FreeChurchAccounting.com

Transcription

1 FreeChurchAccounting.com Presents Basic Fund Accounting SOLD TO THE FINE

2 Basic Fund Accounting By Vickey Boatright Ver. 4.2 Copyright 2015 Free Church Accounting All rights reserved. No portion of the contents of this book may be reproduced in any form or by any means without the written permission of the publisher unless otherwise noted. Best efforts have been made to assure the information in this book is reliable and complete. No representations or warranties are made for the accuracy or completeness of the contents of this book. Any responsibility for errors or omissions is disclaimed by the author. This book is to provide guidance to churches and small nonprofit organizations. No information in this book should be perceived as tax or legal advice

3 Contents Introduction... 1 Accounting Methods... 2 Features of fund accounting... 3 Difference between unrestricted and restricted... 5 Three reasons to use fund accounting... 6 Basic Accounting Concepts... 7 Financial Statements Statement of Activity Income Expenses Example of a Monthly Statement of Activity Example of an Annual Statement of Activity using SFAS Statement of Financial Position Example of a Statement of Financial Position Example of a Statement of Cash Flows Chart of Accounts Example of a Church s Chart of Accounts Characteristics of an Account Debits and Credits vs. Account Types Accounting methods Recording Transactions in Accounts Journal Entry Examples Salary and Liability Journal Entry Examples Funds and Account Payable Journal Entry Examples Example of posting entries to the Cash account Account balances Examples of Single Entry Journal Entries Payroll Journal Entries Payroll vs Accounts Payable Payroll Accounts Payroll Accounting Examples... 41

4 Examples of Payroll Journal Entries Transferring Money between Funds Discovery and Correction of Errors Summary of Double Entry Bookkeeping... 48

5 P a g e 1 Introduction So you have volunteered or was pushed into keeping the books for the church or nonprofit that you love but have no idea where to begin. Are you wondering if you were in your right mind when your pastor or administrator approached you about taking over this wonderful chore? Sound familiar? I can truthfully say I know how you feel! My name is Vickey Boatright and I was thrown into the lion s den of nonprofit accounting over 15 years ago. I did have the advantage of having an accounting degree, but found out pretty quickly that for-profit accounting and nonprofit accounting were two different worlds. First thing I did was search the internet for... how to set up and keep the books for a small church. With the scarcity of helpful information online, I got a sinking feeling in the pit of my stomach that maybe I ought to have run the other way when my pastor came up with this brilliant idea. But even if I doubted my sanity for agreeing, I m persistent. After hours of researching, reading, studying everything I could get my hands on about nonprofit and church accounting, I felt ready to set up a decent accounting system. The secretary was recording everything with paper and pencil so first order of business was finding an accounting spreadsheet to better track expenses. Again, I couldn t find anything online! So. I built an accounting workbook (a set of spreadsheets). It was very basic, but the secretary loved it. She told some secretaries of other churches and they asked for my accounting workbook and that s how I started my site: I figured I would build what I couldn t find on the internet and so desperately needed. I also gave our secretary a crash course in basic accounting and fund accounting and set up some internal controls. Thus my goal was born to help financial administrators of small churches and nonprofits understand the basics of fund accounting and how to set up an effective accounting system.

6 P a g e 2 Chapter 1 Accounting Methods In this chapter we are going to discuss the relationship between accounting and bookkeeping and the difference between commercial accounting and fund accounting. Accounting is define as a system of recording and summarizing financial (business) transactions in such a way that they can later be analyzed or used to communicate with others. Bookkeeping is simply: keeping the books. It involves the process of gathering, organizing, storing, and accessing the financial information of your organization. Michele Cagan, CPA, gave the best analogy of the relationship between accounting and bookkeeping in her book The Everything Accounting Book when she stated, Accounting and bookkeeping are related in the same way as recipes and ingredients. Ingredients are the raw materials you need to create a meal; bookkeeping provides the raw materials you need to develop useful financial reports. Bookkeepers gather and record the financial information and accountants take that information and present it in a more useful way such as financial statements and internal reports. Now let s dig deeper and discuss the difference between for-profit accounting and nonprofit accounting. Commercial accounting is used primarily by for-profit organizations. It focuses on profitability. Fund accounting is used almost exclusively by non-profit organizations. Its main focus is on accountability. Where commercial accounting s main focus is on measuring profit or loss fund accounting focuses more on measuring the incoming and outgoing funds to aid in the ethical and legal responsibilities of the nonprofit.

7 P a g e 3 So, if you are a tax exempt organization per Section 501 of the Internal Revenue Code of the USA, you are a nonprofit fund accounting operation. (Internal Revenue Code Section 501(c) is the portion of the tax code that gives certain entities the right to receive tax deductible contributions.) Most churches automatically fall under this category. Features of fund accounting Keeping funds separate according to donors restrictions Tracking and reporting different funding sources, grants, offerings, etc. separately and as a whole The ability to allocate expenses to different funds Tracking and reporting across different time periods Measuring and analyzing each fund individually The Merriam-Webster dictionary defines "fund" as "a sum of money or other resources whose principal or interest is set apart for a specific objective." In other words, a fund is something restricted for a particular purpose. Before I go any further let me emphasize what a fund is not. A fund is NOT an asset account i.e. a checking or savings account. I will explain more on the pitfalls of treating each fund as separate checking or savings account later. Another definition that may help you visualize what a fund is: an accounting entity that needs to be kept separate, having its own source(s) of income and its own expenses. So keeping in mind exactly what a fund is let s go on to the definition of fund accounting.

