Understanding Nonprofit Accounting Standards and Compliance Requirements

Key Takeaways 

• Nonprofit accounting standards ensure compliance and transparency: Adhering to established accounting standards helps nonprofits maintain transparency, gain donor trust, and avoid legal penalties by ensuring proper financial reporting and compliance with IRS regulations.
• Key standards: Nonprofits must comply with US financial reporting standards including GAAP, FASB ASC 958 (not-for-profit entities), and recent updates such as ASU 2016-14, as well as IRS Form 990 filing requirements.
• Two-category net asset classification: Nonprofits must classify their net assets into two categories: with donor restrictions and without donor restrictions. This classification impacts reporting and determines how funds can be used.
• Four required financial statements for nonprofits: Nonprofits are required to prepare Statement of Financial Position, Statement of Activities, Statement of Cash Flows, and Statement of Functional Expenses to provide a comprehensive view of their financial health.
• Overcoming common compliance challenges: Many nonprofits struggle with maintaining accurate records, tracking restricted funds, and filing timely reports. Leveraging modern financial software and seeking regular audits can streamline compliance efforts and improve financial oversight.

Nonprofits are under increasing pressure to manage their resources efficiently and demonstrate transparency in today’s landscape, where financial accountability is paramount. The 2025 Bank of America Study of Philanthropy reveals that 62% of affluent households evaluate the impact of their charitable contributions before making their next donation. This highlights the growing expectation for nonprofits to showcase clear financial stewardship.

This trend reinforces the critical role of nonprofit accounting standards, the framework of rules and guidelines that govern how nonprofits record, report, and disclose their financial activities.

Nonprofit accounting standards are designed to ensure that organizations operate with transparency, accountability, and compliance with legal requirements. These standards help nonprofits accurately report their financial activities, maintain donor trust, and avoid potential legal and financial pitfalls.

But these standards aren’t just regulatory obligations. They are strategic tools. By adhering to the right financial principles, nonprofits can manage their resources more efficiently, demonstrate their fiscal responsibility to stakeholders, maintain their tax-exempt status, and unlock opportunities for grants and funding. While the complexity of these standards may seem daunting, they are manageable with the right approach and tools.

To understand non profit accounting standards, we first need to grasp the fundamental principles they're built on. Let’s explore the key standards every nonprofit must know.

The Premise of Accounting for Nonprofit Organizations

Nonprofit accounting is fundamentally driven by a core philosophy: nonprofits exist to serve a mission, not generate profit. This distinction fundamentally shapes everything about nonprofit financial practices, from reporting to resource management. 

Unlike for-profit organizations, where the primary objective is maximizing profit for shareholders, nonprofits focus on creating social value, which shifts how their financials are handled.

In practice, this mission-driven approach manifests in several key ways:

• Accountability to donors and stakeholders, not shareholders, means nonprofits must report not on profits but on how effectively they’re using donations to further their mission. This accountability is formalized through Form 990, the annual informational return nonprofits file with the IRS, which becomes a public document accessible to donors and the public.
• Stewardship over donor-restricted resources ensures that funds given with specific intent are tracked and used accordingly, reflecting the trust donors place in the nonprofit.
  For instance, if a donor contributes $50,000 specifically for youth education programs, that restricted contribution cannot be redirected to senior services. It must be tracked separately and spent only as intended.

• Transparency as a public trust responsibility acknowledges that nonprofits hold their financial records publicly, maintaining the integrity required for public funding and support.
• Measuring success by mission impact, not profit margins, means nonprofits assess their effectiveness based on how well they fulfill their mission rather than financial performance.

How these principles shape nonprofit accounting practices

These philosophical principles are embedded into nonprofit accounting practices:

• Net assets replace equity: Unlike for-profit organizations that report shareholders' equity, nonprofits report net assets on the Statement of Financial Position. Net assets represent the organization's accumulated resources available for mission fulfillment, reflecting stewardship of donated funds rather than ownership interests.
• Functional expense reporting demonstrates mission focus: Nonprofits file a Statement of Functional Expenses that separates costs into program, management/general, and fundraising categories, allowing donors to see exactly what percentage of their contribution funds programs versus overhead.
• Restricted fund tracking ensures donor intent: By maintaining separate accounting codes for restricted and unrestricted funds, nonprofits honor the specific intentions donors express when making contributions. This dual-category tracking (net assets with donor restrictions and net assets without donor restrictions) is required by GAAP and directly impacts financial reporting.
• Public disclosure requirements maintain transparency: Form 990 and audited financial statements create accountability mechanisms that foster public trust and demonstrate organizational integrity.

Understanding the Stewardship Foundation

Understanding these principles clarifies why nonprofit accounting standards focus on mission-driven stewardship rather than profit generation. This stewardship-focused premise is formalized through the Generally Accepted Accounting Principles (GAAP) and the specific nonprofit standards codified in FASB ASC 958, along with requirements like Form 990 filing. It’s the foundation all nonprofit accounting standards are built on.

