Nonprofit accounting standards: A guide to basics and best practices for compliance

Managing nonprofit finances comes with unique challenges.  

Whether you’re stepping into a financial role at a nonprofit or serving on a board, understanding accounting standards is key to ensuring compliance, transparency, and financial sustainability. 

Unlike for-profit businesses, nonprofits track and report financial activities differently—focusing on accountability rather than profitability.  

That’s why nonprofit accounting standards, which align with Generally Accepted Accounting Principles (GAAP), exist. They help organizations stay compliant, maintain their tax-exempt status, and build trust with donors, grantmakers, and stakeholders. 

But don’t let the term “accounting standards” intimidate you.  

While it might seem complex, once you understand the fundamentals, it becomes much more manageable. 

This guide breaks down key nonprofit accounting principles in plain language, helping you navigate financial reporting requirements with confidence.  

By the end, you’ll have a clearer understanding of nonprofit accounting best practices and how to keep your organization’s financial records in top shape. 

Here’s what we cover:

What are nonprofit accounting standards? 

Nonprofit accounting standards are based on GAAP 

They are guidelines that govern the financial reporting of all nonprofit organizations.  

The principles specify how nonprofits should record, report on, and disclose their financial activities and ensure accuracy, transparency, and consistency when reporting to donors, board members, and regulatory agencies. 

We’ll cover GAAP in more detail below, including its key principles and why it matters for nonprofit compliance. 

Nonprofit versus for-profit accounting standards 

Nonprofit accounting standards differ from for-profit accounting standards because they consider nonprofits’ objectives and operational focus.  

For-profits prioritize profitability, whereas nonprofits prioritize their missions and social impact.  

This difference shapes the way financial transactions are tracked and reported.  

For example, nonprofits must categorize funds based on donor restrictions, accounting for in-kind donations, and report expenses according to functional categories, such as program services, management, and fundraising. 

The governing body for nonprofit accounting 

The Financial Accounting Standards Board (FASB) is an independent nonprofit organization responsible for establishing accounting and financial reporting standards for companies and nonprofit organizations in the US, following GAAP. 

In 2016, the FASB issued Accounting Standards Update (ASU) 2016-14, which significantly changed the presentation requirements for financial statements of not-for-profit entities.  

The amendments were intended to improve the guidance on net asset classification as well as the information presented in the financial statements and financial statement notes regarding liquidity, financial performance, and cash flows for not-for-profit entities. 

The FASB continues to update and refine accounting standards to address emerging financial reporting issues.  

For instance, in 2025, the FASB plans to explore topics such as the alignment of non-GAAP financial metrics and the proper accounting for research and development spending.  

For nonprofits, FASB standards provide a structured framework to ensure financial transparency, improve donor confidence, and maintain compliance with grant requirements and regulatory expectations. 

Understanding GAAP for nonprofits 

What are the GAAP principles? 

As we have already established, the definition of GAAP is a set of accounting standards that provide a framework for recording and reporting financial information.  

They form the backbone of nonprofit financial reporting, ensuring that financial statements are clear, consistent, and transparent. 

There are ten GAAP standards, including: 

1. Principle of regularity: accountants must follow the rules and standards of GAAP in all financial reporting. 

2. Principle of consistency: the same accounting methods should be used every reporting period so it’s easy to compare financial information over time. If anything changes, it must be clearly explained. 

3. Principle of sincerity: financial reports should honestly reflect the actual financial situation of the organization without bias or manipulation. 

4. Principle of permanence of methods: accounting procedures should remain consistent over time to ensure comparability. Any changes must be justified and clearly disclosed. 

5. Principle of non-compensation: financial reports must show everything as it is. Losses shouldn’t be offset against profits. All numbers should be presented without adjustment. 

6. Principle of prudence: only record revenue when it’s certain, but recognize expenses and liabilities as soon as they are likely. Record revenue when it’s realized or reasonably assured, and recognize expenses and liabilities as soon as they are probable to ensure financial data is based on facts, not speculation. 

7. Principle of continuity: assume your organization will continue operating in the future, so financial reports should reflect long-term stability and ongoing activities. 

8. Principle of periodicity: financial data should be reported at regular intervals, such as monthly, quarterly, or yearly, to allow for easy comparisons over time. 

9. Principle of materiality: all situations and circumstances relevant to the organization’s financial situation should be disclosed. 

10. Principle of utmost good faith: this states that everyone involved in the financial reporting process is assumed to be acting honestly and with integrity. 

