Accounting for Non-profit Organizations: Types, Features & Financial Statements

TAKEAWAYS:

• Non-profit organizations (NPOs) focus on service, not profit, and follow unique accounting rules.
• Their financial statements include Receipts and Payments Account, Income and Expenditure Account, and Balance Sheet.
• Unlike businesses, NPOs do not aim to maximize profits but track funds used for their mission.
• Key differences from profit-making businesses: no profit motive, no capital structure, and special financial statements.
• Common NPOs in Nepal include schools, hospitals, temples, and social clubs.
• NEB exams often test how to prepare the Income and Expenditure Account and distinguish it from a Profit and Loss Account.

What Are Non-Profit Organizations (NPOs)?

Non-profit organizations (NPOs) are groups that operate for social, religious, educational, or charitable purposes—not to earn profits. Examples in Nepal include:

• Schools and colleges (e.g., community schools)
• Hospitals and clinics (e.g., government-run health posts)
• Religious organizations (e.g., temples, gurudwaras)
• Social clubs (e.g., sports clubs, cultural associations)
• Government bodies (e.g., local-level bodies like VDCs)

Unlike businesses, NPOs do not distribute profits to owners. Instead, any surplus is reinvested into their mission.

Key Features of NPO Accounting

NPOs follow special accounting rules because their goals differ from profit-making businesses. Here’s how:

1. No Profit Motive

• NPOs do not aim to earn profits for owners or shareholders.
• Any excess income over expenses is called a surplus, not profit.

2. Funds, Not Capital

• Instead of "capital," NPOs have funds (e.g., donations, grants, membership fees).
• These funds are used for specific purposes (e.g., building a school, running a clinic).

3. Special Financial Statements

NPOs prepare three main statements:

• Receipts and Payments Account (cash-based summary of cash inflows and outflows).
• Income and Expenditure Account (similar to a Profit and Loss Account but for NPOs).
• Balance Sheet (shows assets, liabilities, and funds at a point in time).

4. No Concept of "Owner’s Equity"

• Businesses show "capital" or "owner’s equity," but NPOs show accumulated funds or reserves.

5. Focus on Stewardship

• NPOs must account for how funds are used to ensure transparency and trust from donors/members.

Types of Non-Profit Organizations

NPOs can be classified based on their purpose and structure:

mindmap
  root((Non-Profit Organizations))
    Schools and Colleges
    Hospitals and Clinics
    Religious Organizations
    Social and Cultural Clubs
    Government Bodies (e.g., VDCs)
    Charitable Trusts
    Cooperative Societies

Financial Statements of NPOs

NPOs prepare three key financial statements. Let’s break them down with examples.

1. Receipts and Payments Account

This is a summary of cash received and paid during a period (like a simplified cash book). It does not show opening or closing balances of assets/liabilities.

Example: Suppose a Community Sports Club has the following transactions in 2079:

• Receipts (Cash Inflows):
  • Membership fees: Rs. 50,000
  • Donations: Rs. 20,000
  • Interest on bank deposit: Rs. 5,000
• Payments (Cash Outflows):
  • Salaries: Rs. 30,000
  • Purchase of sports equipment: Rs. 15,000
  • Rent: Rs. 10,000
  • Miscellaneous expenses: Rs. 5,000

Receipts and Payments Account for the Year Ended 2079

Note:

• This account shows only cash transactions.
• It does not show non-cash items like depreciation or outstanding expenses.

2. Income and Expenditure Account

This is similar to a Profit and Loss Account but for NPOs. It shows income earned and expenses incurred during the period, including non-cash items like depreciation.

Example: Using the same data as above, but now including:

• Opening balance of sports equipment (cost Rs. 25,000, accumulated depreciation Rs. 5,000).
• Depreciation for the year: Rs. 3,000.

Income and Expenditure Account for the Year Ended 2079

Key Differences from Profit and Loss Account:

3. Balance Sheet of an NPO

The balance sheet shows the financial position of the NPO at a point in time. It includes:

• Assets (what the NPO owns)
• Liabilities (what the NPO owes)
• Funds (accumulated surplus or reserves)

Example Balance Sheet for Community Sports Club (as of 2079):

Note:

• The accumulated surplus is the total surplus from previous years plus the current year’s surplus (Rs. 27,000).
• There is no "capital" account like in businesses.

How to Prepare the Income and Expenditure Account

Here’s a step-by-step guide with a worked example:

Given: A Youth Club has the following transactions for the year 2079:

1. Opening balances:
   • Furniture (cost Rs. 50,000, accumulated depreciation Rs. 10,000).
2. Receipts:
   • Membership fees: Rs. 80,000
   • Donations: Rs. 30,000
   • Interest on bank deposit: Rs. 5,000
3. Payments:
   • Salaries: Rs. 40,000
   • Purchase of new furniture: Rs. 20,000
   • Rent: Rs. 15,000
   • Electricity: Rs. 5,000
4. Other adjustments:
   • Depreciation on furniture for the year: 10% of the opening net block.
   • Outstanding salaries: Rs. 2,000.

