Nonprofit organizations are central to the fabric of cultural, educational, religious, humanitarian and other mission-driven initiatives in society. Unlike a for-profit entity, which generates product or service revenue streams to create income for its owner, nonprofits primarily rely on donations and grants to fund their cause. They have no owners and aren’t allowed to make profits, so they reinvest leftover funds, if any. Because nonprofits have specific transparency requirements, nonprofit accountants must use a special approach to recording and reporting revenue and expenses, known as “fund accounting.”
Understanding these special accounting rules can help nonprofit organizations stay focused on their goals and adjust their fundraising, programming and long-term investments in ways that make the most of their donor funding — and keep their mission alive.
What Is Nonprofit Accounting?
Nonprofit accounting is a unique form of accounting used by charitable and mission-driven nonprofit organizations. Recording transactions from funding sources, such as donations, memberships and grants, requires reporting with transparency that lets donors and board members see how the money is being used toward the programs and purposes the givers intended. Donations may be restricted or unrestricted, based on the donor’s interest or relationship to the organization.
For example, a local company might give money to help buy a new refrigerator for a food bank as part of a special fundraising campaign; those are restricted funds, because the intent is specified. But a former volunteer might send a check to the same food bank at the end of the year to be used where needed; that is an example of unrestricted funds. Nonprofit fund accounting requires that the food bank create a separate account for funds from the refrigerator donation to track all the expenses related to acquiring and installing the refrigerator. In this way, nonprofit accounting rules help organizations correctly allocate their donations so that they can achieve their missions and grow, while providing confidence to donors that their gifts are being used as intended and the impact of their contributions is being maximized.
In the U.S., nonprofit accounting guidance is established by the Financial Accounting Standards Board (FASB) and follows Generally Accepted Accounting Principles (GAAP) — including a subset specific to fund accounting — to prepare financial statements required for reporting to board members and donors.
Nonprofit Accounting vs. Bookkeeping
In a nonprofit organization, accounting and bookkeeping functions are similar to those in for-profit companies but require additional recordkeeping and reporting based on unique nonprofit rules. For example, day-to-day expenses, payroll and deposits are tracked by the bookkeeping function, as they are in for-profit organizations; but, in nonprofits, these costs must be allocated to specific areas, or “funds.” Due to the complexity that can arise from fund accounting, nonprofit professional associations, such as the U.S.’s National Council of Nonprofits, encourage organizations to use reliable accounting software to provide better controls and accuracy.
Nonprofit accounting professionals use the transactional data recorded by bookkeepers to generate internal reports and assemble external documents, including tax forms and financial statements, for the government and for donors. They do so following GAAP’s specific accounting rules for nonprofits. These reporting documents allow the board of directors to evaluate the organization’s progress and make decisions regarding fundraising, funds allocation and expense reduction.
Key Takeaways
- Nonprofit accounting is a specific form of accounting unique to mission-driven organizations.
- Nonprofit accounting uses GAAP rules for fund accounting, which is not used by for-profit businesses.
- Accounting statements and reports required for nonprofit compliance provide information that internal managers and external stakeholders can use to analyze the organization’s operational efficiency and its adherence to its mission/goals.
- Nonprofit accounting ensures financial transparency and accountability, which helps build confidence among donors regarding the execution of an organization’s mission.