What Are Functional Expenses? A Guide to Nonprofit Accounting

Katie is originally from Indianola, Iowa and received bachelor’s… Page 5 includes other IRS compliance considerations and will alert the IRS to other forms that may be required to be filed such as 1099s or W-2s.

Nonprofit organizations have the unique opportunity to report their Statement of Cash Flows using either the direct or indirect method. The method chosen should be the method that is most user friendly for those reading the financial statements.

Balance Sheet vs. Statement of Financial Position

For example, salaries and benefits expense may be based on estimated time and effort spent in each category, while rent expense may be based on square footage used. There is no one required way to allocate costs, but typically time and effort estimates are the most readily available and can be used to estimate allocations for multiple expenses. There may also be expenses that are direct program, general and administrative, or fundraising expenses and those should be reported as such. It must also show the change in net assets for both net assets without donor restrictions and net assets with donor restrictions along with a total change in net assets. Because net assets with donor restrictions are not available until released, the Statement of Activities will never show expenses of donor restricted amounts. Instead the amounts show as a release of restriction with the qualifying expenses showing as a change in net assets without donor restrictions. Expenses may be shown by nature or by function or both in the Statement of Activities.

Non-profit and for-profit businesses have many similarities, but they also differ in specific areas. For-profit businesses report to shareholders and investors, whereas non-profits report to a Board of Directors or other governing authority. When it comes to bookkeeping for non-profits, many of the processes remain the same as in the for-profit world; however, differences in terminology will apply when managing a charitable organization’s books. If the net income is positive, that means the organization is making more money than it’s spending. It means the organization is doing well and is able to continue its operations. You will note that this report does not include the activity for the current month alone or a current month budget.

Statement of Activities and Changes to Net Assets

We’ll help you determine if outsourcing your accounting and bookkeeping is the right decision for your organization. But if you’re spending more than you bring in for several periods in a row, you’re headed for trouble.

In the example shown below, FAN receives a three-year, $60,000 grant to support a new program for the years 2018, 2019, and 2020. When the award letter is received, FAN records the full $60,000 as grant income With Donor Restrictions on the income statement. A portion of the grant will be released from restriction https://www.bookstime.com/ in each year of the three-year grant period. The sample income statement for 2018 shows $20,000 being released from restriction, while the remaining $40,000 remains in the With Donor Restrictions column. The same release of $20,000 will occur in future years two and three of the grant award.

Change in Net Assets: How much money did you make?

For this reason, it is strongly recommended to report restricted dollars separately, and to pay particular attention to the unrestricted amounts when planning and making operational decisions. In addition, directors and managers need adequate training to understand the nuances of restricted funds that present financial management challenges unique to nonprofit organizations. As opposed to an Income Statement which shows a profit or loss, the Statement of Activities instead shows a positive or negative change in each net asset fund. In the example above, you will see that the amount statement of activities of temporarily restricted revenue collected during the reporting period was less than the expenses incurred using temporarily restricted funding . Thus, there is a drop in the ending balance of the temporarily restricted net assets. Individuals used to reading for-profit financial statements typically consider this a “loss”; however, nonprofits are not in the business of making a profit , thus this is an incorrect assumption. Instead, the financial statement is showing that the organization expended some of the net assets that were obtained in a prior financial period.

• It’s one of the core financial statements that all nonprofits need.
• The accounting requirements for restricted funds can be managed in a few different ways, depending on the accounting software being used and the sophistication of the chart of accounts.
• The following examples – an income statement and balance sheet for the fictional nonprofit Family Advocacy Network – illustrate how these rules work.
• We recommend getting in touch with an accountant to help with these activities.
• Gains and losses affect the net assets without donor restrictions unless their use is explicitly restricted by the donor.
• In a non-profit organization, the statement of activities is used in lieu of an income statement.

These payments may have been made with cash, credit, or even through in-kind donations. A donor could give a single donor that is to equally be split across 3 years. We consider that there is a time restriction on the funds allowing only 1/3 of the donation to become unrestricted in a given year. Below is a general format for a Statement of Financial Activities recommended for internal reporting purposes. The report for your organization would include more detailed line items in each category, but the objective would be to keep the report at one page in length, although narrative explanations may flow to a second page. Your nonprofit Income Statement shows the year-over-year income and spending trends. And how those expenses relate to the work of carrying out your mission.

Expenses

Disregarding the importance of a budget or neglecting to regularly review financial statements is one of the most common mistakes made by nonprofit organizations. When a budget is compiled, it lays out the annual plan for the organization in terms of the money spent, but also the money received. Regular review of the budget and actual financial reports can give leadership the insight they need to make changes when necessary before finances have gone too far off course.

• Functional expense allocation is the process by which a nonprofit organization’s accountant or bookkeeper classifies each expense by its functional classification.
• Page 2 of the Form reports on the mission and programs of the Organization for the year.
• Even if you are not the one preparing financial statements, this overview should give you a good idea of what they entail and why they are important.
• The release shows as a negative number on the “Released to Unrestricted” line and is added as a positive number within the natural income category, for instance foundations or government grants.
• Because net assets with donor restrictions are not available until released, the Statement of Activities will never show expenses of donor restricted amounts.
• The Cash Flow Statement includes total cash received minus total cash spent.

Net assets without donor restrictions that are designated by the board for a specific use should be disclosed either on the face of the financial statements or in a footnote disclosure. As noted earlier, net assets denote the value of the organization. Thus, if the organization had to close its doors, those unspent funds held that were restricted for use would have to be returned to the donors since the organization did not earn them. The basics focus on understanding the financial statements and how to prepare them. Nonprofit organizations must file annual reports with state authorities. Not only does this statement help nonprofits gain a snapshot view of their overall financial health, but it can also be the basis of additional calculations to provide more insight.

That means your revenue will also include any donations pledged in the period and any receivables . A nonprofit statement of activities example will have a heading, body, and bottom line.

Page 3 and 4 are checklists noting which additional schedules may be required. As a board member it is important to know and understand the additional schedules that may be required to ensure you are meeting your fiduciary responsibility. These schedules are lettered A through R and should be attached if indicated here. Hill, Barth & King LLC has prepared this material for informational purposes only.