The Simplified Guide to Not-for-Profit Accounting, Formation, and Reporting

Laurence Scot

• Publisher: Wiley
• Year: 2010
• ISBN:
  9780470626474
• Edition: 1
• Topic: Business
• Subtopic: Nonprofit Organizations & Charities
• Index: Business

A complete and easy to understand guide to the fundamentals of how not-for-profit organizations are formed and run, as well as their structure and the unique accounting and reporting issues they face.

Providing you with a comprehensive understanding of how to maintain the "books" of a typical nonprofit entity and comply with numerous reporting requirements, The Simplified Guide to Not-for-Profit Accounting, Formation & Reporting equips you with everything you need to know to form a Not-For-Profit, setup an accounting system, record financial transactions and report to donors and regulatory bodies.

Topics include:

• Step-by-step guide to forming a Not-For-Profit and applying for tax exemption
• Becoming familiar with unique Not-For-Profit accounting rules such as classifying contributions/grants and recording restrictions, allocation of expenses to programs and supporting services and investment classification and reporting
• Budget development, payroll processing and accounting for personnel costs
• Shows how to prepare and understand required Not-For-Profit financial statement and their components
• Provides you with a broad understanding of the numerous filing requirement required by donors, grantors and government regulatory agencies

Practical and comprehensive in scope, The Simplified Guide to Not-for-Profit Accounting, Formation & Reporting offers a wealth of practical information to accountants and non-accountants alike for understanding Not-For-Profit financial transactions, financial statements and the many internal and external reports they must prepare.

CHAPTER 1

Introduction

Most textbooks define not-for-profits (NFPs) as organizations exhibiting a certain set of characteristics different from a commercial enterprise. If a more descriptive definition was needed, one could say an NFP organization is a legal entity or group formed for some purpose other than to make a profit and not owned by any one or more individuals or entity. NFPs do not have owners, shareholders, or partners who derive a return or income from their investment. Instead there are individuals entrusted with the responsibility of ensuring that the entity accomplishes its purpose for being in existence, otherwise known as their mission. These responsible individuals are known as the board of directors or the board of trustees. If you ask any large group of individuals to give a short description of an NFP organization, the most typical answers would be that it is an organization that performs a service to society, receives tax deductible contributions, and doesn’t pay any income taxes. Although this is true for many NFP organizations it is much too simplistic and doesn’t do justice to the myriad of different activities that NFPs engage in today, nor to the fact that not all NFPs can receive tax-deductible contributions or are exempt from paying all taxes. There is also a lot of confusion regarding terminology used to describe these noncommercial-type organizations, and many terms are used interchangeably. Terms like NFP, nonprofit (NP or NPO), exempt organization, public charity, and foundation. However, there are some technical differences and reasons why one term is preferable or appropriate over others in some instances.

Definitions

Not-for-profit vs. nonprofit: The term nonprofit is probably the oldest and most widely used term. However, it doesn’t accurately describe this unique type of organization because it implies that there isn’t or shouldn’t be any profit. That is to say, either the receipts coming in equal the disbursements going out (i.e., zero net profit), which is very difficult to achieve in reality, or the expenses going out exceed the revenue coming in (i.e., net loss), which would put an organization out of business if experienced on an ongoing basis. A number of years ago, the term not-for-profit started to be used by the accounting profession’s rule-making bodies because it better described the operations of noncommercial entities. Simply put, the term means an organization that is not in business to make a profit but is in existence for some other purpose. That doesn’t mean (and it shouldn’t mean) that it can’t take in more than it spends because, through simple arithmetic, if the pluses don’t exceed the minuses the organization won’t be able to exist on an ongoing or going-concern basis for any length of time.

Exempt Organization: Not-for-profit or nonprofit status is a state law concept and one must apply within a state to receive this status. This status makes an organization eligible (key word eligible) for certain benefits, such as exemptions from federal and state income tax and state sales and property taxes, but it doesn’t guarantee it will receive those exemptions. Although most NFPs are exempt from paying taxes, not all are. The agency empowered with the authority to grant tax exemption is the Internal Revenue Service (IRS). After registering as a not-for-profit organization at the state level, a lengthy application must be submitted to the IRS requesting tax exempt status.

