Nonprofit organizations, also known as non-business entities, are organizations that exist for the purpose of furthering a social cause or to welfare the public. Unlike traditional businesses, nonprofit organizations do not carry out their activities for the purpose of generating wealth.
As the name suggests, these organizations are the opposite of for-profit businesses, the sole purpose of which is to generate wealth.
Nonprofit organizations differ from other businesses in many aspects. Due to the many difference in the nature of nonprofit organizations and other businesses, the accounting for nonprofit organizations also differs from accounting for other businesses.
Nonprofit organizations have different accounting guidelines that must strictly be adhered to.
Nonprofit Organizations Accounting vs Other Businesses Accounting
There are many differences between the accounting for nonprofits and other businesses. Firstly, nonprofit organizations have different financial statements as compared to other businesses.
Nonprofit organizations have the Statement of Financial Position (Balance Sheet), Statement of Activities, Statement of Cash Flows (Cash Flow Statement) and Statement of Functional Expenses.
Other businesses generally have the Statement of Financial Position, Statement of Profit or Loss (Income Statement), Statement of Cash Flows, and Statement of Owner’s Equity.
Since the nonprofit organizations do not have any owners, the financial statements are produced to report to the donors of the organizations. This is different to other businesses where financial statements are mainly produced to report to the owners of the business.
This also means that the Balance Sheet of a nonprofit organization does not report total assets less total liabilities as owners’ equity but is termed as net assets.
Expenses in nonprofit organizations are reported in the Statement of Functional Expenses and Statement of Activities of the organization. These expenses must be categorized according to their function or purpose into either program expenses or operating expenses for reporting in the two financial statements.
This type of accounting for expenses is called functional accounting. This is different from other businesses’ accounting for expenses where no such rules or regulations for categorizing expenses according to their function exist.
Any funds received from donors in nonprofit organizations are categorized as unrestricted, temporarily restricted or restricted funds. When funds are restricted, it means that the donors that provided the funds have set certain conditions for the usage of the funds.
This is different to other businesses where the owners’ providing equity to the business do not set any conditions to the usage of their finance. However, funds may also be unrestricted in nonprofit organizations but these funds are generally used for smaller activities.
Nonprofit organizations generally raise finance through either income or loans. Income is generated from different sources such as donations, program fees, fundraising events, investment income, or grants. Other businesses generate finance through income, equity, or loans.
In other businesses, income can be generated through the sales of goods or services, investment gains, etc.
Other businesses also have the extra option to generate finance through equity by issuing shares and different other types of equity instruments. Obtaining loans for both types of businesses is the same.
Income Recognition for Nonprofits Accounting
Income in nonprofit organizations is recognized using a 5-step process. This process must be followed by any nonprofit organization that enters into a contract to transfer goods or services. This process is as follows:
1) Identifying the contract with customer
The first step in income recognition for nonprofits is to identify the contract that exists with the customer. These contracts can either be written or implied for them to be valid. The contract must meet the following criteria to be accounted for:
- Both parties of the contract have approved of the contract.
- The rights of both sides can be identified.
- It is probable that the nonprofit organization will receive the consideration for exchange of goods or services.
- The payment terms of the contract can be identified.
- The contract must have a commercial substance.
2) Identifying the separate performance obligations within a contract
Performance obligations are the promise of transfer of distinct goods or services to a customer. Some contracts may contain more than one performance obligations.
By identifying the performance obligations of a contract, the nonprofit organization can also determine whether there are conditions associated with the use of the funds provided.
These performance obligations dictate whether the funds provided are unrestricted, restricted or temporarily restricted.
3) Determining the transaction price
The transaction price of a contract is the compensation that the organization can expect to receive in exchange for the goods or services it provides.
When determining the transaction price of a contract, the entity must also consider any variable considerations in the contract. Furthermore, any non-cash considerations or in-kind considerations must also be considered.
4) Allocating the transaction price
Once both the performance obligations and transaction price are determined, the organization must allocate the transaction price to separate performance obligations.
This is done so that if a contract has different performance obligations, the income for each obligation can be recognized separately.
5) Recognizing revenue or income
Once all the above steps are completed, income can finally be recognized for the nonprofit organization. This income is only recognized if the performance obligations for the income is satisfied through the transfer of promised goods or services.
Performance obligations can be satisfied over a period of time or at a specific point in time. The organization must differentiate between the two.
If performance obligations are satisfied over a period of time, then the income associated with the performance obligation is also recognized over a period of time. This income is recognized in accordance with the completion rate of the performance obligations.
In-kind donations are unique to nonprofit organizations. In-kind donations are when instead of providing donations to the nonprofit organization in monetary form, the entities provide goods or services to the organization.
The transaction price for in-kind donations cannot be determined since no money is involved. Therefore, the standard dictates that when in-kind donations are received, they should be recognized at their fair value in the market.
Nonprofit organizations are institutions the purpose of which is to further a cause. Accounting for nonprofit organizations is different from accounting for other businesses. Income in nonprofits accounting is recognized using a 5-step process.
For in-kind donations, these are recorded at the fair market value of the goods or services received.