Non-profit accounting poses a number of unique challenges. After all, NPOs rely on donations and grants for the majority of their income, and must reinvest any leftover funds rather than make a profit. Moreover, nonprofits are subject to stringent transparency requirements.
This can greatly impact your accounting practices.
Understanding Donations and Grants
What constitutes a grant?
In non-profit accounting, grants are considered prime commodities that increase funds, for your nonprofit to achieve its mission and grow. Common examples include scholarships, prizes and awards, charitable loans, and investments.
Grants are typically awarded to NPOs by foundations, government agencies, and other organizations, and can be divided into three main categories:
- Unconditional grants, in which funds are provided with no specific directive for how you should use the grant.
- Conditional grants are given for a specific purpose or use.
- Reimbursable grants, which are provided for a specific project. Such grants reimburse you for project expenses on completion.
Grants can also take the form of exchanges or contributions. Exchange grants are reciprocal transactions in which both your NPO and the grantor receive something of equal or near-equal value. Alternatively, contributions can be considered one-sided, as they do not require anything in return.
What constitutes a donation?
Donations are usually voluntarily given to nonprofits, without expectations of compensation. They can be given by individuals, foundations, governments, or other corporations.
Like grants, there are different types of donations:
- In-kind donations involve offering goods or services to an NPO, rather than cash.
- Appreciated donations include bonds, shares, stocks, or mutual funds that need to be sold to be considered assets.
- Cash donations can be checks, bank cards, cash, or any other means of transferring currency. These can be categorized as either restricted (gifted for a specific use or project) or unrestricted (to be spent however your NPO sees fit).
How donations and grants affect non-profit accounting principles
Thanks to grants and donations, non-profit accounting can be tricky. That’s why NPOs have four main accounting statements:
The Statement of Financial Position
NPOs do not make profits, so do not have profit statements. Instead, the statement of financial position shows your net assets rather than equity. That is done by subtracting your liabilities from assets.
The Statement of Activities
This is similar to a for-profit income statement. However, instead of profits, it emphasizes revenue reporting and expenses.
The Statement of Cash Flows
Just like for-profit businesses, this statement reflects money coming in and out of your accounts.
The Statement of Functional Expenses
This is unique to NPOs, and is a detailed breakdown of expenses. It allows for transparent disclosure of how your nonprofit distributes expenses during a project.
NPOs can also account for grants and donations in one of three ways.
- The income approach. Here, grant funds or cash donations are recognized as revenue in your statement of activities. To be recognized as income, costs must be matched to related expenses.
- The capital approach. This applies to funds provided for the acquisition, construction, renovation, or repair of capital or fixed assets. The revenue is recognized as the assets are depreciated.
- The deferred income approach. This applies to depreciable asset grants and appreciated donations. Here, funds are recognized in your statement of activities over the useful life of the asset.
Transparency and careful documentation are essential when it comes to accounting for grants and donations. However, this can lead to complications in your bookkeeping.
Challenges in Managing Donations and Grants
As mentioned above, grants and donations can take a variety of forms, and come from several sources. This can pose some challenges in non-profit accounting.
Choosing the right accounting method
NPOs need to decide on an accounting method to suit their needs. This could be cash-basis or accrual-basis accounting. In the former, you record income or expenses when funds are received or paid out. For the latter, your income is recorded when the transactions occur, no matter when the funds are received or paid out.
Tracking and recognizing funds
Because both donations and grants may have conditions about how they should be used, it’s essential to keep track of your funds. It’s also important to ensure that you calculate the grant or donation amount correctly, by considering all related expenses.
This is particularly important for revenue recognition. Usually, it’s best to recognize revenue the moment it is pledged to your NPO, as it becomes usable revenue as soon as you receive it. However, if you’re given a reimbursed grant, or donations tied to a specific project which takes some time, such income is considered deferred revenue, because you will not be able to recognize those funds until you have met the necessary requirements.
Ensuring compliance with donor/grantor stipulations
Since grants and donations can be conditional (or restricted), your NPO must correctly allocate and use these funds. Failure to comply with donor or grantor restrictions can result in rescinded funding, penalties, or the loss of nonprofit status.