8 P a g e 4 Fund accounting is a method of segregating resources into categories, (i.e. funds) to identify both the source of funds and the use of funds. It creates a distinction between restricted and unrestricted funds. Commercial accounting practices make no allowance for such a distinction. In plain English all that jargon simply means you should set up separate funds and treat them as separate entities. (something that has a distinct, separate existence). An example of how fund accounting is different from commercial accounting is to picture yourself writing a check to your telephone company for $150.You could not tell the telephone company what to do with the $150. However, now picture yourself writing a check to a church for $150. You may inform them to put $50 toward the operating budget, $50 toward the building of the fellowship hall, and $50 toward missions. These gifts are said to be restricted. The church or nonprofit organization has ethical and possibly legal responsibilities to use the restricted funds as designated by the donors. At the very least, your church should instill confidence in your contributors that their donations are being used as they designated. Churches receive donations for many different areas; general support of the church, an outreach program, a capital campaign, or maybe an endowment. Some of the money given, like the regular church offering, is considered unrestricted. It is assumed the church will use this money as needed, and the donor has not requested any particular use of the funds. Other times, money will be received for a very specific purpose an outreach program or a capital campaign, or for a specific time say next year s pledge. Then the money is considered temporarily restricted. This means it can only be used for the purpose or time period the donor has specified. When the restriction is met, i.e. the building is built or a new year has begun,

9 P a g e 5 then it becomes an unrestricted asset. If land is donated for the construction of a new church or an endowment is started that only the investment earnings may be spent, a permanently restricted fund must be set up. Difference between unrestricted and restricted Unrestricted funds are the tithes, offerings, or donations that come through the regular offerings or donations. They do not have the donor restrictions that special funds have. These funds can be used for operational needs, such as paying salaries, building maintenance, and general office expenses. Restricted funds are monies given for a specific purpose. There are two types of restricted accounts: Temporarily Restricted: Funds restricted by purpose or time, but the restrictions are not permanent. Permanently Restricted: Funds restricted by a donor for a designated purpose or time restriction that will never expire. An example of restricted funds would be if a donor gave a church $20,000 for a new fellowship hall...that money would have to be kept separate from the general fund in the church's accounting records. You would not be required to open a separate bank account, but in your accounting records, all expenses and future donations for that hall should be recorded in a separate church fund account. I have seen some churches with just two or three funds, and I ve seen some with 20 or more. The more funds you have the harder it is on your volunteer staff trying to keep up with all of them. Try to combine as many as you can; however, if they have their own income coming in and their own expenses going out set it up as a fund. Let me stop here and explain that some nonprofit and church treasurers or finance administrators may think you need to open a separate checking account for each fund. This approach requires a lot more paperwork. It also makes it more difficult on your volunteers and staff to keep the books accurate.

10 P a g e 6 I am not saying you can t open multiple bank accounts. Having a specific bank account for a restricted fund such as building can be beneficial. Evaluate whether the extra effort is worth the benefit of opening the account. All funds can be placed in one bank account as long as the accounting system clearly documents net assets and liabilities in each fund apart from operational cash flow. Back to fund accounting Three reasons to use fund accounting With fund accounting, accountability is measured instead of profitability. Financial reports are directed toward contributors, church members, or the nonprofit s governing body, who are more concerned with having adequate fund balances to carry on services provided rather than seeking a profit on investments as businesses do. In fund accounting, funds are set up to provide reporting of expenditures for designated purposes. You should set up and use an accounting system that can detail expenditures and revenues for multiple funds. Each fund should have its own general ledger. You should then be able to produce reports that detail each fund s individual income and expenses as well as summarize and total all of the funds.

11 P a g e 7 Chapter 2 Basic Accounting Concepts We have established the difference between bookkeeping and accounting and between commercial accounting and fund accounting. Now let s go on to some basic accounting concepts everyone should know that takes care of the recording or analyzing of a church s financial data. There are two basic bookkeeping practices: single entry bookkeeping and double entry bookkeeping. Single-entry bookkeeping is similar to a checkbook register where only a single line transaction is recorded, reflecting the credit or debit of cash. It can be employed by small organizations where a statement of financial position (statement of assets and liabilities) is not required for financial control or tax purposes. Single-entry bookkeeping has several advantages. The main one is simplicity as only one or two lists or columns are utilized: one for income received and one for expenses incurred. Secondly you only have to record financial transactions once instead of twice. It is especially beneficial for organizations that rely on volunteers with virtually zero accounting or bookkeeping knowledge. The disadvantages are: Absence of financial control due to limited detailed records of asset and liability accounts. Errors are more common. With double entry bookkeeping everything must balance. In a single entry bookkeeping system you may not catch your errors until you do the monthly bank reconciliation. The common and most used practice is double entry bookkeeping.

12 P a g e 8 Double entry bookkeeping is an accounting technique to record the financial transactions of an organization where every transaction is entered twice, equal and opposite transactions. It is required for all organizations that must produce both a Statement of Activity and a Statement of Financial Position (More on nonprofit financial statements in Chapter 3). Even though most double entry bookkeeping in done in a computer program, it is imperative for the one entering the data to understand accounting basics. So I will give you a crash course in some very important basic accounting concepts. Remember that the basic definition of accounting is a system of recording and summarizing financial (business) transactions in such a way that they can later be analyzed or used to communicate with others. Well an even simpler explanation is the documentation of a transaction. Paying your church s electric bill affects your church s financial condition because it would then have less cash on hand. A transaction that directly changes your church s financial condition is a financial (business) transaction. All business transactions can be stated in terms of changes in the three elements of this accounting equation which is to the base of all accounting: Assets = Liabilities + Fund Equity In plain English this equation means: What you own (assets) equals what you owe (liabilities) plus your church s fund equity (also known as Net Assets). In most churches, this is simply their fund balances. For the rest of this book when I talk about equity, remember, it is most often your church s fund balances. You can see how business transactions affect the accounting equation by studying some typical transactions. For the following example, let s assume that ABC Example Church has $20,000 in assets, $15,000 in liabilities, and $5,000 in equity.

13 P a g e 9 Here is what the accounting equation would look like: $20,000 (asset) = $15,000 (liability) + $5,000 (equity) Now if ABC Example Church receives $3,000 in cash from a bank loan note how it would affect their accounting equation: $23,000 (asset) = $18,000 (liability) + $5,000 (equity) Notice how the equation still balances. (The accounting equation must always balance with each business transaction.) When they received the $3,000 from the bank loan it increased their cash which is an asset and it also increases the church s liability (what is owed) but the equation stayed in balance. Remember these important points: 1. The effect of every transaction is an increase or a decrease in one or more of the three elements in the accounting equation. 2. The two sides of the accounting equation are always equal.

