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Blog: 5 Accounting Terms for Not-for-Profits

5 Accounting Terms for Not-for-Profits

Certified Public Accountant and Senior Manager on the outsourced accounting side of Vault Consulting walks through five phrases she believes every Not-for-Profit should be familiar with. 

Internal Controls

Organizations need to have good policies and procedures to minimize vulnerability and make sure everything is done the correct way. 

To avoid fraudulence or embezzlement, procedures and policies need to be formalized into writing and revised continuously. Equally important is socializing these policies and procedures among staff in all departments of the organization because according to Gewecke, “it will ensure that any financial and nonfinancial transactions are being 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 full control over everything.

Organizations that practice ‘Separation of Duties’ can streamline processes and assure 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 the process of cutting checks. Bills can be sent directly to the system, where they will be coded, and then one person will approve it, and another person will pay it. Without a doubt, Gewecke describes, “the person who is depositing the checks should not be the person doing bank reconciliation.” 

Unrelated Business Income

If a Not-for-Profit is earning revenue on things not directly related to their organization’s purpose, then there is a potential that it could fall under unrelated business income. 

Not-for-Profits are mission-oriented organizations with purposes that are based on goodwill. However, sometimes Not-for-Profits need to generate streams of revenue that may deviate from their organizational purpose. For instance, if a Not-for-Profit 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,” Gewecke recommends. 

Deferred Revenue

A lot of times, Not-for-Profits may receive cash in the form of donations during the year, but if the donors intend the money for a product or service happening the following year, then per Generally Accepted Accounting Principles the Not-for-Profit cannot take that money as the current year’s revenue.

For instance, if a donor gives a generous grant for an event occurring the following year, then the organization cannot mark this contribution as revenue for the current year. 

Accrual Basis of Accounting

In the accrual method, a Not-for-Profit recognizes income during the period they have performed a service, or when a product has been delivered to a member or patron. This type of accounting method is compliant with Generally Accepted Accounting Principles (GAAP) standards. 

To illustrate, let’s say an association has the option for perspective members to pay a large upfront cost in order to hold membership status for twenty-five years. The individual or company would pay, say, $1,200 to the association, and they would not have to renew their membership for the next twenty-five years. In accrual based accounting, the organization cannot recognize $1,200 as the current year’s income. 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 is receiving the benefit of membership.

Conversely, Gewecke acknowledges that some clients report to BODs using a cash basis method to relate cash flow. ‘Cash Basis of Accounting’ is said to be a simpler method to employ than ‘Accrual Basis of Accounting,’ but there is a pitfall in using this method. “For most audits, organizations have to employ accrual basis financials,” reveals Gewecke. Unfortunately, the GAAP and IFRS do not consider cash basis accounting method an acceptable way to report economic activity for an organization. 

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