Nonprofit Bookkeeping and Accounting For Dummies

Introduction

Counting the money in your wallet or purse is an act of accounting. If you ever make a note of how much you have, you’re even performing a bookkeeping function. You count things all the time in everyday life without thinking twice about accounting. For example, you count the plates before setting the table at home. You count the number of e-mails you receive while you’re out of the office. Even a gesture such as looking at your watch and thinking about how much time you have before your next appointment is a form of accounting.

Bookkeeping and accounting are service activities that involve auditing, tax services, management advisory services, general accounting, cost accounting, budgeting, and internal auditing. Even though your organization is a nonprofit, these services are essential parts of your daily activities. Without them, your nonprofit can’t survive the long haul.

In the wake of increased accountability, understanding how to track and account for the everyday activities of your nonprofit is important. Keeping the books for a nonprofit is exciting. Getting federal grant money to fund your programs relieves financial stress. Getting a clean bill of health from your financial audit adds credibility. I devote this book to all nonprofits that add credibility to the sector by keeping their books in order.

About This Book

Bookkeeping and accounting for an organization involve several fundamental steps. Beginning with a simple transaction such as a donation and ending with financial statements, you go through an accounting cycle of 12 months. The cycle repeats as long as your nonprofit continues to operate. To help you with the normal day-to-day transactions — as well as any sticky situations you may find along the way — I wrote this book for the nonprofit director and manager (as well as the nonprofit bookkeeper and accountant).

Feel free to use this book as a quick reference. It’s designed to help you with everything you need to know to operate your nonprofit according to generally accepted accounting principles (GAAP). It covers information about the steps to file your own payroll taxes and tax information Form 990. It also explains how to account for almost every situation that may come up in your nonprofit.

This book serves as a tool that you can pick up from time to time during your accounting cycle to brush up on the following steps:

1. Your nonprofit enters into a transaction with a second party.

2. You or your employee prepares a business document, such as a sales invoice, that leaves a paper trail.

3. You or your employee records the transaction in the book of first entry, your journal.

4. You post the transaction to the general ledger.

5. You balance the general ledger and prepare a trial balance. Your trial balance tests the accuracy of account (debit and credit) balances.

6. You prepare your financial statements.

This book serves as a reference tool, no matter where you are in the accounting process, by helping you reach your ultimate goal of well-prepared and accurate financial statements.

Conventions Used in This Book

Throughout this book, I use the following conventions to help you find your way:

Every time I introduce a new word, I italicize it and then define it.

Boldface text is used to indicate keywords in bulleted lists or to highlight action parts of numbered steps.

Monofont is used for Web site addresses.

What You’re Not to Read

I understand that you’re a very busy person working in a small- to medium-sized nonprofit. Every day throws different and unique challenges at you. You won’t hurt my feelings if you don’t read every word I’ve written. So if you’re strapped for time, feel free to skip the sidebars (the gray boxes). In sidebars, I include some real-world examples that you can skip — don’t worry, you won’t miss anything essential to understanding my point.

Foolish Assumptions

While writing this book, I made the following assumptions about you, my dear reader. Some may be more relevant than others.

You’re the executive director of a newly formed, small nonprofit, and you want to know how to manage your own books.

You direct or manage a midsize nonprofit and want to understand a little more about how to manage day-to-day operations and take care of your own books.

You’re interested in keeping the books of a nonprofit organization.

You’re interested in bookkeeping and accounting as a profession.

You’ve been performing the functions in this book, but you’re not sure if you’ve been doing them right.

You’re thinking about starting your own nonprofit and want to know how an effective nonprofit keeps track of its bookkeeping and accounting needs.

Finally, I assume you know that you can read this book over and over again and discover something new every time. You can refer to this book as a quick reference whenever you need to know the how-to of managing your financial records for your organization. I assume this book takes the guesswork out of bookkeeping and accounting and provides some peace of mind about how the system is designed and how you can work it to benefit your organization.

After reading this book, I hope you’re confident that you can take care of most of your bookkeeping and accounting needs yourself. At least, you can get a better handle on how your accounting cycle functions.