14 P a g e 10 Chapter 3 Financial Statements After transactions have been recorded and summarized, reports are prepared for users. The accounting reports that provide this information are called financial statements. Financial statements for churches used to be generated using the tradition fund accounting method. However since the mid 1990 s this pure fund accounting method has been replaced by the Statement of Financial Accounting Standards (SFAS) Numbers 116 and 117, which describes the way nonprofits should account for contributions, and present their financial statements. The emphasis of the SFAS financial statement reporting is now on net assets classification, rather than tracking each fund. (Net assets mean more or less the same as owner s equity or net worth in a for-profit business.) The net asset categories are: Unrestricted: These funds are donations that are available to use toward any purpose. Unrestricted funds usually go toward the operating expenses of the organization. Temporary Restricted: These funds may be restricted by purpose or time, but the restrictions are not permanent. An example of a purpose-restricted gift is a gift for a certain project or for the purchase of equipment. An example of a time-restricted gift is a contribution of a trust, annuity, or term endowment where the principal of the gift is restricted for a certain term of time. Permanently Restricted: These funds are gifts restricted by a donor for a designated purpose or time restriction that will never expire. An example is an endowment gift with the stipulation that the principal is permanently unavailable for spending, but the investment income from the principal may be used in current operations.

15 P a g e 11 Net assets can now be combined into these three categories and you are no longer required to track each fund individually. However, many small churches continue to use pure fund accounting, even though they no longer have to produce year end reports on a fund-by-fund basis. These churches find that tracking their financial activities internally is easier if they stay with the traditional fund accounting method. Note: Although most small churches use this type of basic fund accounting to monitor the activities of each fund internally if you need to prepare financial statements for external organization such as a financial institution, you will need to check their regulations regarding their required financial statements. Some banks require you to prepare your financial statements using the Statement of Financial Accounting Standards (SFAS) Numbers 116 and 117. Remember the emphasis of the SFAS financial statement reporting is on net assets classification, rather than tracking each fund. The principal financial statements for a nonprofit are: Statement of Financial Position Statement of Activity Statement of Functional Expenses (for some organizations) Statement of Cash Flows Notes to Financial Statements The order in which the statements are normally prepared and the nature of the data presented in each statement are as follows: Statement of Activity (Statement of Revenue and Expense) a summary of the revenue and expenses for a specific period of time, such as a month or year. The definition of revenue is an amount of money regularly coming in so for the remainder of this book you will know I am referring to contributions, building campaign funds, special offerings, etc. when I talk about revenue.

16 P a g e 12 Statement of Functional Expenses reports expenses by their function (general, fundraising, programs, and management) and by the type of expense such as salaries and rent. Note: the FASB does not require the statement of functional expenses for every nonprofit. Churches are tax-exempt and do NOT file annual IRS forms 990 like other nonprofits so they usually are not required to account for or report functional expenses of Program, General/Administration and Fund Raising. Voluntary health and welfare organizations must generate one for audit purposes. Statement of Cash Flows a summary of the cash receipts and cash payments for a specific period of time, such as a month or a year. Notes to Financial Statements - the notes to the financial statements. Provides information regarding the nature of the nonprofit's activities as well as a summary of its significant accounting policies. All financial statements should be identified by the name of your church, the title of the statement, and the date or period of time. The data presented in most of the above financial statements are for a period of time. However, the data presented in the Statement of Financial Position is for a specific date. Statement of Activity Also called a Statement of Revenue and Expenses or Statement of Operations reflects a church s support and revenue, expenses, and changes in net assets (fund balances) for a certain period of time. It is similar to a for-profit Income Statement. It is basically made up of two sections:

17 P a g e 13 Income There can be several income accounts listed in this section. For a church, the first listed income account may be something titled: Offerings, Offertory, Tithes and Offerings, etc. in which your regular tithes and offering are represented. Then you may have one or more of the following: Special Events Revenue: or something similar in which revenue from special events such as fundraising are recorded. Your church should record the gross revenue of the special event and then offset this amount by recording the expenses of the fundraiser in a line item under expenses. Special Designated: Income designated for a special purpose such as missions, buildings, etc. Program Revenue or Program Income : Revenue generated by the sale of goods or services provided by your church in exchange for cash or another asset. Miscellaneous Income or Other: The oddball income that doesn t fit under any other category. Investment Income: This is income earned from investments such as interest on bonds and dividends on stock. Expenses The order in which your expenses are listed in this statement varies among nonprofits and churches. One method is to list them in order of size, beginning with the larger items. Miscellaneous expense is usually shown as the last item, regardless of size. For larger churches and nonprofit organizations, the expense section may be broke down into smaller sections such as Administration, Facilities, Staffing, Ministries, Missions, etc. Subtract the expenses from the income. Note: The terms profit and loss are not usually used in church accounting as it is in a for profit income statement, so a more accurate term for showing the difference between income and expenses at the bottom of the financial statement may be Excess of Income Over (Under) Expenditures instead of Net Profit or Loss.

18 P a g e 14 Example of a Monthly Statement of Activity (Using the traditional fund accounting method) ABC Church Statement of Operations For the month and Year-to-Date (Current Month) General Mission Building VBS Youth Fund Fund Fund Fund Fund Total Revenue Contributions 127,907 6, ,246 Special Events/Fundraiser 1, ,980 Special Designated 10,000 10,000 Interest Income Total Revenue 127,968 7,439 22, , ,287 Expenses Salaries 59,689 59,689 Office Supplies 5,269 5,269 Insurance 6,598 6,598 Worship Supplies 4,698 4,698 Repairs 1,598 1,598 Utilities 11,596 11,596 Youth 3,369 3,369 Evangelism 1,987 1,987 Missions 6,358 6,358 Building Expense 21,965 21,965 VBS Expense Misc.Expense 1,385 1,385 Total Expenses 92,820 6,358 21, , ,409 Increase (decrease) in net assets: 35,148 1, ,878

19 P a g e 15 Example of an Annual Statement of Activity using SFAS Revenue ABC Church Statement of Operations For the month and Year-to-Date (Current Month) Genera l Restricted Plant Endowment Total Fund Funds Funds Funds All Funds Contributions 309,027 5,472 16, ,074 Interest Income 6,132 3, ,130 15,557 Workshop/Events Bequests 10,000 10,000 Total Revenue 315,892 9,127 17,215 15, ,364 Expenses(By Program) Worship 98,541 2,435 5, ,976 Education 10, Care/Fellowship 9, ,095 Evangelism 9,545 9,545 Resources 46,723 46,723 Community Relief 3,000 1,934 4,934 Youth 3,025 3,025 Administration 123,786 11, ,786 Total Expenses 294,496 5,338 11,000 5, ,834 Increase (decrease) in net assets: 21,396 3,789 6,215 10,130 41,530 Beg. Net assets 41,730 72, ,995 55, ,253 End Net assets 63,126 75, ,210 65, ,578