These aren't just compliance obligations; they are mechanisms designed to build donor trust, demonstrate organizational integrity, and ensure that nonprofit resources are managed according to the values and intentions of donors and stakeholders. Let's examine how these principles work in practice.

Key Nonprofit Accounting Standards

Every nonprofit runs on trust, from the people who donate to the partners who fund its programs. That trust depends on sound financial practices. Accounting standards give nonprofits a clear, consistent way to record and report their finances so that anyone looking in can see how funds are managed.

These standards go beyond meeting regulatory boxes. They help finance teams stay organized, give boards reliable information for decisions, and show donors that resources are being used as promised.

In this section, we will focus on the three pillars of nonprofit accounting standards:

• Generally Accepted Accounting Principles (GAAP): The foundational framework for all U.S. financial reporting
• Financial Accounting Standards Board (FASB) regulations: Specialized accounting rules tailored for nonprofits
• IRS requirements: Compliance standards necessary for maintaining tax-exempt status

Each of these elements is crucial for maintaining transparency, trust, and operational effectiveness in nonprofit organizations. Let’s begin with an in-depth look at GAAP, which forms the bedrock of nonprofit financial reporting.

GAAP for nonprofits

GAAP are a set of standardized guidelines used in the preparation of financial statements across various sectors, including the nonprofit sector. These principles help ensure that the financial statements of nonprofit organizations are consistent, transparent, and comparable, which is crucial for stakeholders such as donors, board members, and auditors.

GAAP serves as the foundation for financial reporting in the U.S., providing a uniform framework for how financial activities are recorded and presented. 

While it is not legally mandated, following GAAP is practically essential for nonprofit organizations. Without adhering to GAAP, nonprofits could face difficulties during audits, grants, and funding applications. Moreover, donors and grantmakers often expect nonprofit organizations to comply with these principles, as it assures them that the financial data is reliable and consistent.

Here are the 10 GAAP principles, explained in the context of nonprofit accounting:

10 GAAP principles for nonprofit organizations

1. Principle of Regularity: Nonprofits must follow established rules and regulations. This means that accounting methods and reporting practices must align with GAAP standards to ensure consistency and reliability in financial reporting.
2. Principle of Consistency: Nonprofits are required to use the same accounting methods across reporting periods. This enables stakeholders to make meaningful comparisons over time and assess an organization’s financial performance consistently.
3. Principle of Sincerity: This principle emphasizes the need for honest, unbiased financial reporting. Nonprofits are expected to represent their financial position and results transparently, without manipulation or misrepresentation.
4. Principle of Permanence of Methods: Nonprofits should maintain consistent accounting methods over time. Any changes to the accounting approach must be disclosed to ensure transparency and to allow stakeholders to understand the reasons behind the change.
5. Principle of Non-Compensation: Nonprofits must report assets and liabilities separately. This principle ensures that the financial statements provide a clear and accurate picture of the organization's financial position, without netting out liabilities against assets.
6. Principle of Prudence: Nonprofits must record revenue only when it is certain and recognize liabilities when they are probable. This ensures that the financial statements present a conservative view of the organization’s financial health.
7. Principle of Continuity: Nonprofits assume that their operations will continue indefinitely. This principle reflects the ongoing nature of nonprofit organizations and requires that financial statements are prepared under the assumption that the organization will remain operational in the foreseeable future.
8. Principle of Periodicity: Financial activities must be reported at regular intervals whether that’s monthly, quarterly, or annually. This ensures that financial data is up-to-date and helps organizations track performance over time.
9. Principle of Materiality: Nonprofits must disclose all material financial information that could influence the decision-making of stakeholders. This means that significant financial events or transactions must be clearly communicated to ensure full transparency.
10. Principle of Utmost Good Faith: This principle assumes honesty from all parties involved in the financial reporting process. Nonprofits are expected to act in good faith when preparing and presenting their financial statements.

Key GAAP requirements for nonprofits

While GAAP establishes the overall framework, specific requirements for nonprofit organizations ensure that they meet the unique needs of their stakeholders. These include:

• Transparency in reporting: Nonprofits are required to report all financial activities clearly and comprehensively, providing a full picture of their financial health.
• Accurate classification of net assets: Nonprofits must classify their net assets as either with donor restrictions or without donor restrictions. This distinction is crucial for tracking how donor contributions are used and ensuring compliance with donor intent.
• Expense reporting by function and nature: Nonprofits must report expenses in terms of their function (e.g., program services, fundraising, administration) and nature (e.g., salaries, supplies). This helps demonstrate how resources are being used to support the nonprofit’s mission.
• Revenue recognition: Nonprofits must recognize revenue based on whether contributions are conditional or unconditional, ensuring that revenues are recorded in the period they are earned.
• Preparation of four required financial statements: Nonprofits must prepare Statement of Financial Position, Statement of Activities, Statement of Cash Flows, and Statement of Functional Expenses. These statements provide comprehensive insights into the organization’s financial activities and are necessary for compliance and transparency.

