Nonprofit accounting is different from for-profit accounting. This difference confuses many small nonprofits, leading to financial mismanagement and compliance problems.
The core difference: nonprofit accounting focuses on funds, not departments. For-profit accounting tracks who owns what. Nonprofit accounting tracks restricted vs. unrestricted money and ensures money gets spent according to donor restrictions.
This lecture covers the fundamentals that most nonprofit treasurers and finance volunteers need to understand.
Fund Accounting: The Core of Nonprofit Bookkeeping
Nonprofit accounting is called "fund accounting" because it tracks funds, not accounts. A fund is a pool of money with specific purposes and restrictions.
The Three Main Fund Types
1. Unrestricted Funds (Operating Fund) — Money the organization can spend on any mission-related purpose. This includes operating revenue (membership dues, service fees), annual fund donations where the donor didn't specify a use, and grants that say "use for your mission" without restrictions.
Unrestricted funds give the organization flexibility. They cover overhead, allow quick pivots, and let leadership make strategic decisions about spending.
2. Temporarily Restricted Funds (Purpose-Restricted) — Money donors gave for a specific program or time period. "This $5,000 is for your youth program." "This grant funds educational programming in 2026." The restriction is temporary — once you spend the money on the stated purpose, the fund expires.
When you spend temporarily restricted money on its stated purpose, the fund balance decreases and funds are "released from restriction" — moved to unrestricted. You track this in your financial statements.
3. Permanently Restricted Funds (Endowment) — Money donors gave that can never be fully spent. "Invest this $100,000. You can spend the earnings forever, but never touch the principal." The restriction is permanent and runs forever.
Many small nonprofits don't have endowment funds. This is more common in larger organizations. But if you do, track it separately because you'll never actually spend the principal.
Why This Matters
Imagine you get a $5,000 grant for youth programs. You also have $3,000 in unrestricted donations. If you use all the money for youth programs, your youth program budget is satisfied ($5,000 spent, restriction released). But you've also exhausted unrestricted funds ($3,000 spent).
If you don't track this properly, you might think you're in great financial shape (you spent $8,000) when you're actually depleting flexibility. Good fund accounting prevents this.
Building a Chart of Accounts
Your Chart of Accounts (CoA) is the list of categories where you record income and expenses. It's the backbone of your bookkeeping system.
Income Categories
Donations: Gifts from individuals, typically unrestricted. Break into sub-categories if useful: individual donations, corporate donations, foundation donations.
Grants: Money from government, foundations, or corporations specifically for programs. Usually restricted.
Program Revenue: Money earned through programs (tuition, admission fees, service fees). This is income generated by the nonprofit itself, not gifts.
Membership Dues: If you have members who pay dues.
Investment Income: Earnings from endowment, savings, or invested funds.
Other Income: Rental income, event revenue, business income.
Expense Categories
Program Expenses: Money spent directly on mission-related activities. Salary for program staff, supplies for programs, rent for program space.
Administrative/Management: Overhead to run the organization. Executive director salary, accounting, legal, office rent.
Fundraising: Money spent to raise money. Development staff salary, marketing for fundraising, event costs (mostly).
Within each, add sub-categories: Salaries, benefits, rent, utilities, insurance, supplies, professional services, etc.
Building Your CoA
Start simple. You can always add detail later. For a small nonprofit, 20-30 account categories is plenty. For larger organizations, 50-100 is typical.
Each account has a code (like 4100-Salaries, 5200-Office Rent). Use consistent numbering: 4000s for income, 5000s for program expenses, 6000s for admin, 7000s for fundraising. This makes reports easier to read.
Document your CoA. If your Treasurer changes, the next person needs to understand what each account covers.
Nonprofit GAAP: Generally Accepted Accounting Principles
GAAP is a set of rules for how to record financial transactions. There are versions for nonprofits and for-profits, but most principles overlap.
You don't need to be GAAP-expert. But you should understand a few core concepts:
Accrual vs. Cash Accounting
Cash accounting: Record income when money hits the bank, expenses when you write checks. Simple but less accurate for accrual reporting.
