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Frequently Asked Questions

Question

What are the differences between nonprofit and for-profit accounting?

Answer

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Accounting for Contributions
Capitalizing and Depreciating Assets
Use of Cash- and Modified Cash-Basis Accounting
Functional Expense Allocation
Implications of the Differences between Nonprofit and For-Profit Accounting

Anyone familiar with generally accepted accounting principles and practices will find most accounting for nonprofit activity to be very familiar. There are, however, some significant differences which include:

Accounting for Contributions
Capitalizing and Depreciating Assets
Use of Cash- and Modified Cash-Basis Accounting
Functional Expense Classification

Accounting for Contributions

Nonprofits which qualify for tax exempt status under section 501(c)(3) of the Internal Revenue Code are entitled to receive contributions that are tax deductible to the donor. Since this is unique to the nonprofit sector, there are no equivalent procedures for handling contributions in for-profit accounting. Special procedures have been established for handling the following types of contributions:

Pledges (Promises to Give) In 1993, the Financial Accounting Standards Board (FASB) issued the Statement of Financial Accounting Standards No. 116, Accounting for Contributions Received and Contributions Made. This Statement sets down firm guidelines for pledge accounting, requiring that legally enforceable, unconditional pledges be recorded in the accounting records. An unconditional pledge is one which is not contingent on some uncertain future event, such as a matching grant from another donor.
Donated Materials and Services ( In-Kind Contributions) FASB Statement No. 116 guidelines also requires that nonprofits account for contributions of most goods (with the exception of works of art and other items held in museum collections). In addition, volunteer time must be included in the financial statements when either:
Special Events and Membership Dues People who pay to attend fundraisers (such as dinners, auctions, fashion shows, bake sales, etc.) often receive a tangible benefit in return (a meal, a performance, etc.) Similarly, membership dues may entitle individuals to use facilities, receive services, etc. The portion of the special event charge or membership dues which represents the fair market value of the benefit received is not tax deductible to the donor. Some minimal benefits are excluded from this rule.

In addition, the accounting profession has established guidelines for responsibly tracking monies which have been restricted by the donor for a specific use (e.g. buying a new building, starting a new program, adding to the endowment, etc.). How these monies are tracked and reported depends on the nature of the donor s restriction, what conditions, if any, the donor has imposed on the organization before it can actually receive or use the money, when the restrictions are met, etc.

Capitalizing and Depreciating Assets

As in for-profit accounting, nonprofits are required to record the purchase of long-lasting, substantial property and equipment (such as computers, vans, buildings, etc.) as assets in the financial records, and to charge a portion of the cost of those items in each year in which they have a useful life. This process is called capitalizing and depreciating fixed assets. While all businesses, including nonprofits, are required to record depreciation of assets, some assets in the nonprofit sector receive special treatment. These include museum collections, historical buildings, library books, zoo animals, etc.

Donated items that are added to collections that are held for public exhibition, protected and kept unencumbered, and subject to the policy that, if sold, the proceeds are used to acquire equivalent replacements for the collection, do not have to be recorded as re venue and are not recognized as formal assets in the financial statements.

Use of Cash- and Modified Cash-Basis Accounting

Many small nonprofits use cash-basis rather than accrual-basis accounting to record expenses and revenues. This means that they only record revenue when the cash is received, and only record expenses when they are paid. Some nonprofits use a modified-cash basis of accounting. They will record payroll taxes withheld from employees or large revenue or expense items on an accrual basis. This means recording revenues when they are earned and expenses when obligations are incurred. Most businesses track all expenses and revenue s using accrual accounting.

Functional Expense Allocation

Nonprofits are required to report their expenses by what is known as their functional expense classifications. The two primary functional expense classifications are program services and supporting activities. Supporting activities typically include management and general activities, fundraising, and membership development. Practices vary widely from organization to organization in the nonprofit sector as to how expenses are categorized by functional areas.

Implications of the Differences between Nonprofit and For-Profit Accounting

Because of these few, but significant, differences between nonprofit and for-profit accounting, you will want to select your al personnel, financial advisor, or auditor carefully. The degree to which you receive contributions requiring special handling, or purchase property and equipment covered by special regulations will determine whether you need an accountant who specializes in nonprofit accounting.

In addition, it is important to remember that financial information for nonprofits is interpreted differently from for-profit financial statements. The following is quoted from What a Difference Nonprofits Make: A Guide to Accounting Procedures, 1990, Accountants for the Public Interest:

Meaningful evaluations and comparisons of nonprofit performance almost always prove difficult and complex. While the profitability of two businesses can easily be calculated, it is much harder to compare the effectiveness of two counseling centers to see which is doing a better job of helping the mentally ill. Without the standard of profitability, it is also difficult to compare the job performance of nonprofit staff and managers.

Since the beneficiaries of nonprofits often cannot afford to pay for services, organizations frequently lose money on every sale. As a result, an increase in the number of clients or customers may paradoxically increase the likelihood of a financial crisis. On the other hand, turning a profit may mean that a nonprofit agency has turned away clients, perhaps including the most needy. To determine a nonprofit's success you must refer to its goals: these are the group's self-determined replacement for the bottom line of profit-making. The board can measure [a nonprofit's] success by comparing the results achieved with the results sought.

This points to the importance of a clear mission statement as well as regularly updated short- and long-term goals that reflect the purpose of a volunteer agency. It also underscores the need to include service statistics in conjunction with financial statements. In this way, board members can begin to grapple with the complex issues of efficiency and effectiveness as their organization pursue s its stated goals.