Many nonprofit organizations rely on grants as a significant source of revenue. These vital cash infusions typically fund efforts that benefit the community or the environment, such as green energy projects, research initiatives or educational programs. Though they don’t need to be repaid like loans, grants usually come with intricate conditions, such as providing fully transparent reports that outline precisely how granted funds have been used. Good financial habits and scrupulous grant accounting practices are, therefore, a necessity for any nonprofit looking to fulfill its mission, maintain great donor relationships and secure more grants in the future.
What Is Grant Accounting?
Grant accounting is the meticulous method nonprofit organizations use to keep track of and manage the funds they receive and spend through grants. It’s an important practice for two key reasons. First, it provides a nonprofit with a clear understanding of its financial status, helping the organization to make smarter decisions about how to best use its resources. And perhaps more important, grant accounting helps nonprofits transparently ensure that grant money is being used according to grantors’ requirements. This is key, as noncompliance can lead to a reduction in future funding amounts, grant termination or even fines and penalties.
Here’s another way to look at it: Nonprofits essentially use pristine grant accounting records as “marketing” materials to attract potential grantors and donors, just as for-profit businesses use marketing campaigns to lure customers. Just as successful ads can increase sales, exemplary grant accounting records can attract more funding to improve support for nonprofit missions.
- Grant accounting is a niche subset of nonprofit accounting.
- Whereas traditional for-profit companies aim to max out profits, nonprofits prioritize accountability to their mission and stakeholders. Grant accounting plays a crucial role in upholding that accountability.
- The detailed tracking and reporting required in grant accounting adds a layer of complexity and rigor beyond what’s typically found in a standard business context.
- Nonprofit grant accounting software is all but necessary for any organization looking to simplify its grant accounting and grant management processes.
Grant Accounting Explained
Grant accounting is a niche of nonprofit accounting, the financial recording and reporting approach that nonprofit organizations use. Because they serve the public interest, receive funding from governments or other entities, are often tax-exempt and don’t distribute excess revenue as profit or dividends, nonprofits must adhere to more rigorous accounting practices than traditional for-profit businesses.
For example, a nonprofit generally can’t receive grant revenue and then use those funds to cover just any business cost. So, if a nonprofit receives a $10,000 grant specifically to install solar panels, it can’t use that money to pay for rent, office supplies or employee salaries. The grant funds must be accurately recorded, attributed to the correct source and used only for the intended purposes outlined in the grant agreement. And if the solar panel project costs only $8,000, the nonprofit might need to return the excess $2,000 (unless the grant agreement says otherwise).
Thorough records also provide the basis for reporting, a critical aspect of grant accounting and management. While a for-profit company aims to maximize profits, a nonprofit focuses on transparently accounting for how it uses its funds. Nonprofits are, therefore, typically required to provide grantors with periodic financial statements and progress reports to demonstrate that the funds are being used effectively and in accordance with a grant’s objectives. Grant accounting may also involve external audits or assessments, conducted by either independent auditors or a grantor itself, to further confirm compliance.
Difference Between Grants and Loans
The fundamental difference between grants and loans lies in the repayment requirement. Grants are essentially gifts or donations from entities, such as government agencies, foundations, corporations, businesses, individuals or educational institutes. The sum of money is usually given in exchange for specific deliverables and outcomes and, importantly, doesn’t need to be repaid. However, because grants generally come with strict conditions, misuse can damage a nonprofit’s reputation or lead to penalties, such as being required to repay the funds.
Loans, on the other hand, are borrowed sums of money that must be paid back over a predetermined period, typically with interest. They generally provide more flexibility in how the funds can be used, but specifics depend on the type of loan. An equipment loan, for example, must be used to pay for qualifying equipment. Although loans have a broader range of uses, they still need to be repaid in accordance with the agreed-upon terms. Timely repayment is essential to maintain a good credit standing and to avoid potential consequences of default.
Selection criteria for grants and loans also vary. Grants are usually awarded based on the merit of the proposed project and an applicant’s need. Applicants also typically must submit a detailed proposal, outlining how the funds will be used. Loan approvals are tied primarily to a borrower’s ability to repay, determined by factors such as credit history, income level and collateral.
