a nonprofit is exempt from federal income taxes, it is likely that its employees will be subject to employment taxes. Nonprofits may or may not be exempt from sales taxes, real estate taxes, and other taxes depending on which state in the U.S. they are incorporated or operate.
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Statement of Financial Position
A nonprofit’s statement of financial position (similar to a business’s balance sheet) reports the organization’s assets and liabilities in some order of when the assets will turn to cash and when the liabilities need to be paid. The amounts are as of the date shown in the heading which is usually the end of a month, quarter, or year. (We will present a sample statement of financial position in a later section.)
Net Assets
Since a nonprofit organization does not have owners, the third section of the statement of financial position is known as net assets (instead of owner’s equity or stockholders’ equity).
A nonprofit’s statement of financial position is represented by the following accounting equation:
Because of double-entry bookkeeping, the accounting equation and the statement of financial position should remain in balance at all times. For example, if a donor contributes $500, the effect on the nonprofit’s accounting equation and its statement of financial position is:
If the nonprofit pays $100 for supplies that will be used immediately, the effect on its accounting equation and its statement of financial position is:
The items that cause the changes in Net Assets are reported on the nonprofit’s statement of activities (to be discussed later).
The net assets section of a nonprofit’s statement of financial position requires at a minimum the following:
These classifications are based on the restrictions made by the donors at the time of their contributions.
Net assets without donor restrictions
If a donor does not specify a restriction on his or her contribution, the amount received by the nonprofit is recorded as an assetand as part of unrestricted contribution revenues. Unrestricted contribution revenues (reported on the statement of activities) also cause the amount of net assets without donor restrictions to increase. For instance, if a nonprofit receives an unrestricted contribution of $800 of cash, the effect on the statement of financial position is:
If the nonprofit’s board of directors designates some of the nonprofit’s unrestricted assets for a specific purpose, those assets must continue to be reported as net assets without donor restrictions.
Net assets with donor restrictions
If a nonprofit receives a contribution that has a donor-imposed restriction, the amount is usually recorded as an asset and as donor restricted contribution revenues. Donor-restricted contribution revenues (reported on the statement of activities) also cause the amount of net assets with donor restrictions to increase. For example, James donates $20,000 with the requirement that the nonprofit use it to purchase a vehicle that is urgently needed in one of the nonprofit’s programs. The effect on the nonprofit’s accounting equation at the time the contribution is received is:
When the nonprofit purchases the vehicle at a cost of say $21,000, the purchase and the release of the restriction will cause the following changes:
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Statement of Activities
Since a nonprofit’s primary purpose is to provide programs that meet certain societal needs, it issues a statement of activities (instead of the income statement that is issued by a for-profit business).
The statement of activities reports revenue and expense amounts according to the two classifications of net assets discussed above (without donor restrictions, with donor restrictions). The following is the framework of the statement of activities without its heading and amounts:
Before we illustrate a sample statement of activities, let’s take a closer look at its components.
Revenues, gains, other support, and releases from donor restrictions
This heading will be followed by items such as:
Contributions
Membership dues
Program fees
Fundraising events
Grants
Investment income
Gain on sale of investments
Reclassifications when net assets are released from restrictions (a negative amount in the With Donor Restrictions column and a positive amount in the Without Donor Restrictions column)
Under the accrual method of accounting, revenues are reported in the accounting period in which they are earned. In other words, revenues might be earned in an accounting period that is different from the period in which the cash is received.
Expenses and losses
Under this caption expenses are reported according to the following functions:
1. Program functions
Program expenses (or program services expenses) are the amounts directly incurred by the nonprofit in carrying out its programs. For instance, if a nonprofit has three main programs, then each of the three programs will be listed along with each program’s expenses.
2. Support functions
Support expenses are reported in two subgroups:
Management and general
Fundraising and development
In order to accurately report the amount in each of these subgroups, it may be necessary to allocate some management and general salaries to fundraising based on the time spent by employees performing fundraising activities. For example, a management employee might be spending 30% of her time in fundraising activities but her entire salary has been recorded as management and general expenses.
Under the accrual method of accounting, expenses are to be reported in the accounting period in which they best match the related revenues. If that is not clear, then the expenses should be reported in the period in which they are used up. If there is uncertainty as to when an expense is matched or is used up, the amount spent should be reported as an expense in the current period.
