A nonprofit organization is a legal entity formed and operated for collective mutual, public or social benefits rather than the pursuit or accumulation of profits for owners or investors. The revenues of non-profit bodies are seen as surplus instead of profits in the organization’s income and expenditure account.
A notable characteristic of non-profit organizations is the non-distribution constraint which stipulates that any revenues above expenses must be utilized for the maintenance of the organization and achievement of its objectives rather than for private purposes such as owner/shareholder profits.
Content: Non-Profit Organization
- Receipt and Payment Account
- Income and Expenditure Account
- Balance Sheet
Non-Profit Organizations Explained
However, “non-profit” does not entirely imply that the organization cannot make any profit (it can generate profit from its goods and services). But, as noted above, the primary difference between a nonprofit organization and a for-profit organization is in the allocation of accumulated profits.
Though non-profits are usually not profit-oriented, they still need to keep accounting records and information for others (including the government) to scrutinize. In addition to ledgers and cashbooks, non-profit bodies also keep stock registers which keep track of all their fixed assets and consumables.
Another notable difference between them and for-profit organizations is the use of the term capital funds rather than capital accounts.
Non-profit organizations are mandated to prepare periodic financial statements. The most common of these statements are the receipts and payments account, the above-mentioned income and expenditure account, and the balance sheet. They are briefly discussed below.
Receipt and Payment Account
The receipt and payments account is a summary of receipts and payments made by a non-profit or non-trading entity for a specific period, usually per annum. Since these receipts and payments are derived from transactions recorded in the cash book, the receipts, and payments account is regarded as a summarized version of a cash book.
It is a real account and hence does not reflect only the current year’s transactions but can also record receipts and payments for the coming or previous year. Preparing a receipt and payment account is necessary (but not sufficient) for preparing the income and expenditure account.
Features of the Receipt and Payment Account
- It is a summarized Cash Book.
- It usually starts with opening cash and bank balance and ends with closing cash and bank balance.
- All receipts are recorded on its left (debit) side and all payments are recorded on its right (credit) side.
- The double-entry bookkeeping system doesn’t apply to this account; it is just a summary of transactions already recorded in the cash book.
- Only cash and bank transactions are shown in the receipts and payments account. Therefore, it doesn’t show all the incomes and expenditures incurred by the entity during the period.
- It is mainly used for the preparation of the income and expenditure account of the entity.
- It does not follow the accrual basis of accounting since it records only those items for which cash is received or paid.
- Non-cash transactions are excluded.
- No distinction between capital and revenue receipts and payments.
- Does not require adjustment since it is not prepared on an accrual basis.
Income and Expenditure Account
Non-profit organizations use this account to articulate their earnings and expenses for an accounting period. It is a nominal account that is based on accrual accounting. The account records all the expenditures on the debit side and all the incomes on the credit side.
The income and expenditure account is meant to help the organization determine whether it is in a surplus or deficit situation within the period under review.
A surplus exists if the credit side exceeds the debit side while a deficit exists if the debit side exceeds the credit side. Any surplus is added to the Capital Fund while a deficit is deducted from the same source. The Income and Expenditure account is similar to the trading, profit, and loss account of for-profit organizations.
Features of the Income and Expenditure Account
- It is a nominal account
- It is prepared on an accrual basis
- It is meant for the current period only (all receipts and payments relating to the preceding or succeeding period are excluded)
- It is prepared by following the rules of the double-entry system of bookkeeping
- Records non-cash items
- Records only revenue items and excludes all capital items
- Is prepared with inputs from the receipt and payment account at the end of the accounting year
- It has no opening balance
- Its closing balance represents either surplus or deficit
The balance sheet is used by non-profit organizations to establish their financial position at the end of the year or period. It is a financial statement that shows the assets, liabilities, and shareholders’ equity of an organization.
The preparation of the balance sheet for non-profit organizations is the same as obtains in for-profit organizations hence assets are depicted on the right side, whereas the liabilities are depicted on the left side. However, the difference is that the balance sheet of non-profits uses a Capital Fund from which a surplus or deficit can be added or deducted respectively.
Features of a Balance Sheet
- It is a statement of financial position
- It is prepared on the last day of an accounting year.
- Prepared on the basis of accounting equation (Assets= Liabilities + Equity)
- It is regarded as the last step in final accounts creation (after preparing receipt and payment and income and expenditure account, the non-profit organization then prepares its balance sheet to indicate the position of the organization’s assets, shareholders’ equity and liabilities).
- The total of both sides (assets and liabilities) must always be equal
Features of Non-profit Organizations
The characteristics of the non-profit organizations are discussed as below:
- Non-profit organizations are legal entities that can sue or be sued.
- Their primary goal is to offer society one form of service or another.
- Their revenues are regarded as surplus rather than profit
- Unlike for-profit organizations, the surplus funds are not distributed to owners and shareholders
- They raise funds mainly through donations, grants, and other forms of contributions.
- They usually have an elected board that oversees their management and administration.
- Though they employ staff, many have volunteer members who freely join because the organization’s objectives align with theirs.
Advantages of Non-Profit Organizations
The non-profit organizations are an integral part of the society since it has various benefits as follows:
Help to Improve Society: Through their services, non-profit organizations help to bring about improvements in the areas they specialize in. These can translate to improvements in society as a whole.
Limited Liability: Owners of non-profit organizations are not liable to forfeit their personal properties should their organizations be sued for indebtedness. This is because these organizations are incorporated legal entities separate from their owners/operators.
Eligibility for Tax Exemption: Non-profit organizations are usually exempted from federal and state government tax laws. This helps in the availability of more funds for them not only to maintain their organizations but also to meet their other objectives.
Eligibility for Grants: Grants are an important source of funding for non-profit organizations. Moreover, unlike loans, grants do not require repayments. Some grants are meant for only non-profits.
Volunteer Board Members: Many non-profit organizations have volunteer board members (and other staff) who are usually not paid salaries. This can help save the organization much-needed funds for alternative uses.
Formal Structure: The incorporation of a non-profit organization leads to the emergence of a formal structure such as a board of directors and managers, among others. This structure enables the transfer of duties and even ownership such that a director can easily be replaced. It helps in smooth operations and the continued existence of the entity.
Disadvantages of Non-Profit Organizations
Running a non-profit organization is a challenging task due to its following limitations:
Tax Exemption Not Automatic: Being a non-profit does not automatically qualify an organization for tax exemption. This is because tax exemption status is usually determined by federal and state regulatory bodies. In the US, for example, a country club can be incorporated as a non-profit but does not enjoy tax exemption.
Costs: Establishing and operating a nonprofit organization can consume time and money. In the US, every state has an incorporation fee which is not very high but can still be challenging for new non-profits. There are also fees for applying for tax exemption which can be significantly higher (and therefore more challenging) than incorporation fees.
Competition for Funding: Competition is an important consideration in many facets of life. With the high number of non-profit organizations in many countries (over 1.5 million in the US), obtaining funds from both the private and public sectors can be very competitive.
Lack of Profit Motive: As noted earlier, non-profit bodies are not primarily established to generate profit. This implies that major stakeholders like owners and board members have no profit incentive to motivate them.