Types of Grants
There are two main categories of grants in accounting: conditional and unconditional. Conditional grants have designated usage requirements or other special implementation rules that must be met before the funds can be recognized as revenue. For example, the recipient might be required to submit periodic reports outlining how the grant funds have been used, before the organization can recognize those funds as revenue. Reimbursable grants are a common type of conditional grant, in which the nonprofit must use its own organizational resources to fund an agreed-upon project before the grantor will reimburse incurred expenses. Matching grants are another form of conditional grant. These require the nonprofit to raise a specified amount of money from external sources before the grantor will award funds, usually according to a designated ratio. If it’s a 1:1 grant, for example, a nonprofit might need to fundraise $50,000 before a grantor awards that same amount.
Unconditional grants don’t require the recipient to provide a specific deliverable or outcome in exchange for funds before revenue can be recognized. However, the recipient might still need to submit periodic reports to ensure that funds are being used responsibly in support of the nonprofit’s mission and not being misappropriated.
Conditional and unconditional grants can come in various forms and are available from different types of entities. Accounting rules categorize grants based on their terms, rather than on who the grantor is. Thoroughly understanding the following types of grants and how they work is key to effectively managing nonprofit finances.
Government grants are financial aids provided by government bodies to support specific programs, initiatives or services that align with public objectives. These grants are crucial for nonprofits operating in education, health care, social services, infrastructure, research and the arts. For example, the National Endowment for the Arts Grants for Arts Projects is a U.S. government grant program that aims to help nonprofit arts organizations fund artistic events, exhibitions and performances.
Private grants are financial awards provided by nongovernmental entities, such as foundations, trusts or corporations. These grants can support a variety of initiatives in various fields, including education, health care, social services, research or arts and culture. The Ford Foundation, for instance, is a prominent private foundation that offers grants to address modern social needs and circumstances, such as civic engagement and economic development.
Corporate grants are financial contributions made by businesses to support specific projects or initiatives aligned with their corporate social responsibility goals. These grants are part of a company’s efforts to positively impact communities and address various social and environmental issues. The Coca-Cola Foundation, for example, is a well-known corporate grantor that assists specific initiatives, including sustainable access to water and disaster preparedness and response.
Research grants are financial awards provided to individuals or organizations engaged in scientific or scholarly investigations. These grants fund research projects across various disciplines and are awarded by government bodies, such as the National Institutes of Health; private foundations, like the Bill & Melinda Gates Foundation; or academic institutions. Research grants support a range of activities, such as data collection, experimentation and analysis, and the dissemination of research findings.
These grants often have specific requirements, including research proposal submissions, peer review processes and reporting obligations, to ensure accountability and confirm that the research project has been successfully completed.
Project grants are provided by various entities, including government bodies, private foundations and corporations, to support specific projects or initiatives. They focus on nonprofit organizations, researchers or individuals hoping to carry out proposed projects and bring ideas to fruition. Project grants generally aim at achieving particular outcomes or deliverables within a set time frame, such as preparing and showing a six-month educational exhibit at a museum. The funds generally cover expenses related to materials, equipment, personnel and other resources required to conduct the project.
Project funds do not need to be repaid but are usually conditional in that they must be used exclusively for the designated project, with penalties for any misuse. Depending on the grant’s conditions, project grants may or may not be reimbursable.
Operating grants, also known as general operating support grants, are financial awards given to nonprofit organizations to cover their day-to-day operational expenses and activities. Unlike many other types of grants, operating grants are almost always unconditional. They normally provide flexible funding that can be used for various purposes, including staffing, rent, utilities, administrative costs, program costs or any other purpose the nonprofit chooses.
Operating grants acknowledge the challenges nonprofits can face when obtaining funding to support overall operations by contributing to their stability and ongoing work. In turn, these grants help safeguard longevity, so nonprofits can continue their missions and effectively serve their communities.