Public Charity and Foundation: A public charity is a special type of NFP that is exempt from income taxes under the Internal Revenue Code section 501 (c)(3) and signifies that the organization receives most of its support from the public instead of from a small group of individuals. A public charity differs from a private foundation in that a foundation receives most of its funds from a small number of individuals or entities such as from one family or corporation. Its primary activity is the making of grants to other charitable organizations and individuals, rather than operating charitable programs. When an organization applies for exempt public-charity status but doesn’t meet the public test, it is classified as a foundation. The application process to be an exempt organization (public charity, foundation, or other) will be explained in more detail later in the Chapter 2.

Unique Characteristics and Types of NFPs

In addition to the general characteristic of NOT being in business to make a profit, not-for-profit organizations have a number of other characteristics that distinguish them from a typical commercial entity. The most widely known is their exemption from paying taxes. The allowance can include exemption from paying federal, state, and local income tax, sales tax, property tax, utility tax, and many other types of taxes and fees. However, as will be explained later in this book, not all NFPs are exempt from paying all taxes.

Another widely known characteristic of NFPs is their ability to receive tax deductible contributions from an individual or entity that isn’t getting something in return of equal or greater value. Can all NFPs receive tax-deductible contributions? No. Only those recognized and classified as a certain type of exempt organization by the IRS qualify, such as public charities and private foundations. The justification for the deduction is to provide an incentive for supporting the activities of private organizations that provide a valuable and needed service to society. Other types of NFPs such as membership organizations and civic leagues generally can’t receive tax-deductible contributions.

There are even differences in the maximum amount of contributions that an individual or corporation can deduct from their taxes based on the type of NFP organization they give to. For example, the tax code currently allows an individual to deduct up to 50 percent of their adjusted gross income (AGI) for contributions made to a public charity but typically only up to 30 percent of their AGI if their donations are made to a private foundation.

Other typical characteristics that distinguish NFPs from commercial enterprises include the following:

Administrative/Employment-Related

• Not concerned with serving the interests of owners, partners, or shareholders but rather serving the competing interests of many external parties such as donors (individual, corporate, and foundations), government granting agencies, other NFP organizations (contributors, affiliates), regulatory agencies (IRS, state, local) and the general public.

• Role of the board of directors—NFP boards play a much more active role in the day-to-day activities of the organization and many times assist management with various programs and events.

• Board compensation—Board members don’t usually get paid for their duties and conversely are often expected to make contributions or assist in raising funds through events or other fund-raising activities.

• Budget development and utilization—Most successful organizations use budgets to control costs. With NFPs, budgets are used not just to control costs but also to obtain government and foundation grants, to meet restrictions imposed by donors, and, by way of transparency, to show their board and external parties that they are prudent with their funds and other assets.

• NFPs receive many free services from volunteers who help with administrative duties, programs, events, activities, and so forth. Imagine a bank asking people to work as bank tellers for free!

Accounting and Reporting Related

• Tracking contributions by restrictions (unrestricted, temporarily restricted, and permanently restricted).

• Tracking and reporting contributed services and facilities.

• Tracking and reporting expenses by function (e.g., program, management).

• Accounting for investments on a fair market value basis instead of cost basis.

• Allocating and accounting for joint costs and direct costs related to fund-raising activities

• Most nonpublic small to medium-size commercial enterprises don’t have their financial statement audited by a CPA. NFPs on the other hand are required by many states to have an independent audit performed if they exceed a certain level of support (e.g., New York requires a financial audit if revenues exceed $250,000).

• NFPs receiving federal grants are required to have a specialized audit (in compliance with Office of Management and Budget A-133) performed if their grant expenditures exceed $500,000.

• Many NFPs are audited by government agencies, foundations, and other NFPs who provide them with donations and grants.

• Providing increased transparency and disclosures in financial reporting.

Types of Not-for-Profit Organizations

When most people think of a typical NFP organization, they envision a public charity that performs some public service like the Salvation Army, Goodwill, United Way, Boy Scouts, and so on. It is not generally known that there are many different types of NFPs and, depending on the type, they have different reporting requirements and are eligible for different tax and other exemptions. There are many different ways to group NFP organizations such as by activities, revenue source, asset size or number of employees, local, national, or international operations, and so forth. The most prominent and accepted classification basis is the one used by the IRS to determine an organization’s tax-exempt status as categorized by an Internal Revenue Code section. The IRS has a publication (Publication 557—Tax-Exempt Status for Your Organization) that lists 27 major categories (501(c)(1) to 501(c)(27)) and numerous additional categories and subcategories.

