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Bookkeeping for Nonprofits
By Murray Dropkin John Wiley & Sons
ISBN: 0-7879-7540-0
Chapter One
Overview of the Bookkeeping Function
Keeping the books of an organization is a simple concept to visualize: we can all conjure up the image of an oversized ledger on a desk, and the bookkeeper, wearing a green eyeshade, adding columns of figures. A more modern image is of a worker sitting in front of a computer screen with piles of paper on the desk. But what exactly is bookkeeping?
Bookkeeping is the systematic recording of transactions that affect the financial operations of an organization. While most of these transactions are monetary, nonprofit organizations also receive non-monetary donations (for example, volunteered time) that also must be recorded if they meet certain criteria. Later on, we'll explore what gets recorded, how it gets recorded, and even when it should be recorded; but for now let's examine why bookkeeping is important.
Every organization needs a method of tracking and understanding day-to-day operations. Monetary transactions can take many shapes, but they generally fall into four major categories:
Cash received
Cash disbursed
Cash due to be received (accounts receivable) Cash due to be disbursed (accounts payable)
Theoretically, tracking the cash balance of an organization is the bare minimum you need to do to keep the organization going. You could accomplish this by simply putting all incoming cash into a shoebox, and paying all expenses by removing cash from that shoebox. Count up what's left in the box, and you have your current cash balance.
In the real world, this minimum knowledge is not only impractical but also totally inadequate. To manage the organization effectively, to plan future events, budget, to analyze, to file a tax return, more information and more skills are required.
Nonprofit organizations have a large number of different stakeholders: clients, community members, funders, board members, staff members, volunteers, and (in many states) the attorney general. The Internal Revenue Service, after many years of paying little attention to nonprofit organizations, has more aggressively started enforcing the laws and regulations governing nonprofits. Even small nonprofit organizations are in the public eye to a far greater degree than small businesses are. Each stakeholder needs information, and the accounting system is the primary source of that information.
Communication is essential to the management of any organization. While this chapter focuses on the flow of information from the accounting system to stakeholders, it is equally important for information to flow from stakeholders into the accounting department. Transaction details are just one such type of that information. In a well-managed nonprofit, communication helps the bookkeeper anticipate situations and provide management with the information and analyses needed to run the organization effectively.
Users of the Information
Who are the users of a bookkeeping system's information? The bookkeeper uses financial information all day long. Accountants analyze the information the bookkeeping system produces. Managers use the information to assess past results and to plan for the future. Board members use the information to monitor the financial performance of the organization in comparison to its official budgets. Others-the IRS, banks, lenders, funders, government officials, and the general public-all need access to reliable information generated by the bookkeeping system.
Program managers and department heads benefit greatly when they understand why and how to properly record transactions. Their own performance may be reviewed using financial information. They may evaluate personnel and program effectiveness by looking at the numbers, among other factors. When asked to prepare next year's program budget, the manager relies heavily on this year's financials. Applying for a new grant means the manager must analyze, project, and justify financial information that is based on historical bookkeeping data.
Bookkeeping, Accounting, Auditing: Who Does What?
Bookkeeping, accounting, and auditing are three processes that may appear to overlap, especially in a small organization. They accomplish different goals, but they use the same information. There is not a clear line of demarcation between bookkeeping and accounting. Depending on the size of your organization, one person might perform both functions. Based on recent changes in auditing standards, your organization needs to carefully monitor the role you are asking your auditor to play. Certain funding sources and just plain common sense prevent auditors from playing too prominent a role in bookkeeping and accounting services.
Accountants are often employees of the organization who supervise the bookkeeping function in addition to other responsibilities. They normally perform a more analytical function than bookkeepers, who primarily deal with the posting of transactions. Accountants begin with the accounting information (ledgers and journals) and analyze the results, looking for causes and effects. They also are responsible for maintaining the accounting information so that it can be used to generate financial statements for anyone who needs them.
