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Nonprofit Accounting Practices

Nonprofit organizations exist to pursue missions that address the needs of society. Nonprofits serve in a variety of sectors, such as religious, education, health, social services, commerce, amateur sports clubs, and the arts.  Unlike for-profit companies, which exist to make money for their owners, nonprofits do not have commercial owners. As a result, they must rely on funds from contributions, membership dues, program revenues, fundraising events, public and private grants, and investment income.  This means nonprofit accounting practices are different than for-profit accounting practices.

MLA provides accounting services, financial advisory and strategic advisory for several nonprofits. We have team members with decades of experience serving nonprofits.

The Mission of a Nonprofit

Every organization has a mission. For for-profits, it is to create profit for the owners or shareholders. In the nonprofit sector there are just about as many missions as there are organizations. Nonprofits are formed to educate our children, provide shelter for the homeless, protect our environment, feed our cultural needs, cure illnesses, research solutions to societal or political dilemmas, teach us survival and professional skills, and so on. 

The founder and founding board need to clarify the purpose of the organization and draft an appropriate mission statement that clearly and succinctly explains why the organization exists. Your mission statement is the key to explaining why the organization needs our support.

Tax-Exempt Status

Nonprofit organizations may apply to the Internal Revenue Service in order to be exempt from federal income taxes.  This also allows them to issue tax-deductible receipts for charitable donations that can be claimed as charitable deductions on the donors’ income tax returns. 

Nonprofits such as churches, schools, and Red Cross chapters qualify as tax-exempt and their donors’ contributions will also qualify as tax-deductible.

However, there are nonprofits that qualify as tax-exempt but their donors’ contributions do not qualify as charitable deductions (although they may qualify as business expenses). Examples of these nonprofits include social organizations, chambers of commerce, college fraternities and sororities, amateur sports clubs, employee organizations, and more.

You can learn more about the tax-exempt status for a nonprofit, the deductibility of contributions by donors, and the taxability of activities not directly related to a nonprofit’s exempt purpose in the Internal Revenue Service Publication 557, Tax-Exempt Status for Your Organization, which is available at no cost on IRS.gov. 

Even if a nonprofit is exempt from federal income taxes, it is likely that its employees will be subject to employment taxes. Nonprofits may or may not be exempt from sales taxes, real estate taxes, and other taxes depending on which state in the U.S. they are incorporated or operate.

Nonprofit Accounting Practices

Nonprofits are organized to address needs in society. As a result, instead of the income statement issued by for-profit businesses, nonprofits must issue a statement of activities.  Since nonprofits do not have owners, there is no owner’s equity or stockholders’ equity and there cannot be distributions to owners.

Some people mistakenly assume that if an organization is designated as a nonprofit, it cannot legally earn profits. In fact, earning profits (having revenues that exceed expenses) is almost a necessity for a nonprofit if it hopes to withstand unexpected expenses, rising costs and fluctuations in revenue.

A nonprofit’s statement of financial position (similar to a business’s balance sheet) reports the organization’s assets and liabilities in some order of when the assets will turn to cash and when the liabilities need to be paid. The amounts are as of the date shown in the heading which is usually the end of a month, quarter, or year.

Statement of Activities

Since a nonprofit’s primary purpose is to provide programs that meet certain societal needs, it issues a statement of activities instead of the income statement that is issued by a for-profit business.  This is a key document created by nonprofit accounting practices.

In 2016 the FASB issued Accounting Standards Update (ASU) No. 2016-14 for Not-for-Profit Entities (Topic 958 in its codification). This update improved some financial statement presentations such as replacing the three classes of net assets into two: net assets without donor restrictions and net assets with donor restrictions. It also requires disclosures as to the organization’s liquidity, endowments, board-imposed restrictions, and more. These updates were required beginning in 2018.