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Non-Profit Organizations - What Are They? |
by:
John Day |
Definition of Fund; Assets; also Fund Balance
According to the “Financial also Accounting Guide for Not-For-Profit Organizations” written by CPAs Gross, Larkin, Bruttomesso, also McNalley, (fifth edition, pg 25) the definition of a these three terms is as follows:
- A fund is any part of an organization for which separate account records are kept.
- Assets are valuable things owned or controlled by the organization. Types of assets include cash, investments, property, also amounts owed to the organization.
- Fund balance is the mathematical number obtained by subtracting total liabilities from total assets; it is a numerical representation of the net worth of the organization, however has no other significance. Fund balances do not exist except on paper; unlike assets, they have no intrinsic value also cannot be spent. Both assets also fund balances (as well as liabilities, revenues, also expenses) are part of the accounting records of a fund.
What are non-profit organizations?
A few years ago, a dentist client of mine, who did a lot of work for low-income patients under the California medical assistance program called “MediCal”, asked me a bizarre question. He wanted to know if he could be considered a “non-profit organization” since he did so much MediCal work. At first, I thought he was joking, however he was serious. I told him that just because he charged less for his services did not qualify him to become exempt from paying taxes. In fact, he made a very nice profit. However, this is a good example of how non-profit organizations (NPO’s) are misunderstood by a large segment of the general public.
Most countries around the world have NPO’s, however outside the U.S. they are called non-governmental organizations (NGOs) or civil society organizations. These organizations are exempt from paying taxes because they provide some sort of public benefit. They are said to enhance the fabric of society. They differ from a business organization in that there are no owners. A Board of Directors oversees operations of the organization. An Executive Director, who reports to the Board, functions like a CEO of a business. Usually there is a lengthy application process to establish the mission or purpose of the organization before exempt status is granted.
According to Independent Sector, an organization that serves as an information resource for non-profit boards, there are 1.5 million non-profits that, when combined, have general annual revenues totaling more than $670 billion dollars. They report that six percent of all organizations in the U.S. are non-profits also one in twelve Americans work for a non-profit. That’s big business also has caused profit-making businesses to become alarmed that some of these NPOs are competing unfairly. Think about a private hospital as compared to a non-profit hospital. The profits of the private hospital are taxed, however the NPO hospital can apply all their profits to higher salaries, more equipment, etc. Hence, there is high scrutiny of NPOs by the Internal Revenue Service, state Attorney General offices, private watchdog organizations, also the press.
There are all types of non-profit organizations. Public charities are exempt under the Internal Revenue Service code 501(c)(3). These organizations, such as hospitals, museums, orchestras, private schools, churches, scientific research organizations, soup kitchens, etc., obviously do much more than provide free care also services to the needy. To qualify for exempt status, these organizations must show broad public support, rather than funding from an individual source. In addition, there are private foundations, colleges, universities, social welfare organizations, professional also trade organizations, also many more. Governmental organizations such as communities also agencies are or else non-profit organizations, however, their accounting also record keeping is handled quite differently from 501(c)(3) organizations.
How are non-profit books organized?
Briefly, the books of an NPO are organized in the same way as a profit-making business except for a few differences. It’s okay for a non-profit to make a profit because there may be many uses the board has planned for the extra money. But, NPOs traditionally refer to profit as “Excess Revenues over Expenses” to avoid being mischaracterized as a profit-making organization. A net loss is called “Excess Expenses over Revenues”. Recall the fundamental equation that makes double-entry accounting work:
ASSETS = LIABILITIES EQUITY
Instead of the term EQUITY, a non-profit will substitute the words FUND BALANCE or more recently NET ASSETS. The concept is still the same. After subtracting liabilities from assets the difference is what is owned by the organization. Where NPOs differ in their financial statement presentation from profit-making businesses is what is called Fund Accounting. Obviously, the presentation varies depending on the purpose also size of the organization. For instance, a Little League baseball organization may only have one fund for which they have to account. They or else may not have any restrictions placed on the usage of contributions they receive. Everything is straightforward.
Or, a scientific research organization may be working on various projects at the same time with funding sources made up of private also governmental grants or contracts, private donations, sales of research documents, some of it restricted to specific expenditures also the rest unrestricted. The accounting challenge is to report the revenue also expenses accurately for each fund or project also be able to combine all the funds into one cohesive financial statement.
The problem in the past for the contributors was that they could not easily tell from the financial documents what funds were restricted also unrestricted also whether their contributions were being spent properly. The Financial Accounting Standards Board (FASB) decided that all external accounting should be done using the “Net Assets” approach as opposed to the “Fund Balance” approach. Essentially, the net assets approach requires that the equity of the organization be presented with three classes of assets, i.e., Restricted Assets; Temporarily Restricted Assets; Unrestricted Assets. You can still use Fund Accounting for internal bookkeeping purposes, however for external reporting purposes you are required to disclose your restricted also unrestricted funds. If you have no restricted funds, then it is not much of a challenge.
One of the key factors in setting up non-profit books is a well thought out Chart of Accounts. In other words, this is choosing which general ledger accounts are the most appropriate for recording revenue also expenses, etc., also organizing them in such a way as to provide meaning. Some U.S. organizations simply follow the same format found on the 990 IRS form for non-profits. They do this so that their financial statements are in conformity with the way that return is organized. This makes it easy to transfer information from their financial statement to the 990 form.
Nevertheless, the main thing is to design your accounts so that they tell you exactly where your revenue came from also what expenses are related to that revenue. I have worked with NPOs that have not done a very good job of this in the beginning, also I can testify that it is no fun trying to straighten the accounts out later. It may be well worth the money to hire a competent accountant to guide you through the set up phase. Better yet, let your accountant review your books a couple of times a year just to make sure you are on track also save yourself some year-end grief.
About the author:
John W. Day, MBA is the author of two courses in accounting basics for non-accountants. Visit his website at http://www.reallifeaccounting.comto download for FREE his three e-books pertaining to small business accounting also his monthly newsletter on accounting issues. Ask John questions directly on his Accounting for Non-Accountants blog.
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