This is the second blog in my series on configuring Intuit's QuickBooks for use in a nonprofit organization. In my first blog post, I mentioned that the very first step in configuring QuickBooks is to have a QuickBooks implementation meeting, and I recommended using a questionnaire to facilitate the meeting and act as a centerpiece. See http://www.mac-cpa.biz/resources-for-nonprofits for a sample implementation questionnaire that you can use for this purpose.

Some of the main goals of the implementation meeting are to produce a consensus on the definition of: 

• The chart of accounts
• Funding sources (who funds your organization and what are their reporting requirements?)
• Programs (What service or product does your organization provide or produce ' what does it do?)

This blog will provide some suggestions on building your chart of accounts in a manner that is practical and that will satisfy as many users of the financial statements as possible. It will also provide you with a sample chart of accounts of my design and one called the "Unified Chart of Accounts," which was created by a number of major nonprofit support organizations. This great resource will give you spreadsheets and even a sample QuickBooks database that you can download and use as a learning aid.

Suggestions on setting up your funding sources using the QuickBooks "Customer/Jobs" utility and your programs (what your organization does) using the QuickBooks "Classes" utility will be the subject of blog posts 3 and 4 in this series.

Building Your Chart of Accounts

So, if you followed my advice from the first blog post, you have had your implementation meeting, and (if you are all still speaking to one another) one of the outcomes of that meeting is a listing of the accounts that your organization will need in order to provide the reporting required by all the users of the financial statements. By attending this meeting and participating in it, your accounting staff or contractor will have a good idea of the types of accounts that he or she will need to satisfy the needs of most users. The implementation meeting should have provided for an agreement on the names of accounts so that all readers will have a mutual understanding of the terms and types of transactions captured in each account.

So What Exactly Is a Chart of Accounts?

One definition is that a chart of accounts is a detailed listing of minor categories under the major categories of Assets, Liabilities, Net Assets, Revenue, and Expense. (See http://womeninbusiness.about.com/od/glossaryofaccountingterm/g/definition-chart-of-accounts.htm for a similar definition.) Think of the chart of accounts as the foundation for a building you are about to construct. The stronger the foundation, the stronger the building - and the same holds true of the chart of accounts. Another analogy is to think of the chart of accounts as a filter through which information from the "outside" world will enter your accounting system. The manner in which that filter is set up will be the basis for the reports. If the filter is too summarized, the reports will be too summarized. If the filter is too detailed, the reports will be too detailed. So you can see that if we are to "begin with the end in mind" (as I advised in the first post), we need to let the reports dictate the construction of the chart of accounts - not the reverse.

The FASB, Your Audit Report, and Your Tax Return (and How They Affect Your Chart of Accounts)

You would think that if you have defined all accounts in the major categories of Assets, Liabilities, Net Assets, Revenue, and Expense, you would be finished building your chart of accounts. And you would be finished if you were working in the for-profit sector, but unfortunately many nonprofits (that fall into the category of Voluntary Health and Welfare Organizations) have to make one more distinction in the Expense section of their chart of accounts. They need to keep track of the "functional" expenses directly related to:

• Programs
• Management and Administration
• Fundraising

The reason that many nonprofits must do this is because of Statement of Financial Accounting Standards #117 - Financial Statements of Not-for-Profit Organizations. The body of women and men who guide the accounting world (in the U.S.)  in matters of Generally Accepted Accounting Principles (GAAP) are known as the Financial Accounting Standards Board (FSAB) and they perform this by issuing "Statements of Financial Accounting Standards" (SFAS). One of the requirements of SFAS #117 is that "voluntary health and welfare organizations provide a statement of functional expenses that reports expenses by both functional and natural classifications."

The statement of functional expenses is unique to nonprofit organizations and has become extremely important to taxing authorities (the IRS and state tax agencies), funders, philanthropists, and sophisticated readers of the financial statements of nonprofit organizations. This is because the statement of functional expenses hopes to show the amount and percentage of each dollar spent in the three functional expense categories of Program, Management & Administration, and Fundraising.

Take a look at your audit report and your Form 990 (see http://www.irs.gov/pub/irs-pdf/f990.pdf, page 10, part IX) and, if SFAS #117 applies to your organization, you will see the statement of functional expenses. The logic behind this classification seems to be that the more a nonprofit spends on its programs, the more efficient it is in performing its mission. This ratio and the statement of functional expenses has become a barometer for a very important group of readers of the financial statements, and as such, we need to reflect this in the chart of accounts of a nonprofit organization to which SFAS #117 applies (and this is a large group of nonprofit organizations).

