Whether you're analyzing a non-profit's financials before making a donation, as part of your job, or just out of curiosity, there are a few basic differences between the for-profit world and not-for-profit world that you must understand.
One of the most critical is the difference between unrestricted net assets and restricted net assets.
First, some important differences between for profit and non-profit accounting
The first thing you may notice is that non-profits call their financial statements different names than for-profit companies. The balance sheet is called the statement of financial position. The income statement is the statement of activities. Shareholder equity is replaced with net assets.
The differences may seem like petty semantics, but each is based in a logical purpose. The non-profit doesn't have owners, for example, making shareholder equity an inapplicable label. Net assets is more descriptive, implying that the number represents the net difference between the non-profit's assets and its liabilities.
Another key difference is the limitations non-profits have in deploying their assets compared to a for-profit company. Most non-profits rely heavily on donations or have strict requirements for how it can use its resources to achieve its stated mission. As a result, within the net assets section of the statement of financial position there are specific accounts that reconcile the varying degrees to which the non-profit can use its money. Specifically, there are the unrestricted net assets and two types of restricted net assets.
Unrestricted net assets
When a donor doesn't specify exactly where or how the non-profit is to use the given donation, the contribution is considered to be unrestricted. The donation will appear on the statement of activities (the income statement in for-profit terms) as unrestricted contribution revenue and will appear on the statement of financial position (balance sheet equivalent) as an asset and will increase unrestricted net assets.
Being unrestricted, the non-profit can then use the donation for whatever purpose it sees fit to achieve its stated mission.
Temporarily restricted net assets
Other times, a donor will make a contribution earmarked for a specific purpose. Perhaps the donation is to be used on a specific project or to pay for a specific need the non-profit has. This could be for a specific construction project, the purchase of a vehicle, or for a specific program operating within the non-profit.
In these cases, the donation is recorded as temporarily restricted contribution revenues on the statement of activities and will appear as an asset on the statement of financial position. To balance, temporarily restricted net assets will also increase.
These donations are temporarily restricted because they have a specific purpose for which they must be used within an expected amount of time.
Permanently restricted net assets
In other cases, a donor may make a donation in perpetuity. For example, Andrew Carnegie was well known for making charitable donations in the form of stock, stipulating that only the dividends from the stock be used to fund the non-profit. The stock itself was not to be sold so that it could continue to grow and provide dividends for decades to come.
In cases like these, the non-profit would recognize the donation as permanently restricted contribution revenues on the statement of activities and it would increase permanently restricted net assets on the balance sheet.
Using the Andrew Carnegie example, if Carnegie stipulated that the dividends from his donation were to be used for a specific purpose, those dividends would be treated as a temporarily restricted assets as they are received. If there were no stipulations, the dividends would increase unrestricted net assets. In either case, the stock itself would be accounted for as a permanently restricted net asset.
Total net assets
The sum of these three classifications of net assets gives the total net assets for the non-profit.
The distinctions between the three types are quite logical. For the analyst, investor, or accountant familiar with for-profit financial statements, the hardest part of making the jump to the non-profit world will be learning the new vocabulary. The logic and accounting procedures are otherwise fairly similar.
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