Capacity-building grants are awarded to help a nonprofit strengthen its effectiveness and preserve longevity. These grants often support professional development, training, strategic planning and technology upgrades — all of which can help nonprofits grow, improve their services, reach more individuals and boost innovation.
Scholarship grants are financial awards provided to individuals, typically students, to support their educational pursuits and alleviate the financial burden associated with schooling. These grants assist in covering various educational costs, including tuition fees, textbooks and living expenses. Scholarship grants are usually based on merit, academic achievement, financial need or other specific criteria established by the grantor. Scholarships can be awarded by educational institutions, government organizations, private foundations or corporations.
Conditional scholarships usually require recipients to maintain a certain GPA, complete a specific course of study or meet other academic or performance benchmarks. Unconditional scholarships allow recipients to use the funds for their education as they see fit, without being subjected to ongoing conditions or performance requirements.
Emergency grants are awarded to entities directly affected by or responding to a crisis or emergency situation. For example, nonprofits, individuals and small businesses might be eligible for emergency grants immediately following unforeseen circumstances, such as natural disasters, health emergencies or economic hardships. These grants aim to offer rapid support that helps recipients overcome immediate challenges and stabilizes their situation. Emergency grants can be conditional, unconditional or reimbursable and are usually provided by government agencies, nonprofits, foundations or relief organizations.
Types of Grant Accounting
Nonprofit organizations around the world adopt various approaches to grant accounting. The methods vary based on the set of accounting standards the organization adheres to, namely, the U.S. Generally Accepted Accounting Principles (GAAP), issued by the Financial Accounting Standards Board (FASB), or the International Financial Reporting Standards (IFRS). Each of these sets of standards has a distinct framework that often deals with similar accounting processes in different ways. There isn’t always a direct equivalent between the two systems, but here’s a general overview of these two approaches to grant accounting.
FASB Grant Accounting Guidelines
FASB nonprofit grant accounting standards outline different grant accounting approaches, depending on whether the grant is accounted for as a contribution or as an exchange transaction.
Contributions are gifts of cash or other assets — including grants — from donors who have no expectation of receiving anything with direct reciprocal value. If a grant is classified as a contribution — and most are — it must then be evaluated to determine whether it’s conditional or unconditional. Conditional grants can be recognized as revenue once the grant’s stipulations are met. Unconditional contributions can be recognized as revenue as soon as the grant is committed.
Exchange transactions are reciprocal transfers in which each party receives and sacrifices something of approximately equal value. For nonprofits, this could include situations where the grantor receives a direct benefit approximately equal to the value of the grant provided. Say a government agency provides a grant to a nonprofit to conduct research, and the agency receives the full benefit of that research — that’s an exchange transaction. Grants classified as exchange transactions are typically recognized as revenue when the goods or services are provided.
IFRS Grant Accounting Guidelines
IFRS nonprofit accounting guidelines don’t specifically distinguish between contribution and exchange transactions the way FASB does, nor do they explicitly reference conditional and unconditional grants. But, in a sense, IFRS’s rules are most similar to FASB’s conditional grants guidelines — that is, grants are not recognized until conditions are met and it’s determined that the grant will be received.
Grants received can then be accounted for using the IFRS’s capital approach or income approach. At a high level, the capital approach applies to government grants related to assets, such as a grant specifically given to help purchase a piece of equipment or real estate. The income approach has a broader application, covering all kinds of expenses and losses that a grant may be intended to compensate.
Grant Accounting Requirements for Nonprofits
Though all forms of accounting require utmost accuracy and precision, nonprofit grant accounting is even more rigorous due to the many stipulations and heightened need for transparency and accountability. Because grants can be so restrictive, accounting for them requires particularly careful budgeting, planning and cost allocation processes. Timely financial reporting, thorough performance monitoring and periodic audits are often also mandated to meet compliance obligations, and maintaining tax-exempt status demands adhering to specific regulations set by the Internal Revenue Service (IRS). Here are some key requirements nonprofits must take into account.
