Chapter OneThe 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.
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.
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:
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.
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.
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
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
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:
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.
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 non-profit'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.
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: