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Non-Profit Organizations - What Are They?
Fund; Assets; and Fund Balance
According to the “Financial and Accounting Guide for Not-For-Profit
Organizations” written by CPAs Gross, Larkin, Bruttomesso, and
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, and 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, but has no other significance.
Fund balances do not exist except on paper; unlike assets, they
have no intrinsic value and cannot be spent. Both assets and fund
balances (as well as liabilities, revenues, and 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, but 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, but 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
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 and one
in twelve Americans work for a non-profit. That’s big business
and 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, but 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,
and 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 and 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 and trade
organizations, and many more. Governmental organizations such
as communities and agencies are also non-profit organizations,
however, their accounting and 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 and size of the organization.
For instance, a Little League baseball organization may only have
one fund for which they have to account. They also 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
and governmental grants or contracts, private donations, sales
of research documents, some of it restricted to specific expenditures
and the rest unrestricted. The accounting challenge is to report
the revenue and expenses accurately for each fund or project and
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
and unrestricted and 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, but for
external reporting purposes you are required to disclose your
restricted and 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 and expenses, etc., and 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 and 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, and 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 and 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 3 e-books pertaining to small business accounting
and his monthly newsletter on accounting issues. Ask John questions
directly on his Accounting for Non-Accountants blog.
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