Budgeting and Planning
Within the context of financial management, budgeting and planning refers to the process of anticipating future financial needs and resources. This is key for nonprofits, which rely on grants and donations to operate within their means and to ensure that resources will be available to accomplish goals. For example, nonprofits need to budget carefully so that grant funding will cover the actual cost of delivering the program — and, if it doesn’t, that it has adequate funding from other unrestricted sources to make up the difference. Similarly, when a nonprofit applies for a grant, it might need to detail exactly how it plans to spend awarded funds. Then, ongoing budgeting and planning are needed to manage funds, which is a complex process in itself, due to the complex nature of having to properly account for funds.
For example, if an educational organization receives a state government grant to support a tutoring program, it might estimate the expenses for materials, staff salaries and program activities, as these are the only costs the grant will cover. This budget would guide spending and ensure that the organization appropriately allocates funds throughout the grant period.
In grant accounting, cost allocation involves accurately assigning shared costs to an organization’s different programs, activities or areas funded by a grant. The goal is to accurately reflect how grant funds are being used. Though cost allocation is applied to direct costs, or those that can be tied to a specific project (e.g., materials or the salary of an employee working solely on the project), it also applies to indirect costs. Indirect costs are overhead costs that aren’t directly linked to a particular grant-funded activity, such as administrative expenses or utilities. Because not all grants can be used to cover indirect costs, nonprofits need to have a method for fairly distributing all direct and indirect costs among their different funding sources. Cost allocation also needs to comply with grantor requirements.
Say the same educational nonprofit organization has a general administrative staff that supports multiple programs, including the youth tutoring program funded by the grant. The organization would need to allocate grant funds to cover the salaries of this administrative staff, making sure to record exactly how much of each grant was used toward each individual’s salary. The nonprofit also needs to be sure that it’s not paying salaries with restricted funds that aren’t designated as such.
Timely Financial Reporting
Timely and accurate financial reporting is crucial for grant accounting. Nonprofits must prepare and submit regular reports to grantors to demonstrate how funds are being used. Depending on the grant’s conditions, strict deadlines may be required for each report. If these aren’t met, the nonprofit could be penalized or forced to forfeit the funds.
Keeping with the same educational nonprofit example, the organization might need to provide regular, detailed reports on all expenditures related to educational materials, staff salaries and program activities, by each deadline outlined in the grant’s conditions. Doing so transparently proves to the grantor that funds are being used appropriately and according to stipulations, and timely reporting demonstrates the nonprofit takes the grantor’s requirements seriously.
Program Performance Monitoring
For conditional grants — especially program grants — nonprofits must continually monitor the performance and progress of grant-funded activities to assess whether they align with the grant objectives. Financial data should also be presented to confirm that funds are being used to achieve the program’s goals. If any deviations are identified, it’s crucial for the nonprofit to make adjustments to ensure accountability to the grantor. It’s also wise for the nonprofit to be transparent in communicating any changes and what the organization plans to do to rectify the situation.
The same educational nonprofit, for example, might need to regularly assess the youth tutoring program’s progress against the intended outcomes outlined in the grant. This could involve tracking attendance rates, academic improvements and feedback from participants to evaluate the program’s effectiveness. But suppose the nonprofit identifies an issue — maybe attendance rates were lower than projected. The nonprofit might want to resolve the issue by introducing more engaging educational materials, but it should not do this without first communicating the challenges and proposed changes to the grantor to ensure that any necessary cost reallocation will be in line with the grantor’s regulations.
While the IRS doesn’t have auditing requirements for nonprofits, it’s possible for it to request an occasional audit or compliance check — not unlike the way the IRS occasionally audits ordinary taxpaying citizens. However, some states require nonprofits to perform routine audits. According to the New York Nonprofit Revitalization Act, for instance, nonprofits that exceed a certain revenue threshold are required to conduct an independent audit, usually annually. Many grantors will also require an external audit before giving money to a nonprofit organization. Sometimes, nonprofits will independently choose to undergo internal audits to build trust and verify the accuracy and compliance of their financial records and grant management practices.
Regardless of the reason, audits can be a critical step in securing funding. And because an audit is an objective way to prove fiscal responsibility, its impact tends to go beyond boosting grant approval rates — it also demonstrates responsibility toward employees, volunteers and the general public, while providing peace of mind that the nonprofit’s accounting practices are reliably precise.
