What is the Difference between For-Profit Accounting and Fund Accounting for Nonprofits?

 

fund accountingJust as there are many similarities between for-profit accounting and nonprofit accounting (also referred to as fund accounting for nonprofits), there are many differences in the accounting tasks required for each sector. While both sectors are required to report and track income and expenses and perform payroll duties, the nonprofit sector is faced with many different requirements in the area of accounting. These differences arise out of a nonprofit’s duty to apply their financial (and non-financial) resources to their mission and allocate their funds according to various requirements and regulations.

Nonprofit organizations are required to itemize their expenses across management (general and administrative), program, and fundraising areas. The IRS calls these expenses “functional expenses” and requires that every nonprofit organization report on them. In order to report on the functional expenses of an organization, a cost allocation plan needs to be in place.

A cost allocation plan is basically a system that defines how your organization will allocate expenses across the organization. The cost allocation plan can be extremely useful when trying to determine how much a program or activity costs and can give a clearer picture of the organization’s finances. There are several methods used when allocating costs, and nonprofit organizations need to evaluate which method works best for them. Organizations can apply direct and indirect costs or base their calculations on the percentage of payroll or physical space used. Many organizations use a combination of methods to determine their cost allocation plan.

In addition to creating a cost allocation plan, nonprofit organizations must comply with specific accounting standards set forth by the Financial Accounting Standards Board (FASB). These standards include the following:

  • Value of donated services: This establishes standards for when it is necessary to record donated services (such as volunteer time) in the organization’s financial statements. The services that must be recorded include are those that (a) create or enhance non-financial assets, or (b) require specialized skills (provided by people specialized in those skills) that would typically need to be purchased if not donated.
  • Revenue in the form of donations: This establishes how to recognize (and when to recognize) that revenue has been earned. This includes standards for the accounting treatment of unrestricted and restricted funds, donated goods, pledges, and in-kind contributions.

Another area that affects accounting for nonprofits (that has no effect on for-profit organizations) is the reporting of restricted funds. While these funds and contributions are generally recorded on the organization’s 990 tax return, donors will require more detailed reporting about the use of these funds. By reporting on their restricted funds, nonprofit organizations can inform their donors that the conditions for the use of the donated funds have been (or are being) met. This type of reporting also gives nonprofit organizations the ability to track which funds remain available for the restricted purposes.

So What’s the Same?

Now that we’ve discussed the differences between fund accounting for nonprofits and for-profit accounting, let’s focus on the similarities. Both for-profit and nonprofit organizations prepare the following financial statements regularly:

  • Statement of financial position (or, as for-profit organizations call it, the “balance sheet) – This report summarizes the organization’s assets and liabilities as of a certain date. For-profit organizations also use this report to summarize their company’s assets and liabilities. This report serves to provide nonprofit organizations and companies with a snapshot of their financial position to date.
  • Statement of activity (also known as an income and expense statement) – This report tracks an organization’s (or company’s) financial activity over a certain period of time. It presents income minus expenses, resulting in either a profit or loss for that period.
  • Statement of cash flow – This report tracks the cash flow through the organization or company during the reporting period. Generally, organizations report on income that has been received during a certain time and the expenses that were paid during that time. The statement of cash flow will help the Board anticipate any potential complications for planning purposes.

While they seem to be similar at first sight, fund accounting for nonprofits and for-profit accounting have major differences. Make sure that you understand the differences between the two and comply with nonprofit fund accounting standards to ensure your success.