Step 1: Calculate Depreciation

• Opening net block of furniture = Cost (Rs. 50,000) - Accumulated depreciation (Rs. 10,000) = Rs. 40,000.
• Depreciation for the year = 10% of Rs. 40,000 = Rs. 4,000.

Step 2: Prepare the Income and Expenditure Account

Step 3: Update the Balance Sheet

• Add the surplus (Rs. 31,000) to the accumulated funds.
• Show the new furniture and depreciation in the assets section.

Comparison: Business vs. Non-Profit Accounting

Here’s a quick comparison table to help you remember the key differences:

Common Errors to Avoid in NPO Accounting

Students often make these mistakes in NEB exams. Avoid them!

1. Confusing Income and Expenditure Account with Profit and Loss Account

   • Error: Treating surplus as profit.
   • Correct: Surplus is for NPOs; profit is for businesses.

2. Ignoring Depreciation

   • Error: Forgetting to add depreciation in the Income and Expenditure Account.
   • Correct: Always include depreciation as an expense.

3. Mixing Cash and Non-Cash Items in Receipts and Payments Account

   • Error: Including non-cash items (e.g., depreciation) in this account.
   • Correct: Only cash transactions go here.

4. Incorrect Classification of Funds

   • Error: Treating donations as "capital."
   • Correct: Donations are part of income, not capital.

5. Forgetting Outstanding and Prepaid Items

   • Error: Not adjusting for outstanding salaries or prepaid rent.
   • Correct: Always account for accruals and prepayments.

NEB Board-Style Questions and Solutions

Here are typical NEB exam questions and how to solve them.

Question 1: Receipts and Payments Account

Prepare the Receipts and Payments Account for the year ended 2079 for a Cultural Club with the following transactions:

• Membership fees received: Rs. 60,000
• Donations: Rs. 25,000
• Salaries paid: Rs. 35,000
• Purchase of books: Rs. 10,000
• Rent paid: Rs. 15,000
• Interest received: Rs. 5,000

Solution:

Question 2: Income and Expenditure Account

From the following information, prepare the Income and Expenditure Account for the year ended 2079 for a School:

• Opening balances:
  • Furniture (cost Rs. 100,000, accumulated depreciation Rs. 20,000).
• Receipts:
  • Tuition fees: Rs. 200,000
  • Donations: Rs. 50,000
• Payments:
  • Salaries: Rs. 120,000
  • Purchase of new furniture: Rs. 30,000
  • Electricity: Rs. 10,000
• Adjustments:
  • Depreciation on furniture: 10% of opening net block.
  • Outstanding salaries: Rs. 5,000.

Solution:

1. Calculate Depreciation:

   • Opening net block = Rs. 100,000 - Rs. 20,000 = Rs. 80,000.
   • Depreciation = 10% of Rs. 80,000 = Rs. 8,000.

2. Prepare Income and Expenditure Account:

Question 3: Balance Sheet

Prepare the Balance Sheet for the School from Question 2, assuming:

• Cash at bank: Rs. 40,000
• Cash in hand: Rs. 10,000
• Accumulated surplus (from previous year): Rs. 50,000

Solution:

Note:

• Accumulated surplus = Previous surplus (Rs. 50,000) + Current surplus (Rs. 82,000) = Rs. 132,000.
• Total assets should equal total liabilities + funds (Rs. 152,000 vs. Rs. 137,000 + Rs. 5,000 outstanding salaries = Rs. 142,000). There’s a discrepancy here—likely due to missing information (e.g., other assets or liabilities). In exams, double-check calculations!

Exam Tips for Unit 15

1. Understand the Purpose of Each Statement

   • Receipts and Payments Account: Only cash transactions.
   • Income and Expenditure Account: Includes non-cash items like depreciation.
   • Balance Sheet: Shows financial position at a point in time.

2. Memorize Key Terms

   • Surplus (not profit), funds (not capital), and accumulated funds (not owner’s equity).

3. Practice Adjustments

   • Always account for:
     • Depreciation.
     • Outstanding expenses (e.g., salaries).
     • Prepaid expenses (e.g., rent).

4. Compare with Business Accounting

   • NEB often asks to differentiate between NPO and business accounting. Use the comparison table above.

5. Show Workings Clearly

   • In exams, write steps like:
     • "Depreciation = 10% of opening net block."
     • "Outstanding salaries added to expenses."

6. Common NEB Question Patterns

   • Prepare Receipts and Payments Account from cash transactions.
   • Prepare Income and Expenditure Account with adjustments (depreciation, outstanding items).
   • Prepare a Balance Sheet linking assets, liabilities, and funds.

7. Real-Life Application

   • Think of local examples like:
     • A school (tuition fees, donations, salaries).
     • A hospital (patient fees, grants, medical expenses).
     • A community club (membership fees, sports equipment).