Chapter 7 – Accounting for Nonprofit Organization (NPO)

Introduction to Nonprofit Accounting

From churches to youth organizations to the local chambers of commerce, nonprofit organizations make
our communities more livable places. Unlike for-profit businesses that exist to generate profits for their
owners, nonprofit organizations exist to pursue missions that address the needs of society. Nonprofit
organizations serve in a variety of sectors, such as religious, education, health, social services, commerce,
amateur sports clubs, and the arts.

Nonprofits do not have commercial owners and must rely on funds from contributions, membership
dues, program revenues, fundraising events, public and private grants, and investment income.

Accountants often refer to businesses as for-profit entities and to nonprofit organizations as not-for-
profit entities. We will be using the more common term nonprofit instead of not-for-profit.

Differences between Nonprofits and For-Profits

The following table highlights some of the key differences between nonprofit organizations and for-
profit corporations:

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Mission and Ownership
While businesses are organized to generate profits, nonprofits are organized to address needs in
society. As a result, nonprofits will issue a statement of activities instead of the income statement
issued by for-profit businesses.
Since nonprofits do not have owners, there is no owner's equity or stockholders' equity and there
cannot be distributions to owners.

Some people mistakenly assume that if an organization is designated as a nonprofit, it cannot legally
earn profits. In fact, earning profits (having revenues that exceed expenses) is almost a necessity for a
nonprofit if it hopes to withstand such things as:

 unexpected expenses
 uneven flows of revenues
 a decrease in revenues
 rising costs due to inflation
 an increase in staffing needs
 an increase in the need for its services
 a purchase or replacement of needed equipment
 other needs since a nonprofit cannot issue shares of stock

Financial Statements of Nonprofits

The following table compares the main financial statements of a nonprofit organization with those of
a for-profit corporation.

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Statement of Financial Position

A nonprofit's statement of financial position (similar to a business's balance sheet) reports the
organization's assets and liabilities in some order of when the assets will turn to cash and when the
liabilities need to be paid. The amounts are as of the date shown in the heading which is usually the
end of a month, quarter, or year.

Net Assets
Since a nonprofit organization does not have owners, the third section of the statement of financial
position is known as net assets (instead of owner's equity or stockholders' equity).
A nonprofit's statement of financial position is represented by the following accounting equation:

Because of double-entry bookkeeping, the accounting equation and the statement of financial position
should remain in balance at all times. For example, if a donor contributes $500, the effect on the
nonprofit's accounting equation and its statement of financial position is:

If the nonprofit pays $100 for supplies that will be used immediately, the effect on its accounting
equation and its statement of financial position is:

The items that cause the changes in Net Assets are reported on the nonprofit's statement of activities
(to be discussed later).

The net assets section of a nonprofit's statement of financial position reports totals for each of the
following classifications:
1. Unrestricted net assets
2. Temporarily restricted net assets
3. Permanently restricted net assets

These classifications are based on the restrictions made by the donors at the time of their
contributions.

1. Unrestricted net assets

If a donor does not specify a restriction on his or her contribution, the amount received by the
nonprofit is recorded as an asset and as unrestricted contribution revenues. Unrestricted contribution
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revenues (reported on the statement of activities) also cause the amount of unrestricted net assets to
increase. For instance, if a nonprofit receives an unrestricted contribution of $800 of cash, the effect on
the statement of financial position is:

If the nonprofit's board of directors designates some of the nonprofit's unrestricted assets for a specific
purpose, those assets must continue to be reported as unrestricted net assets.

2. Temporarily restricted net assets

If a nonprofit receives a contribution that has a donor-imposed restriction (other than to be held in
perpetuity), the amount is usually recorded as an asset and as temporarily restricted contribution
revenues. Temporarily restricted contribution revenues (reported on the statement of activities) also
cause the amount of temporarily restricted net assets to increase.

For example, James donates $20,000 with the requirement that the nonprofit use it to purchase a
vehicle that is urgently needed in one of the nonprofit's programs. The effect on the nonprofit's
accounting equation at the time the contribution is received is:

When the nonprofit purchases the vehicle at a cost of say $21,000, the purchase and the release of the
restriction will cause the following changes:

3. Permanently restricted net assets

If a donor stipulates that her contribution must be held by the nonprofit in perpetuity (forever, not be
used up), the amount is recorded as an asset and as permanently restricted contribution revenues.
Permanently restricted contribution revenues (reported on the statement of activities) also cause the
amount of permanently restricted net assets to increase.