20 P a g e 16 Statement of Financial Position This statement shows the financial position of your church at any given point in time. It summarizes the assets, liabilities, and fund balances. It is proclaimed by many financial experts as one of the most important financial document a nonprofit can generate as it describes what the church (nonprofit organization) owns such as equipment and cash (assets) in comparison to what it owes such as loans (liabilities). Remember that the heading will be slightly different for this statement. as the data presented in most financial statements are for a period of time. However, the data presented in the Statement of Financial Position is for a specific date. The form of a Statement of Financial Position is called the account form because it resembles the basic format of the accounting equation, with assets on the left side and the liabilities and fund equity on the right side or it can be presented with Assets on the top and Liabilities and Net Assets(fund equity ) on the bottom. A Statement of Financial Position is a nonprofit s Balance Sheet. The assets section of the Statement of Financial Position normally presents assets in the order that they will be converted into cash or used in operations. Cash is presented first, followed by supplies, and other current assets. (Current assets are cash and other resources that are expected to turn to cash or to be used up within one year of the statements of financial position date.) Current assets are presented in the order of liquidity, i.e., cash, temporary investments, accounts receivable, supplies, prepaid insurance. Then the assets of a more permanent nature are listed, such as land, buildings, and equipment. These assets are referred to as fixed assets or long-term assets. The liabilities and fund balance section usually presents each liability in the order that the liabilities will be paid off.

21 P a g e 17 Account Payables (includes unpaid bills from vendors and creditors for goods and services delivered) are normally listed first, followed by other current liabilities (obligations due within one year of the statements of financial position date). Then long term liabilities (obligations of the nonprofit that are not payable within one year of the statement of financial position date) such as long term notes payable are listed. All the liabilities are then totaled. Next, net assets (fund balances) are listed. Unrestricted are normally listed first, followed by temporary restricted funds (monies on which a donor-imposed restriction that may be terminated either by the church's actions or the passage of time which permits your church to use the funds only as specified.), permanently restricted funds (funds that are restricted by the donor for a designated purpose or time restriction that will never expire.), and finally investments. All net assets are then totaled. Last of all liabilities and net assets are totaled. This total should equal the total assets.

22 P a g e 18 Example of a Statement of Financial Position ABC Church Statement of Financial Position As of December 31, 2015 Total General Restricted Plant Endowment All ASSETS Fund Fund Fund Fund Funds Cash and Cash Equivalents 62,533 32,947 16,210 8, ,190 Account Receivables 1,768 1,768 Pledges Receivables 72,000 72,000 Other Current Assets 4,765 4,765 Land, Buildings, and Equipment 525, ,00 0 Investments 10,000 43,000 62, ,000 TOTAL ASSETS 79,066 75, ,210 70, ,723 LIABILITIES AND FUND BALANCES Accounts Payable 3,621 5,000 8,621 Payroll Withholdings Deferred Revenue 22,000 22,000 Current Portion Long-Term 10,000 10,000 Debt Long-Term Debt 150, ,00 0 TOTAL LIABILITIES 26, ,000 5, ,145 FUND BALANCES Unrestricted 52,921 52,921 Temporarily Restricted 75,947 75,947 Permanently Restricted 65,500 65,500 Net Investments in Plant 453, ,210 TOTAL FUND BALANCES 52,921 75, ,210 65, ,578 TOTAL LIABILITIES AND FUND BALANCES 79,066 75, ,210 70, ,723

23 P a g e 19 Statement of Functional Expenses Nonprofit organizations present the statement of functional expenses in a matrix form. (A matrix is a rectangular array of elements, arranged in rows and columns, and can be used to show the placement of concepts along two axes.) The column headings show the function of the expense such as programs, management and general, and fundraising while the rows show the type of expense such a salaries and rent. Generating a statement of functional expenses can be difficult unless you have the proper nonprofit accounting software and since it is a statement that is not required for most churches I will not go into all the details of this statement. For more information see the Statement of Financial Accounting Standards No. 117 Statement of Cash Flows A Statement of Cash Flows reports a nonprofit organization change in its cash and cash equivalents during the accounting period. This statement is not always needed for small churches. The changes in a small nonprofit organization s assets, liabilities, and net assets are usually reflected in the Statement of Financial Position and Statement of Activities. So unless you have significant debt, capital assets and deferred grant balances, you will probably not be required to prepare a Statement of Cash Flows. However, it can be useful to determining where the church spent its money and where the money came from. So here is a summary of the three sections included in this statement: Cash Flows from Operating Activities: This section reports a summary of cash receipts and cash payments from operations. It details your church s unrestricted and temporary restricted funding. Note: Cash or gifts of any kind with a restricted purpose must be segregated from those that are general or unrestricted assets and from temporarily restricted funds. There are two methods of accounting you can use when generating this section of your statement of cash flows: Indirect and Direct. (There is no difference in the cash flows reported in the investing and financing activities sections.) Under the direct method, the cash flows from operating activities will include unrestricted and temporarily restricted cash inflows and outflows. In contrast, the indirect method will begin with the change in net assets from your Statement of Activities and convert the total net income to the cash amount from operating activities simply stated it converts the amounts from the accrual method to the cash

24 P a g e 20 basis accounting. (See the difference between these two methods of accounting in chapter 5) Most churches and nonprofit organizations use the indirect method. Cash Flows from Investing Activities: This section reports the cash transactions for the acquisition and sale of long-term assets and investments. Cash Flows from Financing Activities: This section reports the cash transactions related to cash investments by the church and borrowings such as receipts and repayments to creditors or donors. Permanently restricted funds that have special requirements that must be completed before the money may be used should be reported in this section as well. After all 3 sections have been completed, the net increase/decrease in income will show how your church s cash has changed during the reporting period and the current cash balance.

