ACCOUNTING FOR NONPROFIT 13
Nonprofitsare organizations that distribute no profits or dividends to members.These organizations play a vital role in ensuring a better life forall members of the society. These institutions are formed to pursue aparticular cause for the benefit of the community (Gross et al.,2005). The nonprofit landscape is broad and varied although most ofthese organizations are associated with charitable activities servingeither their members or the society in general. Nonprofitinstitutions generate revenue although these gains must be retainedfor self-preservation and expansion. Many are controlled by membersor a board of directors who work together with paid personnel or ateam of volunteers to achieve the goals and objectives of anorganization. This discussion will establish the importance of theseagencies in the society, their differences from for-profit entitiesand central focus on the accounting policies governing them, problemsthey face and the emerging trends regarding nonprofit accountingprinciples.
Nonprofitinstitutions such as churches, youth organizations, local chambers ofcommerce and women groups make the communities more livable. Asopposed to for-profit entities that exist to yield revenue for theirproprietors, nonprofit institutions are operated to pursue objectivesthat tackle societal needs (Gross et al., 2005). Nonprofitorganizations operate in different segments which include, but notlimited to religious activities, education projects, healthfacilities, social amenities and commerce as well as proletariansports clubs. Nonprofits have no money-making proprietors andtherefore depend on donations and contributions from members. Theyalso rely on membership dues, revenue from programs, fundraisingfunds, grants from public and private organizations, and income frominvestments. The difference between for-profit and nonprofitorganizations depends on their goals and objectives. The former iscentered on profit maximization while the latter is not. This focushas a substantial effect on the type of accounting techniques eachorganization adopts. Gross, McCarthy, & Shelmon (2005) explainthat while the basis of for-profits accounting is quarterly income,the statements for nonprofits consider their activities only.
TheRole of Nonprofits in Society
Nonprofitinstitutions play an essential function in society. They utilizeavailable resources to provide services to meet needs of the societywithout to profit considerations. They also assist in developing andmaintaining divisions of the society such as the arts and economicadvance, creating cultural awareness, spiritual nourishment andrunning veteran’s affairs as well as health and wellness. Nonprofitassociations have well-built ties with the local communities andhence they can achieve local development and outreach (Mook, 2013).
Nonprofitsorganizations are also a sound source of employment for many peoplein the country. The fact that non-profits are prohibited fromgenerating profit and carrying forward does not imply that they donot require skilled personnel to run their operations. In fact,non-profits operate their day-to-day activities just as thefor-profit enterprises (Mook, 2013). Generating income for suchworkers contributes to other sectors of the economy. Nonprofits alsoconsume producer goods which boost trade in the economy as well asstimulating the economy.
Differencesbetween Nonprofit and For-Profit Accounting
Whilefor-profit entities are obliged to pay taxes based on their netincome, some nonprofits not subjected to paying taxes if they haveapplied and registered to be exempted from taxes. The governmentsupports nonprofit`s activities by minimizing their costs in any waypossible if the objective of the organization is to increase socialwelfare. This variation between the two types of institutions has asignificant impact on the kind accounting methods employed.Additionally, IRS only assesses the taxes that are derived from thescope of an organization such as sales tax or real estate tax when atax-exempt nonprofit present their accounts for assessment. On thecontrary, the IRS examines the income generated by for-profits inaddition to other secondary taxes (Yetman & Yetman, 2009).
Yetman& Yetman (2009) substantiates that although some nonprofitorganizations may qualify for tax exemption, donor contributions maynot qualify as charitable deductions. Organizations such as chambersof commerce and college fraternities as well as sororities providesome examples. On the other hand, nonprofit organizations such aschurches, schools, and Red Cross Chapters qualify for donorcontribution charitable deduction. Additionally, employees of someorganizations may be obliged to pay employment taxes although theemployer is tax exempted. Nonprofits operating in particular statesin the US may be exempted from paying taxes depending on its location(Yetman & Yetman, 2009).
Anonprofit has no balance sheet since it has no owners and henceproduce a "statement of financial position," focusing onassets and liabilities only (Yetman & Yetman, 2009). The additionof assets to liabilities provides the net assets of an organization.Therefore, Accountants analyze net assets to evaluate the financialmagnitude of the nonprofit. On the other hand, most for-profitorganizations generate a balance sheet based on a specified periodsuch as every quarter. The balance sheet outlines the owners’equity of the entity. Owner`s equity consists of assets, which referto all the company owns as well as liabilities, which include allthat the enterprise owes to others. Where applicable, Owner`s Equityhas a definite influence on the common and preferred stock of acompany (Mook, 2013).