To illustrate, let's assume that Mary contributes $100,000 to a nonprofit and stipulates that only the
interest on the $100,000 can be spent. This contribution will have the following affect on the
nonprofit's statement of financial position:

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If Mary also stipulates that the interest earned must be used for scholarships and $3,000 is earned on
the $100,000, the $3,000 must be reported as temporarily restricted net assets until the restriction is
released by the payment for scholarships.

Total net assets

The grand total of the three classifications of net assets is reported as Net Assets or as Total Net Assets.

Statement of Activities

Since a nonprofit's primary purpose is to provide programs that meet certain societal needs, it issues
a statement of activities (instead of the income statement that is issued by a for-profit business).
The statement of activities reports revenue and expense amounts according to the three classifications
of net assets discussed above. Here is an outline of the statement of activities without its heading and
without amounts:

* Revenues often include the reclassification of net assets at the time they are released from
restriction.

Before we illustrate a sample statement of activities, let's take a closer look at its components.

Revenues and Expenses

During any given accounting period, Revenues and Expenses are the two primary sections where
summarized transaction amounts will be reported.

Revenues
The caption Revenues is often expanded to be more descriptive. Here are some of the possibilities:

 Support and Revenues

 Revenues, Support and Reclassifications
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  Revenues, Gains and Other Support
 some variation of the above or a more descriptive caption
Revenues that may be listed on the statement of activities include:

 Contributions
 Membership dues
 Program fees
 Fundraising events
 Grants
 Investment income
 Gain on sale of investments
 Reclassifications when net assets are released from restrictions (a negative amount in the
temporarily restricted column and a positive amount in the unrestricted column)
Under the accrual method of accounting, revenues are reported in the accounting period in which they
are earned. In other words, revenues might be earned in an accounting period that is different from
the period in which the cash is received.

Expenses
The caption Expenses could be termed Functional Expenses since expenses are reported according to
these functions:
1. Program expenses
2. Supporting services expenses

1. Program expenses
Program expenses (or program services expenses) are the amounts directly incurred by the nonprofit in
carrying out its programs. For instance, if a nonprofit has three main programs, then each of the three
programs will be listed along with each program's expenses.

2. Supporting services expenses

Supporting services expenses are reported in two subgroups:

 Management and general

 Fundraising
In order to accurately report the amount in each of these subgroups, it may be necessary to allocate
some management and general salaries to fundraising based on the time spent by employees
performing fundraising activities. For example, a management employee might be spending 30% of her
time in fundraising activities but her entire salary has been recorded as management and general
expenses.

Under the accrual method of accounting, expenses are to be reported in the accounting period in
which they best match the related revenues. If that is not clear, then the expenses should be reported

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in the period in which they are used up. If there is uncertainty as to when an expense is matched or is
used up, the amount spent should be reported as an expense in the current period.

General Ledger Accounts and Chart of Accounts

A nonprofit's transactions are recorded in accounts in the general ledger. A listing of the titles of the
general ledger accounts is known as the chart of accounts.
The accounts in the general ledger and in the chart of accounts are organized as follows:

 statement of financial position accounts

o asset accounts
o liability accounts
o net asset accounts
 statement of activities accounts
o revenues and gains
o expenses and losses
The number of accounts in a nonprofit's general ledger could range from 30 to 1,000 or more. The
number of accounts depends on the number of programs that the nonprofit has, the types of revenues
it earns, and the level of detail required for planning and control of the organization.

For example, a nonprofit is likely to have a separate general ledger account for each of its bank
accounts. It may also have 50 general ledger accounts for each of its major programs, plus many
accounts under its fundraising and management and general expense categories.

The detail in the general ledger accounts will always be available for management's use. However, all of
the account balances will be summarized into a few totals that are presented in the financial
statements and IRS Form 990.

Nonprofit recordkeeping can get a bit challenging, so it is worth noting that accounting software exists
to help nonprofits record transactions efficiently. The accounting software will also allow for reports of
revenues and expenses by function (programs, fundraising, management and general), by the nature or
type of expense (salaries, electricity, rent, depreciation, etc.), and/or by grant.

