What are the major differences between nonprofit and for-profit accounting?
While many aspects of nonprofit and for-profit business accounting are similar (such as the tracking and reporting of income and expenses, and payroll taxes), there are significant differences. These arise out of the nonprofit organization’s duty to drive its resources toward its mission. For example, nonprofits are required to itemize expenses across management (general and administrative), fundraising, and program areas. These are called “functional expenses” and the IRS requires that they be reported.
The requirement for nonprofits to report functional expenses also highlights the importance of a cost allocation plan. This basically means establishing a system that defines how you will allocate expenses across the various functional areas and to specific programs. For example, let’s say that those involved in administrative functions take up 20 percent of your office space. You might then allocate 20 percent of an expense like paper to the administrative functional area.
A cost allocation plan can be extremely useful in determining how much a program or activity actually costs and, done accurately, it gives a clearer picture of the organization’s finances. There are several acceptable methods – such as applying direct/indirect costs, and allocations based on percentage of payroll or physical space used (as in the example above). Frequently, a combination of these methods will be appropriate. Consult with your accountant to determine the approach that best suits your organization.
Other key aspects of interest to nonprofits are outlined by the Financial Accounting Standards Board (FASB), a nonprofit organization authorized by the Securities and Exchange Commission to set accounting standards in the United States. Of particular importance is the FASB’s Statement of Financial Accounting Standards No.116, which defines:
- Revenue in the form of contributions: These standards establish how and when to recognize that revenue has been earned. They include standards for the accounting treatment of unrestricted and restricted funds, donated goods, in-kind contributions, pledges and the like.
- Value of donated services: This establishes standards for when it is necessary to record donated services (i.e., volunteer time) in the organization’s financial statements. According to the FASB, services to be recognized include those that “(a) create or enhance nonfinancial assets or (b) require specialized skills, are provided by individuals possessing those skills, and would typically need to be purchased if not provided by donation.”
Another area that’s important to nonprofits, while rarely affecting for-profits, is the reporting of restricted contributions. While the amounts of restricted contributions are reported on a nonprofit’s 990 tax return, donors will typically require much greater detail about the use of restricted funds. This serves to inform the donor that the conditions of the gift have been (or are being) met, and enables staff to track what funds remain available for the restricted purpose.