Lesson 3 – What

What is the purpose of the revenue and what is the expense used for. What is covered by the principles of fund accounting, or net asset classification. The ‘What’ is based on the principles of (1) fund accounting, or net asset classifications, and (2) functional accounting.

Fund accounting allows a nonprofit to identify ‘what’ their revenue is designated for, and to monitor the restrictions often attached to the revenue. This provides stewardship and transparency. By classifying revenue into appropriate designations, nonprofit accounting enables organizations to keep the revenue it receives in the proper classifications and makes sure this revenue is not being spent on inappropriate expenses. It also highlights areas of strength and weakness, providing transparency for funding sources.

Functional accounting presents the nonprofit’s major types of activities, primarily program or mission-based services and supporting services, such as management and general (administration) and fundraising. Breaking down expenses by functional area reflects major nonprofit reporting requirements as outlined in SFAS-117 and for filing the IRS Form 990, which requires nonprofits to divide expenses by program, management and general and fundraising.

For any organization required to undergo an annual audit, their financial statements must be presented by functional area. If not, then the CPA will render a qualified opinion, stating the statements were not prepared in accordance with GAAP.

Besides the regulatory requirements of reporting by functional area, the most important reason to report on functional expenses is that it is the best method for tracking real costs of program and supporting activities. This makes it an invaluable tool for decision-making. It allows you to see exactly what each of your individual programs cost. This is especially helpful in determining whether you have the resources available to effectively run the program and determine whether the program is sustainable.