Last Updated on November 13, 2023 by Hina Rubab
Accounting matters a great deal for charities. Properly documenting the transactions and providing accurate financial statements can be challenging. This blog post will discuss how to account for donations, what their purpose is, and other important information that nonprofits should know about accounting.
In order to show donors the impact of their contributions, it is essential that organizations provide accurate reporting on how funds are spent. In this blog post, we’ll explore why proper documentation is so important and some best practices when it comes to accounting for donations in an organization’s nonprofit financial statement.
More information on Charity accountancy services can be found on the Financial Accounting Standards Board (FASB) website at https://fasb.org/
Table of Contents
Why is proper documentation important?
Donations are one of the most popular ways donors support nonprofits. Nonprofits should account for donations in their financial statements.
For a nonprofit to receive a donation, they need to have a legal agreement with the donor that defines what is being given and how it will be used. The terms of the gift should be recorded in writing or contract form. Once these steps are completed, nonprofits should include the amounts received from donations on their financial statements.
How do you account for donations?
Nonprofits can receive or exchange numerous types of property for their programs. Each type of donation should be accounted for in a different manner. The fundamentals are the same, but there are important differences between the accounting methods used to account for donations that you should keep in mind. Common examples include returned cash donations, goods, and services donated as a charity, capital assets received as a gift, and donated land.
In Generally Accepted Accounting Principles (GAAP), cash donations should be recorded at the time of receipt as an increase in unrestricted or temporarily restricted net assets, depending on how you plan to use the money. For example, if you receive $200 for your charity’s general fund or for one of its projects, it should be recorded as an increase in generally unrestricted net assets. On the other hand, if you receive a $200 cash donation specifically for your new microfinance project, which is temporarily restricted by the donor’s request, this amount should be recorded as a temporary reduction in expenses.
In charities and tax-exempt organizations (such as churches), the financial statements are audited each year by independent certified public accountants (CPA) for the Internal Revenue Service, who verify that the numbers add up. The audit report should be attached to your financials as an appendix.
Other Financial Documents
Besides a Balance Sheet and Income Statement, you may also want to include other important documents such as:
- A statement of cash changes, which is primarily used to report the cash flow between two specific dates in a given year. In this document, net cash inflows (i.e. proceeds from donations) are reported as positive amounts; net cash outflows (payments for expenses) are reported as negative amounts, and expenses paid from the organization’s own funds are reported as zero amounts. The net cash outflows can be broken down by category and sub-category, similar to how it is done on the balance sheet.
- A report of changes in fund balances (or “Ending Fund Balances”), which shows the ending balance for each asset and liability account from a given date in the previous year. The ending fund balances are often shown with net assets as a percentage of beginning fund balances (using the same accounting basis) and total cash inflows for the entire period, which can be used in a financial ratio analysis to determine if the organization is using its resources effectively.
- A statement of sources and application of funds, similar to a statement of cash flows, which reports the sources and uses of funds for the entire year. It includes all inflows and outflows that occurred during the fiscal period, with some methods classifying certain items as one-time transactions while others classify them as recurring or nonrecurring (usually the latter).
- A statement of functional expenses, which provides a detailed breakdown of an organization’s expenditures for each major function or program (e.g., education, research, etc.).
- A statement of activities and accomplishments, which documents what the organization accomplished during the year in terms of its stated goals and objectives for that year. It is similar to a report on the organization’s operations but focuses on actual results rather than performance in relation to goals.
- A statement of assets and liabilities details an organization’s current balance sheet (assets versus liabilities).
- A statement of cash flows, which documents sources and uses of cash during the fiscal period
- Income statements for component units of a not-for-profit corporation will also be required to show whether the organization conducted its activities with non-arm’s length entities, and if so, how it dealt with transfer pricing.
- A statement of changes in equity that documents the sources and uses of funds during the fiscal period for an organization that has issued shares (the equity section of the statement must describe all transactions with owners, including capital and non-capital contributions).
- A statement of cash flows that documents sources and uses of cash during the fiscal period for an organization that has not issued shares may be required at a minimum to show whether it had arm’s length transactions (and if so, how it dealt with transfer pricing).
- An analysis of the profit for an organization that has issued shares, which in most cases includes a detailed description of the related parties with whom the business was transacted and how transactions or claims were brought to closing amounts (including a description of any adjustments made and justifications included).
- A financial statement signed by authoritative management drawn from sources that are believed to be accurate and reliable.
- The details of an organization’s cost of capital, including a discussion on capital structure decisions, the factors considered in allocating equity between limited partners and general partners, and how the amount of equity was determined (if, for example, it is equal to or greater than 10% of the total capital to be committed).
- A description of the organization’s governing body, its legal structure (including any agreements among partners), and the nature and extent of member participation in the day-to-day management or operation of the business.
- A description of how an organization will identify and resolve disputes arising between it and its lenders, investors, or sponsors.
- Suppose the organization will rely on others to provide any goods or services. In that case, a description of past performance and experience with those entities is required and the criteria for choosing such entities (for example, qualifications that will be used).
- A copy of the statement(s) that registered limited partnerships have to make on their websites, pursuant to section 4-108(a) of the Business Corporation Law.
- A copy of the statement(s) registered limited liability companies must make on their websites, pursuant to sections 302 and 303 of the Limited Liability Company Law.
- Any additional information is necessary to demonstrate how an organization, plan, or other arrangement is qualified as an eligible organization and how the community shares are exempt from Federal income tax.
- A copy of each contract, agreement, or another instrument pursuant to which a community share will be issued, including the voting rights attached to such community share. The application should also include copies of any contracts pursuant to which the organization, plan, or another arrangement will be compensated for services rendered.
- Disclosure of the relationship between any person and the issuing entity consists of an officer/director of a corporate applicant, a shareholder with 10% or greater ownership interest in the entity, or any individual receiving compensation from the entity over $10,000 per year.
- Copies of all solicitations, advertisements, and other materials to be used in connection with the offering or sale of community shares.
- A detailed description of how proceeds from a proposed offering will be utilized, including but not limited to the following:
a) A detailed list of specific projects which the proceeds will finance;
b) The exact location of each project;
c) Describe how each project will benefit the applicant and its residents. Staff should have reasonable assurance that any funds to be expended by the community entity will not be used for personal expenses other than compensation or reimbursement allowed under Bylaw 12.08.020(C)(8).
The information in this blog post should help you understand the importance of accounting for your donations. When you look at all these tips and tricks, it is clear that proper documentation can be a difficult process. However, understanding how to do so will make it simpler and easier for yourself and your organization’s finances. We hope this blog post has given you some valuable insight into what nonprofits need to know about accounting and encourages people like Marandi can donate with ease of mind.