What is nonprofit accounting?

Accounting can be an intimidating area of work, even for experienced organizational leaders. Factor in the additional complexity of nonprofit accounting, and it’s no wonder why nonprofit leaders often struggle to maintain accurate, up-to-date books.

Well, MonkeyPod is here to help! We’re on a mission to make good organizations great — and that includes great books.

After reading this article you may not be an accounting master (yet!), but you will be able to answer these questions:

• How does nonprofit accounting differ from for-profit accounting?
• What accounting statements and reports are required for nonprofits?
• What nonprofit accounting best practices should I follow?

Important note: You may have heard the terms “cash accounting” and “accrual accounting.” Cash accounting recognizes revenue and expenses when money changes hands. It is typically only used by very small nonprofits with very simple accounting needs. Accrual accounting recognizes revenue when it is earned and when expenses are billed/incurred (but not paid). MonkeyPod supports accrual accounting because it is GAAP-compliant and satisfies regulatory requirements.

How do Nonprofit Accounting and For-Profit Accounting Differ?

A fundamental difference between nonprofit and for-profit accounting is what they focus on. For-profit accounting is all about showing how much profit was created for the business. Nonprofit accounting instead focuses on accountability or how the organization spends its money. 

This is particularly important when an organization has more revenue than expenses. A for-profit business can take that excess revenue as profit and pay it out to executives and board members. Nonprofits, however, have to reinvest any excess earnings back into the organization. Any money a nonprofit earns must be used for its mission, and nonprofit accounting is how organizations are held accountable to that rule. 

As we look at how nonprofits record transactions and submit financial statements, you’ll see that accountability is always a critical part of the process. 

Tracking Revenue

Nonprofits can generate revenue in the same ways for-profit businesses do (e.g. sell goods and services or have investment income). However, nonprofits also have unique sources of revenue that for-profit businesses don’t have access to, like donations and grants. 

When a donor or grantmaker makes a gift to a nonprofit, they have the right to restrict how that money is used. Nonprofits are responsible for ensuring those donations and grants are tracked accurately and spent appropriately.

That is where the ‘fund’ in ‘nonprofit fund accounting’ comes from. Nonprofits track their revenue in different funds. Donations and grants that have restrictions placed on them are only spent for the agreed-upon purposes.

The two most common funds for tracking nonprofit revenue are:

• Restricted Funds: can only be used for the purpose specified by the donor
• Unrestricted Funds: can be used for any purpose within the nonprofit’s mission

Each of those funds can have subcategories. For example, some nonprofits may have an Endowment Fund or Scholarship Fund that is a subcategory of Restricted Funds.

Tracking Expenses

When it comes to tracking expenses, nonprofits once again have more complex accounting rules than their for-profit counterparts.

Both for-profits and nonprofits have to track what they spend money on. For example, payroll, rent, and printing.

But nonprofits also have to track why they spend money. The question of why a nonprofit spends money is a matter of accountability. Nonprofits accept donations and grants from the public. To ensure that a nonprofit is spending that money on its mission instead of things like executive bonuses, nonprofits need to track their expenses along this additional dimension.

Nonprofits must report why they spend money along three functional categories:

• Fundraising
• Management and General
• Programs and Services

Those functional categories map directly to one of the unique financial statements — Statement of Functional Expenses — that nonprofits must produce as part of their year-end tax filing. We’ll touch on that a little more later.

Nonprofit Accounting Statements

Speaking of year-end tax filings, nonprofits have different accounting statements than for-profits. While some of these are very similar, there are a few key differences you should be aware of.

Statement of Financial Position

The Statement of Financial Position is the nonprofit equivalent of a for-profit organization’s Balance Sheet. The Statement of Financial Position measures the overall health of the organization.

In for-profits, a typical balance sheet is summarized by the equation:

Assets = Liabilities + Equity (or Retained Earnings)

Keep in mind that nonprofits don’t have owners. So you can’t have Equity or Retained Earnings on your balance sheet. Instead, the nonprofit Statement of Financial Position is summarized by this equation:

Assets = Liabilities + Net Assets

When Net Assets are positive, that usually indicates the organization is in better financial health. When Net Assets are negative that is a sign of trouble.