The history of GAAP and the organizations that maintain it 

GAAP evolved over time to bring consistency and transparency to financial reporting in the US. Its origins date back to the 1930s, following the stock market crash of 1929, which highlighted the need for standardized financial reporting. 

To restore confidence in financial markets, the Securities and Exchange Commission (SEC) was established in 1934. It was given authority to regulate financial reporting and initially played a role in shaping accounting standards.  

However, rather than setting detailed accounting rules itself, the SEC relied on the American Institute of Certified Public Accountants (AICPA) and other professional accounting bodies to develop and maintain these principles. 

AICPA took the lead by forming the Committee on Accounting Procedure (CAP) in 1939 and later the Accounting Principles Board (APB) in 1959, both of which laid the foundation for today’s GAAP.  

However, as financial reporting became more complex, the need for an independent standard-setting body led to the creation of the FASB in 1973, which took over responsibility for establishing and updating GAAP for private sector businesses and nonprofit organizations. 

As financial reporting expanded beyond the private sector, government-specific GAAP was needed, leading to the formation of: 

• The Governmental Accounting Standards Board (GASB) in 1984, which set GAAP for state and local governments. 

• The Federal Accounting Standards Advisory Board (FASAB) in 1990, which developed GAAP for federal government agencies. 

Today, FASB, GASB, and FASAB work alongside the SEC and AICPA to maintain and refine GAAP.  

While the SEC continues to oversee financial reporting for publicly traded companies, it defers standard-setting to FASB. Meanwhile, AICPA continues to provide guidance and best practices, shaping financial reporting across industries, including nonprofits. 

Why nonprofits must comply with GAAP standards 

When nonprofits follow accounting standards, they prioritize accountability in their financial practices, enabling them to address the potential concerns of donors and stakeholders.  

There are other benefits to complying with GAAP standards, including:  

Meeting legal requirements: while GAAP isn’t a legal requirement, the principles guide many laws that all nonprofits must follow. For example, even though nonprofits are tax-exempt, they still need to file an annual tax return, Form 990, with the IRS. This requirement is linked to the GAAP principles of consistency and periodicity, which ensure that financial information is reported regularly and consistently. 

Building credibility: when nonprofits report their finances accurately and follow standardized procedures, it shows external parties that they are professional and trustworthy. This level of transparency and thoroughness helps build confidence among donors, grantmakers, and the community. 

Aligning with grantmaker and auditor expectations: if your nonprofit seeks grants or undergoes financial audits, grantmakers and auditors expect you to comply with GAAP. Meeting these standards makes the process smoother for everyone involved. If you don’t comply, you’ll need to include a disclaimer in your materials stating that your financial statements do not follow GAAP standards, which can raise concerns about transparency and reliability among funders. 

Standardized financial management: GAAP provides a solid framework for managing your nonprofit’s finances. It helps you allocate, record, and oversee your funds effectively, ensuring everyone involved—such as your CFO, treasurer, bookkeeper, and accounting team—is on the same page. 

Key accounting standards for nonprofit organizations 

The FASB has established the Accounting Standards Codification (ASC) as the comprehensive framework for accounting standards.  

Within this framework, certain topics are particularly pertinent to nonprofit organizations: 

FASB 958–Not-for-profit entities: this topic provides guidance on financial reporting for nonprofit organizations, including the presentation of financial statements, recognition of contributions, and disclosures related to net asset classifications. 

ASC 606–Revenue from contracts with customers: this standard is about how nonprofits should recognize revenue when they earn it through contracts, such as fees for services or product sales. Although nonprofit organizations rely heavily on donations, ASC 606 ensures that revenue from things like membership fees or ticket sales is accounted for properly. 

ASC 720–Other expenses: this section is about how nonprofits should report expenses, including start-up costs and advertising expenses, and requires such costs to be expensed as incurred.  

ASC 820–Fair value measurement: this standard provides guidance on how to measure fair value for assets and liabilities, which is relevant for nonprofits when valuing investments or other financial instruments.  

ASC 450–Contingencies: this topic focuses on how nonprofits should recognize and report potential financial gains or losses, such as pending lawsuits or donations with specific conditions. This standard ensures that financial risks or uncertainties are clearly disclosed in the organization’s financial statements. 

Recognizing revenue and managing grant accounting 

Nonprofits must carefully assess when to recognize revenue based on the nature of the funding.  

GAAP provides clear guidelines for recognizing revenue, depending on whether it’s a contribution or an exchange transaction, and if a contribution, whether it’s conditional or unconditional.  

