By Monika Briggs, CPA

This blog is part five in a series designed to guide CPAs through the nuances of nonprofit compliance. Each entry in this foundational series delves into critical aspects of nonprofit management, equipping CPAs with the tools and knowledge needed to confidently support organizations in this sector. Thus far, we’ve explored nonprofit status and tax exemption in "What Every CPA Needs to Know about Nonprofit Status," the intricacies of IRS and federal compliance in "What Every CPA Needs to Know about Federal Filing Requirements," state-level obligations in "What Every CPA Needs to Know about State Regulatory Compliance," and most recently internal governance in "What Every CPA Needs to Know about Governance and Board Oversight." Now, we turn our attention to financial reporting and fund accounting, both essential to nonprofit compliance and transparency.

Nonprofit organizations face unique challenges in financial management, from navigating donor restrictions to ensuring compliance with specialized reporting standards. To maintain the trust of their stakeholders and demonstrate effective stewardship, nonprofits must balance transparency, accountability, and mission-driven goals. This blog explores the critical components of nonprofit financial reporting and fund accounting, including the specialized standards set by FASB ASC 958, the presentation of financial statements, net asset classifications, and fund accounting fundamentals. We’ll also discuss best practices for managing donor restrictions, leveraging technology, and addressing common challenges to support compliance and transparency.

Financial Reporting Standards for Nonprofits

Nonprofits require accounting principles tailored to the complexities of their funding and operations. Adherence to Generally Accepted Accounting Principles (GAAP) ensures that nonprofit organizations maintain transparency and consistency in their financial reporting, building trust with donors, stakeholders, and regulatory bodies.

While nonprofits follow the same GAAP framework as for-profit organizations, they must also adhere to additional guidance designed to reflect their unique funding and operational models. These standards, established by the Financial Accounting Standards Board (FASB), promote accountability and transparency specific to the nonprofit sector.

Central to nonprofit reporting is FASB’s Accounting Standards Codification (ASC) 958, Not-for-Profit Entities, which provides guidance tailored to nonprofit organizations. ASC 958 establishes principles for presenting financial performance and position in a way that aligns with the nonprofit’s mission, donor intent, and diverse funding sources.

It’s important to understand that nonprofit organizations are required to follow all applicable provisions of the ASC, unless a specific provision explicitly exempts nonprofits or the subject matter of the provision precludes applicability. For nonprofits, compliance with GAAP means applying the same foundational principles as for-profits while integrating industry-specific guidance outlined in ASC 958.

ASC 958 provides incremental guidance tailored to nonprofit entities, but it does not function as a standalone framework. Nonprofits are expected to adhere to all relevant topics within the ASC that do not conflict with ASC 958. For example, guidance on revenue recognition, leases, or investments applies to nonprofits, unless specifically exempted. In this way, ASC 958 serves as a complement to GAAP rather than a substitute, addressing areas such as donor restrictions, contributions, and fund accounting.

Financial Statement Presentation for Nonprofits

The distinct nature of nonprofit organizations – mission-driven rather than profit-driven, with unique funding sources and donor expectations – necessitates a specialized approach to financial statement presentation. Unlike for-profit entities, nonprofits must adhere to reporting standards that prioritize transparency, accountability, and alignment with their mission.

To meet these unique needs, nonprofits must prepare and present the following financial statements, each tailored to the nonprofit context:

• Statement of Financial Position – Similar to a balance sheet, this statement provides a snapshot of the organization’s financial health at the end of the reporting period. Key elements include assets, liabilities, and net assets divided into two categories – with and without donor restrictions.
• Statement of Activities – Similar to an income statement, this presentation reflects the organization’s financial performance over the reporting period, showing changes in net assets. Key components include revenue, expenses, and changes in net assts.
• Statement of Cash Flows – This statement details how cash moves in and out of the organization, segmented into operating activities, investing activities, and financing activities.
• Statement of Functional Expenses – In addition to the financial statements listed above, ASC 958 requires nonprofits to disclose detailed expense information in a single location. Expenses are categorized in two ways:
      – By Function: Program services, management and general, and fundraising.
      – By Nature: Salaries, rent, supplies, etc.
  This dual presentation underscores the nonprofit's efficiency and alignment with its mission. The expense information can be presented on the face of the statement of activities, in a schedule in the notes to financial statements or as a separate financial statement (mandatory for some organizations).

