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Wednesday, September 12, 2018

Why Nonprofit Accounting Matters

This guest post was submitted by our friends at Jitasa. Charity Navigator works with Jitasa, the largest national bookkeeping and accounting service provider in the nonprofit sector.

Many people believe accounting is simply making sure revenue and expenses are entered and the checkbook is balanced on a regular basis to ensure you don’t run out of cash. While this may be the case for some people’s personal finances, the world of business accounting is much more complex, with even more unique requirements placed on nonprofit organizations (NPO).

These requirements typically tie back to the regulation of two specific areas: 1) Use of funds and 2) reporting on the use of funds. When discussing the use of funds available to an NPO, donors, and organizations can place restrictions on the funds being donated. This restriction can be how the funds are used or the timeframe in which they are used. For example, if an individual gives $5,000 to an organization who serves inner-city children by supporting their education. The individual could stipulate the use of the $5,000 by restricting it to be spent on school supplies. By accepting the gift, the NPO is agreeing to uphold this restriction and must show the fulfillment of the restriction. 

To show this fulfillment, additional tracking within the accounting system is needed. Many grants require specific reporting to be submitted showing the spending is in alignment with the grant restrictions. NPO’s may have multiple grants and individual gifts with different restrictions and require specific tracking or reporting. Failure to accurately track and report on gifts could result in loss of funding or, in some cases, the repayment of donated funds which can mortally impact the organizations financial status.

This leads to the second area, reporting on the use of funds. When discussing organizational reporting, the discussion generally surrounds the organization's financial statement. Reports reviewed typically include the Statement of Financial Position also known as a Balance Sheet, Statement of Operations also known as a Profit and Loss Statement, Cash Flow Statement and the Statement of Functional Expenses. 

While the first 3 reports can be found in the for-profit world as well, the Statement of Functional Expenses is unique to nonprofits and shows a breakdown of expenses based on their functional use. The IRS defines these functional categories to be Support Services (Administrative and Fundraising activities) and Program Services. Categorization of expenses into these three areas is a reporting requirement on the IRS Form 990. Therefore, each expense recorded in the accounting system must be placed into one of these categories based on the use or purpose of the expense. 

The IRS uses this breakdown as one way of determining the appropriateness of organizational spending. NPOs that do not spend money in accordance with IRS regulations run the risk of losing their nonprofit status, which could cause the organization to shut down. 

There are numerous things that can threaten the existence of a nonprofit organization and its ability to provide programs and services. Sound accounting practices and knowledge are essential to keeping any NPO open and operating. Bad practices can result in poor reporting, misuse of funds, and the loss of IRS Nonprofit status. The emphasis here is the importance of accurate and transparent reporting to current and potential donors as well as governmental and regulatory agencies.  It is therefore imperative that the individual responsible for a nonprofit’s bookkeeping and accounting has extensive knowledge of nonprofit specific accounting best practices.

Written by Christian Spearow, General Manager, Bookkeeping & Accounting Services at Jitasa.

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