Not for Profit Organization (NPO)

Not-for-Profit Organizations are the establishments that are for utilized for the welfare of the community and are set up as charitable associations which operate without any motive for profit. Their primary objective is to furnish service to a specific class or the public at the larger picture. Usually, they do not produce, buy or sell commodities and may not have credit transactions. Therefore, they need not manage many books of account (as the trading entities do) and Trading and Profit & Loss Account. The funds raised by such establishments are credited to the general fund or capital fund. The major sources of their income usually are subscriptions from their member’s donations, income from investments, grants-in-aid etc.,

The main aim of maintaining records in such establishments is to meet the statutory necessities and assist them in exercising control over the consumption of their funds. They also have to prepare the financial statements during the closure of each accounting period (usually a financial year) and determine their income and expenditure and the financial condition and submit them to the statutory authority known as Registrar of Societies.

Types of not-for-profit organization

Not-for-profit organizations exist in both the public sector and the private sector. Most, but not all, public sector organizations do not have profit as their primary objective and were established in order to provide what economists refer to as public goods. These are mainly services that would not be available at the right price to those who need to use them (such as medical care, museums, art galleries and some forms of transportation), or could not be provided at all through the market (such as defence and regulation of markets and businesses). Private sector examples include most forms of charity and self-help organizations, such as housing associations that provide housing for low income and minority groups, sports associations (many football supporters’ trusts are set up as industrial and provident societies), scientific research foundations and environmental groups.

Corporate form

Not-for-profit organizations can be established as incorporated or unincorporated bodies. The common business forms include the following:

• In the public sector, they may be departments or agents of government
• Some public sector bodies are established as private companies limited by guarantee, including the Financial Services Authority (the UK financial services regulator)
• In the private sector they may be established as cooperatives, industrial or provident societies (a specific type of mutual organization, owned by its members), by trust, as limited companies or simply as clubs or associations.

A cooperative is a body owned by its members, and usually governed on the basis of ‘one member, one vote’. A trust is an entity specifically constituted to achieve certain objectives. The trustees are appointed by the founders to manage the funds and ensure compliance with the objectives of the trust. Many private foundations (charities that do not solicit funds from the general public) are set up as trusts.

Formation, constitution and objectives

Not-for-profit organizations are invariably set up with a purpose or set of purposes in mind, and the organization will be expected to pursue such objectives beyond the lifetime of the founders. On establishment, the founders will decide on the type of organization and put in place a constitution that will reflect their goals. The constitutional base of the organization will be dictated by its legal form.

If it is a company, it will have a Memorandum and Articles of Association, with the contents of the latter entrenched to ensure that the objectives cannot be altered easily in the future. Not‑for-profit organizations that are not companies most commonly have a set of Rules, which are broadly equivalent to Articles of Association.

As with any type of organization, the objectives of not-for-profit organizations are laid down by the founders and their successors in management.

Unlike profit maximizes, however, the broad strategic objectives of not-for‑profit organizations will tend not to change over time.

The purposes of the latter are most often dictated by the underlying founding principles. Within these broad objectives, however, the focus of activity may change quite markedly. For example, during the 1990s the British Know-How Fund, which was established by the UK government to provide development aid, switched its focus away from the emerging central European nations in favour of African nations.

It is important to recognize that although not-for-profit organizations do not maximize profit as a primary objective, many are expected to be self‑financing and, therefore, generate profit in order to survive and grow. Even if their activities rely to some extent on external grants or subventions, the providers of this finance invariably expect the organization to be as financially self-reliant as possible.

As the performance of not‑for‑profit organizations cannot be properly assessed by conventional accounting ratios, such as ROCE, ROI, etc, it often has to be assessed with reference to other measures. Most not‑for-profit organizations rely on measures that estimate the performance of the organization in relation to:

• Effectiveness: The extent to which the organization achieves its objectives
• Economy: The ability of the organization to optimise the use of its productive resources (often assessed in relation to cost containment)
• Efficiency: The ‘output’ of the organization per unit of resource consumed.

Many service-orientated organizations use ‘value for money’ indicators that can be used to assess performance against objectives. Where the organization has public accountability, performance measures can also be published to demonstrate that funds have been used in the most cost‑effective manner. It is important within an exam question to read the clues given by the examiner regarding what is important to the organization and what are its guiding principles, and to use these when assessing the performance of the organization.

Management

The management structure of not‑for-profit organizations resembles that of profit maximizes, though the terms used to describe certain bodies and officers may differ somewhat.

While limited companies have a board of directors comprising executive and non-executive directors, many not-for-profit organizations are managed by a Council or Board of Management whose role is to ensure adherence to the founding objectives. In recent times there has been some convergence between how companies and not-for-profit organizations are managed, including increasing reliance on non-executive officers (notably in respect of the scrutiny or oversight role) and the employment of ‘career’ executives to run the business on a daily basis.

Characteristics of Not-for-Profit Organizations

• Service Motive: These organisations have a motive to provide service to its members or a specific group or to the general public. They provide services free of cost or at a bare minimum price as their aim is not to earn the profit. They do not discriminate among people on the basis of their caste, creed or colour. Examples of services provided by them are education, food, health care, recreation, sports facility, clothing, shelter, etc.
• Members: These organisations are formed as charitable trusts or societies. The subscribers to these organisations are their members.
• Management: The managing committee or the executive committee manages these organisations. The members elect the committee.
• Source of Income: The major sources of income of not-for-profit organisations are subscriptions, donations, government grants, legacies, income from investments, etc.
• Surplus: The surplus generated in the due course is distributed among its members.
• Reputation: These organisations earn their reputation or goodwill on the basis of the good work done for the welfare of the public.

Users of accounting information: The users of the accounting information of these organisations are present and potential contributors as well as the statutory bodies.

Accounting for Non-Profit Organisations

As we know that the not-for-profit organisations do not trade in goods or provide services with a profit motive. But, they also require to keep proper records of incomes, expenses, assets, and liabilities. Their major source of income is donations, subscriptions, grants, etc. Therefore, most of their transactions are in cash or through the bank account.

They need to keep proper books firstly because they are accountable to the members and the contributors and secondly because the law requires them to maintain proper books so that the government can keep proper control over the grants. Also, proper accounting reduces the risk of fraud and embezzlement. In addition to the ledgers and cash book, they are also required to maintain a stock register. Also, in a Stock register, a complete record of all fixed assets and consumables is maintained.

In accounting for non-profit organizations, instead of maintaining a Capital A/c, these organizations maintain Capital Fund or General Fund A/c. They credit this account with the surplus, life membership fees, donations, legacies, etc.

The not-for-profit organisations also require to prepare the final accounts or the financial statements at the end of the accounting year as per the accounting principles. The final accounts of these organisations consist of:

• Receipts and Payments A/c: It is the summary of the cash and bank transactions. It helps in the preparation of Income and Expenditure A/c and Balance Sheet. We also need to submit it to the Registrar of Societies along with Income and Expenditure A/c and Balance Sheet.
• Income and Expenditure A/c: It is similar to the Profit and Loss A/c and ascertains the surplus or deficit if any.
• Balance Sheet: We prepare it in the same manner as the Balance Sheet of concerns with a profit motive.