How This Book Is Organized

This book is organized into five parts. You don’t have to read it from cover to cover; you can dip in for reference at any point that interests you and jump from part to part if you like. I won’t tell anyone.

Part I: Accounting and Bookkeeping Nonprofit Style

This part talks about basic bookkeeping and accounting terminology. You can also find a chapter that helps you understand financial statements. And when you’re ready to get your hands dirty, you can read about record keeping and then decide whether to design your own computer system or use store-bought software.

Part II: Balancing Your Nonprofit Books

This part covers the nuts and bolts of setting up and balancing your nonprofit books. I cover how to set up a chart of accounts, how to record transactions in the bookkeeping journal, and how to make entries in and balance your nonprofit’s checkbook. Balancing your cash flows and planning your budget are two important aspects discussed in this part. If you’re not sure how to stay in compliance with federal nonprofit guidelines, follow the tips suggested here for help.

Part III: Accounting for Nonprofit Situations

I should have named this part Documentation 101 because that’s what the chapters here seem to boil down to. Part III focuses on grants, payroll, and accounting for Form 990, all of which are extremely important for keeping your nonprofit up and running. This part covers information about federal grants management and the grant audit. Everything you need to know about payroll taxes and filing Form 990 also is summarized here to keep you in good standing with the IRS and Uncle Sam. All of these tasks come back to staying organized and keeping a good paper trail.

Part IV: Wrapping Up the Books

Part IV shows you how to create your own financial statements. It also describes the steps you have to take to close one accounting period and prepare the books for the next cycle. Finally, in this part, I cover what you need to do to prepare your books for an audit of your financial statements.

Part V: The Part of Tens

This is the famous For Dummies Part of Tens. You can find out how to keep your books in good standing and how to stay out of hot water with the federal government using the helpful tips in this part. After reading these chapters, you can feel confident that you’re indeed going about your books in the right way.

Icons Used in This Book

For Dummies books use little pictures, called icons, to get your attention in the margins. Here’s what they mean:

Tip.eps This icon highlights techniques or draws your attention to something noteworthy.

Remember.eps This icon highlights important information to keep in mind and points out things you shouldn’t forget.

Warning(bomb).eps This icon points out pitfalls and signals red flags of caution.

truestory.eps This icon points out real-life anecdotes from my years of experience and mistakes.

Where to Go from Here

Like every For Dummies book, each chapter stands alone, so you can jump from chapter to chapter and read whichever ones pique your interest. Glance at the table of contents and go to the topic that interests you. You can read this book in many ways, depending on your needs. If you’re new to the nonprofit arena, start with Part I. If you’re a veteran, I suggest you brush up on some info about filing your tax information in Part IV. Make plans to read the information more than once. You don’t have to remember this stuff; just pull your book out and use it as a reference as you need it.

This book is organized in an order logical to the accounting process, but you don’t need to read it from front to back to gain important insight and wisdom about the tricks of the trade. Feel free to read it cover to cover if you’re just biting at the bit to uncover everything you can about nonprofit bookkeeping and accounting.

Part I

Accounting and Bookkeeping Nonprofit Style

In this part . . .

Before you can dive into the pool of nonprofit bookkeeping and accounting, you have to be familiar with basic accounting terminology and financial statements. After grasping the fundamentals, you can account for your nonprofit activities. You may want to use a manual record-keeping system, or you may opt for a sophisticated computerized system instead. Which style you use doesn’t matter as long as you understand the mechanics of the trade.

As you put your toes in the water, you may be asking yourself a few questions: What is a debit? What is a credit? What is an asset? How do I begin keeping my accounting books in order? This part helps you answer these early questions and gives you a basic understanding of the bookkeeping and accounting processes you need to master to get an approved audit.

