Nonprofit Accounting Basics
General Ledger Integration on Salesforce, Part 2
Hello! My name is Alexandra. I am a Solution Engineer for Salesforce.org. Welcome to my blog series about GL integration!
In Part 1, we discussed why nonprofits, now more than ever, need to prioritize strong GL integration.
ANATOMY OF A DONATION
Now that we understand why it’s important to set up your General Ledger integration to ensure your nonprofit is able to prove transparency and impact to donors, it’s time to dig in! In this article, I will explain some common donation and nonprofit accounting terms. If you’re an accountant, you can probably skim over this. If not, this will be a good tool for you to reference.
What Is Fund Accounting?
Nonprofits (as well as public sector entities and educational institutions) utilize a system called “fund accounting” for managing their financial reporting. In a nutshell, fund accounting tracks all the sources of money coming in and the uses of that money. When a for-profit company earns revenue, that money can be used however the company sees fit to benefit its operations and its shareholders (so long as the money is spent legally and ethically, of course). By contrast, when a nonprofit raises revenue, the money must be spent on the purpose for which it was raised. The way they track this is by using funds.
Funds & Allocations
Think of a fund as a bucket of money to be used for a specific purpose. If your parent gives you $20 to start a lemonade stand, they expect you’ll spend it on supplies like lemons, sugar, and cups. Not on potato chips and candy.
Similarly, if a donor makes their gift with an expectation that the money will go towards a specific purpose, the nonprofit has an obligation to spend the money precisely that way. For example, let’s say a foundation gives a hospital a large grant to build a new children’s care wing. A fund is created for that grant, with all of the grant money being allocated to the fund. Every expense incurred building the new children’s wing is tracked against the grant fund. This allows the nonprofit to prove to the foundation that they used the grant money on the exact purpose for which it was given (and not on a private boat for the hospital’s CEO).
So the whole idea behind fund accounting is that every single transaction — every single dollar received and spent — has to tie back to a fund. This allows the nonprofit to report on their operations and impact in a very transparent way.
Types of Gifts
There are many different ways for an individual or corporation to make a donation. The gift type will determine how and when the money will be received by the nonprofit and how it must account for the funds. Gift types are often generally categorized as “cash gifts” versus “non-cash gifts”.
Cash Gifts
While “cash” might, literally, refer to a donation made with dollar bills and coins, the term “cash gifts” broadly refers to all monetary forms of payment including cash, check, credit card, ACH, etc. The following are types of cash gifts:
- One-Time Gift: The name pretty much says it all. This is a singular donation made on a one-off basis.
- Recurring Gift: A donor might choose to make multiple gifts on a repeating basis. The donor will determine the frequency with which the gift is made (eg, monthly, quarterly, yearly) and whether the recurring gift is on a Fixed-Date schedule (the recurrences will end on a specific date or after a specified number of gifts) or is Open-Ended (the giving schedule does not end unless and until the donor cancels it). The payment method is determined at the time the donation is made and the nonprofit can expect to receive payment in accordance with the schedule (eg, a recurring credit card charge or check in the mail).
- Pledge Gift: A pledge is a promise of a gift where the donor will make the payment at some point in the future. Often there will be an intended payment date that the nonprofit can use for revenue forecasting purposes.
Non-Cash Gifts
Some donors choose to support an organization through non-cash contributions. These are gifts of value that could be converted to cash, such as gifts of stock, annuities, mutual funds, and gifts-in-kind. A gift-in-kind is a non-monetary contribution of personal property (such as supplies, food, equipment) or professional services (such as an attorney providing pro-bono legal services).
4 Characteristics of a Gift
Following the fund accounting system requires that you track all the “characteristics” of each gift (sometimes also referred to as gift “attributes”). What does that mean? Essentially, it means that donations come with strings attached. A donor can instruct you on how they intend for you to spend the money they give. In order to maintain your donor’s trust, you must record the “string attached” with the gift and be able to prove that you spent the money in accordance with the donor’s intent. There are four categories of gift characteristics:
Charitable vs. Reciprocal
A charitable gift is made without receiving anything in return, whereas a reciprocal gift is made in exchange for something of value. For example, if you purchase a $100 ticket to a fundraising gala, a portion of the amount that represents the fair market value of your meal (say, $25) would be considered reciprocal because you are receiving food in exchange for your money. The other $75 would be considered charitable. This distinction becomes important for accounting purposes, as different accounting rules apply for the charitable and reciprocal portions of the gift.
Restricted vs. Unrestricted
Unrestricted gift means the organization can spend the funds any way it wants. Typically, unrestricted funds are spent on overhead and administrative costs like staff salaries, utilities, office supplies, etc. Alternatively, a donor can put restrictions on their gift by dictating which program or purpose on which the money should be spent. Recording any restrictions is critical for proper fund accounting, as you must be able to prove that you spent the funds in strict accordance with the donor’s intent.
Conditional vs Unconditional
A donor may put conditions on their gift that are expected to be fulfilled. For example, a corporate sponsor may purchase a table for a fundraising gala, with the condition that their company be featured in an advertisement on the gala brochure. For accounting purposes, the donation revenue cannot be recognized until the condition is met. Unconditional gifts do not need to meet any conditions in order to be recognized.
