Nonprofit organizations have unique accounting standards for recording and tracking net assets. Net assets are essentially the nonprofit equivalent of an organization’s net worth – the funds that are left over after subtracting what the organization “owes” (liabilities) from what the organization “owns” (assets).
Nonprofit accounting standards require incoming contributions to be classified as one of two categories: contributions with donor restrictions, or contributions without donor restrictions. Classifying donations and releasing funds from their restrictions can be confusing, so, let’s first define what each category means.
Net assets with donor restrictions - Net assets resulting from gifts of cash or other assets that are received with donor stipulations that limit the use of the donated asset, until the donor restriction expires (that is, until the stipulation time restriction ends or the purpose restriction is accomplished)
Net assets without donor restrictions - Net assets resulting from contributions with no donor restrictions, or other revenues generated with no external restrictions such as providing services, receiving rents or other income, interest, etc.
Now that we have defined each category, we can learn how to track the additions and releases of net assets with donor restrictions. Proper tracking of these restrictions is imperative to assure donors that their wishes are being honored, and to show your auditors and board the most accurate net assets at year-end that are available for general use.
Nonprofit organizations can track their net assets with donor restrictions in many different ways. Three of the most common methods are:
Class Tracking – Many of our nonprofit accounting clients use Quickbooks Online, which has a built-in function for class tracking. Class tracking can be used for other purposes as well (such as separating expenses for different events within the same general ledger account), but many nonprofits use it to track additions and releases of net assets with donor restrictions. This will allow you to quickly generate reports showing activities by class. These reports can be useful for your internal accounting and reporting needs, but they really come in handy during an external audit. Class reports are a great way to prove to auditors that your organization has a clear system to track and record net assets with donor restrictions. One caveat – if class tracking is utilized within your accounting system, keep in mind that all income and expenses must be categorized by both class and account in order to get an accurate depiction of the balance of each restriction at any given time.
Spreadsheets – If an organization does not receive many restricted contributions, then a simple Excel spreadsheet might suffice as a method of tracking net assets. However, we do not recommend this method if multiple restrictions are received throughout the year, since items could easily be double-counted as a release of a restriction or items could be omitted from the schedule all together. The more restricted contributions your organization receives, the harder it is to track everything accurately on a spreadsheet. That being said, a simple Excel file can be a very effective tool if your organization has limited restricted contributions.
Liability Accounts – Some organizations track their net assets with donor restrictions as a liability on their Statement of Financial Position (balance sheet). Under this method, an organization would record all additions and releases resulting from one purpose restriction within a liability account. This method does have some upsides, but also some potentially big downsides. The benefit of this method is that it usually results in a very accurate balance of net assets with donor restrictions. However, what this method lacks is showing current-year income and expenses resulting from purpose-restricted donor contributions in the Statement of Activities (profit and loss statement). Typically, during an audit, the auditor would view the activity in these “liability” accounts and “unwind” that activity. An annual journal entry would be necessary to record the “unwinding” of the current-year activity at year-end.
While there are other methods for tracking net assets with donor restrictions, they usually require a more advanced (and expensive) accounting software that small- to medium-size nonprofits cannot often afford. The three methods described above – class tracking, spreadsheets, and liability accounts – can be used by nonprofits of any size to help track and records their net assets. To ensure the continued trust of your donors and grantors, it is imperative to track net assets accurately. If your organization is still struggling to accurately record and report net assets with donor restrictions, reach out to an accounting professional to help make a plan for improvement.