Auditing is an attest function; auditors examine the books and determine whether the financial statements derived from those books conform to GAAP (generally accepted accounting principles) and accurately reflect the financial position of the organization. GAAP is a set of commonly accepted standards, principles, and procedures promulgated by the Financial Accounting Standards Board (FASB). Auditors must be independent of the organization, and should report to the board of directors with input from the president or executive director. Auditors use GAAS (generally accepted auditing standards) promulgated by the Auditing Standards Board of the American Institute of Certified Public Accountants (AICPA) and Government Audit Standards from the GAO (Government Accountability Office) and other standards required by funding sources or governmental agencies in auditing nonprofit organizations.
The Nonprofit World
Nonprofit organizations exist to fulfill a mission. In the business world, a for-profit enterprise is ultimately concerned with making a profit in order to provide a return on the owners' investment; if a product or service is not profitable, the for-profit enterprise will shift gears and sell something else. The nonprofit organization is committed to its "product or service"; it focuses on obtaining and allocating resources to get the job done. The goal of the nonprofit organization is to improve society without a profit motive.
There are many types of nonprofits. Some are direct service providers (hospitals, day care facilities); others collect and distribute resources (United Way, funding organizations); and still others are social organizations (local community clubs). Each nonprofit is organized to accomplish a specific mission, and money is one of the main resources used. How the money is collected and spent depends on many factors:
Community needs
Current events
Funding source requirements
Financial planning
Budgeting
Cash flow forecasting
In financial operations, a nonprofit organization is very similar to a for-profit enterprise. All organizations need to be financially healthy to function effectively. For-profit firms seek to maximize their net profits. Nonprofit organizations seek to minimize or eliminate any operating deficits, because they cannot fulfill their mission if they have inadequate resources. In reality, a nonprofit organization uses profits (called increase in net assets) to provide resources for future periods.
This is an important point that unfortunately is often misunderstood. Peter F. Drucker has underscored the point that every organization needs to have an economic basis. Many organizations interpret their nonprofit status to mean that it is improper to show an excess of income over expenses. That makes no economic sense. Any organization, nonprofit or for-profit, needs reserve funds to handle emergencies. Organizations also need surpluses to fund new and innovative ideas (Drucker calls these opportunity budgets). (We will explore this point in more depth in Chapter Thirteen, where we discuss operating budgets.)
Nonprofit organizations apply for tax-exempt status from the Internal Revenue Service. (For more details, see Resource E.)
Terminology
While the terminology used in nonprofit accounting is sometimes different, many of the same accounting concepts apply to both the for-profit and the nonprofit world. As we mentioned, nonprofit organizations can generate a net profit or a net loss, only they call them increases or decreases in net assets. Most accounting terms are the same, and often bookkeepers coming from a for-profit work experience can quickly grasp the differences. We'll explore this topic in more depth throughout the rest of this book.
The Goal of Bookkeeping
Whether nonprofit, or for-profit, the primary goal of bookkeeping is the same:
To capture each transaction one time in a way that is fully documented, completely traceable, and fully usable by every person within and outside the organization who has a stake in the organization.
Let's break that goal down into its components.
Capture Each Transaction. As we mentioned earlier, bookkeeping is about recording monetary transactions. As the bookkeeper, you need a system in place that not only records a transaction; you need a system that helps you record every transaction. A missing transaction is a bigger problem than an incorrectly recorded transaction.
One Time. Ideally, you should deal with a transaction just one time, recording everything you need right then. Remember that there are many potential users of the information you are gathering; your bookkeeping system should be designed with each of those potential users in mind.
Fully Documented. Each transaction should be backed up by appropriate information. The organization's internal control system will specify the details of the documentation, but you should be satisfied that someone looking at the transaction at a later date could see what happened, how it happened, and when it happened without relying on anyone's recollection.
Completely Traceable. As transactions are recorded, either manually or electronically, you need a method to find your way back to the originating entry. Every total in the general ledger and every amount on a financial statement means something. The total usually represents a number of transactions; you need to be able to dig down and examine the individual transactions that make up the total.
