What Is Nonprofit Accounting? Principles & Statements

Nonprofit accounting provides a specialized framework for managing the financial resources of organizations dedicated to public benefit rather than profit generation. This approach ensures financial accountability and transparency to donors, grantors, and the public. It demonstrates how resources are utilized to advance an organization’s mission and adhere to donor intentions.

Defining Nonprofit Accounting

Nonprofit accounting focuses on the stewardship of resources and the fulfillment of a stated mission, setting it apart from for-profit accounting which prioritizes profit maximization and shareholder returns. While both employ fundamental accounting practices like double-entry bookkeeping, their underlying objectives shape how financial transactions are recorded and presented. A core difference lies in the absence of an ownership interest; nonprofits do not have shareholders or distribute profits. Instead, their financial reporting emphasizes how funds are obtained and expended in pursuit of societal goals.

Core Accounting Principles

Nonprofit accounting adheres to Generally Accepted Accounting Principles (GAAP), adapted to reflect their unique operational structure and mission. The Financial Accounting Standards Board (FASB) provides specific guidance for not-for-profit entities, primarily through Accounting Standards Codification (ASC) Topic 958. This framework ensures consistency and transparency in financial reporting for organizations such as charities, foundations, and educational institutions. GAAP compliance is often required by funders, regulators, and for audit purposes.

A central concept in nonprofit accounting is fund accounting, which tracks financial resources according to donor-imposed restrictions. This method segregates resources into different “funds” based on their intended use, ensuring that funds are spent as designated. Under FASB Accounting Standards Update (ASU) 2016-14, net assets are classified into two main categories: net assets without donor restrictions and net assets with donor restrictions. Net assets without donor restrictions are available for general use, allowing management discretion in their application towards the organization’s mission.

Net assets with donor restrictions are subject to specific donor stipulations regarding purpose or time. For instance, a donor might specify funds for a particular program or dictate that they be spent only after a certain date. These restrictions are released when the organization meets the specified purpose or the time restriction expires, at which point the funds are reclassified as net assets without donor restrictions. Permanently restricted net assets, such as endowment funds, maintain their principal in perpetuity, with only the income available for spending according to donor wishes.

Revenue recognition for contributions, which include donations and grants, operates differently than in for-profit entities. Contributions are non-reciprocal transactions, meaning the donor does not receive equivalent value in return. Unconditional contributions are recognized as revenue when received or when an unconditional promise to give is made. This means pledges receivable are recorded when the promise is firm, even if cash has not yet been received.

Conditional contributions are recognized only when the conditions specified by the donor have been substantially met. A condition involves a barrier that must be overcome and a right of return or release of obligation for the donor if the condition is not met. Until these conditions are satisfied, the funds may be recorded as a refundable advance or liability rather than revenue. This ensures that financial statements accurately reflect the organization’s entitlement to the funds.

Nonprofit organizations are also required to classify expenses by their functional and natural classifications. Functional classification categorizes expenses based on the activity they support, including program services, management and general (administrative), and fundraising. Program service expenses are directly related to the organization’s mission, such as costs for delivering educational programs or providing aid. Management and general expenses cover overall administration, while fundraising expenses relate to soliciting contributions.

Natural classification groups expenses by their economic nature, such as salaries, rent, utilities, and supplies. Presenting expenses by both functional and natural classifications allows stakeholders to understand how resources are allocated across different mission-related activities versus administrative and fundraising efforts.

Key Financial Statements

Nonprofit organizations prepare a specific set of financial statements designed to provide stakeholders with a comprehensive view of their financial health and activities. These statements are comparable to those used by for-profit businesses but feature terminology and classifications tailored to the nonprofit context.

The Statement of Financial Position, similar to a for-profit balance sheet, presents the organization’s assets, liabilities, and net assets at a specific point in time. It reflects what the organization owns and what it owes. For nonprofits, the equity section is replaced by “net assets,” categorized into “net assets without donor restrictions” and “net assets with donor restrictions,” clearly showing the availability and limitations on funds.

The Statement of Activities serves as the nonprofit equivalent of an income statement, detailing changes in net assets over a period, such as a fiscal year. This statement reports revenues, including contributions, program service fees, and investment income, and expenses incurred during the period. It illustrates how the organization’s net assets increased or decreased and how these changes are allocated between the “without donor restrictions” and “with donor restrictions” categories.

The Statement of Cash Flows reports the cash inflows and outflows over a period, categorized into operating, investing, and financing activities. Operating activities include cash from program services and donations, and cash used for expenses. Investing activities involve cash related to the purchase or sale of assets. Financing activities include cash from borrowing or repayments of debt. This statement provides insight into an organization’s liquidity and its ability to generate and use cash to support its operations.

A fourth statement, the Statement of Functional Expenses, offers a detailed breakdown of expenses by both their functional and natural classifications. This statement is useful for analyzing how much an organization spends on its direct programs versus administrative overhead and fundraising costs. It presents expenses such as salaries, occupancy, and supplies, showing how each natural expense category is allocated across program services, management and general, and fundraising functions.

External Reporting and Compliance

Nonprofit organizations face specific external reporting obligations to maintain their tax-exempt status and uphold public trust. These requirements primarily involve annual filings with the Internal Revenue Service (IRS) and compliance with various state-level regulations.

The primary annual information return for most tax-exempt organizations is IRS Form 990, “Return of Organization Exempt From Income Tax.” This form provides the IRS and the public with a comprehensive overview of the organization’s activities, governance, and financial information. Form 990 is a public document, making an organization’s financial data and operational details accessible to donors, watchdog groups, and the general public.

There are different versions of Form 990, with the specific form an organization must file depending on its gross receipts and total assets. Organizations with gross receipts normally $50,000 or less may file the simpler Form 990-N (e-Postcard). Those with gross receipts less than $200,000 and total assets less than $500,000 can typically file Form 990-EZ. Larger organizations must file the full Form 990. Private foundations are required to file Form 990-PF.

The filing deadline for Form 990 is generally the 15th day of the fifth month following the end of the organization’s tax year. For example, an organization with a calendar year end (December 31) must file by May 15 of the following year. Organizations can request an automatic six-month extension by filing Form 8868 before the original due date.

Failure to file a required Form 990 on time can result in penalties imposed by the IRS. A significant consequence of non-compliance is the automatic loss of tax-exempt status if an organization fails to file its required annual return for three consecutive years.

Beyond federal requirements, nonprofits also navigate a complex landscape of state-specific regulations. Most states require charitable organizations to register before soliciting contributions from their residents. These charitable solicitation registration requirements often involve annual renewals and the submission of financial reports, which may include the IRS Form 990.