So how does a nonprofit organization report expenses by both functional and natural classifications? Is this akin to asking your accountant to "jump and not come down?" Maybe not - because your implementation meeting will provide you with the raw material for your natural classifications, and I will suggest two methods that you can employ to use QuickBooks to set up the functional expense categories.

SUGGESTED METHOD #1

The first method I can suggest is one I have used with many of my nonprofit clients. I offer this methodology as a suggestion and a guide. I believe that all nonprofits are unique, and my hope is that you can take the best of this suggestion and use it to create your own unique chart of accounts.

In QuickBooks, create the three functional expense categories of Program, Management & Administration, and Fundraising by creating an expense account for each. These accounts will be "major categories," and you will not post transactions directly to these accounts. Next, set up "sub-accounts" underneath each major functional expense category as needed. This may seem redundant in that, as an example, you will have the sub-account "Salaries" under each major functional expense category - but the reality is that you do have salaries in each category (for example, the Executive Director's salary may be split between the three major categories).

The best part of this methodology is that you can create a report in QuickBooks that shows not only how you spent in the functional and natural categories but also the percentages of total expenses related to each functional expense category. This, as explained above, is very important information to many readers of the financial statements.

See this short video on using this methodology in QuickBooks with a sample nonprofit organization.

SUGGESTED METHOD #2

The second methodology I can recommend is for you to take a serious look at the Unified Chart of Accounts (UCOA), which was created by a number of major nonprofit support organizations, including the National Center for Charitable Statistics, The California Association of Nonprofits (CAN), CompassPoint Nonprofit Services, and The California Society of CPAs. (These organizations have other beneficial information for nonprofit organizations on a number of different topics.)

I applaud the sponsors of the UCOA for their efforts. In my opinion, trying to establish a uniform methodology for the chart of accounts in the nonprofit industry is a daunting task - a little like trying to change your tire while simultaneously driving your car! These organizations are trying to create financial statements in the nonprofit industry that meet the needs of all the readers (sound familiar?), and this (as many of you now know) is quite a challenge. This challenge is made even more difficult by recent FASB pronouncements and the massive change in Form 990 by the IRS.

A great resource provided by the sponsors of the UCOA is the Unified Chart of Accounts Toolkit. The UCOA Toolkit is a zipped file containing the QuickBooks chart of accounts files and Excel spreadsheets for working with the UCOA. This toolkit gives you the ability to restore a sample QuickBooks database using your version of QuickBooks (most organizations with at least the 2007 version of QuickBooks should be able to restore and open this sample database). The spreadsheets will also give you a visual of the logic in the design of the UCOA. The main difference in the UCOA and the method I use most (Suggested Method #1 above) is that while my method creates the major functional expenses directly in the chart of accounts, the UCOA employs the QuickBooks utility of "Classes" to create these functional categories.

Please review both methods closely and customize your chart of accounts accordingly. In order to get the most out of QuickBooks in your nonprofit, you should combine your chart of accounts with the "Customer/Jobs" and "Classes" utilities found in the software. My next two blog posts will cover how you can combine those utilities with your chart of accounts to create some very useful reports that can be run by "Funding Source" or by "Program," all within the same QuickBooks setup!

My next posts in this series will be:

• STEPS 3 and 4 - Setting Up the QuickBooks "Customer/Job" Utility in a Nonprofit Environment and Setting Up the QuickBooks "Classes" Utility in a Nonprofit Environment
• STEPS 5 and 6 - Coding Transactions with QuickBooks "Customer/Job" and "Classes" Utilities and Creating Financial Reports in QuickBooks for a Nonprofit Organization

Stay tuned for more!

Mark McCallick, CPA, CITP has a practice dedicated to nonprofit organizations and small business ' see http://www.mac-cpa.biz. He has served nonprofit organizations for over 25 years and is a Certified QuickBooks Pro Advisor. He is also the founder of the website www.nonprofit-connect.com, whose mission is to provide nonprofit organizations with a forum to collaborate with one another and share access to resources and best practices in the nonprofit industry. You can contact Mark McCallick at markm@mac-cpa.biz or markm@nonprofit-connect.com. This blog post series was updated for our readers in February 2013 by Mr. McCallick.

Photo: GenBug