Accompanying Notes to the Financial Statements – Nonprofits are subject to the same note disclosure requirements as any business enterprise; in fact, ASC 958 specifies notes to the financial statements are an essential component of a complete set of nonprofit financial statements. These disclosures provide transparency and context to the financial data, ensuring stakeholders have a comprehensive understanding of the organization’s financial activities and policies.

Some nonprofit-specific requirements for footnotes include the following:

• Nature of organization and mission
• Details about donor restrictions and net asset classifications
• Disclosures on the composition of endowment funds, as well as related spending and investment policies
• Policies for recognizing revenue and contributions
• Liquidity and availability of financial resources
• Functional expense allocation methods

Net Asset Classifications: Understanding Donor Restrictions

One of the defining characteristics of nonprofit financial reporting is the requirement to classify net assets based on the presence (or absence) of donor-imposed restrictions. These classifications, unique to nonprofits, are essential for demonstrating accountability, ensuring compliance with donor intent, and providing stakeholders with a clear understanding of the organization’s financial position.

Net assets are classified into two categories: without donor restrictions and with donor restrictions.

Funds without donor restrictions can be used freely by the nonprofit to support its mission and operations. Some examples include contributions not tied to a specific purpose or timeframe or general operating funds generated through program fees.

Funds with donor restrictions must be used for specific purposes, within certain timeframes, or in accordance with other donor-imposed conditions. Common restrictions may include the following:

• Time: A donor contributes $50,000, stipulating it be spent in the next fiscal year.
• Purpose: A grant of $25,000 is given specifically for a literacy program.

Restrictions may be temporary (satisfied by time or use) or perpetual, such as endowments (which I’ll explore in a future installment of this series).

Impact on Financial Statements – Net asset classifications directly affect how nonprofits present their financial position and performance:

• The Statement of Financial Position clearly separates net assets into “without donor restrictions” and “with donor restrictions.”
• The Statement of Activities reports changes in net assets for each classification, providing a transparent view of how funds with restrictions are used.
• The Statement of Cash Flows tracks the inflow and outflow of restricted cash, ensuring donors can see how their contributions are being used.

These classifications ensure stakeholders can easily discern how resources are allocated and whether donor intentions are being met.

Legal and Ethical Considerations – Respecting donor restrictions isn’t just an operational requirement; it’s a legal and ethical imperative. Failure to honor these restrictions can lead to loss of donor trust, reputational damage, or even legal consequences. Nonprofits must ensure robust tracking systems are in place to manage and report on these funds accurately.

Fund Accounting Basics

Nonprofit organizations often manage a diverse range of funding sources, each with its own restrictions and requirements. To effectively track, manage, and report on these resources, nonprofits use fund accounting, a method specifically designed to meet the unique needs of mission-driven organizations.

Fund accounting is a system of accounting that focuses on accountability rather than profitability. Unlike traditional business accounting, which centers on measuring overall financial performance and maximizing profit, fund accounting categorizes resources into distinct “funds” based on their specific purposes or restrictions. The key differences can be seen in purpose and structure:

• Purpose: Traditional accounting aims to track net income and overall financial health; fund accounting ensures resources are used according to donor intent or regulatory requirements.
• Structure: In traditional accounting, resources are pooled and reported as a single entity. Fund accounting separates resources into individual funds, each acting as its own "mini-account" within the organization.

Setup and Structure of Fund Accounts – Each fund in fund accounting represents a self-balancing set of accounts with their own assets, liabilities, revenues, and expenses. Funds are typically classified into the following broad categories:

• Unrestricted funds – General operating funds with no restrictions, such as revenue from membership fees or unrestricted donations.
• Restricted funds – Donor-restricted funds for specific programs or purposes. Examples include a grant for community outreach programs or scholarships.
• Board-designated funds – Unrestricted funds that the board sets aside for a particular use, such as a reserve fund for future capital projects.

Nonprofits often establish highly specific funds to track individual grants or contributions, ensuring that each donor’s or grantor’s requirements are met. For instance, a federal grant for a job training program may be tracked as its own fund to comply with reporting and audit requirements, or a major donor’s gift for a new building project would be assigned to a dedicated fund to monitor construction expenses. The structure enables nonprofits to clearly isolate and manage resources while ensuring compliance with restrictions.