Why GAAP matters for nonprofits

Adhering to GAAP is not just a matter of compliance; it directly impacts a nonprofit’s credibility and operational effectiveness. Here’s why GAAP is so crucial:

• Required for audited financial statements: Auditors expect nonprofits to follow GAAP to ensure that financial statements are reliable and free of material misstatements.
• Expected by grantmakers and major donors: Donors and funding bodies often require GAAP-compliant financial statements before awarding grants or making contributions, ensuring they can trust the organization’s financial health.
• Maintains tax-exempt status: While GAAP compliance itself isn't directly mandated for tax-exempt status, the IRS expects nonprofits to maintain accurate, well-documented financial records. Nonprofits filing Form 990 must demonstrate responsible financial stewardship. Maintaining GAAP-compliant books strengthens the nonprofit's position during audits and demonstrates sound financial management to regulators.
• Builds credibility and professionalism: By adhering to GAAP, nonprofits show that they operate with a high level of financial discipline, fostering trust among donors, stakeholders, and the public.
• Enables meaningful financial comparisons: GAAP provides a standardized approach to financial reporting, allowing for comparisons between different organizations and over time, which is crucial for strategic decision-making.

While GAAP provides the foundation for nonprofit accounting, the detailed regulations that nonprofits must follow are set by the Financial Accounting Standards Board (FASB). Let’s explore these specific nonprofit regulations in the next section.

FASB standards for nonprofits

The Financial Accounting Standards Board (FASB) is an independent organization responsible for establishing accounting and financial reporting standards for public and private entities in the U.S., including nonprofit organizations. Formed in 1973, FASB develops and issues authoritative guidance through Accounting Standards Updates (ASUs), which clarify and improve existing principles under GAAP.

For nonprofits, FASB provides the backbone of financial reporting transparency, ensuring that donors, auditors, and regulators can interpret nonprofit financial statements consistently. The most critical standard for nonprofits is FASB ASC 958 – Not-for-Profit Entities, which serves as the primary accounting framework for the sector.

FASB ASC 958 – Not-for-Profit Entities

FASB ASC 958 consolidates all guidance related to nonprofit financial reporting under a single framework. It governs how nonprofits present their financial statements, classify net assets, and recognize contributions. In essence, ASC 958 is the “comprehensive guide” for nonprofit accounting and ensures uniformity across the sector.

Key areas covered under ASC 958 include:

• Financial statement presentation: Defines the structure and required disclosures for nonprofit financial reports
• Net asset classification: Establishes how funds are categorized as either with or without donor restrictions
• Contribution recognition: Outlines how to record donations, grants, and other inflows based on donor intent and conditions

Within ASC 958, several major ASUs have reshaped nonprofit accounting practices over time, particularly ASU 2016-14 and ASU 2018-08.

ASU 2016-14 – presentation of financial statements for not-for-profit entities

Issued in 2016 and effective for fiscal years beginning after December 15, 2017, ASU 2016-14 represented one of the most significant updates to nonprofit financial reporting in decades. It streamlined classification, improved liquidity transparency, and expanded disclosure requirements, modernizing how nonprofits communicate their financial position.

Key updates introduced by ASU 2016-14 include:

• Simplified net asset classification: The previous three-class system—Unrestricted, Temporarily Restricted, and Permanently Restricted—was replaced by two clearer categories:
  • Net Assets With Donor Restrictions
  • Net Assets Without Donor Restrictions

Comparing the three-class vs two-class net asset system

This change made it easier for readers of financial statements to understand donor-imposed limitations and how funds are being managed.

• Liquidity and availability disclosures:
  Nonprofits are now required to disclose the availability of financial assets expected to be used within one year. This disclosure helps stakeholders assess short-term financial health and the organization’s ability to meet immediate obligations.
• Functional expense reporting for all nonprofits:
  Previously mandatory only for certain organizations, functional expense reporting became required for all nonprofits under ASU 2016-14. This means expenses must now be reported by both function (program, management, fundraising) and nature (salaries, rent, supplies). The goal is to demonstrate how effectively resources are used to advance the mission.
• Investment return reporting:
  Investment returns must now be reported net of external and direct internal investment expenses, simplifying presentation and ensuring comparability across organizations.
• Underwater endowment funds:
  The update provided new guidance for "underwater" endowments (where the fair value of the fund falls below the original gift amount). Nonprofits must now classify these within net assets with perpetual restrictions—a subset of net assets with donor restrictions—and disclose the aggregate amount by which funds are underwater, along with the organization's spending policy.

This ensures that the perpetual restriction on the endowment principal is maintained even as the fund's value has temporarily declined.

ASU 2018-08 – clarifying the scope and accounting guidance for contributions

Introduced to address widespread confusion over how nonprofits distinguish between contributions and exchange transactions, ASU 2018-08 ensures greater consistency in recognizing grant and donation income.

This update clarifies two main issues:

• • Contributions are nonreciprocal. The donor doesn’t receive equal value in return.
  • Exchange transactions involve the transfer of goods or services of commensurate value.

2. Is the contribution conditional or unconditional?

• • Unconditional contributions should be recognized immediately when pledged.
  • Conditional contributions are recognized only after conditions are met, such as achieving specific outcomes or matching fund requirements.

