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What is accounting?
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How is nonprofit accounting different from accounting for for-profit organizations?
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What is an accounting system?
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When should you develop an accounting system for your organization?
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Why should you do accounting for your organization?
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How do you do accounting for nonprofit groups?
Community organizations often devote substantial attention to securing the financial resources needed to carry out their work. An equally important question is how to manage, document, protect, and understand the resources the organization already has.
Reliable accounting and financial-reporting practices are essential to organizational sustainability. They help organizations understand their financial position, meet legal and funder requirements, protect resources, maintain appropriate internal controls, and make informed decisions about programs, staffing, partnerships, and future commitments.
In this section, we'll provide an overview of accounting and its role in community organizations. We'll also discuss accounting systems, financial reporting, audits and other forms of external financial review, professional accounting support, accounting technology, and the basic processes organizations use to maintain reliable financial information.
This section is intended to provide a general foundation for understanding nonprofit accounting. It is not a substitute for professional accounting, audit, tax, or legal advice. Requirements vary according to an organization's legal structure, size, funding sources, activities, location, and other circumstances. Work with qualified professionals when specialized guidance is needed.
What is accounting?
Accounting is a system for recording, classifying, summarizing, analyzing, and reporting financial information about an organization. Accounting helps leaders understand where resources come from, how they are used, what the organization owns and owes, what restrictions apply to particular resources, and how the organization's financial position changes over time.
Accounting is related to, but broader than, bookkeeping. Bookkeeping generally refers to recording financial transactions and maintaining supporting records. Accounting includes those records but also includes activities such as financial reporting, reconciliations, analysis, budgeting support, grant and fund tracking, internal controls, and interpretation of financial information.
An accountant or other qualified financial professional may help an organization design its accounting system, prepare financial statements, interpret financial information, meet tax and reporting requirements, establish internal controls, and address complex accounting issues.
Accounting standards
Organizations should determine which accounting and financial-reporting standards apply to them. In the United States, the Financial Accounting Standards Board (FASB) establishes generally accepted accounting principles for nongovernmental entities, including nongovernmental nonprofit organizations. Accounting guidance specifically relevant to nonprofit entities is included in the FASB Accounting Standards Codification, including Topic 958, Not-for-Profit Entities.
The Governmental Accounting Standards Board (GASB) establishes accounting and financial-reporting standards for state and local governmental entities. Receiving government funding by itself does not necessarily make a nongovernmental nonprofit organization subject to GASB accounting standards.
Organizations may also have accounting and reporting requirements established by government awards, contracts, lenders, foundations, state regulators, accrediting organizations, or other entities. A qualified accountant can help determine which standards and requirements apply.
Special topic in accounting: What is an audit?
An audit is an independent examination of financial statements and related information performed under applicable professional auditing standards. The purpose of a financial statement audit is to allow an independent auditor to express an opinion about whether the financial statements are presented fairly, in all material respects, in accordance with the applicable financial-reporting framework.
Audited nonprofit financial statements commonly include:
- A statement of financial position
- A statement of activities
- A statement of cash flows
- Information about expenses by their nature and function, presented in the financial statements or notes as applicable
- Notes explaining significant accounting policies, restrictions, commitments, contingencies, investments, leases, contributions, grants, and other relevant matters
- The independent auditor's report
Depending on the engagement and the organization's funding, an audit may also involve consideration of internal controls or compliance with particular laws, regulations, grants, contracts, or federal award requirements.
Not every nonprofit organization is required to obtain an annual financial-statement audit. Requirements may arise from state law, federal awards, grant or contract terms, lender requirements, organizational bylaws, board policy, or other circumstances.
Organizations that expend federal awards above the threshold established under the federal Uniform Guidance may be required to obtain a Single Audit or, when permitted, a program-specific audit. Because federal thresholds and requirements can change, organizations receiving substantial federal awards should review the current Uniform Guidance and obtain appropriate professional advice.
