Accounting is a critical part of running a nonprofit organization. It helps you track your finances, make informed decisions, and comply with regulations. But accounting for nonprofits can be a daunting subject. Below are some of the most essential accounting terms for nonprofits:
Nonprofits must have good policies and procedures to minimize vulnerability and ensure everything is done correctly.
To avoid fraudulence or embezzlement, procedures and policies must be formalized in writing and revised continuously. Equally important is socializing these policies and procedures among staff in all organization departments, as it will ensure that any financial and nonfinancial transactions are done in a way to protect the organization.
Separation of Duties
Organizations should assign accountability of procedures within a process to separate individuals so that no one person has complete control over everything.
Organizations that practice ‘Separation of Duties’ can streamline processes and ensure that no one person has the reign to commit a fraudulent action. Vault upholds this industry practice by setting clients up with a technological platform that automates cutting checks. Bills can be sent directly to the system, where they will be coded, and then one person will approve it, and another will pay it. Without a doubt, the person who is depositing the checks should not be the person doing bank reconciliation.
Unrelated Business Income
Suppose a nonprofit earns revenue on things unrelated to its purpose. In that case, it could fall under unrelated business income.
Nonprofits are mission-oriented organizations with purposes based on goodwill. However, sometimes nonprofits need to generate streams of revenue that may deviate from their organizational purpose. For instance, if a nonprofit puts out a magazine to members featuring stories that cover their quarterly accomplishments, and the magazine has ad space available for sale, then the revenue generated from the magazine may be purpose-related income; however, the advertisement space revenue is not. Reach out to your tax advisor before starting a new offering.
Often, nonprofits may receive cash through donations during the year. Still, suppose the donors intend the money for a product or service the following year. The nonprofit cannot take that money as the current year’s revenue per Generally Accepted Accounting Principles.
For instance, if a donor gives a generous grant for an event occurring the following year, the organization cannot mark this contribution as revenue for the current year.
Accrual Basis of Accounting
In the accrual method, a nonprofit recognizes income during the period they have performed a service or when a product has been delivered to a member or patron. This accounting method complies with Generally Accepted Accounting Principles (GAAP) standards.
To illustrate, an association can afford prospective members to pay an upfront cost to hold membership status for twenty-five years. The individual or company would pay the association. It would not have to renew its membership for the next twenty-five years. The organization cannot recognize the full payment as the current year’s income in accrual-based accounting. They must spread that revenue out over the next twenty-five years, as twenty-five years is the agreed-upon period for which the member benefits from membership.
Conversely, some nonprofits report to BODs using a cash basis method to relate cash flow. ‘Cash Basis of Accounting’ is said to be a more straightforward method to employ than ‘Accrual Basis of Accounting.’ Still, there is a pitfall in using this method. Organizations must employ accrual basis financials for most audits,” reveals Gewecke. Unfortunately, the GAAP and IFRS do not consider cash basis accounting method an acceptable way to report economic activity for an organization.
For more information and insight, feel free to contact Vault Consulting.