The number of accounts in a nonprofit’s general ledger could range from 30 to 1,000 or more. The number of accounts depends on the number of programs that the nonprofit has, the types of revenues it earns, and the level of detail required for planning and control of the organization.
For example, a nonprofit is likely to have a separate general ledger account for each of its bank accounts. It may also have 50 general ledger accounts for each of its major programs, plus many accounts under its fundraising and management and general expense categories.
The detail in the general ledger accounts will always be available for management’s use. However, the account balances will be combined into a few amounts that are presented in the financial statements and IRS Form 990.
Nonprofit recordkeeping can get a bit challenging, so it is worth noting that accounting software exists to help nonprofits record transactions efficiently. The accounting software will also allow for reports of revenues and expenses by function (programs, fundraising, management and general), by the nature or type of expense (salaries, electricity, rent, depreciation, etc.), and/or by grant.
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Illustration of the Statement of Financial Position and the Statement of Activities
We are now ready to present examples of the statement of financial position and the statement of activities. To do that, we’ll follow the activities of a nonprofit organization called Home4U, a daytime shelter for adults.
Let’s assume that Home4U was incorporated in January 2023 and its accounting years end on each December 31. The following transactions occurred during a three-month period.
January Transaction
Transaction 1. On January 31, a donor contributes $10,000, without restriction, for the operation of Home4U. This transaction affects the general ledger accounts as follows:
Assuming this is the only transaction in January, the general ledger account balances will result in the following financial statements:
February Transactions
Transaction 2. On February 1, Home4U rents office space. A check is written for $2,000. This covers a one-time security deposit of $1,000 plus the February office rent of $1,000.
Transaction 3. On February 2, a $400 check is written to the utility as a one-time security deposit for electricity and heat service.
Transaction 4. On February 19, Home4U receives a contribution of $8,000 that the donor specifies must be used for the purchase of furniture. The contribution is deposited into a money market account. This transaction affects the general ledger accounts as follows:
Transaction 5. The electricity and heating bills have not arrived. It is estimated that the amount for February’s usage was $350, so the following accrual adjusting entry is recorded on February 28:
Assuming that Transactions 2 through 5 are the only transactions occurring in February, the general ledger account balances will result in the following financial statements:
March Transactions
During March, Home4U paid the March rent of $1,000. Home4U also paid the February utilities which were equal to the estimated amount of $350. Home4U estimates that March’s utilities will be $300.
On March 31, Home4U paid $8,300 to purchase furniture (using the donor-restricted donation of $8,000). The statement of financial position dated March 31 will report the following amounts:
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Statement of Functional Expenses
The statement of functional expenses is described as a matrix since it reports expenses by their function (programs, management and general, fundraising) and by the nature or type of expense (salaries, rent). For instructional purposes we highlighted the column headings to indicate the expenses by function. We also highlighted the words in the first column as they indicate the nature or type of expenses.
The FASB requires every nonprofit to present expenses by function and nature in one place (statement or notes).
The statement of cash flows consists of three sections:
Cash flows from operating activities
Cash flows from investing activities
Cash flows from financing activities
The operating activities section of the SCF reports the changes in cash other than those reported in the investing and financing sections.
The investing activities section of the SCF reports the amounts spent to purchase long-term assets such as equipment, vehicles and long-term investments. The investing section also reports the amount received from the sale of long-term assets.
The financing activities section of the SCF reports the amounts received from borrowings and also any repayments.
While the statement of cash flows, or cash flow statement, may be a bit difficult to prepare, it is an important financial statement to be read.
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Notes to the Financial Statements
The notes to the financial statements are an integral part of the statement of financial position, the statement of activities, and the statement of cash flows. The FASB Accounting Standards Codification Topic 958 requires important additional disclosures regarding liquidity, restrictions, etc. for creditors, donors, and others.
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Additional Reporting by Nonprofits
The U.S. Internal Revenue Service (IRS) requires some tax-exempt nonprofit organizations to file Form 990 (some can file Form 990-EZ) each year. (However, churches and some other nonprofit organizations are not required to file.) The title of Form 990 is Return of Organization Exempt From Income Tax.