Let’s explore: 

Contributions versus exchange transactions 

• Contributions (nonreciprocal transactions): these occur when a donor provides assets or services and doesn’t receive equal value in return. For example, a donor gives a gift to support a nonprofit’s mission without receiving significant goods or services in exchange. 

• Exchange transactions (reciprocal transactions): these involve a reciprocal transfer where each party receives or sacrifices goods or services of equal value. For instance, a nonprofit provides consulting services to a government agency in exchange for payment. 

When to recognize revenue 

• Unconditional contributions: recognize revenue immediately when received or promised because there are no donor-imposed conditions that must be met first. Example: a general donation to a nonprofit’s annual fund. 

• Conditional contributions: recognize revenue only when conditions are met. If a grant includes a right of return or requires the nonprofit to meet specific milestones (e.g. matching funds or program outcomes), revenue is not recognized until the condition is fulfilled. 

• Exchange transactions: recognize revenue as obligations are met (e.g. when a service is provided). Unlike donations, these transactions are recorded similarly to business contracts under ASC 606. 

While complying with this accounting standard can be tricky, it ensures your financial statements are accurate.  

Proper grant management can help you avoid overreporting income and ensure your funders and donors see an honest picture of your nonprofit’s financial health. 

Essential financial statements for nonprofits under GAAP 

Nonprofit organizations must prepare specific financial statements to give an overview of their financial health and activities.  

Key financial statements include: 

• Statement of financial position (balance sheet): this statement provides an overview of your nonprofit’s financial health by breaking down your assets (what you have), liabilities (what you owe), and net assets (the difference between the two). It’s a useful report if you’re planning for growth. 

• Statement of activities (income statement): this report outlines all the money your organization has received and spent over a certain period, usually a fiscal year. It’s designed to show whether your nonprofit has extra money (a surplus) or spends more than it earned (a deficit). It helps you compare actual results to your budget, evaluate financial performance, and make informed decisions.  

• Statement of cash flows: this statement details how cash moves in and out of your organization through daily operations, investments, and financing activities. It helps you keep track of your cash on hand, ensuring you can meet short-term expenses and plan for future needs. 

• Statement of functional expenses: unique to nonprofits, this statement breaks down your expenses in two ways: by their purpose (program services, management, and general fundraising) and by type of expense (such as salaries, rent, supplies). It provides a detailed view of how you use your funds to support your mission. More on that next. 

Breaking down functional expense reporting 

As mentioned, functional expense reporting is a critical requirement under nonprofit accounting standards that ensures organizations categorize their spending to show precisely how funds are used.  

A well-structured nonprofit chart of accounts can help streamline this process by providing a clear framework for tracking and reporting expenses according to these categories.  

According to GAAP for nonprofits, expenses must be divided into three categories: 

• Program services: these are the costs directly tied to your mission, such as staff time, program supplies, and event costs. Transparent reporting of program expenses helps show how funds are used to support your nonprofit’s work. 

• Management and general: these are the costs associated with anything administrative that keeps the organization running, such as office rent, accounting services, and executive salaries. Reporting these expenses according to nonprofit GAAP standards will demonstrate how operational costs are managed. 

• Fundraising: these are costs related to raising money, such as marketing campaigns or donor events. Correctly categorizing these costs gives a transparent view of how resources are allocated to support growth. 

Common challenges nonprofits face when implementing GAAP 

There are plenty of reasons why implementing accounting standards is essential for your nonprofit.  

But there are some potential challenges to be aware of, including: 

• Limited resources: sometimes, smaller nonprofits don’t have enough staff or the right expertise to fully understand GAAP and implement it effectively. This can make it challenging to comply with accounting standards. 

• Complex fund accounting: it can be tricky to manage different types of revenue, such as restricted and unrestricted funds. Nonprofits need to report on funds under GAAP accurately to mitigate errors. 

• Expense allocation: nonprofits must sort expenses into categories, such as program services, management, and fundraising. This can get complicated, especially when activities overlap. 

• Revenue recognition: understanding how to recognize revenue according to GAAP, especially for grants and donations with restrictions, can be challenging. Misclassifying revenue can result in errors in financial statements. 

Best practices for complying with nonprofit accounting standards 

To help you comply with nonprofit accounting standards and GAAP and overcome some of the challenges, here are some best practices to keep in mind. 

Get to grips with nonprofit accounting basics 

Nonprofit accounting differs from for-profit accounting as it’s all about accountability and stewardship of funds rather than profitability.  

You must get familiar with GAAP standards to ensure your financial reports are accurate and comparable.  

Take the time to immerse yourself in all things nonprofit accounting, such as fund accounting, revenue recognition, and financial statements, so you understand the nuances and breeze through compliance.  

