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a man relaxing in a chair with his eyes closed and an open book on his head while papers flutter all around him, symbolizing that ignorance is not bliss for nonprofit accounting

Why Ignorance Is Not Bliss for Nonprofit Accounting

When it comes to nonprofit accounting, ignorance can have very serious consequences. Take the case of the Maine Lobster Festival, a nonprofit organization that holds an annual event where the proceeds are donated to local civic projects. The 68-year-old, all-volunteer organization had assumed that it was exempt from sales taxes.

After decades of not paying taxes, it discovered that sales taxes were required as well as a sales tax certificate. Ignorance in this case cost the organization thousands of dollars in back sales taxes, which had a severe impact on its mission.

Understanding Nonprofit Accounting Is Key to Survival

A thorough understanding of tax requirements, proper reporting, and transparency is critical for a nonprofit organization's survival. It's safe to say that without ongoing, proper accounting practices, your nonprofit may be in danger of not fulfilling its mission. To make informed decisions, management and funding sources must follow specific nonprofit accounting practices to provide accurate records of how money is received and spent. As donors become more savvy, nonprofits need to provide more relevant information in order to become more accountable and transparent.

Nonprofits Make More Accounting Errors than For-Profit Businesses

illustration of a person holding a magnifying glass over some nonprofit accounting reports and asking questions

In a recent study, an alarming discovery was that nonprofit organizations make accounting errors at a relatively high rate compared to for-profit businesses. Jeffrey Burks, associate professor of accountancy at the University of Notre Dame, led the study. He attributes this to nonprofits not devoting a high percentage of their funding to administrative costs. Furthermore, his team discovered that the rate of accounting errors at nonprofits is nearly double that of for-profit businesses of similar sizes.

"Low administrative costs that nonprofits cite to attract donors may actually be contributing to their high rate of accounting errors." — Jeffrey Burks, Associate Professor at University of Notre Dame

Many nonprofit organizations undervalue the importance of financial accounting and reporting. They spend little or no money on nonprofit accounting professionals, whether in-house or from an outside firm. I've been working with nonprofits for over 30 years. I often see nonprofit organizations hiring individuals with little or no education or training in accounting as their de facto fiscal director.

Common Mistakes Made by Nonprofit Accountants

Here are some examples of mistakes made by accountants and bookkeepers in nonprofits that I have had to correct for various organizations that I work with.

  • Recording vendor invoices as a debit to cash and then when the bills were paid, cash was credited. The problem with this situation is that there were no expenses on the books and cash was overstated.
  • Not reconciling bank accounts.
  • Both the fiscal and executive director thought they were exempt from paying payroll taxes.

Nonprofits Risk Solvency in an Attempt to Lower Overhead Costs

Nonprofit accounting is much more complicated than for-profit accounting, yet nonprofits invest very little in their accounting functions compared to for-profit businesses. Some of the above examples happened in organizations with budgets of over half a million dollars! The primary reason many nonprofits delegate accounting to untrained personnel ties back to funding and the overhead myth. Without realizing it, nonprofits who fall into this trap can put their solvency and mission at risk.

Another huge problem with nonprofit accounting is that most nonprofits use accounting software that is not designed for nonprofit accounting. As a result, their financial statements need to be generated outside their accounting system. This leads to errors and introduces potential internal control deficiencies. When nonprofits try to cut corners with low-cost, off-the-shelf software for untrained bookkeepers, they end up costing the nonprofit far more in the long run.

How to Prevent Disastrous Nonprofit Accounting Errors down the Road

A good solution for nonprofits who cannot hire experienced, knowledgeable bookkeepers or in-house accountants is as follows. They can find someone to simply enter the basic data and then hire an outside accounting firm that specializes in nonprofit accounting to oversee financials on a monthly basis. This will keep costs down and prevent serious errors down the road.

Your Opinion Matters

Accounting is too important for a nonprofit to leave in the hands of someone who does not even understand a debit or a credit. An investment in your fiscal personnel is an investment in your organization's overall well-being. Do you agree that understanding nonprofit accounting is critical to the survival of your nonprofit organization? Your opinion matters.

Additional TechSoup Resources: Nonprofit Accounting and Beyond

Joseph Scarano is the CEO of Araize, Inc., developers of cloud-based FastFund Online Nonprofit Software, accounting, fundraising, and payroll software solutions to help your nonprofit become more transparent, accountable, and sustainable.

This blog post was originally published on araize.com.