Are you considering the addition of nonprofit bookkeeping to your firm’s list of services? If you are already providing services to for-profit corporations, then adding accounting services for charities and other nonprofits is just a matter of understanding the basic differences and associated paperwork these specialized corporations need in order to maintain their compliance with tax law.
All organizations are mandated to achieve specific goals in their vision and mission statements, but how those goals are accomplished differ sharply according to the nature of the business. The money raised by a charity for a tax receipt, donated to a nonprofit or earned from membership dues to help move the organization forward is essential to this mandate. By hiring you, a professional accountant, learning to work with nonprofits and charities, they’re assured of a system of bookkeeping that will track and manage these funds. These funds, and properly accounting for them, is essential to the organization. As such, these specific factors should be carefully considered.
Key Differences Between For-Profit and Nonprofit Accounting
There are several nonprofit accounting rules and regulations that differ from for-profit companies. The most significant difference is in their reporting procedures.
A similarity between these various types of corporation is they all must produce statements each quarter. For-profits have a goal of making money, so balance statements are required that detail the equity in the company and the stock value of its owners. For-profits also produce income statements that illustrate their gains and losses, as well as revenue and expenditures.
A nonprofit or charity does not have the goal of making money for itself, but rather to fill a societal need. These funds are not considered income. Neither a balance statement nor an income statement is required. Instead, they produce a Statement of Financial Position and a Statement of Activities. The Statement of Financial Position outlines a charity’s net assets. This statement includes:
- Values of all assets owned by the charity
- Values of all debts owed by the charity
- The value of all net assets–the charity’s overall worth
The Statement of Activities highlights the group’s revenue less all expenses. Usually, both revenue and expenses are further classified into one of three potential restrictions:
- Permanent–expected to remain held by the corporation
- Temporary–expected to remain temporarily held, but can be utilized/paid at a future date
- Unrestricted–no restrictions apply to when or why this type of revenue/expense can be used/paid
Compliance Measures that Apply to Charities
Charities are expected to adhere to several rules of compliance when conducting their activities. Some of these rules are:
- Compliance with Fundraising Guidance
- Properly issuing donation receipts
- Restrictions on donations to non-qualified recipients
- Compensation rules for charity directors
- Timely filing tax forms
Fundraising Guidance Compliance
There are obligations of Canadian charities that must be adhered to, both legally and ethically, in reference to fundraising. Charitable organizations in Canada cannot engage in any activities that could be construed as:
- Providing private benefit
The Canada Revenue Agency (CRA) takes several factors into consideration to ensure that compliance is met, such as:
- What resources belonging to the charity are used for fundraising?
- Does the fundraising have an easily identifiable use or need?
- What is the ratio of expenses to revenue concerning fundraising?
- Has the charity made any inappropriate purchases?
- Does the charity engage in any inappropriate or unethical staffing practices?
- Does the charity engage in any activities in which most of the proceeds benefit contracted parties not affiliated with the charity?
- Does the charity offer commissions to fundraising staff based on money raised?
As an accountant providing bookkeeping to these organizations, you should also remain vigilant in regards to any misrepresentations of funds received by the charity or in their disclosure of costs related to fundraising. If any of their activities are not well-documented, this could be an issue. Transparency is king above all else when providing accounting.
Properly Issuing Donation Receipts
It is not required for charities to issue receipts to their donors. But, if they do, it is crucial that those receipts are compliant with CRA requirements. Some common mistakes the CRA finds when auditing charities are:
- Receipts missing elements required by the CRA
- Receipts issued for donated services (an ineligible type of donation to receive a receipt)
- Charitable “lending of registration” to another organization, which is prohibited
Even minor errors in the way the receipt is designed or in its content can be very serious offenses. Your client could be penalized for not providing a properly composed receipt, even if it is for a permitted donation.
Charitable Organizations Donating to Non-qualified Recipients
Accounting firms must ensure that their client’s transference of resources occurs only if the receiving organization is qualified to receive those resources. To discern a qualified recipient organization from one that’s not qualified, ask these questions:
- Is the receiving organization foreign?
- Are they able to officially issue donation receipts?
- If it’s a charity that’s also in Canada, is it registered?
The receiving organization doesn’t necessarily have to be a registered charity, but if they’re not, then the donating registered charity has to be able to illustrate its direction and control of these resources. If your client is unable to maintain control, they could be penalized 105% of the value of the property or funds given to the receiving organization-or worse-lose their status as a charity.
Compensation of Charity Directors
Canadian charities are usually prohibited from compensating their directors. Federal tax policies and provincial laws state that directors cannot be compensated for their actions as directors–but, there are circumstances in which a director can be paid for activities that extend beyond governing the charity. If the director’s activities are not directorial in nature, they can be compensated. Some of these circumstances include:
- The director is also a payable employee
- The director personally provides goods or services to the organization
In some cases the organization is considering, or already has, a contract with a firm or other business with which the director has a material association. Even if directorial payments are in the charity’s best interests, the Canadian government and some provinces may not allow it. It is important that your accounting firm studies the provincial laws related to the area in which the charity is located. For instance, Ontario’s provincial laws state that directors are constrained as far as what they can and can’t do for a charity, and whether or not they can be paid for doing so. If you also serve on the board of an Ontario charity, you and your firm can’t conduct an audit on that organization, nor can you charge for your services.
