The most notable accounting difference between nonprofit and for-profit organizations is that nonprofit organizations must ensure that they do not turn a profit at the end of the year and must use all of their assets to further their work towards their mission and bring themselves closer to their goal. Additionally,a nonprofit organization is required to itemize and report all of its functional expenses to the IRS, whereas this is not a requirement of for-profit organizations. Given that this is a requirement, many non-profit organizations opt to have a cost allocation plan. Although this sometimes occurs with for-profit organizations as well, it is generally a plan used exclusively in the non-profit sector.
For-profit organizations do not typically have donations or volunteers and therefore do not have to concern themselves with recording donated goods and services in their financial statements. However, the Financial Accounting Standards Board has guidelines that require in-kind donations and donations of services to be recorded, which is something that nonprofit organizations must do frequently.
Many small nonprofit organizations utilize a cash-basis accounting system, meaning that they only record when funds are received and when expenses are paid. However, for-profit organizations almost always track all expenses and revenues with an accrual accounting system. Why are audits becoming increasingly important in the nonprofit sector? Cite at least three reasons.
Audits have always been important for the nonprofit sector but their importance has risen dramatically ever since 2002 when the Sarbanes-Oxley Act was passed. This act actually requires many nonprofits to undergo audits. Therefore, when it comes to nonprofits undergoing audits it is not just a good idea – it is the law in many cases. (“Roles and responsibilities,” 2011)
Even when the Sarbanes-Oxley Act does not require a nonprofit organization to undergo an audit it is possible that the state the nonprofit is in requires this. Generally states have income thresholds that once met require a nonprofit organization to undergo an audit. (Taylor, 2011)
Even if not legally required, it is a good idea for nonprofit organizations to undergo audits. Nonprofit organizations rely on external funding and are therefore under a great deal of public scrutiny. An audit can provide reassurance to stakeholders, allowing them to feel exponentially more comfortable in their decision to support the nonprofit organization, which can lead to greater donations and public trust.
Because audits shine a light on a nonprofit organization’s use of finances it can be helpful in encouraging a nonprofit organization to improve its use of funds. Ultimately, using funds wisely can be the framework that allows a nonprofit organization to work towards its goals and further its cause.