25 P a g e 21 Example of a Statement of Cash Flows ABC Church Sample Statement of Cash Flows Per Month/Year-to-Date Operating Cash Flows General Restricted Plant Endowment Total Fund Fund Fund Fund All Funds Excess Revenue(Expenses) 11,191 3,789 6,215 10,130 31,325 Adjustments: Depreciation 2,796 2,796 Change in Prepaid Expenses (1,248) (1,248) Change in Accounts Payable 1,525 1,525 Change in Payroll Withholding (78) (78) Change in Deferred Revenue (6,525) (6,525) Net Operating Cash Flows 7,661 3,789 6,215 10,130 27,795 Financing Cash Flows Proceeds from Borrowings - Repayment of Debt (25,000) (25,000) Net Financing Cash Flows (25,000) (25,000) Investing Cash Flows Fixed Asset Sales (Purchases) (5,755) (5,755) Purchases of Investments (10,000) (75,000) (50,000 (135,000) ) Proceeds of Investments 60,000 47, ,000 Net Investing Cash Flows (15,755) (15,000) (3,000) (33,755) Net Increase (Decrease) in (8,094) (11,211) (18,785) 7,130 (30,960) Cash Transfers (10,000) 10,000 - Cash and Cash Equivalents: Beginning Year 80,627 44,158 24,995 1, ,150 End of Year 62,533 32,947 16,210 8, ,190

26 P a g e 22 Notes to Financial Statements The notes to the financial statements are usually found on the Statement of Financial Position, the Statement of Activities, and the Statement of Cash Flows. They usually provide information regarding the nature of the nonprofit's activities as well as a summary of its significant accounting policies. See an example of such notes in the Statement of Financial Accounting Standards No If you think financial reports are not important for your small church or nonprofit, you probably have not had to borrow money from a bank yet. Most financial institutions require you to turn in financial statements for the last three years. Also, without reports it is difficult for your financial administrators to make sound financial decisions. For example a church can review its statement of financial position (balance sheet) for several important issues such as solvency, resources, and outstanding liabilities. A church is considered solvent if the current assets are greater than the current liabilities. Most financial experts recommend maintaining a current ratio of 2:1, assets to liabilities. Many times a greater ratio (when liabilities are greater than assets) is an indication that a church may be having or will have severe financial problems.

27 P a g e 23 Chapter 4 Chart of Accounts Before making a major cash purchase for your church, you need to know the balance of your church s bank account. Likewise, your church s financial administrators need timely, useful information in order to make good decisions regarding your church. How are accounting systems designed to provide this information? I illustrated a very simple design in Chapter 2, where transactions were recorded and summarized in the accounting equation format. However, this format is difficult to use when multiple transactions must be recorded daily. Therefore, accounting systems are designed to show the increases and decreases in each financial statement item in a separate record. This record is called an account. For example, since cash appears on the all Statements of Financial Position, a separate record is kept of the increases and decreases in cash. Likewise, a separate record is kept of the increases and decreases for supplies, equipment, notes payable and other Statements of Financial Position items. Similar records would be kept for Statement of Activity items, such as revenue (contributions), wage expenses, rent expenses, etc. A group of accounts which contains all of the statement of financial position and Statement of Activity accounts is called a ledger. A list of the accounts in the ledger is called a chart of accounts. The accounts are usually listed in the order in which they appear in the financial statements. The Statements of Financial Position, accounts are usually listed first, in the order of assets, liabilities, and fund equity. The Statement of Activity accounts are then listed in the order of revenues and expenses.

28 P a g e 24 Each of these major classifications is briefly described on the next page. Assets are resources that are owned by your church. Examples of assets include cash, account receivables(money owed by customers (individuals or corporations) to another entity in exchange for goods or services that have been delivered or used, but not yet paid for) (not very many small churches will use this asset account), supplies, buildings, equipment, and land. Liabilities are debts owed. Liabilities are often identified on the Statements of Financial Position by titles that include the word payable. Examples of liabilities include: accounts payable (money owed to vendors for products and services purchased on credit), notes payable and wages payable. Equity is the church s right to the assets of the church. Revenues are increases in the church s equity. Examples of revenue include donations, fundraiser net income, and rent revenue. Expenses are assets used up or services consumed in the process of operating the church. Examples of typical expenses include wage expense, rent expense, utilities expense, supplies expense, and miscellaneous expense. A chart of accounts is designed to meet the information needs of a church s financial administrators and other users of its financial statements. Within the chart of accounts, the accounts are numbered for use as references. A flexible numbering system is normally used, so that new accounts can be added without affecting other account numbers. Each account number has at least two digits... most have at least 4. The first digit indicates the major classification of the ledger in which the account is located. Accounts beginning with: 1 represents Assets 2 represents Liabilities 3 represents Net Assets 4 represents Revenue

29 P a g e 25 5 represents Expenses These are not set in stone. There is not a law saying you have to set your chart of accounts of this way. I have seen chart of accounts set up a couple of ways. Usually all churches use 1 for assets and 2 for liabilities; however, some churches then use 3 for revenue, 4 for expenses, and 5 for equity (net assets). The second digit indicates the location of the account within its class. For example, if you didn t have a lot of accounts and were only using two digits, miscellaneous expense would have the number 59 because it is always the expense listed last and cash would have the number 11 because it is always the current asset listed first. Another example of setting up your chart of accounts numbers is while setting up your expenses you may assign the number 54 for your rent expense and 56 for your electric expense a year later you lease a copier and now you can set up your copier rent as number 55 and keep similar items together. Notice: most organizations will have a three or more digits unless you have a very small budget.

30 P a g e 26 Example of a Church s Chart of Accounts Assets 101 Petty Cash 102 Cash Checking 103 Cash Savings 104 Cash Investments 130 Land and land improvements 140 Buildings 150 Furniture and equipment 160 Vehicles 170 Other assets Liabilities 201 Current liabilities Accounts payable 202 Current liabilities Payroll payable 210 Long-term liabilities Property mortgage 220 Long-term liabilities Other debt Income General Fund 301 Tithe and envelope offerings 302 Loose offerings 303 Interest

31 P a g e Miscellaneous income Missions Fund 311 General missions offerings 312 Designated missions offerings 313 Special projects Building Fund 321 General building fund offerings 322 Special fund-raisers Departmental Funds 351 Youth 361 Men 371 Women 381 Music Expenses General Fund Salaries and benefits 401 Salaries 403 Payroll taxes 404 Other benefits Operations 410 Travel and meals

