Explanation of Nonprofit Accounting

Explanation of Nonprofit Accounting

Every organization is different. Most nonprofits need to do the following to get their accounting system up and running:

  • Find a nonprofit accounting solution;
  • Find an accounting solution to track funds;
  • Open a separate bank account;
  • Start doing bank reconciliations;
  • Record in-kind donations;
  • Start budgeting;
  • Prepare and analyze financial statements.

Nonprofit accounting is a unique recording and reporting system that applies to business transactions carried out by a nonprofit organization. A nonprofit organization is an organization that has no ownership interest, has a functional purpose other than making a profit, and receives significant contributions from third parties that do not expect to make a profit.

Nonprofit accounting uses the following concepts, which are different from business accounting.

Nonprofit organizations divide money into groups:

  • Limited funds are spent on specific projects and activities within the organization.
  • Temporarily limited funds must be spent on specific projects and activities within your nonprofit organization up to a particular period. After this time, they become unlimited funds.
  • Unlimited or annual funds can be spent on any aspect of the organization that needs it the most.
  • Another aspect of nonprofit accounting that helps organizations stay accountable for their finances is limiting non-allocation.

Nonprofit organizations don’t require distributing net profits to their leaders, unlike for-profit organizations. If Dog Animal Shelter finds an additional $10,000 in their budget, they will use funds to reinvest the mission.

Explanation of Nonprofit Accounting

Rules and Regulations

Nonprofit organizations need to follow several rules and regulations. Some are for all accounting professionals, and some are for nonprofit organizations only.

Generally Accepted Accounting Principles (GAAP)

GAAP are rules detailing the accounting legal obligations. US law requires businesses (and nonprofits) to follow their rules. They fall into ten concepts:

  • Regularity principles: accountants follow established rules and regulations.
  • Consistency Principles: Uniform standards are applied throughout the financial reporting process.
  • Sincerity Principle: Accountants are committed to accuracy and impartiality.
  • Methods Consistency Principle: Consistent processes are used to prepare all financial statements.
  • The no-remuneration principle: the organization’s positive and negative activities must be fully reflected in the accounts.
  • Prudence Principle: There are no assumptions in presenting financial data.
  • Continuity principle: The valuation of assets assumes that the organization’s activities will continue.
  • The periodicity principle: Reporting income is broken down into reporting periods (quarters or years).
  • The materiality principle: Financial statements fully disclose the organization’s financial position.
  • Utmost good faith principle: All parties are expected to act with integrity.

This standardized system allows understanding information from financial documents almost anywhere. This is especially important for lenders, donors, and grantors. It inspires confidence that your financial statements are accurate and trustworthy.

Best Accounting Practices for Nonprofit Organizations

You want your accounting practices to be as efficient and effective as possible, whether your supervisors are taking charge, outsourcing the responsibility, or hiring someone to do the bookkeeping internally. Check the best-recommended practices to implement in any organization:

  • Since non-revenue accounting is different from commercial accounting, you must ensure your software will handle the individual tasks to your accounting system. Don’t squeeze your processes into an imperfect commercial accounting system. Investing in a nonprofit software solution ensures you have the tools you need to achieve your accounting goals.
  • Review your organization’s budget frequently. Setting and revising your nonprofit budget shouldn’t be a one-time task on your to-do list. Instead, you should review this document regularly, making adjustments when your actual income and expenses deviate from your original plan.
  • Conventional thinking advises limiting overhead costs as much as possible to increase your fundraising efforts. However, sometimes an increase in overhead costs is necessary to spur the growth of your nonprofit organization. Take a close look at your overheads to ensure you’re walking the fine line between investing in your development and overspending on things you don’t need.
  • Support your multi-year strategic plan. Use your nonprofit accounting system to support your multi-year programs. Large nonprofits review their budgets and produce reports every month and quarter to make sure their finances are under control. Review your goals, fundraising campaigns, and projects regularly to ensure your financial strategies align with those goals.

Implementing best practices and taking responsibility for practical accounting in a nonprofit organization results in a positive “trickle-down” effect on management, fundraising, and organizational strategies.

When you have accurate data on fundraising campaigns’ costs and projected revenue, you can end your campaign in the black and expand your program. Once you understand how well you’ve done within your original budget, you’ll be able to make adjustments that will drive your schedule throughout the year, increasing your impact.