Accounting Assumptions for nonprofit organisations: a brief overview

May 28, 2018
By Rang De Team

Lack of proper financial reporting practices can threaten the functioning of an organisation in the long-term

Financial reporting has long been a problem plaguing many organisations in the non-profit sector. While nonprofit entities are responsible for safeguarding the rights of stakeholders, trustees and end beneficiaries, it is a fact that ignorance and a lack of guidance when it comes to financial reporting can threaten the very sustainability of an organisation, jeopardising the rights of everyone involved.

For an organisation to fulfill its duty toward social welfare programmes and social accounts, the accounting assumptions it makes play a vital role. But just what are these accounting assumptions?

Simply put, Accounting Assumptions are a few guidelines under which organisations prepare their business statements. These fundamental assumptions are important because they establish a consistency to the accounting process and provide an accurate view of the organisation’s financial reporting

In other words, these key assumptions are the lifeblood of an entity.

They help the layperson understand how the organisation is running its operation. It provides a structure for recording the financial transaction in the record books and helps avoid any discrepancies.

There are some key differences in the Accounting Assumptions between a for-profit enterprise and nonprofit organisation, which are listed below

1. Consistency

This is the practice of using same accounting standards for all accounting periods. The practice of consistency which is followed by most business organisatons, is very much applicable to the not-for-profit sector. The assumption of consistency helps in comparing the financial statements of different periods.

Of course, NGOs can deviate from the principle of consistency if some change in accounting is mandated by law. In other cases, this first principle of accounting helps organisations show a clear picture of their financial statements.

Following standaring accounting practices helps offer an accurate glimpse into working of an enterprise

2. Going Concern

An organisation, whether it is a business company or a not-for-profit, prepares its financial statement with the assumption that operations with continue for the foreseeable future and there is neither a need nor intention to curtail the scale of the operation.

This assumption of ‘continuity’ or ‘inheritance’ in the financial statement is called going concern. In other words, organisations that are expected to continue are said to be a going concern. Those that are expected to close in the near future are not a going concern. This concept assures people that entities will have a long life and will not be closed or sold in the near future.

This second principle of accounting applies to business enterprises and not-for-profits. The latest update by the Financial Accounting Standards Board provides a few guidelines for not-for-profits to declare their going concerns.

3. Accrual
 
 Accrual is the difference between review and costs of an organisation. The principle of accrual states that profit or loss in an organisation should represent the activities of the enterprise and not the cash flows. As per the Indian Companies Act, the for-profit enterprises have a legal obligation to maintain the accounts on an accrual basis.

When it comes to the not-for-profit sector though, there is no concept of ‘profit’ or ‘loss’. As such, NGOs are not obliged to following ‘accrual’ in their accounting practices. While the cash method of accounting (based on inflows and outflows) is the easiest method, it isn’t the most accurate.

The cash method is best used by small NGOs who might find it difficult to pay their staff or have no immediate plans to scale their operations. A not-for-profit operating at scale with paid staff should not use the cash method of accounting.

However, because the accrual method believes in recognising the income in advance, it can lead to an overstatement. For a not-for-profit, this creates a problem when an expected donation or grant accounted for in the financial statement is delayed or simply does not materialise. In such scenarios, some NGOs might find it helpful to use the cash method of accounting.

There are a few instances when not-for-profits might find it easier to use a form of accounting more suitable to their needs

4. Disclosure

The disclosure principle simply means the declaration of the accounting principles involved in preparing and presenting financial statements. The ‘Disclosure’ helps a layperson immediately understand the basic principles underlying the financial statement of a company. It also helps to compare the financial statement of different enterprises.

A disclosure is not required in case an organisation follows the fundamental accounting assumptions. However, in the case of not-for-profits, where the accounting priciples deviate from that of for-profit enterprises, the organisation might be obliged to show the disclosure of accounting policies.

Nonprofit organisations have an increasingly important role to play in society. So it becomes that much more important for organisations to focus on their processes and objective, so they can help the development sector as a whole become more accountable and organised.

By Aparajita Kusum. 
Aparajita Kusum is a member of the Finance Team at Rang De.