Non-Profit Organizations - What Are They?
John Day
Definition of 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 granted.
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.com
to 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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