32 P a g e Contract labor 416 Guest speakers 420 General supplies 421 Office supplies 422 Cleaning supplies 423 Church supplies 428 Printing costs 429 Postage 499 Miscellaneous Building/Vehicles 431 Utilities 432 Repair & maintenance building 435 Insurance 441 Gas and oil 442 Repair & maintenance vehicles Departmental Funds 471 Youth expenses (detail as necessary) 480 Men s expenses (detail as necessary) 485 Women s expenses (detail as necessary) 490 Music expenses (detail as necessary)

33 P a g e 29 Fund Balance (Net Assets) 502 Mission fund 525 Building fund 545 Youth Ministry fund 547 Men Ministry fund 553 Women Ministry fund 567 Music Ministry fund

34 P a g e 30 Chapter 5 Characteristics of an Account The simplest form of an account has three parts. First, each account has a title, which is the name of the item recorded in the account. Second, each account has a space for recording increases in the amount of the item. Third, each account has a space for recording decreases in the amount of the item. The account form presented below is called a T account because it is similar to the letter T. The left side of the account is called the debit side, and the right side is called the credit side. Title Left side debit Right side credit Amounts entered on the left side of an account regardless of the account title, are called debits to the account. When debits are entered in an account, the account is said to be debited (or charged). Amounts entered on the right side of the account are called credits, and the account is said to be credited. Debits and credits are sometimes abbreviated as Dr. and Cr. Important! Understanding debits and credits is the foundation of understanding accounting systems. So I am going to pause this accounting lesson to tell you something that throws most new church secretaries or treasurers that volunteered for the job because they are good people with a heart to work for God no matter if they have any accounting experience or not. They think of a debit and credit as a positive or a negative; or an increase or decrease.

35 P a g e 31 They are not either! The word Debit means Left and the word Credit means right. That s all! So clear your mind of your check register or what you have thought of as debits and credits your whole life and just remember debit means left and credit means right. Debits and Credits vs. Account Types ACCOUNT DEBIT CREDIT Assets Increases Decreases Liabilities Decreases Increases Equity Decreases Increases Income Decreases Increases Expenses Increases Decreases This chart may look at little confusing at first, but it is the foundation of understanding how to record your transactions. When recording an asset transaction, such as cash, supplies, equipment, etc.--remember this to increase that asset account record the amount on the debit or left-hand side of that T account. To decrease that asset account record the amount on the credit or right-hand side. Here again is where so many people get confused. They don t understand that when you spend cash (asset account) that you are crediting that amount to subtract it from your balance; however, they are thinking of debits and credits as increases and decreases. They are not either. REMEMBER: DEBITS = LEFT and CREDITS = RIGHT When recording a liability transaction, such as accounts payable, wage payable, notes payable, or mortgage loan payable to decrease that liability account record the amount on the debit or left-hand side. To increase that liability account record the amount on the credit or right-hand side.

36 P a g e 32 For example--with a notes payable account--payments on the principal would go on the Debit or left side because it is decreasing that account --- increases or new loans would go on the credit or right-hand side. When recording an equity transaction, such as special purpose funds to decrease that equity account record the amount on the debit or left-hand side thereby debiting that account. To increase that equity account--record the amount on the credit or right-hand side thus crediting that account. When recording an income transaction, such as contributions, fund raiser revenue, etc to decrease that income account record the amount on the debit or left-hand side thereby debiting that account. To increase that income account--record the amount on the credit or right-hand side thus crediting that account. For example, to record your regular church offering, you would put the amount on the credit right-hand side because you are increasing that account---but say if you had a contribution check bounce you would debit that amount (put on left-hand side) because that decreased your offering amount.) When recording an expense transaction, such as office supplies expense, rent expense, utilities expense, etc. to increase that expense account record the amount on the debit or left-hand side. To decrease that expense account record the amount on the credit or right-hand side. If you are just starting out in accounting and doing double entry bookkeeping by hand, I would recommend you post the Debits and Credit vs. Account Types table (on the previous page) on your computer or somewhere you can see it as you record your journal entries. After a while it will become second nature to you and you will not have to refer to the chart anymore. Now that you understand the basics of credits and debits, let s discuss. Accounting methods There are basically just two accounting methods of keeping track of your revenue and expenses available to most churches and nonprofit organizations: Cash or Accrual

37 P a g e 33 The main difference between these two accounting methods is the timing of when your expenses and income are recorded. Cash Basis Method of Accounting: Revenue is counted and recorded only when cash is received. Expenses are recorded when they are actually paid. Accrual Basis Method of Accounting: Revenue is counted and recorded when it is earned. For example, your church rents out its fellowship hall for a wedding, under the accrual method the fee would be recorded at the time of the rental...not when it actually receives the money. Expenses are recorded when you receive the goods or services. For example, a church buys supplies on credit; you would record the expense when you receive the supplies not when you actually pay the bill. Most small to medium churches and nonprofit organizations use the cash basis method of accounting especially since many smaller churches and nonprofits rely on volunteer help that may not be familiar with accrual accounting. Cash basis is much simpler as income is not recorded until there is cash in hand and expenses are not recorded until the check is written much like your personal check register.

38 P a g e 34 Chapter 6 Recording Transactions in Accounts Every business transaction affects at last two accounts. To illustrate how transactions are recorded in accounts, I will give you some common church accounting examples. Each of your transactions will initially be recorded in a record called a journal, a book of original entry, used to record accounting/bookkeeping entries in order by date. The title of the account to be debited is listed first, followed by the amount to be debited. The title of the account to be credited is listed below and to the right of the debit, followed by the amount to be credited. This process is called journalizing. This form of recording a transaction is called a journal entry. Some journal entries involve more than two accounts as in my first example in the table below. Journal Entry Examples DATE ACCOUNT REF DEBIT CREDIT 2/13/09 Office Supplies Expense (Expense) Office Furniture (Asset) Cash (Asset) /15/09 Cash (Asset) Offering (Revenue) Say you went to an office supply store and bought several items: pens, paper, paper clips, etc. and a desk. To record this transaction, you would debit your office supply expense account---because purchasing office supplies is an expense and remembering our account chart to increase an expense account you would record the amount on the