Understanding this distinction is essential for accurate revenue recognition. Misclassifying conditional contributions as unconditional can lead to overstated income and compliance issues during audits.

Example: If a foundation pledges $100,000 to a nonprofit contingent upon reaching 1,000 program participants, that revenue is recognized only when the participation target is achieved, not when the pledge is made.

Other relevant FASB standards affecting nonprofits

While ASC 958, ASU 2016-14, and ASU 2018-08 form the core of nonprofit accounting, several other FASB standards also impact financial reporting:

• ASC 606 – Revenue from Contracts with Customers: Applies to exchange transactions, such as membership fees, program service fees, or tuition, where a reciprocal value is provided. It standardizes revenue recognition based on performance obligations and timing.
• ASC 842 – Lease Accounting: Requires nonprofits to record most leases on the balance sheet as both a right-of-use asset and a lease liability, improving transparency around long-term commitments.
• ASC 820 – Fair Value Measurement: Provides guidance on valuing assets and liabilities at fair value, ensuring consistency in how investments, donations-in-kind, and endowment assets are reported.

Contribution recognition under FASB guidelines

Contribution recognition remains one of the most critical elements of nonprofit accounting. Under FASB’s framework:

• Unconditional contributions are recognized immediately upon receipt or when the promise is made, as long as there are no barriers or measurable conditions attached.
• Conditional contributions are recognized only once the specified conditions or performance barriers have been satisfied.
• Donor-imposed restrictions fall into three main types:
  • Purpose restrictions: Funds must be used for specific programs or activities.
  • Time restrictions: Funds may be used only after a particular date or event.
  • Perpetual restrictions: Funds must be maintained in perpetuity, such as an endowment where only the investment income can be spent.

This structured approach ensures that nonprofits honor donor intent while maintaining accuracy in revenue reporting.

FASB’s updates have fundamentally improved how nonprofits communicate their financial information, offering greater clarity, comparability, and accountability. By following these standards, nonprofits strengthen their credibility with donors, grantmakers, and auditors alike.

FASB standards govern how nonprofits prepare their financial statements, but there’s another critical compliance layer: IRS reporting requirements, which determine how nonprofits maintain their tax-exempt status and public accountability.

IRS Form 990 compliance

Form 990 is the annual information return required by the Internal Revenue Service (IRS) for most tax-exempt organizations in the U.S. Unlike income tax filings for for-profit entities, Form 990 isn’t about paying taxes, it’s about demonstrating transparency, accountability, and adherence to tax-exempt purposes. 

Through this form, nonprofits disclose their financial activities, governance practices, and how they use funds to support their mission.

The primary purpose of Form 990 is threefold:

1. To maintain eligibility for tax-exempt status under Section 501(c)(3) of the Internal Revenue Code
2. To ensure public transparency, since the document is publicly accessible and used by donors, regulators, and journalists to assess nonprofit performance
3. To uphold organizational accountability, requiring nonprofits to show how their financial resources support their stated mission rather than private interests

Variations of Form 990

Different versions of Form 990 apply depending on the organization’s financial size:

• Form 990-N (e-Postcard): For nonprofits with gross receipts of $50,000 or less. It’s an eight-question electronic filing with no detailed financial statements required.
• Form 990-EZ: For organizations with gross receipts under $200,000 and total assets under $500,000. It offers a simplified reporting format compared to the full version.
• Form 990 (Full): For larger organizations exceeding those thresholds. This version provides the most comprehensive disclosure of financials, governance, and program outcomes.

Regardless of size, all versions serve the same purpose, offering a transparent view into how funds are raised, allocated, and managed.

How Form 990 relates to GAAP financial statements

A well-maintained GAAP-compliant accounting system simplifies Form 990 preparation. Many sections directly reference GAAP-based financial data:

• Part IX – Statement of Functional Expenses: Aligns with GAAP expense reporting by function and nature, ensuring visibility into how much is spent on programs versus administration and fundraising
• Part X – Balance Sheet: Derived from the GAAP Statement of Financial Position, showing assets, liabilities, and net assets (with or without donor restrictions)
• Parts XI and XII – Reconciliation of Net Assets: Tie directly to the Statement of Activities, reconciling revenues, expenses, and changes in net assets

In essence, GAAP-compliant books make Form 990 filings accurate, consistent, and audit-ready, reducing the risk of errors and improving public credibility.

Key compliance points

• Filing deadline: Due on the 15th day of the fifth month after the end of the nonprofit’s fiscal year (e.g., May 15 for calendar-year filers).
• Extensions: A six-month extension is available using Form 8868.
• Penalties: Late filing can result in penalties of $20 per day (up to $12,000 or 5% of gross receipts, whichever is less) for organizations with gross receipts less than $1,208,500, and $120 per day (maximum $60,000) for organizations with gross receipts exceeding $1,208,500. Repeated non-filing for three consecutive years automatically revokes tax-exempt status.
• Public disclosure: All filed Form 990s are publicly available via platforms like GuideStar (Candid) or the nonprofit’s own website.
• Unrelated business income tax (UBIT): Nonprofits earning income from unrelated business activities must report and pay taxes on that income via Form 990-T.

