Contrary to popular belief, the nonprofit designation does not mean that an organization should not earn a profit, but rather that the mission of the organization is to address needs in society instead of creating income for shareholders. Accounting for nonprofit is similar to for-profits in that the financial statements should be prepared in accordance with Generally Accepted Accounting Principles (GAAP), but there are several differences that will be outlined below.
Accrual basis records transactions for revenue when earned and expenses when incurred. For example, a three-year pledge would be recorded with the entire three years as revenue in the first year, with a debit to cash for the first year's pledge received, with the remaining two years to pledge receivable, along with an allowance for bad debts at present value. The receivable would have a discount and allowance that would be remeasured in the following years. Subsequent receipt of pledges would reduce the pledge receivable account.
The accrual basis matches revenues with the related expenses, so that the complete impact of a transaction can be seen within a single reporting period. This will result in recording expenses at the end of the reporting period, even though the cash has not been spent yet, with a credit to accounts payable and a debit to the expense account. When the cash is expended, the cash will be credited and accounts payable will be debited.
Auditors will only certify financial statements if they have been prepared using the accrual basis of accounting.
Required Financial Statements
Statement of Financial Position
Reports the organization’s assets and liabilities in order of when the assets will turn to cash and when the liabilities need to be paid.
A nonprofit’s statement of financial position is represented by the following accounting equation: Assets = Liabilities + Net Assets.
Basis of Assets
Purchased fixed assets are recorded at cost as required by GAAP.
Investments in marketable securities (debt and equity) are carried at fair value with increases or decreases recognized in the period in which they occur. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
Donated assets, including securities, are recorded at their fair value (defined above) on the date the asset is received. An exception is made for works of art or historical treasures. If the work of art is not to be resold and only exhibited, the asset need not be recorded as a revenue or recorded as a fixed asset, as long as it is disclosed in the financial statements.
Depreciation of fixed assets is required to be recorded in accordance with GAAP.
Investments of funds without donor restrictions are made to earn additional income until such time as the funds are to be used for general purposes.
Investments must be carried on the books at fair market, with the increases or decreases recognized in the period in which they occur.
The net assets section of a nonprofit’s statement of financial position requires at a minimum the following: Net assets without donor restrictions and net assets with donor restrictions.
Classifications of net assets are based on 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 their contribution, the amount received by the nonprofit is recorded as an asset and as contribution revenues. These revenues (reported on the statement of activities) cause the amount of net assets without donor restrictions to increase.
Net assets with donor restrictions – If a nonprofit receives a contribution that has a donor-imposed restriction, the amount is recorded as an asset and as donor restricted contribution revenues. Donor-restricted contribution revenues (reported on the statement of activities) cause the amount of net assets with donor restrictions to increase.
Board/finance committee/etc. designations of gifts should be used judiciously and are not accounted for as a donor restriction and should be reported as net assets without donor restrictions and identified as board designated within this net asset class. Board designations are not donor restrictions.
Statement of Activities
Since a nonprofit’s primary purposes is the provide programs that meet certain societal needs, it issues a statement of activities instead of the income statement issued by a for-profit business.
The statement of activities reports revenue and expense amounts in columnar format according to the two classifications of net assets discussed above.
Program fees (for example VBS)
Gain on sale of investments
Reclassifications when net assets are released from restrictions (aka you spend a restricted gift on the item for which the donor restricted the funds…for example if a donor restricted a gift for choir robes…when you purchase the choir robes the asset, in this instance the cash, is released from the restriction. This results in a positive amount in without donor restrictions and a negative amount in with donor restrictions)
Statement of Functional Expenses are now required by FASB 2016-14.They have to be shown as part of the financial statements or in the notes. Overall, the non-profit should be tracking the buckets into which expenses fall.
Expenses are reported according to the following functions:
Program functions – the amounts directly incurred in carrying out the programs, for example church, preschool, after school program. Each program is listed with their expenses.
Supporting functions – these include the management and general expenses of the nonprofit (accounting, HR, etc.) and any fundraising and development expenses (such as the cost of having a capital campaign)
Statement of Cash Flows
Reports the organization’s change in its cash and cash equivalents during the accounting period.
Consists of three sections
Net cash from operating activities – change in cash other than those reported in investment and financing sections.
Net cash from investing activities – amounts spent to purchase long-term assets such vehicles, equipment, and long-term investments as well as any amount received from the sale of long-term investments.
Net cash from financing activities – reports the amount received from borrowing money as well as any repayments.
Should Our Church Have an Audit
The United Methodist Book of Discipline assigns the responsibility for the annual audit of financial records to the committee on finance.
Specific guidance for the Audit of the Local Church may be found here.