Accounting for Nonprofits vs For-Profits: A CPA’s Perspective

As a certified public accountant (CPA), I have worked with both nonprofit and for-profit organizations and have seen the differences in how they account for their financial activities. Here, I will explain three of the main differences between accounting for nonprofits and for-profits, and why they matter.

What is a Nonprofit Organization?

A nonprofit organization is one that operates for a public or social benefit, rather than for the profit of its owners or shareholders. Examples of nonprofit organizations include charities, foundations, educational institutions, religious groups, and advocacy groups. 

Nonprofits are generally exempt from paying income taxes, but they may still be subject to other taxes and regulations.

What is a For-Profit Organization?

A for-profit organization is one that operates for the purpose of generating profit for its owners or shareholders. Examples of for-profit organizations include corporations, partnerships, sole proprietorships, and limited liability companies. 

For-profits are subject to income taxes and other obligations, but they may also enjoy certain benefits and incentives.

How Do Nonprofits and For-Profits Differ in Accounting?

There are many differences between accounting for nonprofits and for-profits, but here are three of the most significant:

1. Financial Statements

Nonprofits and for-profits use different financial statements to report on their financial performance and position.

• Nonprofits use a statement of financial position (like a balance sheet), a statement of activities (like an income statement), and a statement of cash flows.
• For-profits use a balance sheet, an income statement, a statement of changes in equity, and a statement of cash flows.

The main difference between the statement of financial position and the balance sheet is that nonprofits do not report equity, but rather net assets.

Net Assets Categories

• Unrestricted net assets are those that can be used for any purpose by the nonprofit.
• Temporarily restricted net assets are those that are subject to donor-imposed restrictions that can be lifted by the passage of time or by fulfilling certain conditions.
• Permanently restricted net assets are those that are subject to donor-imposed restrictions that cannot be removed.

The difference between the statement of activities and the income statement is that nonprofits do not report revenues and expenses, but rather changes in net assets.

Changes in Net Assets Categories

• Support includes contributions, grants, donations, and gifts from donors.
• Revenue includes fees for services, membership dues, interest income, and other sources of income from operations.
• Expenses include program expenses, administrative expenses, fundraising expenses, and other costs incurred by the non-profit. 

2. Accounting Principles

Nonprofits and for-profits follow different accounting principles to recognize and measure their financial transactions:

• Nonprofits follow the generally accepted accounting principles (GAAP) for nonprofit organizations issued by the Financial Accounting Standards Board (FASB).
• For-profits follow the GAAP for business entities issued by the FASB.

A key difference between the GAAP for nonprofits and for-profits is the revenue recognition principle:

Revenue Recognition Principle

• Nonprofits recognize revenue when they receive it, or when they receive a promise of a contribution or grant from a donor, regardless of when funds are spent or used.
• For-profits recognize revenue when they deliver or perform a good or service to a customer, regardless of when they receive or expect to receive payment.

Another difference between the GAAP for nonprofits and for-profits is the expense allocation principle. 

Expense Allocation Principle

• Nonprofits allocate their expenses to different programs and functions based on reasonable methods that reflect the actual use of resources. A non-profit may allocate salaries based on time spent by employees on different activities.
• For-profits allocate their expenses to different products or services based on cost drivers that reflect the causal relationship between the expenses and the revenues. A for-profit may allocate materials based on units produced or sold.

3. Accounting Methods

Nonprofits and for-profits may also use different accounting methods to record their financial transactions. For example:

• Cash or Accrual Basis: Nonprofits may use either the cash basis or the accrual basis of accounting, depending on their size and complexity. The cash basis records transactions when cash is received or paid, while the accrual basis records transactions when they occur, regardless of cash flows. For-profits generally use the accrual basis of accounting.
• Fund or Entity-Wide Accounting: Nonprofits may use either fund accounting or entity-wide accounting, depending on their needs and preferences. Fund accounting separates the financial activities of different funds or accounts within a non-profit, such as restricted funds, unrestricted funds, endowment funds, etc. Entity-wide accounting consolidates the financial activities of all funds or accounts within a non-profit. For-profits generally use entity-wide accounting.
• Direct or Indirect Method: Nonprofits may use either the direct method or the indirect method to prepare their statement of cash flows, depending on their choice and disclosure requirements.
  • The direct method shows the sources and uses of cash by operating activities, investing activities, and financing activities.
  • The indirect method shows the reconciliation of changes in net assets to net cash flows from operating activities, and then shows the net cash flows from investing and financing activities. For-profits generally use the indirect method to prepare their statement of cash flows.

Why Do These Differences Matter?

The differences between accounting for nonprofits and for-profits matter because they affect how the financial information of these organizations is presented, interpreted, and used by various stakeholders, such as donors, creditors, regulators, auditors, and managers. 

• Donors may use the financial statements of nonprofits to evaluate their financial health, efficiency, effectiveness, and impact. They may look at indicators such as net assets, liquidity, solvency, program ratio, fundraising ratio, etc. Donors may also use the financial statements of for-profits to assess their profitability, growth potential, and risk. They may look at indicators such as net income, return on equity, earnings per share, etc.
• Creditors may use the financial statements of nonprofits and for-profits to assess their creditworthiness, ability to repay debts, and collateral value. They may look at indicators such as debt ratio, interest coverage ratio, current ratio, etc.
• Regulators may use the financial statements of nonprofits and for-profits to monitor their compliance with laws and regulations, such as tax laws, disclosure requirements, reporting standards, etc.
• Auditors may use the financial statements of nonprofits and for-profits to verify their accuracy, completeness, reliability, and fairness. They may also use the accounting principles and methods of these organizations to determine the appropriate audit procedures and tests.
• Managers may use the financial statements of nonprofits and for-profits to plan, control, evaluate, and improve their operations and performance. They may also use the accounting principles and methods of these organizations to make decisions and communicate with stakeholders.

Appreciating the Differences

Tax Considerations: For-profit entities are subject to income taxes and must therefore maintain detailed profit and loss accounts. Non-profits, however, are typically exempt from income tax but are obliged to provide detailed reports of their activities to maintain their tax-exempt status. They are required to submit Form 990, which is a public document that provides information on their mission, programs, and finances.

Performance Metrics: For-profit entities measure success primarily by profitability and return on investment. For non-profit entities, the performance is evaluated based on how effectively they meet their mission and service goals. Therefore, non-profits often need to focus more on non-financial metrics.

Making Informed Decisions

The differences in accounting for non-profit and for-profit entities are substantial, reflecting their distinct objectives, revenue generation mechanisms, and regulatory requirements. Understanding these differences is crucial for accurate financial reporting and for providing stakeholders, from donors and board members to shareholders and regulators, with the information they need to make informed decisions.

Whether you are a practitioner, donor, investor, or regulator, comprehending these divergences enable a better understanding of an entity’s financial health and operational efficiency. Better informed stakeholders get better results. 

If you have questions or need advice, whether for a for-profit or non-profit entity, please contact us.