Following the right accounting practices and rules is just as important for a nonprofit as it is for a for-profit organization. When a nonprofit organization has its books in order, it can foster and maintain its trustworthy reputation. This can help the organization remain a vibrant and healthy organization for decades to come, allowing them to fulfill their organizational mission of providing key services or products to individuals either within or outside their community. By understanding some of the common pitfalls, nonprofits can avoid potential accounting headaches that, even in the best of circumstances, often distract a nonprofit organization from its primary mission, both in terms of time and unexpected costs.
Mistakes to Avoid
1. No internal review procedures or control policies
To maintain trust with donors and other organizations, it is important to create internal control policies and institute regular internal reviews to both deter and catch any fraudulent activity. Implementing policies over internal control can set an appropriate tone at the top and avoid control issues in the future. Having a public mission statement and an official code of ethics statement can also help show employees what is expected of them. These statements also display to the public, the board of directors, and donors, that transparency, trust, and ethical behavior is of primary importance to those managing the nonprofit organization.
2. Missing or misreporting in-kind contributions
Following correct accounting practices means recognizing the fair market value of goods and services (in-kind donations), both in terms of revenue and expense. However, in-kind services need only be recorded if they consist of a specialized skill such as services donated by a lawyer, an accountant, or an IT professional.
3. Mishandling conditional contributions
If a contribution is conditional, it should not be recorded until the condition has been resolved. If cash is received prior to the condition(s) being met, the cash contribution should be recorded as a refundable (cash) advance. This is per the Clarifying the Scope and the Accounting Guidance for Contributions Received and Contributions Made (ASU 2018-08) update, issued by the Financial Accounting Standards Board (FASB).
In addition, nonprofits should closely examine any contribution agreements they have to ensure the agreement(s) do not contain any conditions. Also, keep in mind the difference between “conditions” and “restrictions.” An unconditional contribution may or may not have donor-imposed restrictions.
4. Not acknowledging donor restrictions
If a contribution does have donor restrictions, in other words, contributions given for a specific purpose, they must be labeled as such. If a contribution that does have donor restrictions is not spent within the year it was given, it should be classified as a net asset with donor restrictions at the end of the year. Nonprofit organizations should keep track of these types of contributions to ensure the funds are used and recorded properly.
5. Inappropriate allocation of functional expenses
It is possible to have certain expenses allocated across multiple categories; however, a nonprofit organization must have a rational method for these types of allocations. Expenses pertaining to obvious functional categories such as fundraising, program, or general and administrative should be allocated only to their respective categories.
6. Mistakenly recording expenses in the wrong period
When a product is accepted or service is provided to a nonprofit, any related expenses should be recorded in the period in which they were received. In the case where services are provided over a period of time rather than all at once, nonprofits should spread the amount associated with the services over the period of time. For example, if a nonprofit has an annual contract with a lawyer, they should refer to the annual contract to determine how to appropriately rate their services over the course of a year.
If a nonprofit organization provides a grant to another organization, and there were no conditions associated with receiving the grant by the grantee, the transaction should be recorded in the period the grant agreement was signed, even if the grant agreement spans more than one year.
7. Incorrectly attributing contributions to the wrong period
Finally, it is important to consider the period in which a contribution should be recorded. Some nonprofits receive multi-year pledges. Often times, nonprofit organizations will record the contribution as revenue in the period the cash is received. In these situations, the contribution should be recorded in the year the initial pledge is received as long as there are no conditions.
It is also important to consider whether a contribution is truly a contribution or whether it is an exchange transaction. An exchange transaction is where two parties both receive a commensurate value in a transaction. These types of reciprocal transactions are recorded as deferred revenue when they are received. On the other hand, a true contribution is a non-reciprocated transaction where the resource provider does not receive any direct benefit. When the pledge is received, the nonprofit will record the transaction directly to revenue.
If you want to ensure your nonprofit organization is up-to-date and complying with all accounting standards for nonprofits, we can help. Please contact us today to schedule a consultation.