Tax-exempt organizations may also have federal and state filing requirements that are separate from audit requirements. Depending on the organization, federal reporting may include Form 990, Form 990-EZ, Form 990-N, Form 990-PF, and applicable schedules. Schedule A, for example, applies to organizations required to provide information about public charity status and public support; it is not simply a universal attachment for every tax-exempt organization.
An organization may choose to obtain an audit even when one is not legally required.
Reasons may include:
- A funder, lender, partner, or governing board requests audited financial statements
- The organization has grown significantly or its financial transactions have become more complex
- The board wants additional independent assurance regarding the organization's financial statements
- The organization wants to strengthen financial reporting and internal controls
- Significant financial concerns or irregularities have occurred and independent review is appropriate
Other CPA services may include a review or a compilation. These provide different levels of service and assurance from an audit. A review provides limited assurance based primarily on inquiry and analytical procedures. A compilation involves presenting financial information supplied by management in financial-statement form and does not provide assurance on the financial statements.
Work with a qualified CPA or other appropriate professional to determine which service fits your organization's legal requirements, funding requirements, governance needs, and resources.
How is nonprofit accounting different from accounting for for-profit organizations?
Many accounting principles apply to both nonprofit and for-profit organizations. Both need reliable transaction records, internal controls, financial statements, cash-flow management, appropriate tax reporting, and accurate information for decision-making.
Nonprofit accounting, however, also reflects the organization's mission, donor restrictions, grants, contributions, and accountability for resources that may be limited to particular purposes.
Financial challenges should be addressed through responsible planning rather than assuming that staff members will work without pay, defer compensation, or absorb unsustainable workloads to keep an organization operating. Organizations facing financial stress may need to examine revenue, expenses, reserves, staffing, program scope, financing, partnerships, and other options while considering legal obligations and effects on staff and community commitments.
Some areas especially important in nonprofit accounting include:
- Accounting for contributions and grants. Nonprofits may receive contributions, grants, donated assets, and other forms of support that require specialized accounting. Current FASB guidance for nonprofit entities addresses issues such as donor restrictions and whether contributions are conditional or unconditional.
- Donor restrictions. Financial statements for nongovernmental nonprofit organizations generally distinguish between net assets with donor restrictions and net assets without donor restrictions.
- Grant and contract accounting. Organizations may need to distinguish among contributions, exchange transactions, government contracts, and other arrangements and track the requirements associated with each.
- Contributed nonfinancial assets and services. Certain donated goods, professional services, facilities, and other nonfinancial contributions may require accounting or disclosure under applicable standards.
- Capital assets and depreciation. Buildings, vehicles, technology, equipment, and other long-lived assets may be capitalized and depreciated over their estimated useful lives according to applicable accounting policies and standards.
- Functional expense reporting. Nonprofit organizations may need to report expenses both by their nature - such as salaries, rent, supplies, and professional services - and by function, such as program services, management and general activities, and fundraising.
Cash-basis and accrual-basis accounting
Organizations may encounter several accounting methods.
Cash-basis accounting generally records revenue when cash is received and expenses when cash is paid.
Accrual-basis accounting generally recognizes revenue when it is earned or otherwise recognizable under applicable accounting guidance and records expenses when obligations are incurred, regardless of when cash is received or paid.
Some smaller organizations may maintain internal records using a cash or modified-cash approach. Financial statements intended to comply with generally accepted accounting principles, however, need to follow the applicable GAAP requirements. Organizations should select accounting methods with guidance from a qualified accountant and based on their reporting, tax, funder, and management needs.
Regardless of accounting method, organizations must also monitor actual cash. An organization can appear financially healthy on an accrual basis while still experiencing a shortage of cash available to meet immediate obligations.
What is an accounting system?
An accounting system includes the records, technology, policies, controls, processes, and people used to capture financial transactions and produce reliable financial information.
The goals of the accounting system are to ensure that transactions are authorized, documented, recorded accurately, classified appropriately, protected from loss or misuse, reconciled, and reported in a timely way.
Components of an accounting system
- Chart of accounts. The chart of accounts is the organized list of accounts used to classify financial activity.
- Common categories include assets, liabilities, net assets, revenue and support, and expenses.
