Section 3. Handling Accounting

Learn about the process of accounting and its uses for your organization, and obtain help in person or with some of the software available today.

 

• What is accounting?

• How is not-for-profit accounting different from accounting for for-profit organizations?

• What is an accounting system?

• When should you develop an accounting system for your organization?

• Why should you do accounting for your organization?

• How do you do accounting for not-for-profit groups?

For many community organizations, how to get cash is the burning question on everyone's mind. "How can we possibly get the money we need to do what we want to do?" Usually, the director, the staff, Board members - everyone - spends a good deal of time and energy trying to find the best answer to this question. And find it again, and again, and again.

Often - and to the detriment of many not-for-profit organizations - the equally important question "How do we handle the money we do have?" is ignored or is handled haphazardly, without proper thought and expertise. Proper accounting procedures are often left by the wayside, to be addressed at the last minute, if at all.

Despite this reality, thorough and proper accounting procedures are crucial to the financial sustainability of an organization. In the business world, statistics show that the second leading reason businesses fail is inadequate accounting procedures. For nonprofit organizations, then -- who often have much smaller incomes on which to survive -- the use of good accounting procedures is even more important.

In this section, we'll give an overview of the process of accounting and its uses for your organization. We'll also talk briefly about obtaining help with accounting, both in person and in some of the software that is available to use today.

This section is not meant to take the place of legal or professional accounting advice. In fact, we strongly recommend you obtain the assistance of a Certified Public Accountant (CPA) when trying to make heads and tails of your organization's figures. Instead, this section is meant to give you a foundation of understanding that you can use when choosing and speaking with those who will do the accounting for your organization.

What is accounting?

Accounting is simply a system for providing financial information about a business or other type of organization. This system includes the everyday tasks of documenting, classifying, analyzing, and interpreting the financial (bookkeeping) records of an enterprise. These jobs, taken together, can be used to evaluate the progress or failures of a business and to track its financial condition.

Accounting also includes activities that occur less often, such as auditing and figuring taxes. By auditing, we mean the examination of an organization's accounts by people who had no part in their preparation. Annual audits are required for all publicly held businesses and for many non-profit organizations. They are discussed in more detail below.

While accounting is sometimes confused with bookkeeping, you can see from the above paragraphs that accounting is much more comprehensive. Bookkeeping is simply a means of accurately entering information into the organization's books. Depending on the complexity of your organization's finances, you may or may not require knowledge of accounting. An accountant will generally know how to analyze the organization's finances, and how to set up an appropriate accounting system to track them.

In the United States, there are a lot of regulations that dictate how accounting procedures must be carried out. Most public and many nonprofit organizations are required to follow generally accepted accounting principles (GAAP), which are developed by two different organizations: the Governmental Accounting Standards Board (GASB ) and the Financial Accounting Standards Board (FASB).

The GASB was developed in mid 1980s as a way to oversee accounting for governmental agencies. It works to improve standards of state and local governmental accounting, financial reporting, and to guide the public, including issuers, auditors, and users of governmental financial reports. Some not-for profits that receive government funding are also subject to its control.

Not-for-profits not subject to GASB control should follow the standards set forth by the FASB, which also sets regulations for for-profit organizations. The FASB works to establish and improve standards of financial accounting and reporting to guide the public, including issuers, auditors, and other users of financial information such as funders and Board members.

Special topic in accounting: What is an audit?

An audit is a process for testing the accuracy and completeness of information presented in an organization's financial statements. This testing process lets an independent Certified Public Accountant issue what is referred to as an opinion on how fairly the agency's financial statements represent its financial position and whether they comply with generally accepted accounting principles (GAAP).

The audit report is addressed to the organization's Board of Directors, and usually includes the following:

• A cover letter signed by the auditor, stating the opinion
• Financial statements, including the statement of financial position (balance sheet), statement of financial activity (income statement), and statement of cash flows. Health and social service organizations also have a statement of functional (i.e., operational) expenses.
• Comparison of previous fiscal years (optional)
• Notes to the financial statements, as required by GAAP, which might include information about functional expenses, a depreciation schedule (that is, a schedule of the decline in value of certain items the group owns), further information about contributions and volunteer services, and other significant information not obvious in the financial statements.

In addition to the financial statements, the audit may include results of an investigation on whether the money is being spent exactly as specified in grants and contracts -- both general areas and line items -- and whether the organization functions as it says it does. For example, for audits of one literacy project, the director had to provide the minutes from all Board meetings during the audited year. This regulation was to show that the Board actually met, and also to prove that financial decisions that required a Board vote actually got one.

