If you are someone involved in the financial aspects of a nonprofit organization, then you know all about the various challenges that surface on a daily basis. From managing donations and recording pledges to organizing charity events, not-for-profit companies face a set of accounting challenges that for-profit companies simply don’t experience.
One of the main differences nonprofit organizations face is their tax-exempt status on certain contributions. The accounting software they use has to be able to accommodate this caveat as well as various other rules and regulations put in place by the Financial Accounting Standards Board (FASB) and the Governmental Accounting Standards Board (GASB).
Fund vs Commercial Accounting
There is a fundamental difference between the accounting systems of nonprofit and commercial companies. Nonprofit organizations utilize fund accounting while for-profit organizations use commercial accounting:
- Fund accounting reports measure performance against budgets and income versus expenses.
- Commercial accounting reports only measure income versus expenses.
To put it more simply, fund accounting is designed to show accountability, while commercial accounting is designed to show profitability.
By its very nature, fund accounting requires that you maintain each fund separately with its own set of accounting features. Every contribution or donation made needs its own set of reporting, self-balancing, and donor-tracking capabilities. Additionally, nonprofit accounting software usually offers a more flexible account numbering scheme. Finally, the nonprofit accounting system needs to accommodate different types of accounting methods, such as cash and accrual..
Cash vs Accrual Accounting
Commercial companies all use the accrual method, which records revenue when it is earned and deductions when expenses are incurred. For example, an expense is recorded when an item is purchased even if it won’t be paid for until a later date. The accrual method shows the ebb and flow of a business’s expenses and revenue more clearly, but it doesn’t accurately show how much cash a company has at any given time. Your books may say you’ve made twenty sales in March, but you may have no actual cash in the company because the sales won’t be paid for until June.
However, nonprofits use either modified-accrual or cash-basis accounting. The cash method of accounting records revenue when cash is received and expenses when cash is paid. Cash accounting, as you can guess, is the opposite: it tells you how much money you have at any given point in time, but fails to deliver an accurate image of the company’s long-term profitability. Nonprofit accounting software offers both cash and accrual accounting to give organizations more flexibility and control in their accounting system.
Accounting and Tracking for Donors/Contributions
Nonprofits qualify for tax-exempt status and are entitled to receive donations that are tax-deductible for the donor. There are no equivalent practices in for-profit accounting, so special procedures specific to nonprofit accounting are required to handle and track these contributions.
These tax-exempt contributions include:
Pledges: There are strict guidelines for pledge accounting that require legally enforceable, unconditional pledges to be recorded in all accounting records.
Donated Materials and Services: Aside from works of art that would go in a museum, nonprofits must account for all contributions of goods as well as volunteer time.
Membership Dues and Special Events: Payments to attend events such as fundraisers, auctions, fashion shows, etc have to be recorded. Similarly, membership dues need to be recorded as well. Note: Not all of these payments are tax-deductible; it changes based on various criteria. You can visit the FASB or GASB websites for a detailed breakdown on what qualifies for tax exemption.
Flexibility for Nonprofits
What it boils down to is that nonprofit accounting software needs to be flexible in its capabilities. It needs to do everything a commercial system does and more. It has to offer features that help nonprofits while following the rules set up by the GASB and FASB. It is imperative for nonprofit organizations to look into a nonprofit accounting system designed from the ground up with nonprofit infrastructure and challenges in mind. In the long run, this will save you money, time, and trouble as your organization grows and scales. Our deep dive series for nonprofit organizations provides a more detailed look into the financial operations of nonprofit organizations and is a great resource if you’d like to know more about the inner-workings of nonprofit organizations.
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