All businesses want to be profitable. Even nonprofits.
Any entity that isn’t making money is essentially in the process of going out of business. For-profit companies are trying to make as much money as possible to grow, meet expectations of stockholders, or fund the lifestyle of the owner. Nonprofit organizations also need a positive flow of revenue (typically in the form of donations) in order to continue fulfilling whatever their mission is.
When it comes to accounting, nonprofits have an additional burden on top of profitability…accountability. If donors are giving them money, then those people have a right to know that their money is being used as expected.
The lifeblood of all non-profits is trust. If people cannot be confident that donations are being used wisely and honestly, then they will simply give their hard-earned money somewhere else.
FUND ACCOUNTING BEST PRACTICES
In order to demonstrate fiscal trustworthiness, nonprofit organizations generally utilize what is known as “fund accounting.” Where a standard company might basically have “revenue” and “expense” columns on its ledgers, a nonprofit will break those categories down further to better track money that has been designated for specific programs. Creating “funds” within one main account (multiple accounts are not necessary) is how they do it.
3 WAYS THAT REVENUE IS CATEGORIZED:
These are donations that have been given to the organization, but have not been specified to go to a particular project or program. They can be spent however the nonprofit sees fit.
They are often used for general expenses such as: basic overhead, administrative costs, salaries, rent, utilities, etc. In this category, people just want to know that a nonprofit is not being foolish with spending.
2. TEMPORARILY RESTRICTED
If a donor specifies how they want their gift to be used, it falls into this category. This is where results must meet expectations in regards to how money is spent.
If a homeless shelter collects funds for a “Christmas Coat Drive,” then that money can only be used for expenses related to purchasing coats at Christmas. If an animal shelter raises money to be able to spay and neuter stray cats, they cannot use that money on the staff Christmas party.
Temporarily Restricted funds usually have an end date, often within a year. Many grants will come with such a stipulation. That way the organization can’t park the money indefinitely (and run the risk of it sitting idle or being used improperly because it goes unnoticed for too long).
3. PERMANENTLY RESTRICTED
These funds are usually tied to gifts like land, real estate, or mineral rights. The intention is for the nonprofit to draw continual long-term income from these things, so they do not have any sort of specified end date.
These 3 categories satisfy GAAP (Generally Accepted Accounting Principles) and FASB (Financial Accounting Standards Board) 116 & 117 requirements, and they allow nonprofits to easily report assets on IRS form 990.
HOW EXPENSES ARE CATEGORIZED:
When it comes to how nonprofits track expenses, they need some kind of system that easily allows people to see where every dollar is being spent. So they operate using “fund categories.” These are usually represented by 3 numbers that end up looking something like:XX-XX-XXXX
- The first 2 digits refer to which revenue category the expense is pulling from:
- 01 – unrestricted
- 02 – temporarily restricted
- 03 – permanently restricted
- The second set of digits refers to subcategories or temporary projects. For example:
- 10 – Christmas Coat Drive
- 20 – Meals on Wheels
- 30 – Housing
- The last 4 digits refer to a specific line item within that project. For example:
- 4100 – Bed linens
- 3200 – Men’s Winter Coats
Therefore, money spent to replace worn out sheets on beds in the homeless shelter would look like: 01-30-4100
IT CAN EASILY GET COMPLICATED, THOUGH.
This is an extremely simplified overview of accounting for nonprofits, but it is essential that every such organization has a system like this set up to track every dollar spent. As you can imagine, even a small charity with relatively meager donations and expenses could easily find itself overwhelmed with categories and subcategories.
That’s why it is important that groups who exist financially because of the generosity of others partner with an experienced accounting firm that knows how to accurately help them keep their books. (You can read more about how we help nonprofits in our post 3 Ways Nonprofits Can Benefit From Having A Trusted CPA.)
WE’RE HERE TO HELP.
CRS CPA has been doing accounting like this for nonprofits for over 40 years. Our team can help you navigate your nonprofit financials and give your donors peace of mind that their gifts are being handled well. Give us a call today to learn more.