Nonprofit organizations receive contribution revenue that comes in the form of funds with donor restrictions or without donor restrictions. Contributions with donor restrictions must be used for either a particular period or for a purpose that is narrower in scope than the organization’s general mission or programs. Some restrictions are temporary, while some are permanent.
Tracking these restrictions is an imperative process that allows the organization to demonstrate to the donor and auditor that the funds were spent according to the donor’s wishes. Additionally, this allows the organization to accurately present the amount of net assets remaining at year-end that are not available for general use.
Nonprofit organizations use several methods – here are four of the most common.
- Fund accounting. Some organizations choose to use fund accounting and record all the activity for contributions with donor restrictions in a separate, restricted fund. Any unspent funds at year-end will remain in the fund and be recognized as net assets with donor restrictions. If your organization employs this method, you likely receive restricted contributions from multiple sources or for multiple purposes and will want to employ the next method as well.
- Program codes. It will likely be necessary to use special codes to directly associate the expenses with the revenues for a restricted funding source. For example, you receive contribution A for $50,000, which is restricted for a special program. You would credit your contribution revenue account of 4000-001, where 001 is the program code that uniquely identifies this revenue as contribution A. When funds are spent, you would record expenses of (for example) $30,000 to various expense accounts ending with -001. At year-end, a profit and loss statement for program code 001 would show net assets of $20,000, which are restricted for program 001. Contribution B for $100,000 might get coded to 4000-002, and so on.
- QuickBooks classes. Organizations that use QuickBooks sometimes use the classing system to track donor restrictions. This method will work only if you are sure to categorize all applicable revenues and expenses into classes. Should you forget to do so, any unclassified transactions will show up in the unclassified column when a profit and loss statement by class is run. This can create questions and cleanup at year-end and is not an ideal process.
- Excel spreadsheets. In general, this is the least ideal method. Several problems can result with this method, one of which is potential double-counting of expenses. Any expenses listed to satisfy the restrictions of contribution A could also be listed to satisfy contribution B or C, which would not be appropriate. When using this method, it will be difficult for your auditor to have confidence that the spending was not double-counted.
On the flip side, there is also an opportunity for the spending to be incomplete or otherwise incorrect in an Excel spreadsheet since it is a manual process and you must remember to transfer any spending to it. Errors are possible due to changes in the general ledger. Since the Excel is not linked to your accounting system, a voided check or reclassification would need to be updated in the spreadsheet. The possibility of mis-keyed information exists as well. Limiting the opportunity to commit human error is vital when designing a system of internal controls, and a great deal of human error is possible with this method.
This method will cause the most headaches for both you and your auditor when auditing restricted contributions as it usually means more time and effort spent by both parties. It is also the least reliable documentation to have in future years after the audit is complete.
However, Excel spreadsheets can be essential in certain situations, such as endowment tracking. Some organizations have an endowment fund that may have been in existence for more than 50 years. Over the years, there likely have been contributions to the endowment and investment gains. The organization may even be using the investment accounts at its financial institution to invest unrestricted funds as well. Additionally, you may have switched banks multiple times over the years, your bank may have been acquired several times, and your nonprofit may have gone through several CFOs and CEOs who don’t have a lot of history with the organization. A spreadsheet for endowment funds can be vital to supporting the different components of the endowment, such as corpus and spendable earnings and showing any other unrestricted funds that may be invested with these at the bank.
At year-end, many organizations choose to supplement the above methods by making a physical or electronic file with the donor award, general ledger detail specific to the program code, and backup for the spending to have a complete record of how the contribution was spent. Consideration as to the significance and materiality of the contribution should be considered when using this method.
Sound internal control design is key to ensuring the above methods are implemented accurately. A qualified individual should review the recording of all contributions to ensure the presence or absence of donor restrictions are properly recorded. Further, the review should also ensure that expenses used to satisfy donor restrictions are following the donor’s wishes. This review should be conducted by someone separate from the individual responsible for recording the transactions to ensure the ideal separation of duties.
If you would like more information on methodologies for tracking donor restrictions, contact me via email at email@example.com or call 269.329.7007, or contact your Yeo & Yeo professional.