Fully Usable. This is the complex part about designing a bookkeeping system. You need to stand back and take a look at the organization: who funds it, who runs it, who oversees it, and so on. Your system has to provide information to a wide variety of users in a form that they require. Here is a brief example:
Your organization employs a driver. The driver spends approximately one-half of the day working for Program A; approximately one-quarter of the day working for Program B; and the remainder of the day working for Program C. As you process the payroll, you'll charge the driver's gross pay to an expense category called Driver Wages. This satisfies some reporting requirements; it might be enough information to provide a financial statement to a bank or to file a payroll tax form.
Without capturing more information, how can you report to the funding source for Program C? How will the program managers plan their operations; how will they prepare future budgets?
Of course, if acceptable to a funding source, you might be allowed to estimate an allocation of the driver's gross pay, and in some cases the result would be the same. You'll make a judgment about when to capture details and when to allocate, but for items such as gross pay it is generally better to capture the details. Work schedules change; employees come and go; rates of pay change throughout the year.
If your organization receives money from federal, state, county, or city governments, some very detailed cost-definition and cost-allocation rules exist. (See Resource G for more information.)
The Bookkeeper As Information User
The bookkeeper represents the most basic user of an accounting system's information. Having up-to-date balance information-whether petty cash, cash in a checking account, cash in a savings account, accounts receivable, accounts payable, loan balances, lines of credit, or other balances-is essential to the bookkeeper's role in the organization. You'll constantly be checking these balances and reconciling them to more detailed sources (such as the accounts receivable detail report) or documents prepared by third parties (such as the monthly bank statement).
Management relies on the bookkeeper to summarize certain information and to provide frequent snapshots of balance statuses. A very useful report that many bookkeepers produce for management has the information shown in Exhibit 1.1.
Using today's computer software, producing this type of snapshot report takes only a few minutes if your books are properly set up. The information is gathered from various accounting reports, such as the Trial Balance, the Aged Accounts Receivable (A/R) Report, and the Aged Accounts Payable (A/P) Report. Tasks that used to take a bookkeeper hours to do, such as adding up vendor ledger cards to produce the Accounts Payable Aged Invoice report, are now accomplished by the software with a few mouse clicks. This gives the bookkeeper time to investigate the anomalies: the very old vendor invoice or the accounts receivable balance that is now 120 days past due.
Other Information Users
As we mentioned earlier, the organization's managers will frequently be using the information from the accounting system.
Cash Flow Management. This is an essential function, and management needs accurate information about cash, A/R, and A/P in order to do it properly. Most enterprises that fail, both nonprofit and for-profit, do so because of a lack of adequate cash flow. Even when the organization is generating a surplus of revenues over expenses, inadequate cash flow can result. Timing is the key to good cash flow management. Payroll is often disbursed every two weeks; some vendors have very short payment terms (such as seven days); yet some funding sources only send in their checks every few months. Without adequate cash flow management, the organization could run out of cash, despite a financial statement (prepared on an accrual basis of accounting) showing an increase in net assets. This is a very important topic. (Chapter Fourteen discusses the concept in much greater detail.)
Budgeting. All nonprofit organizations should prepare accurate and complete budgets. The more successful nonprofits prepare budgets for every aspect of the organization. Budgeting is a means of financial planning, and, with a proper reporting system, it is a means of evaluating results. We devote an entire chapter (Chapter Thirteen) to the topic.
Pricing Services. Without quality cost information, management would not be able to price services accurately. As in any organization, you want to price the services you offer at a point that covers all of your costs. There is no room for the old joke, "We lose money on each sale, but we hope to make it up with volume." (Since nonprofit organizations meeting specific IRS guidelines can solicit and accept donations and grants, necessary but unprofitable services can be subsidized.) The nonprofit typically tries to price services at a point where the targeted clientele can afford them. Frequently, nonprofit organizations adopt a sliding scale for services to accommodate clients on an ability-to-pay basis. So the price must be not too high, nor too low. A careful ongoing analysis of the accounting information helps management to determine what to charge.
(Continues...)
Excerpted from Bookkeeping for Nonprofits by Murray Dropkin Excerpted by permission.
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