Introduction to non-for-profit accounting

February 9, 2014

Most articles on this site deal with companies that operate for profit. In this article, we discuss a few differences encountered when accounting for companies that have non-for-profit purposes.

1. General aim of non-for-profit accounting

Unlike businesses that operate for profitable gain, not-for-profit (NFP) entities have no shareholders. They do not have to satisfy investors with regular reports of activities that could eventually lead to future gain. On the other hand, NFP organizations are regularly entrusted with millions of dollars in donations by individuals or entities that want to make sure their gifts are being used wisely. Accounting for these NFP entities is therefore somewhat different than accounting for a profit-oriented company.

2. Net asset categorization

Corporations generally have two categories of assets -- short term and long term. Both categories are utilized to create shareholder value. By contrast, most of a NFPís assets come from donations, although some money can be gained internally by investing donated assets. Donors can sometimes tell the organization how it must use the contributed property, which means that the NFP must account for three different categories of net assets.

The first category is unrestricted net assets. This class of assets can be used in any way and carries no donor-imposed restriction. Expenses are generally deducted from this category of assets. The second category is temporarily restricted net assets. An asset belongs in this category when the donor has specified when it can be used or how it can be used. An asset is not restricted if the organization itself earmarks unrestricted funds for a specific project. The final category is permanently restricted net assets. These are usually investment assets given to the organization under the stipulation that only the funds gained by the asset can be used. The original property itself can never be used. An example would be a donation of real estate property that cannot be sold for cash. Endowments are a common source of permanently restricted assets.

When the temporary restrictions on an asset have been satisfied, the property is transferred to unrestricted assets. Letís take a look at an example of how a non-for-profit organization accounts for contributions and asset shuffling. XYZ, a fictitious NFP entity involved in cancer research, receives $200,000 in unrestricted cash from donors as well as $50,000 from one donor who stipulates that the money must be used for research lab supplies. Below is the initial journal entry for the contributions. Notice the use of categorization in the entry.

Account Names

Debits

Credits

Cash

250,000

 

†††† Contributions Ė Unrestricted

 

200,000

†††† Contributions Ė Temporarily Restricted

 

50,000

The Contribution accounts are similar to revenue accounts for profit-oriented businesses. Now letís see what happens when XYZ pays for research supplies to satisfy the donation restriction.

Account Names

Debits

Credits

Supplies

50,000

 

†††† Cash

 

50,000

     

Reclassification from Temporarily Restricted
Assets Ė Satisfaction of Restrictions

50,000

 

     Reclassification to Unrestricted Assets Ė
     Satisfaction of Restrictions

 

50,000

3. Non-for-profit financial statements

NFPís, like for-profit corporations, produce financial statements for donors and other stakeholders. The statements are similar, but not exactly the same.

The statement of financial position is similar to a balance sheet - it shows the NFPís assets, liabilities, and net assets (separated into the three categories discussed previously) as of a specific date. The statement of activities is similar to an income statement. A major difference is that each category of assets is tracked separately. A statement of activities, therefore, has three columns, not just one. The statement has a section for gains, a section for reclassifications, and a section for expenses.

An important distinction to make in the statement of activities is between program expenses and administrative expenses. Donors want to know that money is being used more for the organizationís charitable purpose and less for advertising and salaries. This distinction is what is referenced by the common advertising phrase, ďX cents of every dollar given is used for charitable purposes.Ē

The statement of cash flows is the same as the cash flow statement of a corporation. It includes sections for operating, investing, and financing activities.

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