The FASB outlines how non-profit accounting should track and record transactions through the Statement of Financial Accounting Standards (SFAS) No. 116 and SFAS No. 117. However, these undergo occasional amendments, so it’s crucial to ensure you maintain compliance.
Reporting and transparency requirements
Donations and grants are given to NPOs to meet their specified mission and vision. As such, you’ll need to communicate how all received income is used. This is where the four accounting statements mentioned earlier come into play.
Transparency in how you allocate and use funds is key here. It helps in decision-making and accountability, and assures your grantors or donors that their funds are being used correctly, per their intentions.
This means you need to adhere to accounting best practices.
Best Practices for Recording Grants and Donations
Following accounting best practices helps your NPO comply with the Generally Accepted Accounting Principles (GAAPs) defined by the Financial Accounting Standards Board (FASB), as well as IRS reporting rules. Below are key aspects to consider:
Establish clear lines of communication
In addition to carefully tracking and logging grants and donations, your NPO needs good internal and external communication. This includes timely acknowledgment of funds and thanking your donors or grantors, as well as being proactive in communicating any problems that may come up.
Understand the specific requirements of the funds
Always thoroughly review grant or donation agreements for any stipulations or reporting requirements, as well as possible deadlines. With conditional or restricted funds, you need to know exactly what you may or may not use your income for. You must ensure that all parties involved are clear about any conditions, and that these are correctly documented and met.
Set up detailed reporting procedures
Detailed reporting can help you meet all the necessary grant or donation requirements and deadlines. It also makes financial management easier, and prevents errors.
Your reporting should include strategies for logging grants and donations immediately, correctly allocating funds to specific projects, and tracking expenses to ensure that funds are used appropriately and efficiently. It’s also essential to keep records of grantor or donor information, especially if the income is restricted or conditional.
Conduct regular audits and reconciliations
Your donation or grant records need to match your bank statements and other financial documents. This can be done through regular reconciliation.
It’s also advisable to conduct regular audits of all funding and activities. This allows you to ensure the continuing financial health of your organization, while maintaining transparency. After all, audits are a great way to share information about your projects with other funders, and can help you to identify potential cost savings.
Leveraging Technology for Non-Profit Accounting
The intricacies of non-profit accounting mentioned above mean that NPOs require tailored accounting software. Ideally, accounting software should allow for donor and grant management, as well as FASB compliance.
With accounting software tailored to the needs of an NPO, you can automate processes for streamlined operations. You’ll also have access to detailed reporting to ensure compliance and accuracy in your financial management.
QuickBooks for nonprofits
QuickBooks is a well-known and easy-to-use accounting program ideal for smaller NPOs. It allows you to track donations, grants and expenditures by project, while managing donors and handling traditional accounting needs. The program also offers Digicert certification, meaning that your data is safe, and helps with reporting compliance.
NetSuite for nonprofits
NetSuite is a go-to program for larger businesses. However, with its free Social Impact program, it’s also ideal for smaller NPOs.
The program features core accounting features, as well as automated GAAP-compliant financial reporting. In addition, it allows you to manage revenue streams, match revenue, and comply with funding restrictions.
Ensuring Compliance and Transparency
GAAP rules for nonprofits were created to ensure that NPOs have transparent financial reporting. The guidelines allow donors and grantors to see that their funds are going toward a financially sustainable organization, and that they’re being used for the right reasons. Following these guidelines is also essential for your NPO to keep its tax-exempt status.
However, GAAP guidelines are not the only ones to which your NPO needs to comply. The accounting standards set by the FASB affect nonprofits in several key areas, including:
- Revenue recognition
- Expense allocation
- Reporting requirements
- Net asset classification
- Disclosure requirements
- Annual IRS Form 990 filings
What about tax compliance?
The final aspect to consider when it comes to non-profit accounting is tax compliance. While many nonprofits are tax-exempt, they still need to adhere to state-specific requirements and are subject to IRS audits.
This means annual completion of IRS Form 990 for tax-exempt NPOs receiving more than $200,000 in annual revenue, or with more than $500,000 in assets.
In addition, nonprofits that don’t meet state-specific registration and filing requirements can be penalized, or lose their tax-exempt status. A CPA or tax expert can help you to ensure that you remain compliant with any necessary tax laws.
If you need help with financial management or tax compliance of your NPO, schedule a Discovery Call with one of our CPAs.
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