Accrual accounting: Record income when you earn it (invoice sent), expenses when you incur them (invoice received), not when you pay. More accurate but more complex.
Most nonprofits use accrual accounting. If you're audited, they'll expect accrual. For example: A grant arrives on December 20th, but you don't spend it until January. Under accrual, you record the grant income in December (when earned) and the expense in January (when incurred). Under cash, both happen in January.
Recording Restricted Grants
When you receive a grant for a specific program, record the income as restricted. Track it separately. As you spend money on the program, release the restriction. Your financial statements show how much restricted money you've released (spent on intended purpose) and how much remains.
This is critical for funder relationships. If a funder gives you $50,000 for youth programs and you only spent $30,000, you need to report that clearly and explain why.
Depreciation and Fixed Assets
If your nonprofit buys equipment (computers, vehicles, furniture), don't expense it all at once. Instead, capitalize it (record it as an asset) and depreciate it over its useful life.
Example: You buy a $10,000 laptop. Instead of recording a $10,000 expense, you capitalize it and depreciate $2,000/year for 5 years. This matches the expense to the years the asset is used.
For small nonprofits, there's usually a threshold: assets under $5,000 are expensed, assets over $5,000 are capitalized. Check your policy.
Internal Financial Controls
Even small nonprofits need basic financial controls to prevent fraud and ensure accuracy.
The Core Controls
Segregation of duties: No one person should handle money from start to finish. Split the work: one person receives donations and deposits them, a different person reconciles the bank account, a third person reviews the reports. This prevents embezzlement.
In tiny organizations with 2 people, you can't fully segregate. But you can still do this: one person handles day-to-day cash, a board member monthly reconciles the bank statement and reviews expense reports.
Dual signature on checks: Require two authorized people to sign checks over a certain amount ($500, $1,000, your choice). This is a classic control.
Monthly bank reconciliation: Someone (usually the Treasurer) compares the bank statement to your records every month. Catches errors and detects fraud.
Board review of financials: Monthly financial reports go to the board. Board members review spending, ask questions, catch problems early.
Documented approval process: Before paying an invoice, someone approves it (verifies the work was done, price is correct, it's budgeted). Large organizations use purchase orders and approval workflows. Small organizations can use a simple checklist.
The Three Key Financial Statements
1. Statement of Financial Position (Balance Sheet) — A snapshot of assets, liabilities, and net assets at one point in time. "On December 31, we had $50,000 in the bank, $20,000 in receivables, $10,000 in equipment, $5,000 we owe, and $65,000 in net assets."
2. Statement of Activities (Income Statement) — Shows all income and expenses over a period (usually one year). "In 2025, we raised $200,000, spent $180,000, and ended the year with a surplus of $20,000."
3. Statement of Cash Flows — Shows where cash came from and where it went. Important because a nonprofit can show a surplus but have negative cash flow (e.g., donors promised gifts but haven't paid, or you have lots of restricted grants you haven't spent yet).
For small nonprofits, statements 1 and 2 are essential. Statement 3 becomes important as you grow and have complex cash timing.
Getting Started with Accounting
1. Set up a separate bank account. Never mix personal and organizational money, even temporarily.
2. Choose accounting software. See Lecture 1.4.2 for comparison of options.
3. Design your Chart of Accounts. Start simple, document it.
4. Track fund types. Separate unrestricted from restricted at minimum.
5. Monthly reconciliation. Treasurer reconciles bank account and reviews spending monthly. Not quarterly, not annually — monthly.
6. Annual financial statement. At year-end, prepare financial statements (even simple ones) for the board. This is also the basis for your tax return.
7. Annual review or audit (if required). Many nonprofits aren't required to audit, but check your bylaws and funder requirements.
For guidance on accounting software and financial dashboards, see Lecture 1.4.2: Choosing Accounting Software and Lecture 1.4.3: The Nonprofit Financial Dashboard.