39 P a g e 35 left-hand side or debit side. You also purchased a desk which is also an asset so you would debit (record the amount on the left side) your office furniture account. You wrote a church check for 575 dollars which decreases your cash account so remembering the chart---to decrease an asset account you record it on the credit or right-hand side. Notice how this transaction is balanced. Everything we entered on the left hand (debit) side equals the (credit side) right hand side. That s what double entry bookkeeping is all about transactions must balance. It s kind of like what you learned in basic algebra classes if you can remember back that far what you did to one side of the equation you had to do to the other side. You would also include the reference number from your chart of accounts. (See Chapter 4 Chart of Accounts ) Note: If you enter a check into a computerized accounting system, your cash account is automatically credited; however, you must know which account then needs to be debited. Alright now for the second entry in the previous table: It s Monday morning and we re recording yesterday s offerings. It increased our asset account---cash---so we would debit cash. It also increased our income account---offerings---so we would credit our offering account. See how even though both accounts were increased the transactions balanced each other. Salary and Liability Journal Entry Examples DATE ACCOUNT REF DEBIT CREDIT 2/16/09 Salary (Expense) Cash (Asset) /16/09 Cash (Asset) Notes Payable (Liability) Okay, we also wrote a check for our pastor s payday. So, we would debit our Salary Expense account since we are increasing an expense account and credit our cash account since we are decreasing that asset account. (See more detailed examples of journal entries involving salaries and payrolls in chapter 7.)

40 P a g e 36 Then we went down to the bank and borrowed 3,500 dollars. So, we would debit our asset account Cash increasing it and credit out liability account Notes Payable-- because we are increasing it also. Funds and Account Payable Journal Entry Examples DATE ACCOUNT REF DEBIT CREDIT 2/18/09 Cash (Asset) Missions Fund (Equity) /20/09 Church Supplies (Expense) Accounts Payable (Liability) On the 18 th we took up an offering for missions. It increased our cash account and also increased our mission fund, so we would debit our asset account (Cash) and credit our equity account (Missions). On the 20 th we ordered some offering envelopes, Communion supplies, and some bulletins from our favorite church supplies organization. It increased our expense account (Church Supplies) and since we got them on credit, it also increased our liability account (Accounts Payable). Periodically, the journal entries are transferred to the accounts in the ledger. (Remember in Chapter 4 Chart of Accounts that a ledger is a group of accounts.) This process of transferring the debits and credits from the journal entries to the accounts is called posting. Example of posting entries to the Cash account Account 11- Cash DATE ITEM REF DEBIT CREDIT 2/1/09 Balance from 1/31/ /13/09 GJ /15/09 GJ /16/09 GJ /16/09 GJ /18/09 GJ Balance:

41 P a g e 37 The title contains the name of the account and its reference number from your chart of accounts. First column is the date. Fill in the date of the transaction. Second column is the item. (It is not necessary to write out a description unless you just want to.) The third column is your reference column and will refer to the transaction and where it is located in the general journal. The fourth and fifth column is the debit and credit columns. Summary of example above: First line is the balance carries forward from the month before. Second line is the transaction to the office supply store on the 13 th. On the 13 th we wrote a check to the office supply store for $575, so we credit our cash account for that amount. On the 15 th we increased our account with the offerings. On the 16 th we decreased this account $350 with the payroll check and we also increased it $3,500 with our loan proceeds. Notice where I put the balance. It is in the Debit column. Sometimes there are two additional columns labeled Debit and Credit. In these columns you will keep a running total in the column which the account has a normal balance in. Each type of account will have a normal balance in either the debit or credit column depending on the category of the account. See a list of account balances on the next page.

42 P a g e 38 Account balances Asset accounts have a debit balance. Liabilities have a credit balance. Equity (net assets) has a credit balance. Incomes have a credit balance. Expenses have a debit balance. All of the above examples are how to post accounting entries into a double entry bookkeeping system. Many small churches and nonprofits can and do use a single entry bookkeeping system. Remember what I told you in Chapter 2 about a singular entry bookkeeping system? It is similar to a checkbook register where only a single line transaction is recorded, reflecting the credit or debit of cash. Here s an example of the previous entries we did with the double entry system entered into a single entry bookkeeping system. CREDIT/ REVENUE BALANCE Examples of Single Entry Journal Entries DATE DESCRIPTION DEBIT/ EXPENSES 2/1/09 Balance from 1/31/09 2/13/09 Office Supply Storesupplies/file cab. 2/15/09 Offering /16/09 Salary-Pastor Smith /16/09 Loan Proceeds /18/09 Offering (Missions) /20/09 Church Supplies Total:

43 P a g e 39 Note how we put all our expense amounts in the left-hand side and all our revenue amounts in the right-hand side. You can also use a very simple system using only one column by listing each item and then adding revenue and subtracting expenses. Even though the above example uses two columns, it is still considered to be a singleentry system since only one line is used to record each transaction in the cash account. This single entry bookkeeping is often is expanded to provide additional columns for different fund accounts. However, even with additional columns, single entry bookkeeping is limited in its ability to provide detailed financial information. My Recommendation: Single entry bookkeeping is fine for small and startup churches, but as you grow bigger and acquire more assets and liabilities a double entry bookkeeping system should be put in place. Having said all that, I will now show you a way to obtain my free single entry financial spreadsheets. I usually ask people to sign up for my free newsletter Stewardship first.only because it gives me the opportunity to inform them if an error is found in one of my accounting spreadsheets and how to fix it; however, I will provide the link below to instantly download all of the spreadsheets and leave it up to you if you want to sign up for my free monthly newsletter using the link above. I built my accounting spreadsheets using the single entry bookkeeping system mainly because our church secretary, whom I built them for, had no accounting knowledge and secondly because the double entry system would be too complicated for me to build and give away. I believe a lot of small churches and nonprofits rely on volunteer help. A lot of these special people have very limited accounting experience and could benefit from my simple spreadsheets. Click here for the download page for my free financial spreadsheets.

44 P a g e 40 Chapter 7 Payroll Journal Entries Payroll accounting involves both expense and liabilities accounts such as FICA Taxes Payable, Federal and State Income Tax Payable, Health Insurance Premiums Payable, etc. Accounting for those taxes can get a little complex. This chapter will show you examples of nonprofit accounting payroll journal entries. Let me start out by saying payroll is one area of nonprofit accounting that I recommend getting professional help or using payroll software. There are many federal, state, and local laws that regulate payroll. Keeping up to date on all of them can be a hard task. There can also be fees and penalties for improperly handling your payroll. You must also be aware of the special rules that apply to payroll for ministers. See this page on Clergy Tax or the ebook on clergy (minister) taxes included in my Church Accounting Package. However, even if you have a payroll service provider, it is important to know the basics of payroll accounting as you are the one that is ultimately responsible for your payroll. Payroll vs Accounts Payable To begin with, let me point out the difference between accounts payable and payroll. Accounts payable is a current liability account in your chart of accounts that accounts for invoices that your churches owes and pays. Payroll is defined as the cost that your church accrues as part of paying your employees. It is a current liability account too, but is recorded separately from accounts payable entries.