- An organization may also use dimensions such as program, department, grant, funding source, location, restriction, or project so that financial information can be analyzed in several ways.
- General ledger. The general ledger contains the organization's financial transactions organized by account and forms the foundation for financial reporting. Modern accounting systems generally update ledger information automatically as approved transactions are entered.
- Subledgers and transaction records. Organizations may maintain detailed records for accounts payable, accounts receivable, payroll, fixed assets, grants, contributions, purchasing, credit cards, and other areas. These records should reconcile with the general ledger.
- Bank and payment records. Bank statements, electronic payments, checks, credit-card transactions, deposits, and other cash activity should be recorded and reconciled regularly.
- Supporting documentation. Invoices, receipts, contracts, grant agreements, donor documentation, timesheets, payroll information, approvals, reimbursement records, and other evidence should be retained according to organizational policy and applicable requirements.
- Accounting policies and procedures. Written procedures explain how financial responsibilities are handled, including purchasing, payments, deposits, payroll, reimbursements, grants, restricted funds, journal entries, reconciliations, financial reporting, record retention, cybersecurity, and approval authority.
- Internal controls. Controls help reduce errors, misuse, fraud, and unauthorized transactions. Examples include separation of duties, approval thresholds, bank reconciliations, restricted system permissions, documentation requirements, multi-factor authentication, and review by people independent of the original transaction when feasible.
Small organizations may use simpler systems than large organizations, but simplicity should not mean incomplete records or lack of oversight. Even a small organization should know how much money it has, where resources came from, what restrictions apply, what it owes, what others owe it, and whether transactions are properly documented and authorized.
When should you develop an accounting system for your organization?
Develop basic financial controls and accounting records as soon as your organization begins receiving, spending, or managing money.
The system can grow with the organization. A small volunteer-led group may begin with a relatively simple accounting platform and a limited chart of accounts. As the organization adds employees, grants, contracts, programs, restricted contributions, credit cards, property, or other financial complexity, the accounting system should evolve accordingly.
It is usually easier to establish appropriate procedures early than to reconstruct financial records later.
Periodically reassess whether the accounting system still meets the organization's needs. Growth, remote work, new funding requirements, new programs, increased transaction volume, cybersecurity risks, staffing changes, or expansion into new locations may require different technology, controls, or expertise.
Why should you do accounting for your organization?
Reliable accounting can help your organization:
- Meet applicable legal, tax, accounting, grant, contract, and regulatory requirements
- Provide staff, board members, funders, donors, partners, and other appropriate stakeholders with useful financial information
- Understand the organization's financial position and operating results
- Track restricted and unrestricted resources appropriately
- Monitor programs, grants, contracts, and departments
- Prepare realistic budgets and forecasts
- Manage cash flow and avoid committing resources the organization does not have
- Identify financial risks and unusual transactions
- Strengthen internal controls and accountability
- Support strategic and operational decision-making
- Demonstrate responsible stewardship of organizational resources
How do you do accounting for nonprofit groups?
For purposes of this section, three areas deserve particular attention:
- Obtaining appropriate accounting expertise
- Choosing and maintaining an accounting system
- Carrying out and reviewing the accounting process
Obtaining accounting expertise
Decide who will handle routine bookkeeping, higher-level accounting, financial reporting, tax filings, and other financial responsibilities. These responsibilities may be divided among employees, contractors, accounting firms, volunteers, board members, or shared-service providers depending on the organization's size and resources.
A very small organization may be able to handle routine bookkeeping internally with periodic professional review. Organizations with payroll, significant grants or contracts, complex restrictions, substantial assets, or external financial-reporting requirements will often need greater professional accounting expertise.
Look for professionals who understand nonprofit accounting and the types of funding your organization receives. Experience with grants, restricted contributions, federal awards, indirect costs, functional expenses, payroll, Form 990 reporting, and nonprofit governance may be particularly important.
Pro bono or volunteer professional assistance can be valuable, particularly for technical advice, board service, training, or short-term projects. However, organizations should not assume that essential ongoing accounting work will or should be provided free of charge. Include adequate financial-management capacity in organizational budgets whenever possible.