Chapter 1

The Nuts and Bolts of Nonprofit Bookkeeping and Accounting

In This Chapter

Getting an overview of bookkeeping and accounting

Performing a balancing act with your books

Hitting up Uncle Sam for some free money

Closing the year with financial statements

Your accounting year indicates the beginning of your accounting period and the end of your accounting period. This period may reflect the calendar year from January to December or some other 12-month period. If you use the calendar year, then the first transaction after January 1 starts your accounting cycle, and your last transaction on December 31 ends the cycle. You compile your financial statements after the cycle ends, get your financial statements audited, and start the cycle over again. It always feels good to finish something, doesn’t it? If you start with the end in mind, you have audited financial statements that summarize your accounting activities for the accounting period.

Now more than ever people are calling for accountability in the world of nonprofits. Long gone are the days when you can assume that your stakeholders will just take your word that you’re successful at your mission and are spending their donations wisely. People want to see proof — cold, hard numbers in black and white. So you must dot every i and cross every t in your day-to-day operations.

Being accountable for your nonprofit requires that your books adequately reflect your activities. You need sound financial management by qualified individuals to keep your head above water. I wish you could focus only on your programs and the people whom you help, but you need a penny pincher and a number cruncher to keep up with the money coming in and going out. This chapter serves as a jumping off point into the world of nonprofit bookkeeping and accounting and touches on the important concepts. Throughout this book, I then dive deeper into these topics.

Getting Started with Your Nonprofit’s Books

Before you can fully get going with your books, you first need to know where to begin. Start by identifying your destination: to have audited financial statements. You begin with a journal entry of a transaction, in which you record the exchange of something (money or time) for something else (products or services). Every financial transaction creates a record or document to support its occurrence. For example, if you buy a pen, you either give up cash or add to your charge account.

Tip.eps Adapting the habits of a packrat isn’t a bad idea when it comes to keeping up with your paperwork. Hold on to every receipt and record it in the proper location by posting to the right accounts. The central location of most transactions starts with your checking account in which you make deposits from donors and write checks to pay the bills. The key to properly tracking your steps starts with your checkbook. (Check out Chapter 7 for more on getting a checkbook going.)

Of course, lots of things happen during the course of an accounting year. This section outlines the basics of nonprofit bookkeeping and accounting and what you need to understand before you can delve into your books.

Identifying the difference between bookkeeping and accounting

Before you can make sure your nonprofit’s books are okay, you need to have a firm understanding of bookkeeping and accounting. Here are the main differences. Chapter 2 provides more insight on the two.

A bookkeeper records day-to-day activities by recording one side of the transaction. They usually record transactions when cash changes hands (called the cash basis of accounting; see the next section for more details). Usually bookkeepers pass the books to the accountant at the end of the year to generate financial statements.

Accountants balance both sides of a transaction (the debit and credit sides) by evaluating how one transaction affects two or more accounts. Accounting isn’t complicated mathematics; it’s adding, subtracting, dividing, and multiplying, with some analysis thrown in based on principles and rules written by the profession. Accountants dig a bit deeper into understanding the treatment of accounts or the right way to handle financial situations based on principles. A bookkeeper may not be able to analyze accounts, but she can record the transaction.

You may say, well, what’s the real difference here. Accountants understand the why of everything that takes place, whereas a bookkeeper may not grasp the concept behind the action. I’m not saying that bookkeepers function like robots, but some bookkeepers haven’t had the level of education as an accountant. Accountants have a minimum of a four-year degree, whereas a bookkeeper may be trained on the job to perform her duties.

Accountants also get paid more than bookkeepers. You’re likely to have a bookkeeper on your payroll to perform day-to-day functions and an accountant on retainer to put together reports on a quarterly or annual basis.

Some accountants take a standardized test, called the CPA exam, to prove they know the mechanics and ins and outs of the profession. Accountants who pass the test are called certified public accountants (CPAs). CPAs are the only individuals who can audit your financial statements.

Remember.eps Don’t be intimidated by CPAs because they have passed this tough exam. By all means, show some respect for their devotion to analyzing your financial situation, but do use their knowledge and ask them some questions about your affairs. That’s what you’re paying them for!

Picking your accounting method

Your accounting method determines when you record activities. Your accounting method answers this question: Do you record a transaction when it happens or when cash exchanges hands?

You have two choices:

Cash basis: This method records transactions only when cash is received or paid. Bookkeepers use this method.

