7 Tips to Enhance Your Nonprofit's Chart of Accounts

Nonprofits have it hard. Sure, they don’t have to pay taxes, but that tax-exempt status comes with a price: increased levels of responsibility to the general public. The focus, then, of their financial accounting is on accountability rather than profitability. One way nonprofits can enhance their accountability is by creating a compelling Chart of Accounts. As described in more detail below, the overarching goal is to keep things organized and to be able to provide useful reporting to management and other stakeholders.

What's a Chart of Accounts?

A Chart of Accounts (COA) is a list of the different accounts an organization uses to record transactions in the general ledger. The typical COA has five categories: assets, liabilities, equity, revenues, and expenses. Most organizations maintain COAs that suit their needs and may add or reduce the number of accounts depending on the type of organization.

1. Numerical Classification

Nonprofits should ensure that their chart of accounts provides sufficient information without bogging down the reader with too much detail. One way to keep things concise and organized is by using a logical numbering system to represent different sets of accounts. Typically, accountants employ a numerical classification system such that thousands represent the main categories and hundreds represent the sub-categories.

For instance, the Organization can have assets taking numbers 1000-1999 while sub-categories for assets such as cash and buildings take 1010 and 1020, respectively. This approach provides  flexibility as there are 999 numbers for the sub-categories. The logical arrangement of accounts along numerical order makes it easy for accountants to sort transactions by category and make accurate financial reports. It’s also a good idea to build in room for flexibility by leaving spaces between numbers for new accounts to add later. When building the COA from scratch, the Organization should not waste time creating unneeded accounts.

2. Organize Accounts by Divisions

Nonprofits can enhance their accounting by creating a COA that resembles their organization chart. For instance, if an organization has ten divisions, each division can have its own set of accounts. The resulting chart will show how each division manages its finances. This increases transparency, so stakeholders can see how each unit utilizes funds. Additionally, the nonprofit can track its restricted gifts to ensure it is honoring its fiduciary duty to use the gift as the donor intended.

3. Consistent Coding

Nonprofits should use a consistent coding system for their accounting records. This is especially important for organizations with several divisions because it ensures that all the accounting data is entered correctly into the accounting software. Consistent coding makes it easier for accountants to process information and ensures that the organization publishes accurate financial reports that donors can trust.

4. Functional Expenses

Accounting standards for nonprofits require organizations to account for functional expenses. These functional categories relate to program services, fundraising, and management and administration, which  aims to ensure that nonprofits spend funds efficiently and transparently.

5. Core Operations

An effective COA s should reflect the main activities of the organization. It should show the organization's core operations and how they affect important measures of financial stability, such as cash flows and net assets. The COA should indicate the primary sources of income for the organization and major expenses. Such a setup will enable managers to focus their attention on major donors and expense categories that have the most impact on the organization.

6. Short and Concise Reports

An effective COA should enable the organization to create short and organized financial reports. It should have clear guidelines on how to enter different types of transactions to avoid duplication. For instance, expenses such as electricity and water can be entered as utilities instead of making an entry for each expense. Similarly, travel expenses can be listed under the travel account instead of making an entry for each cost. Such a system makes it easier for stakeholders to read financial reports.

7. The Multi-Dimensional Approach

Modern accounting software allows organizations to run their general ledgers using dimensions. For example, an organization can use eight dimensions for managing financial transactions and preparing reports. All the organization needs to do is create primary account codes and use them for any transaction. This setup enables organizations to track their expenditure and revenue while maintaining a simple COA.

Bottom Line

Nonprofits have an obligation to create COAs that demonstrate the organization is efficient in mobilizing resources and uses them effectively to achieve its mission. The charts should be neat, brief, and focused on the core operations of the organization. You’ll want to find your organization’s balance between useful levels of granularity and over-cumbersome details. Lutz can help nonprofits develop and implement effective COAs. Contact us if you have any questions.