Anonprofit association does not prepare an income statement. Instead,it produces a report of activities every quarter. Fundamentally, thisprocess involves listing the revenues minus expenses of anorganization, plus net assets (Mook, 2013). For-profit organizationsprepare an income statement in addition to a balance sheet. Theincome statement lists the revenues, gains, and expenses as well thelosses of a company. The most important rationale of the incomestatement is to review the quarterly financial performance of anentity. This evaluation of the financial results is vital as itinfluences the value of a company and its share price as well as thefact that company shareholders have a legal right to access theincome statements.
AccountingPolicies and Procedures for Nonprofits
Accountingfor nonprofits is guided by the Financial Policies and ProceduresManual (Gross, McCarthy, & Shelmon, 2005). The elements coveredin the manual depend on the particular distinctiveness and activitiesof an organization. The accounting policies and procedures for anonprofit accounting must conform to GAAP to ensure that informationis accurate and that there is compliance with external standards. Theprinciples that guide the conduct and procedures of business includethe following.
i. Ethics Statement – this policy outlines the basic ethics andvalues that relate to financial management and conduct. It isrecommended that all nonprofits formulate and publicize institutionalstandards of ethics since they demonstrate a commitment to serve thesociety as well as the assurance to operate in a trustworthy publicmanner.
ii.General Compliance and Government Returns- this part outlines thecommitment to abide by all external regulations like thosehighlighted by IRS 990 and the accounting standards outlined by FASB.This section should also integrate and clarify procedures to complyand proper review.
iii.Conflict of Interest- this policy ensures that personal interestseither from the board or senior personnel do not impede theirintentions to act in the best of interest of the charitable purposeof the organization. This policy requires members and otherstakeholders outline conflict of interest to be revealed and theprocedures for yearly disclosure as well as addressing conflicts.
iv.The Whistleblower Policy- this outlines how employee complaintsregarding misuse of organizational funds should be addressed andprotected.
v.Compulsory Vacation of Financial Staff- this policy clarifies theamount of annual leave for financial management staff. This way,fraud is reduced by allowing staff members to access financialrecords as well as practices of their colleagues.
FinancialPolicies and Procedures
Authorizations of Signers- Nonprofits are required to authorize signatories and approve them on an annual basis and mostly during the annual meeting. This authorization is shared with all financial institutions that hold the financial resources of the organization. Changes in regulations allow financial institutions to confirm the identity authorized signers to the accounts.
Cash Receipts- Cash receipts form a very critical part of nonprofits. Organizations are required to have a concise plan outlining how cash flows through the institution and its accounting methods. The tasks and procedures are dispensed to positions as opposed to individuals. All cash receipts are required to be secured from the time of receipt to the moment they reach the bank.
Accounts Receivable- these are necessary to manage the organizational cash flows. The agency management needs to formulate policies that regulate the process of realizing the receivables and collecting the same. There is also the need to analyze and conclude if it is important to offer a billing for services received.
Travel Expenses-this section presents a high risk for organizations where if no proper policies are put in place could result in audit issues. Travel policies need to address all the expenses associated with employees, the board of members as well as volunteers.
Procurement- this refers to the process of purchasing goods or services that are required by the agency. The federal government requires all nonprofits to have a policy covering procurement to ensure grants are well used and documented.
Accounts Payable- this shows how cash is disbursed. The disbursement process needs to outline a fundamental comprehension of organizational cash flow. The process should be concisely communicated to all members to ensure timely settlement of bills.
Chart of Accounts- this is a numeric sequence that indicates the account codes that describe the accounting structure of a nonprofit. The chart shows accounts such as assets, liabilities, revenue and expenditures among others. Individual accounts should be contained in the chart to follow their expenses with a budget.
Budget- this presents the organizational roadmap to achieve its goals and objectives. The annual meeting and the timing of the annual calendar should be taken into consideration with the budget preparation process. This way, the process is completed in its entirety. The most critical element in the process of budgeting is the development of a budget narrative that aims to offer contextual information.
Financial reporting- this comprises the internal and external reporting (Gross, McCarthy, & Shelmon, 2005). Internally, decision makers should be provided with timely and accurate information. This data is essential in measuring the goals and objectives against the set standards. Organizations are required to develop internal reports to help them compare the budget to actual costs. External reporting is needed to show compliance with regulations outside the institution. These regulations could emanate from IRS, Federal Government, and other state agencies as well as donors. Annual auditing is required to be carried out by a CPA firm to ensure accuracy and totality of financial statements.
FederalGovernment Policies and Procedures
Nonprofitsare required by the Federal Government to have a document outliningthe principles, rules, and responsibilities as well as actions of themanagement and its operations. Some of the policies outlined in thissection include internal grant funds control, procedures forpurchasing and procurement, property management, Record retention anddestruction, Employees Codes of conduct, Cost Allocation Plans, Cashreceipts and disbursements and Financial Reporting (Mook, 2013).
FinancialStatements of Nonprofits
Statementof Financial Position
Mook(2013) clarifies that this statement is similar to a company’sbalance sheet, and it reports the liabilities and net assets of anorganization in some order. The amounts shown are as at the dateindicated in the heading and usually cover a month, quarter, or year.Since nonprofits have no proprietors, the third segment of thestatement is referred to as net assets as opposed to owner`s equity.