Some not-for-profits are legally required to obtain audits. Many states require an audit for not-for-profits that receive contributions over a specified amount (the amount varies from state to state) and/or not-for-profits who hire a paid fundraiser. You might want to contact the Secretary of State for regulations in your state. In addition, not-for-profits that receive $300,000 or more in federal funding during a fiscal year are usually required to have a specific audit, called an A-133 audit.

In addition to the financial statements required for audit purposes, not-for-profits are required by federal and state governments to file various information returns to maintain their tax-exempt status and document tax compliance. The primary federal reports are the annual Form 990 and Schedule A to the 990. (These are available from the IRS). State governments may require additional reports.

Your organization may choose to obtain an audit even if you are not legally required to do so.

Common reasons to obtain an audit include:

• Funders commonly request audited financial statements or a review (see below )
• The Board may seek reassurance that the financial information they are considering is accurate and complete. In cases where financial problems or irregularities in the financial system have occurred, the Board and the general public may look to an audit to provide assurance that these problems have been resolved.
• The audit process can be valuable to your executive director and finance staff because it confirms your financial picture and helps you strengthen internal control procedures.
• Finally, an audit signals a new phase in the organization's maturity. As your organization's financial transactions become more complex, undergoing the rigors of an audit will help your staff develop and understand the financial systems required to track and manage finances responsibly.

Alternatives to an audit include a review, which is a more limited examination of the financial statements by a CPA, and a compilation. During a review, a CPA asks questions of management and conducts some analysis, but does not undertake the extensive testing required for an audit. A review provides only limited assurance that the financial picture is fairly presented. A review may cost less than half of what an audit does, however, and it may satisfy state requirements for smaller not-for-profits. Contact your Secretary of State's office for details.

A compilation is a report prepared by an accountant using financial data supplied by the organization. The accountant organizes this financial information into standard financial reporting formats, but does not review the numbers for accuracy or provide assurance regarding the information that is included.

How is not-for-profit accounting different from accounting for for-profit organizations?

The basics of accounting are the same for for-profit and not-for-profit organizations - both record and analyze transactions, both will need to figure taxes, and both may be audited.

However, parts of not-for-profit and for-profit accounting can be very different. Certainly, a huge difference is the fact that for-profits generally spend what they need to spend in order to run the business, and either show a profit or a loss at year's end. If they're generally viable from year to year, and not too concerned about growth except to keep up with inflation, they figure expenses and income will even out.

Most community-based and grassroots organizations, on the other hand, spend only as much as they take in, because there isn't any more. If they can't meet operating expenses, their situation is more serious. Options are: to go out of business; try to fundraise the difference quickly; lay people off or ask them to defer or forego salary -- many staff people in such organizations will do almost anything to keep things going; or beg a bank for a loan that they may not be able to get (or pay back if they do get it).

Some specific differences between for-profit and not-for-profit accounting are:

• Accounting for contributions - Not-for-profits that qualify for tax-exempt status under 501(c)(3) of the Internal Revenue Code can receive tax-deductible contributions. Since this certainly doesn't happen in the for-profit world, there aren't any comparable procedures for handling these contributions. Special procedures have been established for handling different types of contributions. This is discussed in the Statement of Financial Accounting Standards No. 116, Accounting for Contributions Received and Contributions Made; Analysis of FASB 116 provides a helpful summary.
• Capitalizing and depreciating assets - Both for-profits and not-for-profits are required to record the purchase of long-lasting, substantial property and equipment (such as computers, vans, buildings, etc.) as assets in the financial records. They must also depreciate those items for each year in which they have a useful life. However, some assets in the not-for-profit sector receive special treatment. These include museum collections, historical buildings, library books, zoo animals, etc..

Depreciation is the amount of value a piece of equipment, property, or other large, long-lasting item loses each year because of age and wear. If the expected useful life of a computer, for example, is five years, then it will depreciate - lose value - by 20%, or 1/5, each year up to the fifth, when it will, in theory, be replaced. Depreciation is figured as an expense or loss against the assets - the total worth - of the organization.

• Use of cash-basis and modified cash-basis accounting - Many small not-for-profits use cash-basis rather than accrual-basis accounting to record expenses and revenues. This means that they only record revenue when the cash is received, and only record expenses when they are paid. Some not-for-profits use modified cash-basis accounting. They will record payroll taxes withheld from employees or large revenue or expense items on an accrual basis. Accrual-basis accounting reports income when it is earned and expenses when they are incurred. Most businesses track all expenses and revenues using accrual accounting.

If you get public money (and, quite possibly, even if you don't), the accrual method is more accurate and more effective. It tracks line items better, and tells you how much of your annual budget you've actually spent. If you go purely on a cash basis, it's a little like not recording the checks you write from your personal checkbook, but only checking the balance occasionally. Doing that, you can end up overdrawn with no trouble at all, since your balance rarely matches the amount you've actually recorded in your checkbook. If you use accrual, you always know when you can spend and when you can't; it makes sense in that circumstance to keep track of cash as well, but not necessarily to keep books on a cash basis.