Timely T3010 Filing
Just like a for-profit, a charity can choose its fiscal year–though most charity and nonprofit fiscal years end on June 30. Your client’s Form T3010 for their charity is due to the CRA no later than six months past the end of their fiscal year. If this form isn’t received by the CRA within a few months of that cutoff date, the nonprofit runs the risk of deregistration and a loss of their charitable status–not to mention their privileges to provide receipts. Be sure all associated schedules and statements are provided with the filing.
You and the director should record the T3010 due date and check with the CRA to be sure the address the agency has for the corporation is correct. Failing to receive reminder notices from the CRA, due to a bad address, can result in a deregistration without notice.
Proper Accounting Procedures
Accounting for a nonprofit or a charity in Canada is much different than for a for-profit corporation. Budgeting, proper preparation of financial statements, and control procedures are all intended to ensure that the organization is operating legally and ethically.
It can be tough for organizations to budget. For nonprofits, it’s an exceedingly complex procedure. Nonprofit budgeting is driven by goals–what does the mission need to be in order to succeed? Proper budgeting is crucial to your client’s financial stability. While for-profits have several ways that they can prepare budgets, a nonprofit’s budget categories overlap and require constant modification. The budget of a nonprofit is meant as a guide for future progress, as well as a financial health statement–both of which are variable and as such will fluctuate throughout the fiscal year.
Your client’s nonprofit must prepare a written budget outlining the way in which it plans to work toward its goals. Operating budgets should be assessed and prepared with each new fiscal year. A capital budget should also be prepared at the same time, with cash-flow statements prepared periodically. All budgets and statements should be assessed at given intervals to ascertain if the organization is meeting the goals set forth within them.
Your role in the budgeting process is to make sure all journals balance at any given time, and that board members are aware of what is at their disposal for use in working toward the organization’s goals. You’ll also be responsible for the creation of budget sheets, in addition to the preparation of financial outlooks from time to time and some of the organization’s year-end activities.
Preparing Financial Statements
Your firm, managers within the nonprofit organization, and its board of directors have vital roles in ensuring that the organization’s financial reporting is complete and truthful.
Management chooses the nonprofit’s accounting policies. They are also responsible for the preparation, presentation and action with regard to financial information. The board of directors oversees management and its processes and maintains that the information presented reflects the reality of the nonprofit’s financial standing. Your role is to provide your guidance and professional opinion on the overall presentation regarding the nonprofit’s finances. Each of these roles depend on the others.
Canadian charities must have three separate journals for recording the organization’s receipts, expenses, disbursements and petty cash. Meanwhile, nonprofits must have annual meetings, an annual summary and financial statements. Nonprofit corporations are also responsible for filing a Form T2 corporate tax form and/or a Form T1044, the Nonprofit Information Return.
Of the many control procedures an organization can implement, one of the most important is an up-to-date account with pre-numbered cheques. There should be at least two members designated as signing officers upon opening the account. The responsibility of the account will be shared equally among the members. Any transactions related to the nonprofit should be processed through this account, and cash should never be used to pay a bill. Account reconciliations should occur on a monthly basis.
Maintenance of Bookkeeping Documents
Charities registered in Canada must maintain their books and keep all records within an office in Canada. The nonprofit also has to maintain a file of source documents supporting the information that is recorded in their books. These requirements ensure that, should the nonprofit be subjected to a CRA audit, the agency can review the revenue and expenses claimed by the charity, as well as verify all donation receipts issued by the charity.
How Long is a Charity Required to Keep Records?
All of a charity’s financial records must be retained by the charity for at least six years past the year they pertain to. After this time has elapsed, the records can be destroyed. Some records can’t be destroyed, regardless of how much time has elapsed. These records include:
- Minutes from board meetings
- Private journals
- General journals
- Share logs
- Special agreements and contracts
As far as records retention, nonprofits must maintain a duplicate record of receipts for no less than two years from when the donations were made. Nearly all other documents and records must be kept no less than six years. A few other records must be retained permanently. If the nonprofit closes, these records must still be kept for at least two years past the date of dissolution. If there’s ever a question of whether your client should hold onto a specific document or record, it is better to err on the side of caution and keep it.
Avoidance of Business Activities by Private Foundations
Generally, a business has some degree of commercial activity. In other words, revenue is derived from the provision of goods and services with the intent to turn a profit. When considering if an activity of a nonprofit falls into this category, there are certain pre-established criteria that must be considered:
- What was the action’s intended course?
- Is there a potential for the activity to show a profit?
- Is there a record of profits from past activities?
- What is the professional experience of the individuals undertaking the activity?
If the answers to any of the questions above point to the fact that the activity was most likely an attempt to earn a profit, the activity is considered a business–which is disallowed for nonprofit organizations. Where the lines become blurred is when the activity is performed with the intention to generate profits, but do not fall under the definition of business, such as:
- Soliciting for donations–not considered a business transaction because the donor doesn’t expect anything in return.