Therefore,the accounting equation for a nonprofit is represented as Assets =Liabilities + Net Assets (Mook, 2013). This equation should alwaysremain balanced owing to the book-keeping equation requirements. Thenet assets part of the equation comprises the unrestricted,temporarily and permanently restricted assets. Unrestricted assetsarise when the donor does not specify a condition on one`s donationswhile temporarily restricted assets are as a result of a donorimposing a restriction that may be held in perpetuity. Permanentlyrestricted net assets arise when a donor imposes a limitation of thedonations that must be held in perpetuity.
AsMook (2013) exemplifies, the primary purpose of a nonprofit is tofacilitate programs that meet particular needs of the society. Hence,it issues a statement of activities rather than the income statement.This statement reports revenues and expenses according to the netassets classifications discussed above. Revenues are classified intosupport, reclassifications and gains. Revenues that may be includedin the statement include contributions, dues from members, programfees, funds from fundraising events, grants, income from investmentand gains from investment sales. Revenues are accounted for in theaccounting period they are earned according to the accrual principle.On the other hand, expenses are reported from the program andsupporting services expenses.
GeneralLedger and Chart of Accounts
McMillan& McMillan (2003) explain that transactions of nonprofits arerecorded in general ledger accounts and the chart of accounts liststhese accounts. The organization of the accounts in the generalledger and the chart of accounts classified as Statement ofFinancial Position include Asset, Liability and Net Asset Accounts.Statement of activities includes the revenues and gains accounts aswell as expenses and losses accounts. The general ledger accountscould be as low as 30 or above a 1,000. The number of programs, thenature of revenues, the level of planning information required andorganizational control organization determines the number of ledgeraccounts. Nonprofit recordkeeping is becoming more challenging andtherefore, accounting software has been developed to assist inrecording transactions efficiently.
Statementof Functional Expenses
Thisstatement is presented as a matrix because it outlines expensesaccording to their function and the nature of expenses. Nonprofitsare not required by the FASB to produce this statement. However, itis encouraged. Nonprofit accounting software help in generatingexpenses reports depending on function and/or nature.
Statementof Cash Flows
Thestatement of cash flows is similar for both a nonprofit andfor-profit enterprises. This statement reports the changes cash andcash equivalents for an organization during a particular accountingperiod. The statement covers sections such as net cash fromoperating, investing and financing activities.
ChallengesFacing Nonprofit Accounting
Theever changing complexity in accounting standards, and especially thecompliance requirements, is the foremost concern faced by thenonprofit audit team. Moreover, several nonprofit personnel haveinadequate accounting and financial skills. The Board meets a fewtimes in a financial year where agendas are packed. Therefore,maintaining the required training for fiduciary accountability iscomplicated. In this regard, nonprofits are advised to consideroutsourcing advisory services on governance seminars to assist boardmembers to recognize their duty and fiscal transactions (McMillan &McMillan, 2003).
Changesin Nonprofit Accounting Policies and Principles
In2015, the FASB proposed changes in to enhance the current model offinancial reporting for nonprofit organizations (Bramwel, 2015). Someof the changes touch on net asset classification, liquidityinformation, and statement of activities and the presentation of thestatement of cash flow. According to the proposed changes,nonprofits are required to state two categories of assets includingthe restricted and unrestricted assets as opposed to three classesearlier outlined. The organizations are required to disclose bothqualitative and quantitative data on liquidation of assets as well asnear- term requirements for cash as at the date of reporting. On thestatement of activities, nonprofits are required to report changesamounting to the two classes of assets as opposed to three. Inaddition, operating expenses need to be reported by nature andfunction (Bramwel, 2015).
Inconclusion, accounting for a nonprofit is imperative as theseorganizations play a vital role in ensuring a better life in thesociety. The accounting field for a nonprofit is varied withdifferent approaches as compared to accounting for- profitorganizations. Although the field is challenging, development ofaccounting software is a significant milestone in this area.Nonprofit accounting is faced with challenges of inadequate skillsjust like accounting for-profits. The field is also undergoingchanges to cope with the dynamic economic conditions.
Bramwel,J. (2015). FASBProposes Major Changes to Not-for-Profit Reporting Rules.
Gross,M., McCarthy, J., & Shelmon, N. (2005). Financialand accounting guide for not-for-profit organizations.Hoboken, N.J.: Wiley.
McMillan,E. & McMillan, E. (2003). Creatingnonprofit financial administration policies.New York: Wiley.
Mook,L. (2013). Accountingfor social value.Toronto, ON: University of Toronto Press.
Yetman,M. & Yetman, R. (2009). Determinants of nonprofits’ taxableactivities. JournalOf Accounting And Public Policy,28(6),495-509.