45 P a g e 41 Payroll is not just one account. It is made up of expenses and payroll payable accounts, such as; wages salaries payroll taxes payroll withholding Accounts payable and payroll payable accounts are used in accrual basis accounting because you are recording expenses when they are incurred which may be before or after they are paid. Even though most small churches and nonprofits use a cash basis accounting method, it is still possible to use accounts payable and payroll payable accounts. It is called the hybrid method. In this system, you can generally use any combination of cash, accrual, and special methods of accounting if the combination clearly reflects your income and you use it consistently. There are some restrictions to using this method. See IRS Publication 538 for more details. Payroll Accounts Nonprofit accounting payroll involves both expense and liability accounts. Gross earnings are recorded using expense accounts such as salary or wage expense. Net pay for your employees is recorded using liability accounts such as net payroll payable, wage payable, or accrued wages payable. Payroll liability accounts such as FICA (Social Security and Medicare) tax payable and federal income tax payable are used to record withheld amounts owed to third parties. The following is an example of some of the accounts you may set up to manage and record your payroll: Salary or Wage Expense FICA (Federal Insurance Contributions Act) Tax Payable Federal Income Tax Withholding Payable State Income Tax Withholding Payable 401K Payable Health Insurance Wage Payable (employee's net pay or take home pay) Payroll Accounting Examples In this section of nonprofit payroll accounting, we will use a fictitious church to provide examples of journal entries to record gross wages, payroll withholding, and related payroll costs.

46 P a g e 42 These journal entries can be used in a manual accounting system and also in a computerized accounting system such as Aplos and QuickBooks. Examples of Payroll Journal Entries ABC Church has one employee, Mary Smith, which is paid weekly. The examples below are a typical weekly payroll journal entry which includes her gross wage, payroll withholding, and ABC Church s cost. Journal Entry #1: Date Account Names REF Debit Credit 3/1 Wage Expense FICA Tax Payable (7.65% x 720) Federal Income Tax Payable State Income Tax Payable Health Insurance Payable Wages Payable When ABC Church issues Mary her paycheck, they would post the following entry to decrease (debit) the Wage payable account balance and decrease (credit) cash. (In computerized accounting systems such as Aplos and QuickBooks...you will credit the bank account you are paying your employee from.) Journal Entry #2: Date Account Names REF Debit Credit 3/1 Wage Payable Cash In addition to the wages and withholding in the previous payroll journal entries, ABC Church has incurred additional expenses that must be recorded. These expenses include their share of Mary s FICA, worker compensation insurance, and ABC Church s portion of Mary s health insurance.

47 P a g e 43 Journal Entry #3: Date Account Names REF Debit Credit 3/1 ABC Church FICA Expense Workers Comp Insurance Expense Health Insurance Expense ABC Church FICA Payable Workers Comp Insurance Payable Health Insurance Payable When it comes time to pay the payroll payable such as FICA and Federal Income Tax Payable, you would simply debit the payable accounts you are paying and credit cash. Date Account Names REF Debit Credit 4/30 FICA Payable Federal Income Tax Payable ABC Church FICA Payable Cash

48 P a g e 44 Chapter 8 Transferring Money between Funds Another common financial transaction that occurs with churches is the transferring of money between two funds. Yes in some circumstances it is ok to transfer money out of one fund in to another. Below are some examples on how to record it. You can easily transfer monies from the general fund into another restricted fund. (Check your church policy, sometimes this requires board approval.) However, you cannot normally transfer monies from a restricted fund into the general fund. One of the ways it is possible to transfer restricted funds into an unrestricted fund is with the donor s permission. For example, a donor gives you church $2,000 to replace your old church sign with a new one. He s done his research and knows that is how much it is going to cost to replace the old sign with the new one the church really wants. However, the sign dealer gave you a price break because you are a church and the sign ends up costing only $1,800. You would then need to consult that donor and explain the price savings and explain he had 2 options with the remaining balance. The church could refund the $200 balance or with his permission the balance of his donation could be put into the general fund (or any other fund). (See the next page for an example on transferring monies between two funds.) Now, as I said before, transferring monies from the general fund into a restricted account is no big deal. For example, suppose that your church transfers $100 from the General Fund to the Building Fund each month. This means that the Building Fund will acquire ownership of the $100 and does not have to repay it to the General Fund.

49 P a g e 45 It should also be noted that this type of transfer does not require a physical bank transaction. Using a fund accounting system, fund balance transfers can be made entirely with bookkeeping entries. To record a fund balance transfer with bookkeeping entries, you would need to add a couple of accounts to your chart of accounts: Acc.# Account Name Account Type Related Fund Bal. 598 Transfers to Building Fund Other Expense General Fund 599 Transfers from General Fund Other Income Building Fund Then the monthly $100 transfer would be recorded as follows: DATE ACCOUNT REF DEBIT CREDIT 3/13/09 Transfers to Building Fund Transfers from General Fund

50 P a g e 46 Chapter 9 Discovery and Correction of Errors No matter how careful you are errors will sometimes occur in journalizing and posting transactions. These errors may be discovered in various ways: 1. Through audit procedures 2. By chance 3. Reconciling the bank statement Two common types of errors beside additions errors are: 1. Transposition occurs when the order of the digits is changed mistakenly, such as writing $245 as $ Slide occurs when the entire number is mistakenly moved one or more spaces to the right or left, such as writing $ as $24.50 or $ To locate the error, you should retrace your steps from the place the error was discovered. Once the error has been found, the procedures used to correct the error in journalizing or posting will vary according to the nature of the error and when the error is discovered. These procedures are summarized in the table on the next page. Correcting the first of the two types of errors shown in the table below involves simply drawing a line through the error and inserting the correct title or amount. That person making the corrections should normally initial the correction in case questions arise later.