Accrual basis: This method records revenues when they are earned, expenses when they are used, and purchases when they take place. Accountants use this method.

For example, if you ordered copy paper over the Internet for your office and charged it to your account, when does the transaction take place? Does it happen when you charge the purchase to your account? Or does it transpire when you pay the bill? If you were using the cash method, you’d record the transaction when the bill is paid. If you were using the accrual basis of accounting, you’d record the transaction right after charging the purchase to your account. Check out Chapter 2 for more in-depth discussion about these two methods and which one may be best for your nonprofit.

Keep watch over your nonprofit’s finances

Sometimes nonprofit directors and managers feel they don’t have the knowledge to do their own books, so they turn everything over to a CPA. This book gives you the help you need to do some of your nonprofit’s basic bookkeeping and accounting. However, you may rightfully need a licensed professional to help with the more technical aspects of keeping your nonprofits books. That’s where a CPA can help. However, when using a CPA, don’t put all of your eggs in one basket. Although most CPAs are trustworthy and knowledgeable, I strongly suggest you keep some checks and balances in place to prevent any potential fraud. Checks and balances are periodic times when you sit down with your CPA for a layman’s analysis of what’s going on with your finances. You can also check for ways to improve your accounting procedures. (Check out Chapter 2 for more info.)

Don’t become a victim by trusting a CPA to handle everything without asking questions. All too often, the media reports on an accountant or CPA embezzling funds from organizations. Oftentimes employers trust them because they don’t want the hassle of trying to understand the lingo. Therefore, many fall victim to situations that can be prevented. To avoid these problems, keep a close eye on your finances and ask your CPA questions. Also have someone in your office who works with the numbers so you’re not leaving everything up to your outside CPA.

For example, I received a call from a small boating company that had been taken for $80,000 by its accountant. The woman on the phone was hurt because the accountant had robbed the company of its entire savings. The accountant took care of everything — made all the purchases, paid all the bills, wrote all the checks, balanced the books — and never missed a day of work.

This accountant also owned a check-cashing company. This allowed him to write checks to individuals and companies and cash them at his check-cashing store. This setup was a neat little scheme until the bottom fell out. One day the accountant took ill and couldn’t report to work for a week. The owners had to take care of the payroll and accounts payable. When they reviewed the books, they found out that they were flat broke.

The owners could have prevented this situation by not allowing the accountant to collect the money and pay the bills. They needed to find someone else to handle one of those tasks. This is called segregation of duties.

Understanding the basic terms

Before jumping into bookkeeping and accounting, make sure you understand some basic terminology. Throughout this book, I use the basic language the professionals use. That’s all you need to get a good grasp of processes and procedures. There’s no need to add another nerd to the accounting profession. Here I only share the need-to-know information.

To break down the accounting process, start with the basic accounting equation:

Assets = Liabilities + Owner’s equity

This equation needs to stay in balance. That’s why some call it double-entry accounting. (Check out Chapter 2 for more info on double-entry accounting.) What happens on one side must take place on the other in order for everything to stay in balance.

To help you understand how you can use this equation, I cover the accounts found on your statement of activities (the nonprofit term for what the for-profit world calls the income statement) and your statement of financial position (the nonprofit term for the for-profit balance sheet). Walking through the equations used to complete these two statements gives you an accurate picture of your nonprofit’s financial situation. Knowing these two equations can make you a better decision maker and better financial manager by understanding how every transaction affects your financial statements.

Statement of activities equation, also called the income statement equation: Revenues – Expenses = Income

Statement of financial position equation, also called the balance sheet equation: Assets – Liabilities = Equity or Assets = Liabilities + Equity (equity explains the difference between assets and liabilities)

Tip.eps Your statement of financial position summarizes how financially stable your organization is and how solvent it is. A quick eye can look at this statement and gain great insight into your future to determine whether your organization can sustain the forces of the market. (Check out Chapter 16 for more about how this statement works.)

Assets, liabilities, and equity

Think of assets as something that you own or that adds value. Think of liabilities as something you owe or that takes away. Think of equity as the difference between the assets and liabilities.