• Functional expense classification - Not-for-profits are required to report their expenses by what is known as their functional expense classifications. The two primary functional expense classifications are program services and supporting activities. Supporting activities typically include management and general activities, fundraising, and membership development. Practices vary widely from organization to organization in the not-for-profit sector as to how expenses are categorized by functional areas.
• Development of financial statements - The FASB has issued Statement No. 117: Financial Statements of Not-for-Profit Organizations, which establishes standards for general-purpose external financial statements provided by a not-for-profit organization. Analysis of FASB 117 provides a more in-depth explanation, but basically it requires that those financial statements provide certain basic information that focuses on the organization as a whole and meets the needs of those outside of the organization with an interest in the group's financial situation. .

What is an accounting system?

An accounting system is composed of accounting records (checkbooks, journals, ledgers, spreadsheets, etc.) and a series of processes and procedures assigned to staff, volunteers, and/or outside professionals. The goals of the accounting system are to ensure that financial data and economic transactions are properly recorded and that financial reports necessary for management are prepared accurately and in a timely fashion.

Components of an accounting system:

• Chart of accounts: The chart of accounts is a list of each item the accounting system tracks. You might think of the chart of accounts as the "table of contents" for the general ledger.
  • Accounts are generally divided into five categories: assets, liabilities, net assets or fund balances, revenues, and expenses. Each account is assigned an identifying number for use within the accounting system. Examples of accounts include things such as the payroll account, office supplies, donations, and so on.
• General ledger: The general ledger organizes information by account. In a manual system, summary totals from all of the journals (see below) are entered into the general ledger each month. The general ledger maintains a year-to-date balance for each account. In a computerized system, data are typically entered into the system only once. Once the entry has been approved by the user, the software includes the information in all reports in which the relevant account number appears. Many software packages allow the user to produce a general ledger that shows each transaction included in the balance of each account. For example:

Acct 3102	Account Name: Office Supplies
Beginning Balance @ Sept 30:	$1,535.26
Ck. No. 1729 Mick's Office Supplies 10/12	$347.40
Ck. No. 1746 Quality Paper Store 10/17	$32.89
Closing Balance @ October 31:	$1,154.97

• Journals and subsidiary journals: Journals, also called books of original entry, are used to systematically record all accounting transactions before they are entered into the general ledger. Journals organize information chronologically and by transaction type such as receipts, disbursements (the payment of a debt or other expense), or other transaction types. There are three primary types of journals:
  • The cash disbursement journal is a chronological record of checks that are written,categorized using the chart of accounts.
  • The cash receipts journal is a chronological record of all deposits that are made, categorized using the chart of accounts.
  • The general journal is a record of all transactions that do not pass through the checkbook, including non-cash transactions (such as depreciation) and corrections to previous journal entries.
  • As organizations mature and handle greater numbers of financial transactions, they may develop subsidiary journals to break out certain kinds of activity from the primary journals noted above. The most common examples include payroll journals, accounts payable journals, and accounts receivable journals.
• Checkbook: In very small organizations, the checkbook may serve as a combined ledger and journal.
• Accounting procedures manual: The accounting procedures manual is a record of the policies and procedures for handling financial transactions. The manual doesn't need to be a professional book: it can be a simple description of how financial functions are handled (e.g., paying bills, depositing cash, and transferring money between funds). Creating an accounting procedures manual for your organization helps ensure consistency in how your books are handled. It can be very useful when someone new begins handling accounting duties.

When should you develop an accounting system for your organization?

• If your organization spends or earns any money at all, you probably do some accounting already, even if it is just balancing your checkbook. The important thing to remember is that your accounting system will change as your organization's needs and resources change.
• Each organization is unique, and will develop accounting procedures that make most sense to them. Even a relatively new, small organization, however, should think about the long term from the start. It's never too early to speak with a CPA (especially if you can convince one to donate his or her talents) about what makes most sense to your organization, and where you might be going in the future.
• If it's at all possible, we recommend setting up a regular accounting system, with real books, from the start. It can be very difficult to switch over when you need to, especially since it's usually overdue by the time you realize the necessity. If your organization has a computer, it's worth it to set up an accounting system on it, even if it's only a simple program. If you have to do it after the fact, data entry becomes a serious problem, whereas if you have the data in the computer already, switching over to another program is often not a problem.

Why should you do accounting for your organization?

So, what are the advantages of using proper accounting procedures for your organization?

There are quite a few, including:

• To meet government requirements, such as those prescribed by the FASB and the GASB - not to mention the IRS!
• To help members of the organization and the general public better understand the financial activities and the condition of the organization
• To ensure that financial resources are used effectively and efficiently
• To make sure you're not spending money you don't have

How do you do accounting for not-for-profit groups?