Relationship between GAAP and Form 990

While GAAP compliance is not legally mandatory, Form 990 filing is. Yet, following GAAP principles directly benefits Form 990 preparation in several ways:

• It ensures figures reconcile seamlessly across statements.
• It provides clarity for questions tied to donor restrictions, functional expenses, and net assets.
• It helps nonprofits present data that auditors, grantmakers, and regulators can easily interpret.

In short, GAAP forms the internal structure of nonprofit accounting, while Form 990 serves as its public-facing counterpart, together building accuracy, compliance, and trust.

Understanding these standards is important, but why do they matter beyond just compliance? Let’s explore the strategic value of nonprofit accounting standards.

Why Nonprofit Accounting Standards Matter

Beyond compliance, nonprofit accounting standards provide a structured way to plan strategically, demonstrate integrity, and make data-driven decisions that strengthen both mission delivery and donor confidence.

1. Strategic decision-making

Accurate financial statements are vital tools for informed decision-making. By following nonprofit accounting standards, leadership teams can allocate resources based on reliable, comparable data rather than estimates or assumptions. These standards make it possible to assess which programs are most cost-effective, identify inefficiencies, and evaluate long-term sustainability.

Budget-to-actual comparisons become more meaningful under GAAP and FASB guidelines, helping boards monitor progress toward financial and operational goals. Reliable financial reporting also supports scenario planning, ensuring nonprofits can respond to unexpected funding fluctuations or new opportunities.

For example, analyzing functional expenses, a GAAP requirement, helps leadership determine whether too much is being spent on administration or fundraising instead of core mission programs. This insight directly informs strategic adjustments to optimize impact.

2. Regulatory compliance

Adhering to nonprofit accounting standards is essential for maintaining tax-exempt status under IRS Section 501(c)(3) and meeting state-level registration and reporting requirements. Properly prepared GAAP-based statements align with Form 990 disclosures, ensuring transparency and minimizing errors that could trigger IRS scrutiny.

Compliance also extends to grant reporting. Many foundations and government funders require audited, GAAP-compliant financials as part of their due diligence. Failure to comply can lead to penalties, delayed disbursements, or even grant clawbacks.

Non-compliance risks are not theoretical. Organizations that consistently file late or inaccurately can face financial penalties or, in extreme cases, revocation of exempt status. Maintaining accurate, standards-based records significantly reduces these risks while supporting audit readiness and funding eligibility.

3. Stakeholder trust & transparency

Trust is what keeps nonprofits running. Clear, consistent accounting helps earn that trust by showing exactly where every dollar goes. When donors and funders can see how much supports programs versus operations, they know their contributions are being used wisely.

For board members, standards-based reporting demonstrates professionalism and accountability, equipping them with credible data for oversight and governance. Transparent reporting also improves the nonprofit’s public reputation, making it easier to attract both new donors and corporate partners.

For instance, when a nonprofit clearly reports functional expenses, donors can quickly assess that, say, 75% of funds go directly to programs while 25% cover operations. This level of clarity differentiates well-managed organizations from less transparent peers and contributes to stronger fundraising performance.

Together, strategic decision-making, compliance, and transparency create a virtuous cycle: strong standards promote compliance, compliance builds trust, trust attracts funding, and funding fuels greater impact. Nonprofit accounting standards are not just about recordkeeping; they are about creating financial integrity that sustains mission success.

The benefits are clear, but how do nonprofits actually achieve and maintain compliance? Let’s walk through the implementation process step by step.

How to Comply with Nonprofit Accounting Standards

7-Step Process to Comply with Nonprofit Accounting Standards

Compliance is not a one-time task. It is a repeatable system that touches daily operations, monthly closes, and annual reporting. The steps below create a practical framework that helps nonprofits stay audit ready, protect donor intent, and keep leadership aligned. Follow them in order, then cycle through them each month to keep controls tight and reporting accurate.

Step 1: Establish strong internal controls

Internal controls are the backbone of compliance. They are the documented policies, procedures, and systems that protect assets, reduce risk, and keep financial data accurate. A simple, written internal control manual clarifies who does what, how approvals work, and which records must be retained.

Key internal controls to implement:

• Segregation of duties: different people authorize, record, and reconcile
• Dual signatures: required for checks or ACH above a set threshold (example: $1,000)
• Monthly bank reconciliations: completed and reviewed by someone independent of cash handling
• Approval workflows for expenses: pre-approval for purchases, travel, and grants
• Budget-to-actual monitoring: monthly variance review with explanations
• Board oversight and audit committee: charter, calendar, and minutes
• Documentation requirements: invoices, receipts, grant terms, donor letters
• Access controls for financial systems: role-based permissions, MFA, change logs
• Regular inventory of assets: tag fixed assets, update schedules, spot-check custody

Benefits:

• Prevents fraud and errors
• Improves accuracy of financial data
• Creates a clear audit trail
• Demonstrates strong governance

With controls in place, the next step is organizing your financial data properly.

