Why Is GAAP Such a Big Deal for Nonprofits?

There’s a lot of confusion out there about what qualifies an organization as “nonprofit”. And it’s no wonder. While we understand nonprofits generally as organizations dedicated to furthering some sort of social cause or mission, not all nonprofits benefit the same cause nor do so in the same way.

Some nonprofits have charitable aims, whereas others relate to religion, health, or consumer information. Some sell goods; others generate memberships; and still others publish reports.

Aside from the mission-focused nature shared by all in the incredibly diverse nonprofit sector, the only other shared identifier of a nonprofit organization is its lack of shareholders and dividends. While these organizations may take in more funds than they spend on organizational liabilities (ie., they technically make a profit), to qualify as “non-profit”, those funds must go to further the organization’s mission or cause instead of into the pockets of those who manage it.

That requirement has a number of implications for how nonprofit bookkeeping and funding must be managed and documented, but one tool that simplifies these is GAAP, or Generally Accepted Accounting Principles. GAAP also plays a huge role in translating the functions, goals, and results of all nonprofits, regardless of how niche or varied, into one neat and tidy accounting language. And that’s a very big deal for these types of organizations.

What Is GAAP?

Before we get into why that is, let’s back up and cover what GAAP is.

GAAP is set by the Financial Accounting Standards Board (FASB). While the U.S. Securities and Exchanges commission originally set up the FASB, the group exists as its own completely independent, private, nonprofit dedicated to creating and improving accounting standards. In particular, the FASB strives to improve inclusivity and transparency in accounting. GAAP is the set of rules that it uses to drive those efforts.

How GAAP Benefits Nonprofits

GAAP has become need-to-know information for nonprofit accounting and fundraising staff thanks to federal and state reporting regulations. However, that’s not the only reason we recommend following GAAP principles in nonprofit bookkeeping.

GAAP does an amazing thing for nonprofits – it levels the playing field between non-charitable nonprofits, charities, and for-profits by forcing all three types of organizations into the same reporting language. That may not seem like a big deal, but it gives nonprofits of all types multiple advantages, especially against for-profit competitors:

  • It allows nonprofits to more clearly demonstrate performance. We’ve all heard that you can’t compare apples to oranges. GAAP allows nonprofits to resolve this issue, establishing a blueprint for all organizations, in all sectors, to follow when reporting spending, efficiency, and performance to peers. This advantage is what makes the next two on this list possible.

  • It arms nonprofits with universally useful fundraising data. Nonprofit organizations tend to use a mix of fundraising, grants, sales, and donations to sustain their operations. Much of that mix gets fueled by proof of outcomes. A nonprofit applying for a government grant must model the effectiveness of its efforts; one making an annual appeal to powerful donors must do the same; another focused more on grassroots donations may need to show the public that of X donations received, Y number of people were helped, studies were completed, or structures were constructed. Clear and accurate financial reporting empowers nonprofits to better sustain themselves and their mission. GAAP allows them to produce this in a way that anyone, at any level or advocate group can understand and appreciate.

  • It simplifies nonprofit response to audits by watchdog groups and the government. Both the government and investigative journalists operate watchdog groups charged with assuring that nonprofits adhere to both their mission and their nonprofit finance model. These groups are especially important in arenas where a nonprofit’s mission impacts a broad segment of the public, public health and safety, or holds a tax exempt status. While many in the nonprofit sector know to expect periodic regulatory audits, it’s not unheard of for irregular ones to occur if watchdogs suspect financial or functional misdeeds. Maintaining financial record keeping in accordance with GAAP allows nonprofits to respond to and resolve both kinds of audits quickly, efficiently, and transparently.

GAAP, while somewhat complicated, is a critical tool available to nonprofit organizations. We recommend getting your organization compliant with GAAP rules if you have not already. It may seem like a chore at first, but once you have your books set up using a GAAP foundation, you’ll be better positioned to better serve your mission, your advocates, and your organization’s longevity.

Contact RAE to learn more about how GAAP impacts your particular organization or to verify whether or not your nonprofit is GAAP compliant.