Implement internal controls 

Establishing strong internal controls is crucial for maintaining compliance as it not only protects your organization’s assets but also enhances transparency and operational efficiency.  

For example, consider having different people responsible for recording, approving, and reconciling financial transactions.  

You could keep detailed records of all transactions to ensure payments are properly authorized.  

You might also perform monthly bank and credit card reconciliations to detect and resolve discrepancies early. 

Establish clear policies for managing donor-restricted vs unrestricted funds 

Nonprofits receive both restricted and unrestricted, and having clear policies in place helps ensure compliance with GAAP and donor expectations.  

To manage funds effectively:  

• Set up separate accounts for restricted and unrestricted funds to ensure accurate tracking and reporting. 

• Keep detailed records of donor agreements and any restrictions, using internal memos, acknowledgment letters, or grant agreements. 

• Regularly review fund balances to confirm restricted funds are spent correctly and prevent unintentional misallocations. 

Leverage nonprofit accounting software 

Using nonprofit accounting software helps to simplify compliance with GAAP. The right financial reporting software can automate tasks such as tracking grants, categorizing expenses, and preparing detailed financial statements.  

This makes it much easier to follow best practices and comply with financial requirements. 

Continuously monitor compliance 

Compliance isn’t a one-time task—it’s an ongoing process.  

Regulations are constantly evolving, so you must regularly review your financial statements and the effectiveness of your internal controls and procedures to stay compliant.  

Consider assigning a compliance officer or forming an audit committee to oversee compliance efforts at your nonprofit organization, so any issues are addressed promptly and effectively. 

Work with accounting and compliance experts 

Navigating nonprofit accounting standards can be complex, especially for smaller organizations. Working with the right financial expert can help ensure compliance with GAAP and maintain financial transparency.  

However, the type of accountant or financial expert your nonprofit needs depends on your financial complexity, reporting obligations, and whether you require audited statements. 

Certified Public Accountants (CPAs): For full GAAP compliance and audits 

• Conducts financial audits required by funders, government agencies, or board policies. 

• Certifies financial statements, ensuring they comply with GAAP. 

• Provides expert guidance on GAAP-based financial reporting, fund accounting, and IRS Form 990 tax filings. 

• Helps nonprofits prepare for audits and financial reviews required for grant eligibility. 

Nonprofit Accountants (Non-CPAs): For day-to-day GAAP-compliant accounting 

• Maintains GAAP-compliant financial records, including revenue recognition for grants and contributions. 

• Tracks restricted versus unrestricted funds in accordance with nonprofit accounting standards. 

• Prepares financial statements, such as the Statement of Financial Position and Statement of Activities, ensuring they align with FASB 958. 

• Assists with budgeting, internal financial controls, and grant reporting. 

Nonprofit compliance consultants: For regulatory and grant compliance 

• Ensures your organization follows state and federal nonprofit reporting requirements. 

• Helps nonprofits understand how to apply GAAP standards for financial transparency. 

• Advises on internal controls, donor restrictions, and fund allocation to prevent compliance risks. 

• Supports nonprofits in navigating grant reporting requirements and financial governance policies. 

How to choose the right expert for nonprofit GAAP compliance 

• If you need an audit or must certify financial statements, work with a CPA. 

• If you need help with GAAP-based financial tracking and reporting, a non-CPA nonprofit accountant may be sufficient. 

• If your nonprofit receives large grants or government funding, a compliance consultant can ensure proper financial oversight and donor accountability. 

Nonprofit accounting standards FAQs 

Do nonprofits have to follow GAAP? 

Nonprofits aren’t legally required to follow GAAP since these are guidelines and principles rather than laws. However, adhering to GAAP is highly recommended and often expected in the nonprofit sector.  

Following GAAP ensures your financial statements are accurate and transparent, which builds trust with donors, grantmakers, and stakeholders who rely on your financial information. 

Moreover, if you’re applying for grants or undergoing audits, many funders may mandate GAAP compliance as a condition for funding.  

By aligning with GAAP standards, you demonstrate financial responsibility and commitment to best practices, increasing your organization’s credibility and chances of securing support. 

Can nonprofit accounting software ensure compliance with GAAP? 

Yes, using nonprofit-specific accounting software can greatly help to ensure compliance with GAAP and other nonprofit accounting standards.  

This type of software is designed to handle the unique accounting needs of nonprofits, automating many essential tasks and reducing the risk of errors. It becomes much easier to produce accurate financial statements that meet compliance requirements.