What is Nonprofit Accounting?

Nonprofit accounting refers to the unique system of recordation and reporting that is applied to the business transactions engaged in by a nonprofit organization. A nonprofit entity is one that has no ownership interests, has an operating purpose other than to earn a profit, and which receives significant contributions from third parties that do not expect to receive a return. Nonprofit accounting employs the following concepts that differ from the accounting by a for-profit entity:

Net assets. Net assets take the place of equity in the balance sheet, since there are no investors to take an equity position in a nonprofit.
Donor restrictions. Net assets are classified as being either with donor restrictions or without donor restrictions. Assets with donor restrictions can only be used in certain ways, frequently being assigned only to specific programs. Assets without donor restrictions can be used for any purpose.
Programs. A nonprofit exists in order to provide some kind of service, which is called a program. A nonprofit may operate a number of different programs, each of which is accounted for separately. By doing so, one can view the revenues and expenses associated with each program.
Management and administration. Costs may be assigned to the management and administration classification, which refers to the general overhead structure of a nonprofit. Donors want this figure to be as low as possible, which implies that the bulk of their contributions are going straight to programs.
Fund raising. Costs may be assigned to the fund raising classification, which refers to the sales and marketing activities of a nonprofit, such as solicitations, fund raising events, and writing grant proposals. There is some pressure to keep these reported costs as low as possible, so that donors will think that the organization is being efficient in directing most of their funds toward programs.
Financial statements. The financial statements produced by a nonprofit entity differ in several respects from those issued by a for-profit entity. For example, the statement of activities replaces the income statement, while the statement of financial position replaces the balance sheet. Both for-profit and nonprofit entities issue a statement of cash flows. Finally, there is no nonprofit equivalent for the statement of stockholders' equity, since a nonprofit has no equity.
Budgeting. A budget is not necessarily used in a for-profit business, but is considered an essential component of the accounting for a nonprofit business. This is because a nonprofit typically has quite limited revenue sources, and so must maintain tight control over its expenditures at all times. Consequently, its budget must be rigorously developed based on reasonable revenue expectations, with all cost variances being promptly investigated.