Statement of Activities

The Statement of Activities is the nonprofit equivalent to a for-profit organization’s Income Statement or Profit and Loss (P&L) Statement. The Statement of Activities measures all of the organization’s revenue and expenses in a given period.

The Statement of Activities can be summarized by the following equation:

Total Revenue - Total Expenses = Changes in Net Assets

Remember, nonprofits must track their revenue by fund (e.g. restricted vs. unrestricted). Showing that breakdown on your Statement of Activities is an important component of transparency and accountability.

Statement of Functional Expenses

Remember when we mentioned that nonprofits must report on why they spent money? That information is used for the Statement of Functional Expenses. This statement is unique to nonprofits, there is no for-profit equivalent. Every nonprofit must produce this document for year-end tax purposes. 

The Statement of Functional Expenses tracks expenses by the functional categories we mentioned earlier – fundraising, management and general, and programs and services. 

You can track your expenses by as many subcategories as you’d like. But all of those subcategories must roll up to their parent category when producing your year-end Statement of Functional Expenses.

Form 990

At the end of the fiscal year, for-profit organizations and nonprofits must report to the IRS. Because nonprofits are exempt from income tax, they must submit a unique tax form: IRS Form 990, "Return of Organization Exempt From Income Tax."

Tax-exempt organizations, nonexempt charitable trusts, and section 527 political organizations all have to file Form 990. A nonprofit’s 990 can be viewed publicly and includes important financial information about the organization.

All three financial statements we discussed earlier — the Statement of Financial Position, Statement of Activities, and Statement of Functional Expenses — are used to fill in Form 990 and are attached to it when submitted to the IRS.

Nonprofit Accounting Best Practices

Now that you know the basics of nonprofit accounting, we’ll highlight a few best practices that will help you keep your books and organization in compliance.

Use accounting software designed for nonprofits

Nonprofit accounting is more complex than for-profit accounting. Many organizations end up using software like Quickbooks to manage their accounting, but because this tool is designed with for-profit organizations in mind, it can take a lot of work for nonprofits to use. Using software that is designed specifically for nonprofits, like MonkeyPod, will help you keep your books accurate and up-to-date.

With MonkeyPod you won’t need to create dozens of workarounds to make your accounting system work for you. Your Chart of Accounts and financial statements are intuitive and easy to read, and they’re formatted correctly for nonprofits from day one. You can track your spending by functional area, track grant, and program budgets, and automate a ton of data entry.

Create internal controls

Internal controls are the checks and balances that your organization creates for itself. By creating a set of internal controls, your organization will be able to identify errors as well as limit potential cases of fraud.

MonkeyPod helps nonprofits develop internal controls by providing unlimited users with fine-grained permissions. That way usernames and passwords are not shared and employees can have the appropriate level of access they need to do their jobs. Effectively managing users and granting the appropriate permissions helps create internal controls for your organization.

Conduct audits

One of the best things you can do for your organization is to conduct financial audits. Audits help identify errors and ensure that your records are accurate. Your accounting software should help support your preparation for an audit. Also, keep in mind that some nonprofits are required to conduct financial audits. So it is always good practice to be prepared.

In MonkeyPod, every transaction has a built-in digital paper trail so you can see who recorded a transaction and if anyone has modified it. You can upload and attach documents to every transaction. That way you don’t have to store physical copies of receipts and invoices in a folder or filing cabinet where they are likely to get misplaced.

Organize and Automate Your Nonprofit Accounting

Running a nonprofit is challenging and demanding enough on its own. Keeping track of your books shouldn’t be the most difficult part of your day. You deserve to use a software system that makes nonprofit accounting intuitive and easy. That’s what MonkeyPod is designed to do.

It’s all part of our mission to get nonprofits away from busy work and back to their mission.

Check out our demo to see how MonkeyPod can help make your bookkeeping a breeze.