When looking for accounting support, consider:
- Professional qualifications and licensing where relevant
- Experience with nonprofit organizations
- Experience with your organization's funding sources
- Knowledge of current accounting and tax requirements
- Availability and responsiveness
- Cost and scope of services
- Ability to explain financial information clearly to non-accountants
- Independence requirements if the professional will provide audit or other assurance services
Choosing accounting software
Most organizations use digital accounting systems, whether locally installed or cloud-based. Accounting technology can improve efficiency, accuracy, reporting, collaboration, and recordkeeping, but software cannot compensate for weak financial procedures or inaccurate information.
Begin by identifying the functions your organization actually needs.
Questions to consider include:
- Can the system track programs, grants, contracts, departments, projects, and donor restrictions at the level we need?
- Can it produce the financial statements and management reports required by leadership, the board, funders, auditors, and regulators?
- Does it integrate appropriately with payroll, fundraising, banking, expense-management, accounts-payable, budgeting, and other systems?
- Does it provide user roles, approval workflows, audit trails, and separation-of-duties controls?
- Does it support multi-factor authentication and other appropriate security controls?
- How are backups, disaster recovery, encryption, and data privacy handled?
- Can access be limited appropriately for staff, board members, accountants, contractors, and auditors?
- Can data be exported in usable formats if the organization changes systems?
- Does the system scale with expected organizational growth?
- Is the interface accessible and reasonably easy for staff to use?
- What are the implementation, subscription, training, integration, support, and migration costs?
- What customer support and training are available?
Some nonprofit-specific accounting systems provide specialized grant, fund, restriction, and nonprofit-reporting features. Other organizations may successfully use broader accounting platforms configured to track nonprofit activities appropriately. Discuss your requirements with an accountant and with people who will actually use the system.
Before selecting a system, consider requesting a demonstration or trial and testing typical tasks such as recording restricted revenue, entering expenses, allocating costs, reconciling bank accounts, generating grant reports, preparing financial statements, and correcting transactions.
Carrying out the accounting process
The exact workflow depends on the organization and its accounting system, but the process generally includes:
- Conducting and authorizing financial transactions
- Collecting appropriate supporting documentation
- Determining how transactions should be classified
- Recording transactions in the accounting system
- Posting activity to the general ledger and appropriate program, grant, fund, or project records
- Reconciling bank accounts, credit cards, receivables, payables, payroll, and other accounts
- Reviewing transactions and making properly documented adjusting entries when necessary
- Closing accounting periods on a regular schedule
- Preparing financial statements and management reports
- Comparing actual results with budgets and forecasts
- Reviewing reports with organizational leadership and the governing board
- Maintaining appropriate records for taxes, grants, contracts, audits, and other reporting requirements
Good accounting also requires regular review. Bank accounts should be reconciled promptly, unusual transactions should be investigated, restricted resources should be monitored, and financial reports should be reviewed by people who understand both the numbers and the organization's activities.
The board should receive understandable financial information often enough to perform meaningful oversight. Program staff should receive financial information relevant to the programs and grants they manage. Financial staff, in turn, need accurate and timely program information so accounting records reflect what actually occurred.
In Summary
Accounting provides the financial information an organization needs to manage resources responsibly, comply with requirements, monitor its financial position, and make informed decisions. It includes more than recording transactions: accounting also involves classification, reconciliation, financial reporting, analysis, internal controls, grant and restriction tracking, and communication among financial staff, organizational leaders, program staff, and the governing board.
The complexity of an accounting system should reflect the complexity of the organization. Even a small community group should maintain reliable records and basic controls, while organizations with employees, grants, contracts, restricted funds, multiple programs, or substantial assets may need more sophisticated systems and professional expertise.
Accounting standards, tax rules, audit requirements, software, and financial practices change over time. Review your systems periodically, use current authoritative guidance, obtain qualified professional assistance when needed, and make sure financial procedures continue to support the organization's mission and accountability to the people and communities connected to its work.