For our purposes in this section, we will look at three things your organization will need to do to handle its accounting procedures:

• Find an accountant
• Choose accounting software
• Carry out the accounting process

Finding an accountant

First, decide who will do the accounting. Will you do it yourself? Doing it yourself will be most feasible if your organization is very small, with very simply financial reporting needs. Alternatively, will you hire an accountant or try to find a volunteer accountant? For many mid-size and larger not-for-profit groups, this is an absolute necessity.

For many community organizations, the best of all options is to find an accountant who is willing to do a little pro bono work for your organization. But how can you find someone who is willing to volunteer their time and expertise? Our suggestions are:

• Ask around. Use the networks of your Board members to find a willing volunteer. Most organizations have someone involved who either is a professional herself, or knows someone who is. Don't be shy about asking for help. Remember, you're not asking for yourself - you're asking on behalf of a cause you believe in.
• Look and see who advertises in publications related to what you are doing. For example, if you are a member of the local AIDS project, you might want to see if any lawyers or CPAs advertise in the local gay press. Some of the people advertising may well be willing to volunteer or work inexpensively for a cause they believe in.
• Another source of cheap or free accounting help is other organizations. You may be able to work out a shared or a donated position. Another alternative is to find an organization that pays people to work for other organizations. For example, the accountant at a literacy project in the Northeast came to the organization through a work program for senior citizens. The work program paid him for two years, at the end of which the literacy project had enough money to pick up his salary.
• Accountants for the Public Interest is a not-for-profit organization whose mission is to encourage accountants to volunteer their time and expertise to not -for-profits and others in need.

The next thing that you and your accountant will need to decide is whether or not you will use accounting software. There's no doubt that accounting software can be very helpful. It offers increased efficiency and accuracy, and better control over the numbers, but it is not a cure-all. A mess on paper will just become a bigger mess if it's entered into a computer without fixing any of the underlying problems.

Choosing accounting software

If you have decided to purchase software, sit down with whoever will do the accounting and make a list of the features you are looking for.

A first decision you will need to make is whether you want fund accounting software or not. Fund accounting software programs are sophisticated software for not-for-profits that use fund accounting methods. That is, they maintain separate balance sheet data (assets, liabilities, fund balance) for each account. This method (and software) encompasses most of the aspects of commercial accounting, but it will include a lot of information that is not part of a commercial program.

Drawbacks to fund accounting software programs:

• Cost - this type of software can be expensive
• Difficulty of use - unless you are an accountant or experienced bookkeeper, you will most likely find the fund accounting software programs daunting

A relatively small not-for-profit organization may find regular business software suitable for its needs. Our suggestion is to discuss your needs in depth with an accountant you trust.

There are a lot of programs on the market that can produce basic fund financial statements, but like anything else, they all have their own strengths and weaknesses. Some questions to ask yourself include:

• What sort of computer and operating system do you have? Do you want to buy new equipment to run the system? Can you run any worthwhile accounting software on the computer you have? (Do you have enough memory and enough storage space on your hard drive to run it?)
• Do you need fundraising software, fund accounting software, or both? If you need both, do they need to be connected?
• How many funds do you have? How independent are they? How many accounting transactions do you conduct each month?
• What is your budget for this project?
• Do you have specific reporting requirements from your funders?
• Can you support the software internally, or are you going to need long-term help from the consultant who installs it?
• Can you get a demo of the software to evaluate it before you buy? This is common practice with many companies.

Information about options for different types of fund accounting software is available from the Nonprofit FAQ. The Fund Accounting Software Checklist also provides lots of helpful information.

And before you buy, you should also talk to others about what might be best for your organization. For example, you might speak with an accountant you know and trust for her recommendations. You might also ask other not-for-profit managers in your area what software they use. Then, not only can you get an honest appraisal of the software, you will have someone to talk with when you have questions.

Carrying out the accounting process

Whoever does your accounting (and whether or not they use software to do it), the procedure they follow will be similar. Detailing how to go about the process is beyond the scope of a Tool Box section - remember, the science of accounting takes up many, many college courses.

However, a brief overview of the process shows that it will include:

• Conducting financial transactions
• Analyzing transactions
• Recording transactions in journals
• Posting journal information to the general ledger
• Analyzing the general ledger account and make corrections (e.g., reconcile your information with bank statements)

If you will be involved in your organization's accounting, we strongly encourage you to check out the resources listed below.

In Summary

The tasks involved in doing the accounting for your organization can seem daunting, especially if numbers and formulae aren't a language you speak. As the manager of a community organization, however, it's important to have at least a basic understanding of the vocabulary and ideas, so that when the grants coming raining down on you, you won't let valuable resources slip away through poor management.