The most widely known Internal Revenue Code section is the 501(c)(3). This is the code section for public charities and there are many different types, performing many different functions such as:

• Charitable (food, clothing, shelter, financial support)

• Religious (church, synagogues, mosques)

• Educational (elementary through high school, colleges and universities)

• Scientific, research, and literary

• Museums and performing arts (opera, ballet)

• Health and welfare (hospitals, drug treatment, counseling)

• Prevention of cruelty to children or animals

• Amateur sports

Other common categories of NFPs listed by code section are: 501(c) (4)—civic leagues, local associations of employees; 501(c)(6)—membership organizations, business leagues, chambers of commerce, real estate boards, and economic development; and 501(c)(7)—social and recreation clubs. There are many other categories including political groups, cemetery companies, mutual insurance companies, and so on (see Appendix A for a complete list).

CHAPTER 2

NFP Organization Formation

Many NFP organizations are started by one or more people who have an idea that they believe will enrich people’s lives in some beneficial or productive way, either individually or in groups, and can benefit communities, towns, cities, states, society domestically or internationally, or affect the whole planet (e.g., global warming). Because the idea consists of something that will be ongoing, as opposed to a one-shot activity, they need to create an entity to convert this idea into a reality. The entity that would be created is an NFP whose business goal is to create products or services that have some benevolent purpose and not exist simply to generate income and maximize profits.

There are numerous ways of creating and building a successful NFP organization, and there is no one absolute or perfect method. That being said, the author believes there are certain fundamental steps that should be taken to increase the chance that the outcome will be successful.

How Does One Start an NFP?

The first step after envisioning your idea is to create a name for your organization. Like any commercial business, the name should be descriptive of the entity’s mission but not so long that it becomes cumbersome. For example, The Society for the Advancement of People Who Believe in Peace on Earth and Brotherhood of All Mankind is a tad too long. A much better name would be EarthPeacePeople (maybe not perfect, but you get the idea). For purposes of this book, the author has created a fictitious organization called Job Training Now, Inc., or JTN for short.

After creating the organization’s name, the next step is to develop a plan of how the organization will achieve its goals. The plan will be the result of answering the 4W-H questions:What, How, Who, When, and Where. This plan is similar to what is known in the business world as a business plan. It doesn’t have to be a formal, 40-page, bound document with color financial projections, but it should be documented in writing to provide the creators with direction and clarity. It doesn’t have to cover every conceivable and possible situation but should cover the basic goals of the new organization to provide a guide to move forward.

The first question to be answered is the What question. What programs or major activities will the organization perform? In the case of our fictitious organization, JTN, the two major programs will be simulated on-the-job training and corporate on-site training. Next, how will the programs or activities be performed and how will support and revenue be obtained? If prioritization was required, the How question should be the first to be addressed before moving on. Too many times NFPs with great missions are created without first determining how support will be obtained only to end up closing up within a short period because of a lack of funds. In JTN’s case, the creators believe they can obtain funding from government grants and program fees earned from corporate customers.

The next question to be answered: Who will perform the programs and manage the organization. In many startup situations the creator of the organization...

Table of contents

• Praise
• Title Page
• Copyright Page
• Preface
• CHAPTER 1 - Introduction
• CHAPTER 2 - NFP Organization Formation
• CHAPTER 3 - NFP Organizational Structure
• CHAPTER 4 - Introduction to NFP Accounting and Reporting
• CHAPTER 5 - NFP Accounting System and Financial Statements
• CHAPTER 6 - Assets—Concepts and Data Flow
• CHAPTER 7 - Liabilities and Net Assets—Concepts and Data Flow
• CHAPTER 8 - Accounting for Support and Revenue
• CHAPTER 9 - Accounting for Personnel Costs and Other Expenses
• CHAPTER 10 - Investments, Pooling, and Split-Interest Agreements
• CHAPTER 11 - Subsidiaries and Interrelated Entities
• CHAPTER 12 - Budget Development and Applications
• CHAPTER 13 - Special Types of NFP Organizations
• CHAPTER 14 - Regulatory Reporting (990, 990-T, and 990-PF)
• CHAPTER 15 - Contribution/Grant Applications and Reporting
• CHAPTER 16 - Audits—Preparation and Response
• CHAPTER 17 - Conclusion
• APPENDIX A - Tax-Exempt Organization Reference Chart
• APPENDIX B - Sample NFP Chart of Accounts
• APPENDIX C - Abbreviations
• Glossary
• About the Author
• Index