Nonprofit organizations are similar to for-profit entities in many ways. Both generally have employees, insurance issues, marketing programs and the need for inflows of resources that exceed outflows in order to stay in operation.
There are, however, a number of differences that not only impact how the organizations operate, but also impact their accounting.
Nonprofits often receive the bulk of their revenue from contributions as opposed to sales, services provided or rental revenue. The source of revenue affects how revenue is recognized and presented. Also, most nonprofits do not need to account for income taxes, while for-profit organizations do.
Tax Exemption
Nonprofits that qualify as charitable organizations under section 501(c)3 of the Internal Revenue Code (one of many tax exempt sections) are generally not taxed on net income except for unrelated business income. This includes income not related to the tax exempt purpose of the organization’s exemption. For example, if an organization’s tax exempt purpose is to provide funds for cancer research, and it owned a building from which they received rental income, the rental income could be considered unrelated business income.
It should be noted that while these nonprofits may be exempt from income tax, they are still liable for payroll taxes and possibly sales and property taxes.
These organizations are also able to receive donations that are tax deductible to the donor.
Revenue Sources
Tax deductions for donors are unique to nonprofit accounting and require their own set of rules regarding how they are treated.
- Pledges: A pledge, an unconditional promise to give money to a nonprofit organization, is generally recorded in its entirety the year it is pledged. For example, if a donor decides to contribute $1,000 a year for the next five years, that would be considered a pledge assuming it is unconditional -- and the full $5,000 of the pledge would be recorded as revenue during the year it was pledged.
- Donated goods and services: Nonprofits often receive donated goods and services. These goods and services come in many forms, such as the use of office space or equipment, professional services such as legal or accounting help, or help from volunteers. These contributions need to be recorded as revenue (and the appropriate expense or asset) if one of the following conditions are met:
- They create or enhance a non-financial asset such as a building or piece of equipment
- They require specialized skills and are provided by an individual possessing those skills (e.g., accountant performing bookkeeping)
- They would typically need to be purchased if they were not donated
- Nonprofits must also account for and track any restrictions that have been imposed by donors. These can include a temporary or permanent restriction and a time and/or purpose restriction. A temporary time restriction occurs in the pledge noted above. During the first year, the $1,000 received in the first year would be “released from restriction” while the remaining $4,000 would remain temporarily restricted to be released each year as the pledge monies are received. Donations that are restricted by the donor for a certain use such as new equipment, are considered purpose restricted. Those monies must remain temporarily restricted until they are used for a suitable purpose, in this case new equipment, before they can be released from restriction.
Financial Statement Presentation
Along with the classifications of restricted and unrestricted net assets, nonprofits’ financial statements are also presented differently.
Rather than the traditional balance sheet, nonprofits have a “statement of financial position.” Similar to the for-profit balance sheet, it lists assets and liabilities, but the equity section is replaced by net assets. The net assets are typically shown as unrestricted, temporarily restricted, and permanently restricted.
Nonprofits also have a statement of activities as opposed to an income statement. This statement of activities lists the revenues and expenses as well as the net assets. The most significant change is evident when there are restricted net assets and a release is recorded. The revenue section of the statement lists all revenue classified by its restriction and also shows all amounts that were released by restriction during the period. One other difference is for-profit entities show the difference in revenue less expenses as net income. In the nonprofit world the difference is shown as changes in net assets because the goal of the nonprofit is not to generate net income but to reflect how it uses its net assets to accomplish its mission.
Functional Expense Allocation
Another difference is expenses are most commonly classified as two types of functional expenses: program services and support services. The functional expense allocation determines the amounts included in the statements of activities. Expense allocation varies by organization. Supporting services generally include fundraising activities and management and general activities such as accounting services.
Need Help?
Contact us online or call 800.899.4623.