Since the Form 990 filed by the nonprofit becomes public information, you can learn much about a nonprofit by reading the information on Form 990. The website guidestar.org is a resource one can use to obtain financial (and other) information reported on nonprofits’ Form 990.
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Budgeting for Nonprofits
Budgeting for nonprofits can become complex when it involves several overlapping categories, such as grants, programs, function, and nature.
Budgeting is also complicated when sources of support are not secured at the time the budget is prepared for the upcoming year. This could lead to the use of an account entitled Resource Development in order to balance the budget.
Since resource development is often ongoing, budgets may require frequent modification. Good accounting software will also allow directors to compare budgeted amounts to actual amounts and make the necessary adjustments.
Where to Go From Here
We recommend taking our Practice Quiz next, and then continuing with the rest of our Nonprofit Accounting materials (see the full outline below).
We also recommend joining PRO Plus to unlock our premium materials (certificates of achievement, video training, flashcards, visual tutorials, quick tests, quick tests with coaching, cheat sheets, guides, business forms, printable PDF files, progress tracking, badges, points, medal rankings, activity streaks, public profile pages, and more).
You should consider our materials to be an introduction to selected accounting and bookkeeping topics, and realize that some complexities (including differences between financial statement reporting and income tax reporting) are not presented. Therefore, always consult with accounting and tax professionals for assistance with your specific circumstances.
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An organization without owners and with the main purpose of providing services needed by society. After application and approval by the U.S. Internal Revenue Service, a nonprofit organization may be granted tax exempt status.
One of the main financial statements of a nonprofit organization. This financial statement reports the revenues and expenses and the changes in the amounts of each of the classes of net assets during the period shown in its heading. This statement is issued by a nonprofit instead of the income statement issued by a for-profit business.
One of the main financial statements (along with the balance sheet, the statement of cash flows, and the statement of stockholders’ equity). The income statement is also referred to as the profit and loss statement, P&L, statement of income, and the statement of operations. The income statement reports the revenues, gains, expenses, losses, net income and other totals for the period of time shown in the heading of the statement. If a company’s stock is publicly traded, earnings per share must appear on the face of the income statement.
Fees earned from providing services and the amounts of merchandise sold. Under the accrual basis of accounting, revenues are recorded at the time of delivering the service or the merchandise, even if cash is not received at the time of delivery. Often the term income is used instead of revenues.
Examples of revenue accounts include: Sales, Service Revenues, Fees Earned, Interest Revenue, Interest Income. Revenue accounts are credited when services are performed/billed and therefore will usually have credit balances. At the time that a revenue account is credited, the account debited might be Cash, Accounts Receivable, or Unearned Revenue depending if cash was received at the time of the service, if the customer was billed at the time of the service and will pay later, or if the customer had paid in advance of the service being performed.
If the revenues earned are a main activity of the business, they are considered to be operating revenues. If the revenues come from a secondary activity, they are considered to be nonoperating revenues. For example, interest earned by a manufacturer on its investments is a nonoperating revenue. Interest earned by a bank is considered to be part of operating revenues.
Costs that are matched with revenues on the income statement. For example, Cost of Goods Sold is an expense caused by Sales. Insurance Expense, Wages Expense, Advertising Expense, Interest Expense are expenses matched with the period of time in the heading of the income statement. Under the accrual basis of accounting, the matching is NOT based on the date that the expenses are paid.
Expenses associated with the main activity of the business are referred to as operating expenses. Expenses associated with a peripheral activity are nonoperating or other expenses. For example, a retailer’s interest expense is a nonoperating expense. A bank’s interest expense is an operating expense.
Generally, expenses are debited to a specific expense account and the normal balance of an expense account is a debit balance. When an expense account is debited, the account credited might be Cash (if cash was paid at the time of the expense), Accounts Payable (if cash will be paid after the expense is recorded), or Prepaid Expense (if cash was paid before the expense was recorded.)
Usually financial statements refer to the balance sheet, income statement, statement of cash flows, statement of retained earnings, and statement of stockholders’ equity.
The balance sheet reports information as of a date (a point in time). The income statement, statement of cash flows, statement of retained earnings, and the statement of stockholders’ equity report information for a period of time (or time interval) such as a year, quarter, or month.