Step 2: Gather and organize financial data

Organized documentation speeds monthly close, strengthens audits, and supports Form 990. Build a filing structure that mirrors your chart of accounts and key processes.

Actions to take:

• Collect all financial documents: bank statements, credit card statements, invoices, receipts, donor correspondence
• Set up an organized filing system: consistent folder names for physical and digital records
• Create a document retention policy: periods for finance, payroll, and grant records
• Maintain grant agreement files: budgets, allowability rules, reporting schedules
• Keep gift acknowledgment letters: amounts, dates, and restriction language
• Store board meeting minutes: approvals, financial votes, and policy changes
• Track all donor restrictions in writing: purpose, time, and any conditions

Once your data is organized, you need to categorize it properly according to GAAP requirements.

Step 3: Categorize transactions properly

Correct categorization is essential for GAAP reporting, Form 990, and decision-quality analytics.

Revenue categorization:

• Contributions vs. exchange transactions: donations with no commensurate value vs. fee-for-service
• Conditional vs. unconditional contributions: recognize only when barriers are met for conditional gifts
• Restricted vs. unrestricted funds: apply purpose or time limits when stated by the donor
• Document donor restrictions for each gift: keep letters, grant terms, and emails

Expense categorization:

• By function: Program services, Management and general, Fundraising
• By nature: Salaries, benefits, occupancy, supplies, professional services
• Create allocation methodologies for shared expenses: time studies, square footage, headcount
• Document allocation decisions: methods, percentages, and effective dates

Net asset tracking:

• With donor restrictions: purpose, time, or perpetual
• Without donor restrictions: include board-designated amounts
• Track restriction releases: move to without donor restrictions when met

Importance:

• Enables accurate financial statement preparation
• Supports Form 990 completion
• Provides timely data for board and leadership decisions

Manual categorization is time-consuming and error-prone. The right software makes this process automated and accurate.

Step 4: Choose GAAP-compliant accounting software

Accounting software is the engine of efficient compliance. Pick a system designed for nonprofits so your books align with GAAP, FASB ASC 958, and IRS reporting needs.

Features nonprofits need:

• Fund accounting capabilities: separate funds and projects
• Restricted vs. unrestricted tracking: donor intent, releases, and roll-forwards
• Functional expense allocation: by function and nature with auditable methods
• Grant tracking and reporting: budgets, allowability, drawdowns, reports
• GAAP-compliant financial statements: statements and footnote support
• Form 990 export capabilities: schedules and functional expense mapping
• Multi-user access with permissions: least-privilege roles and approvals
• Audit trail: user, timestamp, and change history
• Integration with other systems: CRM, payroll, online giving, and banking

Common nonprofit accounting systems

Choosing the right accounting software is one of the most important steps in building a compliant, scalable financial foundation. Nonprofit accounting systems are designed to handle the unique requirements of fund tracking, grant reporting, and donor restrictions: features that traditional business accounting tools often lack.

Some of the most widely used platforms include:

• QuickBooks Nonprofit: Popular among smaller organizations for its affordability and ease of use. It supports basic fund accounting and donation tracking but may require add-ons for complex grants or multi-entity reporting.
• Aplos: Built specifically for churches and small nonprofits, offering user-friendly fund tracking, budgeting, and donation management features.
• Sage Intacct: A cloud-based system designed for midsize and larger nonprofits that need advanced automation, multi-dimensional reporting, and integration with fundraising or payroll platforms.
• Blackbaud Financial Edge NXT: Geared toward larger organizations and foundations. It offers robust grant and fund accounting capabilities with strong audit and reporting tools.

Each system varies in depth, pricing, and scalability, so selection should reflect the organization’s size, funding sources, and reporting obligations.

Implementation considerations

Switching or upgrading financial systems can be complex, and success depends on thoughtful planning:

• Data migration: Map the chart of accounts carefully, carry forward opening balances, and ensure subledger details (such as payables, pledges, and grants) reconcile correctly.
• Staff training: Equip finance teams with closing checklists and hands-on sessions for allocations, reconciliations, and report generation.
• Chart of accounts setup: Align accounts to programs, grants, and Form 990 categories to simplify compliance reporting later.
• Regulatory alignment: Confirm that your chosen system supports FASB ASC 958 and IRS Form 990 requirements, including functional expenses, net asset classifications, and disclosure formats.

While traditional accounting systems manage day-to-day bookkeeping, Limelight, an Excel-free FP&A solution, complements them by automating financial planning and analysis tasks.

It connects directly with tools like QuickBooks, Sage Intacct, NetSuite, and Blackbaud to pull real-time actuals into dashboards, budgets, and grant reports. This allows nonprofit leaders to monitor spending, compare forecasts to results, and prepare board-ready insights without relying on spreadsheets.

Now even with great software, regular reconciliation is essential to ensure accuracy.

Step 5: Reconcile accounts regularly

Reconciliations are a non-negotiable control and a top audit focus.

