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Nonprofit Accounting: Understanding The Basics

In the United States, charitable nonprofit organisations play a crucial role in the advancement and support of disadvantaged communities and minority groups. From coast to coast, and around the world, nonprofits stretch their influence across various sectors, ranging from environmental, educational, sport, science, religious, and business activities, among others.

Posted: 29th July 2022 by
Jacob Wolinsky
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Today, perhaps more so than previously recognised, nonprofits have garnered immense support from the civil community, as the internet and social media enable them to share their causes more frequently and to a wider audience. 

According to The NonProfit Times, a leading publication and media outlet for nonprofitable organisations, 2021 contributions totalled more than $484.85 billion, with 67% coming from individuals alone, a significant increase from the 33% it represented at the start of the century in 2000. 

As society and younger generations look to become more vocal around the causes and communities nonprofits serve, the more than 1.5 million American nonprofits - that employ around 10% of the American workforce, and contribute roughly 5.4% to the nation's GDP - will only increase their impact and empower them to advance their mission. 

Although nonprofits do make a difference in our civil society, whether it’s through the programmes they orchestrate or the support they offer, regulatory factors regarding taxation and accounting still require nonprofits to adhere to strict protocols outlined by the federal government and the Internal Revenue Services (IRS).

Luckily for the 27 types of nonprofit organisations, there are specific rules that guide them on their tax-deductible contributions and nonprofit accounting. 

To make sense of this whirlwind of information, this simple guide looks to help add more clarity for accountants, and non-accountants that have found themselves working for a nonprofit. Here’s a simple look at the basics for beginners. 

Nonprofit Tax-Exemption Status

Seeing as nonprofits conduct efforts on a charitable basis, with most of the donations and proceeds going towards fulfilling the organisations' mission, a majority of these groups and organisations will generally be exempt from paying federal taxes. 

Organisations are only exempt if they meet requirements outlined by Publication 557 on Tax-Exempt Status released by the Department of the Treasury and IRS. 

With no direct ownership, shareholders or investors, nonprofits are required to fulfil certain requirements to keep their nonprofit status - and this is where nonprofit accounting becomes a crucial part of their operations. 

A Short Summary Of Nonprofit Accounting 

Oftentimes referred to as fund accounting, nonprofit accounting records all financial and monetary accounts held by the organisation. 

Seeing as all nonprofits are different, the fund accounting system works to keep track of income and expenses to help ensure organisations can achieve their goals and adhere to regulatory conditions. 

Nonprofit accounting can include some of the following: 

  • Setting up a budget 
  • Analysing financial records and statements
  • Recording transactions such as in-kind donations 
  • Managing various bank accounts 
  • Performing bank reconciliations 
  • Fund accounting and bookkeeping 

Simply put, nonprofits will need to appoint a treasurer or accountant that will help to balance the books and keep track of funding accounts. 

Setting up a budget 

Just like with for-profit businesses and companies, a budget helps to determine how profits will be used to achieve certain goals, and how the money will be allocated accordingly. 

For nonprofits, a budget may look somewhat different, as they generate income from donations and other forms of charitable causes. This means a budget will usually have an expected income and expenses. 

The expected income and expenses will outline where money will be coming from, whether it’s through corporate contributions, in-kind donations, voluntary work, or other programmes. At the same time, expenses will help keep track of where nonprofits are spending money including payroll, programmes, and events. 

Analysing financial records and statements

The second part of fund accounting is making sure to analyse financial records and statements the nonprofit incurs during the financial period. As with regular businesses, financial records and statements help to keep track of all income generated by the organisation, where it was spent, and how it got there. 

For the sake of accounting and taxation purposes, nonprofits must make use of digital tools that will help them manage and control their financial statements more seamlessly. Ultimately, these statements act as a way to keep a record of all accounts, and expenses a nonprofit generates over time. 

Recording transactions

As mentioned, financial statements can play a big part in the overall funding account management procedure and seeing as many nonprofits will oftentimes receive in-kind donations and voluntary aid, these will need to be recorded as well. 

In-kind donations are those that are acted upon by a person or company as a gesture of goodwill. For example, if a photographer says that he will assist with new portraits and photographs for the organisation's website, the nonprofit will need to record the in-kind donation in their statements. 

The nonprofit will have a separate account in its accounting ledgers for all in-kind donations and will record a receipt based on the fair market value of the donation. Thus saying, if the photographer charges $550.00 for 100 photos, the nonprofit will record the $550.00 as an in-kind donation. 

Managing various bank accounts

Smaller nonprofits may have one or two bank accounts at the beginning, but over time, as the organisation grows, different bank accounts will be required for different activities. 

Some nonprofits may have a regular check account but will have a separate savings account for emergencies. Some financial institutions offer tailored checking accounts for nonprofits that act as regular business accounts but have been customised for nonprofits. 

It’s not a smart idea to have a singular bank account from which all transactions are conducted, as this makes accounting practices increasingly difficult and complex. 

Performing bank reconciliations

Both individuals and businesses tend to perform bank reconciliations when it comes to filing annual taxes. A bank reconciliation is simply checking to see whether transactions completed on a specific bank account line up with those recorded on the financial statements. 

The bank reconciliation helps to keep track of purchases and expenses that may be exempt from tax, or which are filed and accounted for differently. 

Fund accounting and bookkeeping

Then finally, fund accounting and bookkeeping are where most nonprofits will start to organise their financial and monetary statements or transactions in one place. 

Instead of having different ledgers that help to keep track of the various transactions completed by the nonprofit, some organisations tend to make use of automated software and computerised programmes to help keep all their financial proceedings in one secure place. 

Additionally, it’s advised that nonprofit organisations make use of some form of bookkeeping and accounting services that are tailored to their needs and their tax-exempt status. Not only does it help them ensure more financial credibility, but it enables them to align their financial proceedings with their missions and regulatory factors. 

To Finish Off 

We know that nonprofit organisations play a massive role in our general community and civil society, acting as a voice for disadvantaged communities across the world. While it’s true that these organisations can make a difference, regardless of their mission, they must align their accounting and financial position with the regulatory factors outlined by federal authorities. 

Nonprofit accounting may seem like a tumultuous challenge at first, but once a person gets used to the ins and outs, it becomes almost instinct for people to keep better track of their financial situation. 

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