Financial statements are crucial in reporting an entity’s finances. Usually, these include the two reports known as the balance sheet and income statement. Some entities may also prepare other reports. These may consist of the cash flow statement and statement of changes in equity. Each financial statement serves a purpose in informing the entity’s stakeholders. Usually, these statements are common for companies and businesses.
For nonprofit organizations, however, the primary financial statements may differ. Usually, these entities include donations, charities, and similar organizations. These entities do not have similar operations to other businesses. The name also implies that they don’t exist to generate profits. Therefore, the primary financial statements may not suffice or not help stakeholders. The reporting standards for donations and charities may also differ.
Financial statements can also present critical information about nonprofits. These entities may not have the typical owners that other business structures include. However, these entities must report to other parties about their operations. They may consist of donors, grantors, the board of directors, the government, etc. However, the traditional financial statements may not apply to nonprofits. Before discussing that, though, it is crucial to understand these entities.
What are Nonprofit Organizations?
A nonprofit organization (NPO) is an entity that receives tax-exempt status from a jurisdiction. Usually, NPOs do not exist to profit from their operations. These entities may still conduct business, generate revenues and earn money. However, they do not focus on increasing their earnings. Instead, NPOs exist to serve a purpose, which can come from their mission. There are several forms of nonprofits.
NPOs work and operate for a collective, public or social benefit. These entities work in contrast to other businesses that earn money for their owners. Usually, NPOs act to provide welfare to a targeted user group. Most jurisdictions also offer these entities tax-exempt status. This status allows NPOs to operate without any tax implications. However, it does not exempt them from reporting their operations.
Nonprofits usually receive funds or donations from several donors. These donors may be specific or include the general public. While these donations serve as the primary fund source for the entities, they may also earn revenues. As mentioned above, these revenues do not help the nonprofits achieve profitability goals like other entities. Instead, nonprofits use these revenues for their operations.
Some nonprofits may also have a non-distribution constraint. This feature entails the entity committing any additional revenues to its purpose. Consequently, the donors or grantors do not receive the residual amount after paying expenses. The entity keeps it until it can use it toward its objective. Nonprofits are accountable to several parties. These may include their donors, founders, volunteers and the general public.
Nonprofits must abide by various ethical and moral standards. These usually include accountability, honesty, openness and trustworthiness. Usually, these standards apply to any party that contributes to the entity. Due to these requirements, nonprofits must provide to those parties regularly. Usually, it occurs through the preparation and presentation of financial statements. As mentioned above, however, these statements may differ.
How Do Donations Report Income Statement and Balance Sheet?
Donations and charities do not prepare the same financial statements as other entities. Usually, these entities receive funds from outside parties. Once they get them, they contribute them to other causes or entities. For most tax-exempt entities, the financial reporting standards may also differ. However, these entities still use similar financial statements as the mainstream ones.
Donations report the income statement and the balance sheet under different names and formats. For most of these entities, the titles may also differ for those statements. Usually, these entities refer to the balance sheet as the statement of financial position (SOFP). On the other hand, they do not prepare the income statement. However, they may use an alternate financial statement, known as the statement of activities (SOA).
An explanation of each of the financial statements and how donations report them is below.
Statement of Financial Position or Balance Sheet
The statement of financial position follows a similar format as the balance sheet for other entities. This statement shows the asset, liability, and equity balances at a specific date. Usually, this statement report on two aspects, what a company owns and owes. The statement of financial position shows the NPO’s financial picture for that date.
The statement of financial position reports on three crucial areas, assets, equity, and liabilities. Assets include resources owned or controlled by an entity that brings inflows of economic benefits. In contrast, liabilities are the opposite. They represent obligations from past events which cause outflows of economic benefits. Equity refers to the shareholders’ rights in the company after repaying its liabilities from its assets.
While the first two aspects are usually similar, the third does not apply to nonprofits. For donations, equity cannot exist as these entities do not have shareholders. Therefore, these entities replace this part with “Net assets” in the statement of financial position. While it has a similar meaning as equity, the presentation and content may differ. An explanation of what each of these is for nonprofits is as below.
As mentioned, assets are resources that entities own or control. Another crucial part of this definition for these assets is the inflow of economic benefits. For donations, these assets may include furniture, office supply and cash. Some donations may also invest in fixed assets, such as vehicles, property, etc. However, most others prefer to stay liquid.
Liabilities represent obligations that entities accumulate due to their operations. These obligations cause outflows of economic benefits in the future. Usually, they include accounts payable, grants payable, loans, etc. Some donations prefer to keep the liabilities low. However, others may accumulate some debts over time. Either way, donations report these liabilities on the statement of financial position.
Net assets replace equity on the balance sheet for donations. Like equity, it represents the differences between assets and liabilities. Usually, it breaks down into donations and grants. Entities must also split those donations into restricted and unrestricted categories. These donations come from the donors who provide the finance. These restrictions require donations to use funds for specific purposes. Unrestricted funds, in contrast, don’t have the same criteria.
Statement of Activities or Income Statement
Donations report the income statement in the form of the statement of activities. This statement follows a similar structure as the income statement. However, it does not focus on highlighting profitability. Instead, it shows the difference between revenues and expenses as net assets. The statement of activities reports the donation’s financial activity and result for a specific period.
Like other entities, donations also report the revenues and expenses in the statement of activities. It starts with revenues that the donation may generate. Usually, it includes contributions, membership duties, grants, fundraising events, etc. On top of that, donations can also report net assets released from restrictions under this head.
Once donations include their revenues in the statement of activities, they must report their expenses. This statement requires them to split their expenses into various heads. Usually, it may include program expenses, management, and general expenses, and fundraising costs. From there, donations can calculate their net assets.
The net assets at the bottom of the statement of activities also include a reconciliation. This amount reconciles the opening net assets with the closing. Usually, the only movement in this amount is the difference between revenues and expenses. This amount also comes from the statement of activities. The ending net assets must agree with the balance reported in the statement of financial position.
The financial reporting format for donations may differ from other entities. Most entities focus on profitability. Therefore, their financial statements also reflect that focus. However, the same does not apply to donations. This difference does not exempt those entities from reporting altogether, though. Donations must report their finances through the statement of financial position and statement of activities.