An asset adds value, whether it’s monetary or not. Examples of assets are

Accounts receivable

Buildings

Cash

Equipment

Furniture

Homes

Inventory

Pledges receivable

Prepaid expenses

Property (land)

Vehicles

A liability is something you owe or an obligation of time, money, or resources. Anything that must be paid is considered a liability. Some common liabilities are

Accounts payables

Accrued expenses

Bills

Car notes

Mortgages

Notes payable

Short-term payables

Utility bills

Equity is the difference between assets and liabilities. Equity is your net worth and is also referred to as net assets. When you have a list of all assets and all liabilities, you have everything needed to calculate your net worth. Net means the remainder after positive and negative amounts are combined.

Your goal at the end of the year is to have an increase in net assets and not a decrease in net assets. This means your net worth has increased.

Debits and credits

Accounting reflects what happens financially by increasing and decreasing accounts in the form of debits and credits. After you grasp the normal balances — what it takes to increase an account — for all accounts, you’ll know when to apply debits and credits.

Accounts are like coins in that they have two sides:

The left side is the debit side of an account.

The right side is the credit side of an account.

Some people refer to this as T accounting because the record keeping is set up in the shape of a giant T. Imagine taking a piece of paper and drawing a horizontal line across the top and a vertical line down the middle. You’ve drawn a large T. On the left side of the vertical line you record debits, and on the right side is where credits go.

For example, take the statement of financial position with its assets and liabilities. Asset accounts normally have a debit balance, so the normal balance for assets accounts is a debit balance. Normal balance of any account is a positive amount or what is done to increase that account. So if you want to decrease an asset, you credit it. Asset accounts are debited for increases and credited for decreases. On the flipside, the normal balance for all liability accounts is a credit balance. To increase a liability account, you credit the account. To decrease a liability, you debit the account. Liability accounts are debited for decreases and credited for increases.

Debits and credits are done through double-entry accounting to keep your accounting equation in balance. Every transaction affects two or more items in your accounting equation. When you record entries in two or more places, you’re doing double-entry accounting.

Throughout your accounting period, you make debits and credits not only to your statement of financial position accounts, but also to your statement of activities accounts. Understanding how to increase and decrease these accounts is important.

Revenue accounts are debited to decrease and credited to increase.

Expense accounts are debited to increase and credited to decrease.

These mechanics are part of double-entry accounting, and the basis of every transaction is knowing what to do to increase and what to do to decrease an account. Check out Chapter 2 for more on double-entry accounting.

Adhering to GAAP

Before you can play a game, you read the instructions, right? Well before you can fully understand bookkeeping and accounting for your nonprofit, you have to familiarize yourself with the ground rules. The ground rules of the accounting profession can be attributed to generally accepted accounting principles (GAAP). GAAP are the standards that accountants follow when making decisions about how to handle accounting issues. Call them the rules of the profession.

GAAP were put in place to help accountants put their clients’ needs first and behave ethically. The idea is to make sure that your accountant treats you and your nonprofit’s business the same as he treats his other clients, and that all accountants are playing by the same rules. See Chapter 9 for more on GAAP.

Keeping a paper trail

Leaving tracks in the sand is essential to proper management of your nonprofit’s books. You need documentation to prove why you did what you did. It adds credibility to your management of funds. Good housekeeping starts by keeping your checkbook register balanced (see Chapter 7) and continues with maintaining organized records (see Chapter 4).

It’s best to keep copies of where every donation comes from and how each dollar is spent. Part of being a good steward is leaving marks in the sand to account for your nonprofit activities.

Warning(bomb).eps Watch out for your debit cards issued by your bank. Transactions for these cards are so easy to forget to record in your checkbook register. They’re like the little foxes that catch you off guard.

Additionally, your auditor will want to backtrack in your steps to find the initial record that began a single transaction. Auditing is like looking for a needle in a haystack. Sometimes only your auditor knows what she’s looking for and why, but you have to let her look. Getting an audit of your financial statements is a necessary part of keeping your nonprofit status. Chapter 20 tells you what to expect during an audit.