Reconciliation practices:

• Monthly bank reconciliations: compare statements to the general ledger and resolve differences
• Credit card statement reconciliations: tie charges to receipts and approvals
• Accounts receivable aging review: chase past-due pledges and fees
• Accounts payable verification: match invoices, purchase orders, and receiving
• Investment account reconciliations: units, fees, and fair value changes
• Grant budget-to-actual comparisons: spending vs. allowability and timelines

Why it matters:

• Catches errors and discrepancies early
• Flags potential fraud
• Improves financial statement accuracy
• Required by auditors
• Best practice before closing monthly books

Regular reconciliation feeds into the next critical step: reviewing financial statements.

Step 6: Review financial statements monthly

A disciplined monthly review keeps leadership informed and issues contained.

What to review:

• All four required financial statements: financial position, activities, functional expenses, cash flows
• Budget vs. actual comparisons: programs, admin, and fundraising
• Key financial metrics: cash position, net assets, current ratio, program ratios
• Restricted fund balances and compliance: releases, aging, and pending conditions
• Unusual transactions or variances: explanations and corrective actions

Who should review:

• Executive Director and, or CFO: monthly
• Finance Committee: at least quarterly
• Full board: quarterly or annually, depending on size and complexity

Questions to ask during review:

• Are we on budget?
• Do we have sufficient cash for operations?
• Are restricted funds being used appropriately?
• Are any accounts out of balance?
• Do the numbers make sense given our activities?

Benefits:

• Catches problems early
• Enables course corrections
• Keeps leadership aligned
• Demonstrates effective oversight

The final step is ensuring transparency through proper distribution and publication of reports.

Step 7: Distribute and publish reports

Transparency is a core nonprofit value and a practical fundraising lever. Plan distribution for internal governance and public accountability.

Distribution requirements:

• Internal distribution: monthly financials to the Executive Director, quarterly financials to the board, annual audited statements to the full board, grant reports to program staff as needed
• External distribution: annual report to donors, Form 990 on the website and GuideStar, audited statements available upon request, grant reports to funders per agreements, state filings as required

Best practices:

• Publish Form 990 on your website prominently
• Include a plain-English financial summary in the annual report
• Make audited statements easy to request or download
• Respond promptly to donor inquiries about finances
• Optimize your GuideStar profile for transparency seals

Benefits of transparency:

• Builds donor trust
• Demonstrates accountability
• May increase donations
• Meets grant requirements
• Enhances reputation

Following these steps creates a solid compliance foundation, but many nonprofits still struggle with implementation. Let’s address the common challenges.

Common Challenges in Implementing Nonprofit Accounting Standards

Adopting and maintaining nonprofit accounting standards can be difficult in practice. Many nonprofits, especially smaller ones, face limited staffing, complex funding requirements, and evolving regulations. 

Yet, these challenges are not insurmountable. By pairing strong internal processes with the right tools and expert guidance, organizations can build compliance systems that are both sustainable and scalable.

Below are four of the most common challenges nonprofits encounter, and practical solutions to address each one.

Challenge 1: Limited resources and expertise

Many small and mid-sized nonprofits lack dedicated finance staff or accountants familiar with nonprofit-specific requirements such as fund accounting, FASB ASC 958, and Form 990 preparation. Without specialized knowledge, even well-intentioned teams may struggle to classify funds correctly, produce GAAP-compliant statements, or meet audit expectations.

Solutions:

• Outsource bookkeeping to firms specializing in nonprofit accounting.
• Use fractional CFO services for strategic oversight without full-time costs.
• Adopt nonprofit-specific accounting software with built-in compliance templates and reporting functions.
• Invest in training for administrative or finance staff to build internal capability.
• Join nonprofit finance networks, such as the AICPA Not-for-Profit Section or state nonprofit associations, for continuing education.
• Engage board members with finance backgrounds to provide governance support.

These measures help close skill gaps, improve accuracy, and reduce compliance risks for organizations with lean teams.

Challenge 2: Complex fund accounting and restrictions

Tracking multiple donor-restricted funds, each with its own spending rules, timelines, and reporting requirements, can quickly become overwhelming. Without disciplined processes, nonprofits risk misclassifying funds or failing to release restrictions on time, which can lead to audit findings or donor mistrust.

Solutions:

• Implement a robust fund tracking system capable of monitoring donor intent, usage, and balances.
• Develop a gift acceptance and documentation policy that records donor restrictions clearly.
• Conduct regular restriction compliance reviews with program and finance teams.
• Use automated restriction tracking tools, such as those available in Limelight, to monitor releases and generate audit-ready reports.
• Maintain a centralized spreadsheet or database to reconcile restricted funds with the general ledger.
• Train program staff on grant compliance to ensure spending aligns with donor terms.

Communication Service for the Deaf client testimonial for Limelight’s financial reporting capabilities

These practices safeguard donor intent and provide transparency to funders and auditors alike.

Challenge 3: Expense allocation complexity

Nonprofits must allocate shared expenses—like rent, utilities, or administrative salaries—across functional categories (program, management, fundraising) for both GAAP and Form 990 reporting. Many organizations struggle to apply consistent, supportable methods, leading to inaccurate functional expense statements or auditor concerns.

