Top 5 things we find in Nonprofit bookkeeping systems

1. Too many accounts in a nonprofit’s chart of accounts

In their infancy, many nonprofits create lines for every expense type possible. We find line items for office supplies and staff positions of every imaginable type—we even find line items organized by funding source. Sure, this is helpful for tracking budgets and expenses when you’re starting out, but it can end up being expensive in the long run. As the organizations grow—in staff time , external accounting, and tax costs—so does overall cost. Many software programs have the ability to run sub-ledger detail for you when necessary—it’s just a matter of setting it up behind the scenes in the settings.

The IRS Form 990 only has 24 expense lines, and most audited financial statements have even less. When you have more expense lines than lines on the tax return or financials, you’re paying a premium for someone to merge these into single lines for external reporting. You’re also paying staff for potential non-added value time for recordkeeping. In addition, we see boards spending time asking why the copy paper expense is over budget versus spending time looking at the larger picture sometimes.

By focusing your chart of accounts to only what is necessary, it not only gives staff more flexibility to use buckets of funds on what they need, it also focuses comparing budgets to actual excpenses on the big picture. We recommend a review of those buckets of revenue and expenses on your financial statements, any external grant reporting needs, and 990, and try to match those to your chart of accounts.

2. Using cash basis instead of accrual-based accounting

This is probably the number one oversight we see. Nonprofits are required to be on accrual basis accounting unless they elect to do so otherwise on their 990. Audited financial statements are almost always on accrual basis and most grantors want to see financials following Generally Accepted Accounting Principles (GAAP) What’s the difference between cash and accrual? Cash basis means you record revenue when you receive the check and the expense when paid. Accrual basis is generally recording the revenue when earned and the expense when deemed due. We see this a lot with prepaid expenses such as insurance, payroll that borders between two fiscal years, and most importantly, grants with restrictions (see below).

3. Classes not set up for functional expense reporting

NFPS have to report their expenses by three function expense classifications to the external world, both on their IRS Form 990 and their Audited Financial Statements.These are:

1. Program expenses related to fulfilling their mission or programming

2. Management-overhead expenses such as management, accounting, office, etc.

3. Fundraising costs incurred to raise funds—this could be staffing, software, and donation credit card fees

Many grantors ask for this information now, too. Most software allows you to set up these fields and code expenses as you go. For example, in QuickBooks, you can simply use the “class” system to break out expenses as you pay them. You can even have subclasses, such as with programming. You can have up to 3 different program subclasses that roll up to the main program bucket.

This is also helpful for grant reporting. You can create a reasonable allocation and allocate expenses on a regular basis. By maintaining this information throughout the year, it saves on audit and tax preparation fees, while allowing the organization to see what they are reporting out to the general public in advance. Many websites use these breakouts to determine a nonprofit’s percentage for how a dollar is spent. Local media outlets also review and report out these percentages as well.

4. Revenue recognition around restricted gifts and grants

Boards and management are responsible to ensure, when donor gifts are received, that any special restrictions are handled appropriately. This is the one of the highest risk areas of compliance for nonprofits and special attention is needed in this arena. I’ve run into too many situations where I have had to report back to boards that there is not much unrestricted cash left to operate because designations were not monitored closely. If someone donates $100 for a widget, the $100 needs to be spent on a widget, not payroll, to avoid compliance concerns.

Accrual basis accounting (mentioned above) can be a huge help in this area around restricted grants where you receive the funding for a program in advance. Make sure that grants are recorded as deferred revenue when the cash is provided up front, but the restriction has not been met. It is not generally recorded as revenue when the deposit is received unless it is an unrestricted grant for general use or operations. When the restriction is met (i.e. expense incurred), then the revenue can be recognized as earned. This is helpful to reporting because on cash basis, the revenue could be recognized in one year and the expense in the other. In the accrual accounting format, the revenue and expense are recognized in the same time period.

This stuff is not easy—even staff accountants and bookkeepers struggle to understand NFP accrual information. We suggest creating templates and training staff to help reduce audit entries, year-end adjustments, and budgeting issues.

5. Not clearing out old outstanding items in reconciliations in software

Simply put, if there are unreconciled items showing up in your bank reconciliation, they need to be cleared. These can be duplicate entries, misclassified items, or simply errors. Bank accounts, loans, and credit card accounts should be reconciled to the statements on a regular basis. This includes any ancient payroll clearing accounts, if you are still using them. The payroll clearing account is the number one place I’ve found fraudulent activity in my career. These unreconciled items show up in your statements of financial positions and activity and could be throwing off your numbers.