Auditing 101: It’s a GAAS!

In addition to playing by the rules when keeping your nonprofit’s books, you also need to follow other important rules concerning audits. Generally accepted auditing standards (GAAS) are rules or standards used to perform and report audit findings. Auditing is gathering and reviewing evidence about your organization to report on the degree between the way your nonprofit’s financial information is presented and the standards set by rule makers. The American Institute of Certified Public Accountants (AICPA) sets the rules and requirements for audits, among other things.

Auditors give opinions by writing a report about your operating procedures, compliance with specific laws, and whether your financial statements are stated according to GAAP. As a nonprofit director or manager, you need to be concerned with three types of audits:

An audit of financial statements, sometimes called an accounting audit, verifies whether statements have been prepared according to GAAP. Check out Chapter 20 for what happens during this type of audit.

A compliance audit, sometimes referred to as a grant audit, reviews your financial records to determine whether your nonprofit is following specific procedures, rules, or regulations set down by some higher authority, like the IRS or some other government or rule-making body. See Chapters 9, 12, and 20 for more information about compliance.

An operational audit (also called the management audit or performance audit) measures and evaluates how efficiently you’re operating and how effectively you’re managing your nonprofit’s resources. Boards of directors often request this audit to evaluate organizational structure, computer operations, marketing, and so on.

Making Sure Your Books Are Balanced

Staying on top of your nonprofit’s financial activities is important because as the director, you can be held accountable. The way to start is making sure you have balanced books. Balanced books are up-to-date current information about your accounts. Every transaction that takes place affects two or more items in accounting, and you have to make sure everything stays in balance. Whether you create your own manual system or take advantage of the software on the market, you need to keep your books in order.

This section walks you through some basics to help you ensure your books are balanced. Follow the chapters in Part II for tools to assist you in maintaining balanced books.

Establishing a chart of accounts

Your chart of accounts is your blueprint for assigning numbers to specify accounts and having a method to track all accounts. By having a chart of accounts, you can recognize what type of account it is based on the beginning number. For example, accounts beginning with 1 are usually assets accounts. After you get used to using the chart of accounts, you’ll enjoy the benefits of coding transactions according to their classification. Chapter 5 has more on setting up your chart of accounts.

Tracking transactions

To have a firm grasp on your nonprofit’s financial status, your records have to be accurate. The only way to have accurate records is to record transactions when they take place.

Tracking your revenues and expenses is like in-house overdraft protection. It helps you know when you’re short on cash and when you’ve got plenty of money to pay the bills. For example, you know the feeling you get when someone doesn’t cash a check you’ve written? That outstanding check sort of bugs you and leaves you wondering if the check is lost. Then, one day after a few months, the check clears. Without a good tracking device or accounting system, you can easily lose track of your true checking account balance.

Tip.eps So how can you keep track of transactions? Don’t feel overwhelmed. You don’t need a PhD in aeronautical engineering. The following are a couple of easy ways to track them. Check out Chapters 6 and 7 for more on recording transactions and using a checkbook.

Use online banking. Online banking gives up-to-date current balances anytime, day or night.

Itemize your transactions when they happen. When you swipe your credit card or bank debit card, write it down right away in your checkbook register.

Remember.eps One of the most important things you need to keep track of is your donors list. A donors list includes contributors’ names, addresses, and phone numbers, as well as the donation dates. Your auditor will use this list to verify where the money came from and when.

Developing a budget

Your budget is your financial plan. It tells you how much money you have, how much you expect to receive, and how much you expect to spend. When you create a budget, you develop a formal plan for paying for your organization’s future activities.

You not only need an operating budget for your organization, but you also need a separate budget for each and every program. Chapter 8 explains how to create a budget.

Remember.eps Always know how much money is needed to operate your nonprofit. If a private donor asks, you should know the exact amount needed to break even (the amount of money it takes to run all programs and pay all expenses within a given year).

Staying within the lines: Compliance

Only a few things can knock your nonprofit off the map. Not filing your paperwork with the IRS, operating as a