Nonprofit Accounting Basics for Board Members

Your nonprofit just received a substantial grant for a new community program, and your board treasurer wants to know where that money sits on the financial statements. If the answer seems like it should be simple, you’re bumping up against one of the most misunderstood aspects of nonprofit accounting: fund accounting.

This concept trips up even the most experienced board members who come from the business world. Nonprofit accounting operates on fundamentally different principles than for-profit companies, and the difference matters more than most people think, especially when donors, grantors and regulators come knocking.

Why Fund Accounting Exists in Nonprofits

For-profit companies focus on one primary question: did the business make money? Nonprofits need to answer something more complex: is the organization using money the way it promised it would?

Fund accounting creates separate buckets that track resources based on donor restrictions and organizational purposes. When a foundation gives $50,000 specifically for an afterschool tutoring program, those dollars can’t be mixed with unrestricted donations and spent on administrative salaries. The organization needs to prove the money went exactly where the donor intended.

The Financial Accounting Standards Board sets the rules through ASU 2016-14, which reorganized how nonprofits classify net assets into two categories: net assets without donor restrictions and net assets with donor restrictions, with a critical distinction between time-restricted and purpose-restricted funds within the latter.

Here’s what that looks like in practice. A donor writes a check for $10,000 with no strings attached. That’s unrestricted, available for whatever the organization needs most. Another donor pledges $25,000 but specifies it must fund mental health counseling services. That’s purpose-restricted. A third donor commits $15,000 to be paid out over three years. That’s time-restricted, even if the organization can use it however it wants once the payment arrives.

What Board Members Need to Watch

Nonprofit financial statements look different than the profit and loss reports that board members might review at their day jobs. The Statement of Financial Position (the balance sheet) shows assets, liabilities and those net asset categories. The Statement of Activities (similar to an income statement) tracks revenue and expenses across programs, not just overall organizational performance.

Board members often fixate on the wrong numbers. A healthy amount of net assets without donor restrictions matters, but if 90% of revenue comes in restricted and the organization is constantly struggling to cover basic operating costs, that’s a sustainability problem that doesn’t show up in total net assets.

Liquidity deserves equal attention. A Statement of Financial Position showing $500,000 in net assets doesn’t mean there’s cash to meet payroll next month. Those assets might be tied up in restricted endowments, fixed assets like the building or pledges receivable that won’t arrive for months.

The IRS Form 990 requires extensive disclosure about financial activities, governance and programs. Board members bear oversight responsibility for the accuracy of this document and should understand what’s in it, particularly Part VII (compensation), Part VI (governance) and the Schedule of Contributors.

Common Pitfalls That Trip Up Nonprofit Boards

The biggest mistake is treating restricted funds as available money. Organizations face serious problems when they borrow from restricted accounts to cover unrestricted expenses, planning to “pay it back later.” That’s not how fund accounting works, and it can trigger donor clawbacks or legal issues.

In-kind donations create confusion too. When someone donates $5,000 worth of advertising space or professional services, the organization generally needs to record both the revenue and the expense. Revenue looks higher, but it doesn’t mean there’s more cash. Board members who don’t understand this see inflated income numbers and wonder why the organization still struggles financially.

Program expense allocation deserves more scrutiny than it typically gets. Donors and watchdog organizations want to see high percentages going to programs versus administration and fundraising. But the methodology for splitting shared costs (like the executive director’s salary or rent) requires judgment calls. Allocation methods need to be reasonable, consistent and documented.

Questions Every Board Member Should Ask at the Next Meeting

Effective financial oversight starts with asking the right questions. Don’t just nod along when the treasurer presents reports. Ask about cash flow projections for the next 90 days. Question any significant variances between budget and actual. Understand which revenue sources are growing or shrinking and why.

Review accounting policies at least annually. The capitalization threshold, revenue recognition methods and expense allocation approaches should be documented in writing. When board turnover happens, institutional knowledge needs to be preserved somewhere besides people’s memories.

Financial literacy across the full board makes a meaningful difference. Not everyone needs to become an accountant, but everyone should understand fund accounting basics, how to read financial statements and what red flags to watch for. If the board is looking at financial reports each quarter and still feeling uncertain about where the organization really stands, our team can help build clearer reporting and strengthen financial oversight. Let’s talk.

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