Revocable vs Irrevocable
Planned giving offers individuals a myriad of ways to make charitable donations as part of their financial and/or estate planning. These are typically large gifts and by their nature necessitate legal documentation. An irrevocable gift cannot be changed once it has been given, whereas a revocable gift can be changed over time.
ACCOUNTING FOR A DONATION
Now that we’ve mastered some key fund and gift concepts that are important to nonprofit accounting, we’re ready to begin applying those concepts to the general ledger and bookkeeping. Before we do, let’s briefly set the stage with a couple of accounting terms that are foundational to any bookkeeping practice.
Accounting Methods
One determination a nonprofit must make is the accounting method it will use to guide the timing of when its revenues and expenses are “recognized.” There are two choices of accounting methods typically employed by nonprofits:
Cash Basis
Cash basis accounting is the more simple and straightforward accounting method. It’s similar to how most of us manage our personal checking accounts. On a cash basis, revenue and expense transactions are recorded to the ledger (or “recognized”) at the time money is actually received by the business or paid out by the business. For example, a donor might pledge to give $100 next month. Under cash basis, that revenue transaction is not recorded until the donor actually writes the check and the organization has it in hand. On the expense side, the nonprofit receives a usage bill from their electricity utility on the 1st of the month. The transaction is not recorded until the accounting staff cuts a check to pay it on the 10th of the month.
Accrual Basis
By contrast, accrual basis accounting is more complex. On an accrual basis, the business will recognize revenue as soon as it is “earned.” For example, a donor pledges to give $100 next month. The organization goes ahead and records that donation to a “pledges receivable” account so that the projected income is reflected in the general ledger. Once the $100 check is actually in hand, accounting staff reflect the updated status of the donation by entering a payment transaction. On the expense side, as soon as the utility bill comes in on the 1st it is considered a liability and will be recorded to an “accounts payable” account in the ledger. Once a check is cut to pay the bill on the 10th, another transaction is entered to reflect the paid status. While this is a more complicated method of bookkeeping, it has the significant advantage of providing the nonprofit with a much more accurate and reliable snapshot of its financial standing at any point in time.
Accounting Periods
Another consideration for any financial office is the accounting periods it will follow in its accounting practice. An accounting period is a specified period of time throughout a nonprofit’s calendar or fiscal year during which financial transactions are recorded. A typical accounting period for most nonprofits is a month.
Within each accounting period interval, the accounting books are “open” to record all financial events that occur during the period. At the end of the period, the accounting team undergoes a process called “closing the books,” wherein they ensure that all ledgers are in balance for the period (more on “ledgers” and what it means to be “balanced” in the subsequent Anatomy of the General Ledger article). Once an accounting period is closed, no further transactions can be entered against that period so as to keep the ledgers in balance and keep all accounting activity highly transparent.
But, you may be wondering, what if something changes? While most nonprofit accounting systems will allow you to re-open the books for a closed month and make a change (with security guardrails in place to ensure the action is appropriate), typical accounting best practice is to keep previous periods closed. In this case, accountants will create an “adjustment” entry or “write off.” These are both forms of journal entries that accountants use to properly record financial events that occur in the business. I will dive deep into journal entries in the next article.
TECHNOLOGY BREAKDOWN
This series will not only focus on the principles of fund accounting and GL integration, but the technology systems that nonprofits use to power this process as well.
Constituent Relationship Management (CRM)
A CRM is the system of record for every touch point an organization has with their external constituents. Nonprofits use CRM systems for everything from managing their donor relationships to moves management to program management. They will also use CRM to manage their revenue, including donations of any type such as one-time gifts, recurring donations, pledges, grant awards, and planned gifts. Some CRMs designed for nonprofits, such as Salesforce Nonprofit Cloud, are also built to act as your revenue subledger (more on that in subsequent articles).
Financial Management System
Financial Management Systems come in a few different flavors. You might use an “accounting system.” You might refer to it as a “GL system.” Some nonprofits manage their finances and GL in an Enterprise Resource Planning (ERP) system. (I will use these terms interchangeably throughout this series.) Whatever type of financial software your nonprofit uses, your general ledger is managed in this system. Ultimately, your financial system will account for all of the business’s financial activity (money coming in and going out) and will produce your financial reporting.
GL Integration
So how do revenue transactions in the CRM make their way into the FMS for complete accounting and financial reporting? Organizations will enter donations into their CRM, then export a transaction file from the CRM and import it (or otherwise automatically integrate the transaction data) into their financial management system. I will refer to this process as “GL integration.” While I will go into nonprofit accounting technology in far greater detail later in this series, know that Salesforce’s Accounting Subledger product complies with all the fundamental accounting principles we’ve discussed here to support GL integration. This includes the flexibility to utilize either the Cash Basis or Accrual Basis accounting methods, as well as an Accounting Periods feature to open and close periods, and the ability to enter adjustments and write offs as necessary.
Summary
All these different gift types, gift characteristics, accounting concepts…you can see why nonprofit fund accounting can get complex! Fear not, in the next article I will give you an overview of how nonprofits account for and report on their revenue and spending. Keep reading if you are newer to general ledger concepts. If you’re already an accounting whiz, you can skip ahead to Why is GL Integration So Hard to Get Right?