One of the main financial statements. The balance sheet reports the assets, liabilities, and owner’s (stockholders’) equity at a specific point in time, such as December 31. The balance sheet is also referred to as the Statement of Financial Position.
Obligations of a company or organization. Amounts owed to lenders and suppliers. Liabilities often have the word “payable” in the account title. Liabilities also include amounts received in advance for a future sale or for a future service to be performed.
One of the main financial statements of a nonprofit organization. This financial statement reports the amounts of assets, liabilities, and net assets as of a specified date. This financial statement is similar to the balance sheet issued by a company.
The result of subtracting total liabilities from total assets. It is also the term used by not-for-profit organizations instead of owner’s equity or stockholders’ equity.
Assets = Liabilities + Owner’s Equity. For a corporation the equation is Assets = Liabilities + Stockholders’ Equity. For a nonprofit organization the accounting equation is Assets = Liabilities + Net Assets. Because of double-entry accounting this equation should be in balance at all times. The accounting equation is expressed in the financial statement known as the balance sheet.
The accounting method under which revenues are recognized on the income statement when they are earned (rather than when the cash is received). The balance sheet is also affected at the time of the revenues by either an increase in Cash (if the service or sale was for cash), an increase in Accounts Receivable (if the service was performed on credit), or a decrease in Unearned Revenues (if the service was performed after the customer had paid in advance for the service).
Under the accrual basis of accounting, expenses are matched with revenues on the income statement when the expenses expire or title has transferred to the buyer, rather than at the time when expenses are paid. The balance sheet is also affected at the time of the expense by a decrease in Cash (if the expense was paid at the time the expense was incurred), an increase in Accounts Payable (if the expense will be paid in the future), or a decrease in Prepaid Expenses (if the expense was paid in advance).
That part of the accounting system which contains the balance sheet and income statement accounts used for recording transactions.
An account in the general ledger, such as Cash, Accounts Payable, Sales, Advertising Expense, etc.
A listing of the accounts available in the accounting system in which to record entries. The chart of accounts consists of balance sheet accounts (assets, liabilities, stockholders’ equity) and income statement accounts (revenues, expenses, gains, losses). The chart of accounts can be expanded and tailored to reflect the operations of the company.
Gains result from the sale of an asset (other than inventory). A gain is measured by the proceeds from the sale minus the amount shown on the company’s books. Since the gain is outside of the main activity of a business, it is reported as a nonoperating or other revenue on the company’s income statement.
The systematic allocation of the cost of an asset from the balance sheet to Depreciation Expense on the income statement over the useful life of the asset. (The depreciation journal entry includes a debit to Depreciation Expense and a credit to Accumulated Depreciation, a contra asset account). The purpose is to allocate the cost to expense in order to comply with the matching principle. It is not intended to be a valuation process. In other words, the amount allocated to expense is not indicative of the economic value being consumed. Similarly, the amount not yet allocated is not an indication of its current market value.
One of the main financial statements (along with the income statement and balance sheet). The statement of cash flows reports the sources and uses of cash by operating activities, investing activities, financing activities, and certain supplemental information for the period specified in the heading of the statement. The statement of cash flows is also known as the cash flow statement.
A balance sheet heading or grouping that includes both cash and those marketable assets that are very close to their maturity dates.
One of the main financial statements (along with the income statement and balance sheet). The cash flow statement reports the sources and uses of cash by operating activities, investing activities, financing activities, and certain supplemental information for the period specified in the heading of the statement. The cash flow statement is also known as the statement of cash flows.
The ability to generate cash.
A detailed plan with dollar amounts. Examples of budgets used in business include the cash budget, sales budget, production budget, department budgets, the master budget, and the capital expenditures budget. Some budgets are designed to be flexible budgets, while others are static budgets.
A record in the general ledger that is used to collect and store similar information. For example, a company will have a Cash account in which every transaction involving cash is recorded. A company selling merchandise on credit will record these sales in a Sales account and in an Accounts Receivable account.
For the past 52 years, Harold Averkamp (CPA, MBA) has
worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. He is the sole author of all the materials on AccountingCoach.com.