Illustration of the Statement of Financial Position and the Statement of Activities

We are now ready to present examples of the statement of financial position and the statement of
activities. To do that, we'll follow the activities of a nonprofit organization called Home4U, a daytime
shelter for adults.

Let's assume that Home4U was incorporated in January 2015 and its accounting years will end on each
December 31. The following transactions occurred during a three-month period.

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January Transaction
Transaction 1. On January 31, a donor contributes $10,000, without restriction, for the operation of
Home4U. This transaction affects the general ledger accounts as follows:

Assuming this is the only transaction in January, the general ledger account balances will result in the
following financial statements:

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February Transactions
Transaction 2. On February 1, Home4U rents office space. A check is written for $2,000. This covers a
one-time security deposit of $1,000 plus the February office rent of $1,000.

Transaction 3. On February 2, a $400 check is written to the utility as a one-time security deposit for
electricity and heat service.

Transaction 4. On February 19, Home4U receives a contribution of $8,000 that the donor specifies must
be used for the purchase of furniture. The contribution is deposited into a money market account. This
transaction affects the general ledger accounts as follows:

Transaction 5. The electricity and heating invoice has not arrived. It is estimated that the amount for
February's usage was $350, so the following accrual adjusting entry is recorded on February 28:

Assuming that Transactions 2 through 5 are the only transactions occurring in February, the general
ledger account balances will result in the following financial statements:

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March Transactions
During March, Home4U paid the March rent of $1,000. Home4U also paid the February utilities which
were equal to the estimated amount of $350. Home4U estimates that March's utilities will be $300.

On March 31, Home4U paid $8,300 to purchase furniture (using the restricted donation of $8,000). The
statement of financial position dated March 31 will report the following amounts:

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Statement of Functional Expenses

The statement of functional expenses is described as a matrix since it reports expenses by their function
(programs, management and general, fundraising) and by the nature or type of expense (salaries, rent).
For instructional purposes we highlighted the column headings to indicate the expenses by function. We
also highlighted the words in the first column as they indicate the nature or type of expenses.

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Statement of Cash Flows

The statement of cash flows for a nonprofit organization is similar to that of a for-profit business. It
reports the organization's change in its cash and cash equivalents during the accounting period.

The statement of cash flows consists of three sections:

1. net cash from operating activities

2. net cash from investing activities
3. net cash from financing activities

The operating section reports the changes in cash other than those reported in the investing and
financing sections.

The investing section of the statement of cash flows reports the amounts spent to purchase long-term
assets such as equipment, vehicles and long-term investments. The investing section also reports the
amount received from the sale of long-term assets.

The financing section of the statement of cash flows reports the amounts received from borrowings
and also any repayments.
While the statement of cash flows, or cash flow statement, may be a bit difficult to prepare, it is an
important financial statement to be read.

You can learn more about this financial statement by reading our Explanation of the Cash Flow
Statement.

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Notes to the Financial Statements

The notes to the financial statements are an integral part of the statement of financial position, the
statement of activities, and the statement of cash flows. The notes to the financial statements often
provide several pages of information regarding the nature of the nonprofit's activities as well as a
summary of its significant accounting policies.

Budgeting for Nonprofits

Budgeting for nonprofits can become complex when it involves several overlapping categories, such as
grants, programs, function, and nature.

Budgeting is also complicated when sources of support are not secured at the time the budget is
prepared for the upcoming year. This could lead to the use of an account entitled Resource
Development in order to balance the budget.
Since resource development is often ongoing, budgets may require frequent modification. Good
accounting software will also allow directors to compare budgeted amounts to actual amounts and
make the necessary adjustments.

Homework:

The following transactions occurred on January 2018 at the PKRF (Papasa Ka Rin Foundation)

January 4 – recognized the contribution of donor amounting to P100,000, without restriction, for
the operation of Papasa Ka Rin Foundation.

Jan 5 - paid rental of office space (for January) - P10,000. (use prepaid account)

Jan. 15 - received a contribution of P20,000. The donor specifies that it must be used for the
purchase of Office Equipment.

Jan 20 – purchased in cash P18,000 Office Equipment (using the restricted donation of P20,000)

Jan 25 – recognized the contribution of BSAct 4 – P150,000 & with condition that only the
interest in the P150,000 can be used/spent.

Jan 30 – paid utility bills – P15,000.

Requirements:

· Journal Entries
· Statement of Financial Position (w/heading)
· Statement of Activities (w/heading)
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