Guide to Complying With Nonprofit Accounting Standards
Nonprofit accounting standards can be very confusing and dangerous if not properly understood and applied. The last thing you want is to not follow nonprofit accounting standards and have to pay large fines just because you didn't know how to do nonprofit accounting correctly.
This guide is meant to help you understand the basics of nonprofit accounting and nonprofit accounting standards so you can confidently run your nonprofit organization.
It's important that you're aware of these standards as they help maintain your organization's financial transparency and integrity.
The Basics of Nonprofit Accounting
Nonprofit accounting is the act of recording and reporting the financial activities of your nonprofit organization. Nonprofit accounting not only helps you stay compliant with regulators but it also helps you understand the financial performance of your nonprofit.
Proper nonprofit accounting is important for internal and external reporting. For example, proper books can be helpful when presenting to a board of directors or when being audited.
Let's dive into the four basic principles of nonprofit accounting that you need to understand:
Fund accounting, a key component of nonprofit accounting standards, requires you to track and report funds according to their restrictions: unrestricted, temporarily restricted, or permanently restricted.
Recognition of donations, another accounting standard, ensures accurate recording of donor contributions, whether cash or assets.
Your financial statements' presentation should adhere to the accounting standards for nonprofits, specifically the ones outlined in the FASB 117.
Lastly, tax compliance is crucial. You must follow the IRS's specified accounting standards, file the appropriate forms and pay any related taxes.
The idea behind these principals is to be able to maintain transparency with donors, grant funders, and the government. Apart from transparency, they are useful for internal budgeting and planning as you have a clear picture of your organizations financial performance.
What Are the Nonprofit Accounting Standards
In the United States, nonprofit accounting standards are set by the Financial Accounting Standards Board (FASB) and known as the generally accepted accounting principles (GAAP). These standards are mandatory regulations for reporting financial activities.
Although GAAP is also used by for-profit entities, nonprofit organizations have a specific set of standards they must follow within GAAP depending on the nonprofit sector. These standards may vary within sectors, even in the nonprofit world, which can cause some confusion.
It's crucial to stay updated as FASB frequently provides amendments and new guidance. Your compliance to these standards assures the transparency and reliability of your financial records, which is essential in maintaining trust among stakeholders.
Why do Nonprofit Accounting Standards Exist?
You might wonder why these specific accounting standards exist. They're in place to prevent misuse of the privileges nonprofits receive, such as tax exemptions, and to deter potential fraud.
Each type of entity - government, for-profit, and nonprofit - has its unique accounting standards due to differences in their funding sources and purposes. Unlike businesses that generate revenue through sales, or governments funded by tax dollars, nonprofits rely on donations.
The specific standards for nonprofits ensure transparency and accountability in managing these funds. So, while understanding these standards might seem complex, they're crucial in maintaining your nonprofit's integrity and public trust.
Complying with these standards isn't just about legal obligations, it's also about ethical stewardship.
Identify Relevant Accounting Standards
Identifying the relevant accounting standards is a vital step in your organization's financial compliance. You'll need to consider key statements such as:
The Statement of Activities
The Statement of Financial Position
The Statements of Cash Flows
The Statements of Functional Expenses
Don't forget, nonprofits also need to complete Form 990, the 'Return of Organization Exempt From Income Tax.'
Statement of Activities
This document, also known as an income statement, itemizes your organization's revenue and expenses. It's critical not only for reporting but also for observing changes from the start to the end of your fiscal year.
Be meticulous and analytical when categorizing your nonprofit's various income sources and expenses. The Statement of Activities should align with the Generally Accepted Accounting Principles (GAAP), which provide consistency and reliability in your financial reporting.
It is important to have a well-structured Chart of Accounts to ensure you maintain proper recording. A solid Chart of Accounts can help you stay organized and give you enough detail into the sources of your funding and expenses.
Statement of Financial Position
In essence, the statement of financial position provides a snapshot of your organization's assets and liabilities. This statement calculates your net assets (assets - liabilities), which is an important metric when analyzing the financial standing of your organization. This statement is also known as the balance sheet.
It's important that you accurately report your assets, liabilities, and net assets in compliance with the Generally Accepted Accounting Principles (GAAP). With accurate reporting, you can use the statement of financial position to calculate your liquidity ratio, a critical indicator of your ability to pay off short-term debt obligations.
Incorrect or misleading information could potentially lead to penalties or loss of donor trust. Always remember, the quality of your financial reporting directly impacts your organization's reputation and financial stability.
Hence, adhering to these standards isn't just a requirement - it's a necessity.
Statements of Cash Flows
The statement of cash flows provides an in-depth view of your nonprofit's liquidity and solvency, tracking the inflow and outflow of cash from operational, investment, and financing activities. It's a key tool for financial planning and budgeting as it helps you determine how much cash you have available to pay for expenses you may have.
Accounting Standards Codification (ASC) 958-230, issued by the Financial Accounting Standards Board (FASB), guides nonprofits on the presentation and content of the Statement of Cash Flows.
Statements of Functional Expenses
Next on your list should be understanding the Statements of Functional Expenses, which is governed by the Accounting Standards Codification (ASC) 958-720. This document categorizes your organization's expenditures into three main areas: program expenses, fundraising expenses, and administrative expenses. It's crucial to ensure accurate categorization, as it helps maintain an orderly and organized financial record.
A 2017 update further requires you to break down these expenses based on the nature of listed activities. For instance, a program expense could be further classified as 'education', 'fundraising', 'membership', or 'government affairs.' This extra layer of categorization aids in tracking and analyzing expenses, enhancing your financial management and compliance.
Stick to these standards to ensure your nonprofit operates smoothly and transparently.
Form 990
In the process of keeping your nonprofit's financial records clean and compliant, it's essential that you're aware of the accounting standards relevant to Form 990. The IRS mandates that this form is filled out annually for all 501c3 tax-exempt organizations. The Form 990 is basically proof of legitimacy and transparency to the IRS, showing your revenue and expenses for the year.
It's vital to record your yearly revenue, expenses, and the allocation of finances accurately. Any discrepancy or failure to file could lead to severe consequences. Engage a financial professional to establish systematic spreadsheets which can be updated effortlessly. Once set up, they're not hard to maintain.
We want to reiterate the importance of filing Form 990 each year. Don't forget to do it!
Monitor Compliance
To keep up with the ever-evolving accounting standards, you should set up a compliance monitoring system in your organization.
Start by staying up-to-date with new regulatory developments. You should stay informed through the FASB's website and the IRS' website to see if they release any updates that are relevant to your organization. Make it a habit to regularly review your financial statements for accuracy and completeness.
Implement an internal audit system to identify potential risks and areas for improvement. Set up a process to monitor compliance regularly, ensuring the efficacy of internal controls, financial policies, and procedures. It's crucial to assess risks regularly and make necessary changes to mitigate them.
If discrepancies are found, have a procedure for taking corrective action. Depending on your organization's size, assign this responsibility to an individual or an audit committee.
Its always a good idea to meet with a bookkeeper and tax accountant at the very least to have them review your financial statements to ensure you're staying compliant.
If you feel like you need more information on any of the topics covered in this article, reach out to a member of our team to get assistance. We are here to help your organization stay compliant and scale.