Given the educational nonprofit’s theoretical challenges with attendance rates and its proposal to reallocate funds, it may decide to engage with an external auditor to review its financial records and grant management practices. The auditor might examine the organization’s financial reports, supporting documentation and grant-related expenses to underscore the nonprofit’s commitment to transparency and proper fiscal management. This can help convince the grantor that the proposed cost reallocation is worth approving.
Compliance With Regulations
When managing and reporting grants, nonprofits must comply with regulations set by the grantor and/or any relevant regulatory bodies. For example, grantor regulations often require nonprofits to keep accurate records, adhere to fund usage limitations or report on the status of scheduled milestones. Depending on the nonprofit’s locale, its level of funding and other factors, it might also be obligated to keep up with location-specific regulations. If a California-based nonprofit receives a state grant, for instance, it needs to comply with the procedures and regulations specified for nonprofits by the California State Contracting Manual, such as adhering to FASB’s accounting principles.
Keeping up with all this red tape can be challenging for nonprofits, but it’s important to note that these regulations and compliance laws exist to protect the public in two key ways:
Grant funds, especially those from federal, state or local government sources, often come from public money. Compliance confirms that grants are being used responsibly and for their intended purpose.
Grants are often awarded to help nonprofits achieve specific social objectives. Compliance helps ensure that these goals will be met and, in turn, benefit the public.
Furthermore, tax-exempt organizations must file IRS Form 990 (or one of its variants) every year. They also need to adhere to a variety of IRS requirements to continue qualifying for tax exemption. For example, 501(c)(3) nonprofit organizations (also known as charitable organizations) must refrain from direct or indirect participation in political activities. Otherwise, they can lose their tax benefits.
In the hypothetical case of the educational nonprofit organization, the two spending restrictions and reporting requirements mentioned above play a key role in making sure the nonprofit is effectively using the resources that have been granted, rather than allowing the organization to spend public funding without discretion. The organization also makes sure to file IRS Form 990 every year to maintain its tax-exempt status.
Benefits of Nonprofit Grant Accounting
Though demanding, diligent grant accounting has its benefits. Namely, the process can help nonprofit organizations establish themselves as accountable and financially sound entities that are committed to the public’s best interest. This not only strengthens relationships with funders but can also support the organization’s ability to make data-driven decisions, meet regulatory requirements and position itself for sustainable growth. Here are some of the key benefits nonprofit grant accounting can deliver.
Grant accounting enhances accountability by providing a detailed record of how grant funds are received and used. For example, nonprofits demonstrate transparency showing funders, board members and stakeholders itemized expenses incurred and outcomes achieved. This level of accountability builds trust and confidence in the organization’s financial management practices.
Imagine that a nonprofit receives a $20,000 local grant for a project to renovate dilapidated restrooms in a public park. The nonprofit must clearly delineate where each grant dollar went, including itemized construction, supply and labor costs. If total expenses are only $18,000, the nonprofit must handle the remaining $2,000 according to the grant’s requirements — in this case, by returning the unused funds. Rather than keeping the excess for other uses, by providing the transparent return, the nonprofit demonstrates that it holds itself accountable to honest fiscal practices.
Better Financial Management
Effective grant accounting practices support better financial management by ingraining processes that result in consistent access to accurate and up-to-date financial information. This allows nonprofits to closely monitor how grant funds are being managed, as well as to track expenses and assess the organizations’ overall financial health.
Consider a nonprofit that uses grant accounting to manage an initiative providing food assistance to underprivileged communities. The organization must accurately track grant income, segregate it from other funding sources and further designate it for specific expenses, such as food, transportation, storage and distribution. Through this continuous evaluation, the nonprofit can calculate the cost per meal or per person served, thereby presenting a clear picture of the program’s financial efficiency.
Comprehensive financial oversight can facilitate better budgeting, planning and decision-making to support financial stability. By analyzing financial data, nonprofits can assess the impact, effectiveness and sustainability of each grant-funded initiative. This information empowers decision-makers to make strategic choices about how best to allocate resources, expand successful programs or modify ineffective ones — and whether to seek additional funding, based on financial realities and performance outcomes.