Fund accounting is essential for nonprofits to remain mission-focused while maintaining financial integrity and transparency. It offers several advantages for nonprofits, including improved accountability and transparency to stakeholders, simplified tracking and reporting to meet donor, grant, or legal compliance requirements, and more informed decision-making when leadership understands resource availability by fund, enabling better planning and budgeting.

Best Practices in Managing Donor Restrictions and Fund Accounting

Effectively managing donor restrictions and fund accounting is essential for maintaining donor trust, regulatory compliance, and the organization’s financial integrity. Below are some key strategies, tools, and training recommendations to optimize these processes:

• Develop robust policies and procedures – Establish clear internal policies for accepting, categorizing, and tracking restricted funds. Require documentation of all donor agreements, including specific restrictions, and keep the documentation easily accessible for easy reference.
• Create detailed budgets and plans – Tie restricted funds to specific programs or projects in the budget, and regularly monitor spending to ensure funds are used as intended.
• Regular reporting and reconciliation – Periodically reconcile restricted fund accounts to ensure expenditures align with restrictions. Provide detailed reports to donors and grantors, demonstrating how their funds were used.
• Maintain a centralized fund accounting system – Use accounting software capable of tracking multiple funds and generating reports by donor or grant.

Tools and Software for Fund Accounting and Donor Reporting – Technology plays a crucial role in managing fund accounting efficiently. Nonprofit accounting tools can streamline tracking, reporting, and compliance. Here are a few tools to consider:

• Fund accounting software – Options such as QuickBooks Nonprofit, Blackbaud Financial Edge, or Sage Intacct offer robust fund accounting capabilities, including fund tracking, budget management, and donor reporting.
• Grant management tools – Software like Fluxx or Foundant can help track grant applications, deadlines, and expenditures.
• Donor management systems (DMS) – Tools like Bloomerang, DonorPerfect, or Salesforce Nonprofit Cloud integrate with fund accounting systems to provide a comprehensive view of donor activity and fund utilization.

Importance of Transparency and Accuracy in Financial Reporting

Transparency is at the heart of nonprofit financial reporting. Clear and accurate financial statements not only comply with regulatory requirements but also build confidence among donors and grantors. Stakeholders need assurance that their contributions are used effectively and in line with their intentions. Moreover, accurate reporting helps nonprofits identify areas for improvement, allocate resources efficiently, and plan for long-term sustainability.

By adhering to the proscribed standards, nonprofits uphold their fiduciary responsibility, strengthen relationships with their supporters, and maintain credibility within the broader community. Whether reporting to donors, regulatory bodies, or the public, following GAAP and ASC 958 ensures that the organization’s mission remains at the forefront of all financial activities.

Conclusion

This article explored the critical financial reporting standards and fund accounting practices that help nonprofits maintain transparency, accountability, and donor trust. By adhering to GAAP, implementing fund accounting, and effectively managing donor restrictions, nonprofits can ensure compliance while demonstrating financial integrity. Embracing these best practices is essential for any organization striving to fulfill its mission and achieve lasting success.

In the next installment I’ll look at donor relations, disclosure, and transparency – essential pillars of nonprofit success. I plan to explore best practices for acknowledging contributions and to delve deeper into the nuances of donor restrictions, including perpetual funds like endowments. The next installment will also examine how finance teams collaborate with development teams to support fundraising efforts and align them with the organization’s mission and goals.

The Essential Nonprofit Compliance Series

May 6 | What Every CPA Needs to Know about Nonprofit Status 
June 3 | What Every CPA Needs to Know about Federal Filing Requirements 
July 15 | What Every CPA Needs to Know about State Regulatory Compliance 
Aug. 19 | What Every CPA Needs to Know about Governance and Board Oversight

Monika Briggs, CPA, is the chief financial officer at the Philadelphia Corporation for Aging in Philadelphia, Pa. She can be reached at monika.briggs@gmail.com.

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^{Statements of fact and opinion are the authors’ responsibility alone and do not imply an opinion on the part of the PICPA's officers or members. The information contained herein does not constitute accounting, legal, or professional advice. For actionable advice, you must engage or consult with a qualified professional.}