Solutions:

• Develop written allocation methodologies approved by management or the audit committee.
• Use time studies or activity logs to allocate personnel costs accurately.
• Apply reasonable bases such as square footage for occupancy or FTE count for shared services.
• Review and update allocations annually to reflect operational changes.
• Obtain input from auditors to validate allocation methods.
• Document all allocation decisions for transparency.
• Choose accounting software that automates allocations, minimizing manual errors and increasing consistency.

Standardized, well-documented allocations strengthen financial credibility and streamline both audits and grant reporting.

Challenge 4: Keeping up with standard updates

FASB continuously refines nonprofit reporting requirements through Accounting Standards Updates (ASUs). For smaller teams, tracking and implementing these changes, such as those in ASC 842 (leases) or ASC 958 updates, can be difficult. Delayed adoption can cause inconsistencies, audit issues, or compliance gaps.

Solutions:

• Subscribe to FASB email updates or the FASB Action Alert newsletter for real-time guidance.
• Join professional groups like the AICPA Not-for-Profit Section for summaries and implementation tools.
• Partner with an accounting firm specializing in nonprofits to interpret new standards.
• Attend webinars or training sessions hosted by CPA firms or state nonprofit associations.
• Conduct an annual policy review to incorporate new ASUs into internal accounting manuals.
• Assign a staff member or finance committee liaison to monitor regulatory changes.
• Budget for implementation costs, including system updates and staff training.

Staying proactive keeps financial statements aligned with the latest standards and demonstrates a commitment to best practices.

These challenges are real, but they’re manageable with the right approach and tools. Speaking of tools, let’s explore how Limelight addresses these compliance pain points.

How Limelight Supports Nonprofit Financial Planning & Compliance

Limelight FP&A for nonprofits

Compliance in the nonprofit sector demands more than accurate bookkeeping. It requires ongoing visibility, forecasting, and accountability.

While accounting systems like QuickBooks, Sage Intacct, NetSuite, and Blackbaud handle day-to-day transactions, Limelight adds a strategic layer of financial planning and analysis (FP&A). It complements existing accounting tools, turning static reports into actionable insights for better planning, fund management, and compliance oversight.

Limelight integrates directly with leading accounting platforms, automatically importing financial actuals to eliminate manual data transfers. Nonprofits gain real-time visibility into restricted and unrestricted funds, ensuring donor conditions are honored without spreadsheet tracking. Built-in budgeting templates and scenario models help organizations plan multiple grant or program outcomes. The platform also enables grant budget tracking, fund compliance monitoring, and detailed audit trails that document every change for accountability. 

With version control and automated workflows, Limelight supports audit readiness while reinforcing strong internal controls.

Nonprofit clients like Communication Service for the Deaf using Limelight report faster month-end closes, greater budget accuracy, and improved fund visibility across teams.

To see how Limelight integrates with your accounting system for real-time fund tracking and streamlined financial planning, book a personalized demo today.

FAQs

1. How can nonprofit accounting standards help build donor trust?

By providing transparent, consistent financial reports, accounting standards show donors exactly how funds are used. This accountability builds confidence, encourages repeat giving, and demonstrates that the organization uses resources responsibly to achieve its mission.

2. What is GAAP for nonprofits, and how does it differ from for-profit GAAP?

GAAP for nonprofits follows the same core principles but focuses on stewardship, not profit. It emphasizes net assets (with or without donor restrictions), functional expense reporting, and public accountability instead of shareholder returns or profit margins.

3. How does FASB regulate nonprofit financial reporting?

The Financial Accounting Standards Board (FASB) issues and updates accounting standards under FASB ASC 958 – Not-for-Profit Entities. These standards guide how nonprofits classify net assets, recognize contributions, and present financial statements for transparency and comparability.

4. What tools should nonprofits use to prepare financial statements in compliance with GAAP?

Nonprofits commonly use QuickBooks Nonprofit, Sage Intacct, Aplos, or Blackbaud Financial Edge NXT for accounting. For planning and reporting, tools like Limelight integrate with these systems to automate financial consolidation, forecasting, and compliance tracking.

5. What is ASU 2016-14 and why does it matter?

ASU 2016-14 simplifies nonprofit reporting by reducing net asset classes from three to two, requiring liquidity disclosures, and mandating functional expense reporting for all nonprofits. It improves clarity, comparability, and donor understanding of financial statements.

6. Do all nonprofits have to follow GAAP?

While not legally required, GAAP is strongly recommended. Most auditors, grantmakers, and large donors expect GAAP-compliant financials. Following GAAP also simplifies IRS Form 990 preparation and supports eligibility for federal or foundation funding.

7. How do I track restricted vs. unrestricted funds?

Use accounting software with fund accounting features. Track each donation’s purpose or time restriction in the ledger, release restrictions when conditions are met, and reconcile regularly to ensure compliance with donor intent and FASB requirements.

8. What are the four required financial statements for nonprofits?

1. Statement of Financial Position (balance sheet)
2. Statement of Activities (income statement)
3. Statement of Functional Expenses
4. Statement of Cash Flows

Together, these present a complete picture of financial performance, cash flow, and resource allocation.