- Selling donated goods–also not considered a business transaction because retailers do not need donations in order to create an inventory. In the instance of selling donated items, the nonprofit is merely converting donated assets into cash.
The Canada Income Tax Act (CITA) recognizes that charities and other public nonprofit organizations carry on business related to their endeavours promoting their charitable goals. If the majority of the people assisting with these “related business” activities are volunteering their time, the associated activity is not considered commercial. For instance, when hospitals provide food in their cafeterias, this can be considered an associated activity that isn’t commercial. On the other hand, private charitable organizations are disallowed from carrying on any type of business activity. If these regulations aren’t adhered to, the nonprofit can face penalties, such as fines, and even lose their charitable registration.
Avoidance of Disallowed Fundraising Activities
Another job you have as an accountant for a Canadian nonprofit is to maintain vigilance in knowing how to spot an abusive charity gifting tax scheme. In recent years, the CRA has announced nearly $7 billion dollars worth of “donation” receipts that were in fact fraudulent. Only around 1% of the amount was actually spent by the reported nonprofit organizations on actual charitable activities. Nearly 200,000 tax returns filed by individuals and corporations were involved with some type of gifting scheme.
Among the different ways these schemes are structured, the most widely used is fraudulent receipting, in which a “donor” gives a $500 “donation” and receives a $1000 receipt from the organization. If you or your client are unsure if a scheme is appropriate or not, it’s best to avoid it. While a given scheme may not violate any current laws, ethics also come into play, and ethical missteps can cause you and your client to lose credibility. Fraudulent charitable activities can cause the public to lose confidence in the entire charitable sector.
It’s important to note here that a section of the Income Tax Act states that the CRA must maintain confidentiality for all individuals, charitable organizations and corporations when it comes to matters of taxation. While a charity maintains its registration, even if it has engaged in illegal or unethical dealings, the CRA is not permitted to disclose this information. If that charity loses their charitable status, only after the status has actually been revoked, the CRA can disclose misconduct.
Frequently Asked Questions about Nonprofit Accounting
Are nonprofits required to disclose financial information?
The short answer is yes. Not all information regarding a charity must be disclosed, such as board member status or exact salaries, but all financial information regarding an incorporated nonprofit must be disclosed and publicly available.
The Companies Act is a set of rules that apply to incorporated charitable foundations. Some of these rules pertain to the accurate keeping of records and their subsequent retention. Other rules for incorporated nonprofits include having a general meeting for all members once per year, at which the board of directors presents statements regarding the current affairs and position of the nonprofit financially. The board is allowed to set the meeting time and location, but this information must be present in the nonprofit’s bylaws. The organization must also file a return annually with the Corporate Affairs Branch of the CRA. If they fail to file on time, or do not file at all, they risk losing their incorporated status.
Do charities have to report or disclose salaries?
According to the CRA, registered charities need only provide the salary ranges of paid staff members, but not the exact amounts.
What are retained earnings called in a nonprofit organization?
One of the basic concepts in nonprofit accounting is the term “net asset.” Basically, gross assets minus liabilities equal net assets, or net funds, for a nonprofit. Where a for-profit entity’s statements would reflect retained earnings or the equity of the owner(s), the nonprofit’s statements reflect net assets. At the end of each accounting period, you close the organization’s books–but you won’t close them into an account for retained earnings. Each type of net asset has its own account, so each net asset would be closed out in the proper net asset account (permanent, temporary or unrestricted).
Does a nonprofit organization have to disclose its donor list?
The Federal Act forms the basis of the surrounding provincial acts. According to these acts, following a set of suggested rules assists nonprofits with compliance issues with regards to donor lists. These basic rules are the bare minimum requirements. Limit the collection of personal information. To ascertain if the information is relevant for the purpose, ask these questions:
- Why is the nonprofit asking for this specific personal information?
- What information required to attain the specified objective?
- How will the nonprofit use the information it obtains?
Ask for consent. Before the nonprofit collects any personally identifying information from anyone, it should be clearly understood by the individual how the information will be used and stored, and if it will or will not be disclosed. To properly inform potential donors, the nonprofit should:
- Disclose clear reasons why they require the information
- Explain how the organization plans to use the information
- Specify whether or not the organization plans to share the provided information with third-parties
- Provide information about where and how the information will be stored
In the carrying out of activities, sometimes aspects of the organization have to be changed or altered. If this occurs in respect to your client’s private donor information, it’s imperative that they once again ask for consent from the individuals. The change pertains to as a way of maintaining public trust.
Limit the use, disclosure, access, and retention of private information. Certain information given by donors may not need to be accessed by all people who work or volunteer with your client’s nonprofit. As a guide, consider these questions:
- How long does the organization need to keep this information?
- How should this personal information be classified?
- If the organization no longer needs certain information, will it be destroyed? If so, how? Whose responsibility is it to ensure adequate destruction of records that are no longer necessary?
To be thorough in your examinations and practices, take a look at this indispensable legal checklist for nonprofits in Canada. Ready? Accelerate your year-end adjustment process and start saving time on corporate returns with QuickBooks Online Accountant. Sign up for free.