Using the same food assistance program example as above, continuously evaluating the program’s efficacy allows the organization to make data-driven decisions about whether it’s optimizing food procurement to get the most nutritious meals at the best cost. Then, if the program is successful, the organization can begin to analyze available resources and funding opportunities to evaluate the likelihood that it can sustainably scale the initiative to help more people.
Compliance With Regulations
Nonprofit organizations must comply with reporting deadlines, expenditure restrictions and documentation standards, among other potential state or federally mandated compliance obligations, such as the IRS’s annual filing requirement. At a high level, these compliance laws exist to safeguard public interest and prevent misuse of funds. Keeping up with regulatory compliance is necessary for organizations to avoid penalties, remain eligible for future grants, remain tax-exempt and cultivate a reputation for dependability. Fortunately, the precise nature of grant accounting can make it easier to adhere to regulations and grantor-specific stipulations.
For instance, suppose a nonprofit receives a grant from the Environmental Protection Agency (EPA) for a wetlands restoration project. In that case, it must adhere to the EPA’s stringent reporting guidelines. The organization might need to submit semiannual financial and progress reports, verifying that funds are spent only on approved project costs through detailed records of all project-related transactions, as well as federal and state regulatory requirements. This level of compliance is demanding, but it’s essentially built into the world of grant accounting; a nonprofit can’t get grants if it can’t comply with the rules.
Increased Funding Opportunities
For any nonprofit, retaining donors and lenders is key to keeping revenue predictable and expenses manageable. One way to increase funding opportunities is to uphold robust and transparent grant accounting practices. By providing timely and precise financial reports, for instance, nonprofits illustrate how grant funds are being used to achieve targeted results. Over time, this kind of transparency and accountability can help build stronger relationships between a nonprofit and its grantors. Grantors gain confidence in the organization’s ability to manage funds responsibly and achieve meaningful outcomes and, in turn. become more willing to provide additional funding in the future. Satisfied grantors may even recommend the nonprofit to other potential donors or grantors.
For instance, if a nonprofit effectively uses a grant for a community health program and shows positive results, it is more likely to draw additional funding from other sources. These sources, seeing the nonprofit’s dedication to fiscal transparency and successful program delivery, may be more inclined to contribute, thereby broadening the nonprofit’s funding opportunities.
Stronger Relationships With Funders
Building a strong, trusting relationship with grantors goes beyond securing funds; it establishes an avenue for understanding and flexibility. Take, for example, a nonprofit that proves its reliability through transparent grant accounting practices and effective use of funds. Not only do its grantors find the organization trustworthy, but they also deeply understand and support its mission. In such a case, the grantors may be more likely to allow for adjustments in project timelines or reallocation of funds should challenges or unforeseen circumstances arise. While this level of flexibility shouldn’t be abused, it can, at times, be a advantage for nonprofits that need to amend plans in order to achieve goals.
A strong connection can also turn grantors into advocates. A satisfied grantor might help spread the word about the nonprofit’s work, provide strategic advice or even facilitate introductions to other potential funders, effectively helping to widen the organization’s network and resources.
Improved Organizational Sustainability
Any nonprofit that wants to continue its operations and fulfill its mission over the long term needs to have a stable financial position, at minimum. Diligent grant accounting contributes to a nonprofit’s long-term viability by providing insights into the impact of grant-funded programs from two vantage points: internally (financially) and externally (socially). This level of detail can help identify cost-effective programs and reveal grant-related return on investment (ROI), among other benefits.
Then, by focusing resources on high-impact initiatives, nonprofits can demonstrate their financial savviness and effective use of funding to attract more grants and donations, making it easier to achieve their mission. Transparent reporting further builds trust with funders and the public, elevating the nonprofit’s reputation as a financially sound community asset. Genuine community need, combined with stable finances (and good leadership), are critical to a nonprofit’s longevity.
Challenges of Nonprofit Grant Accounting
Grant accounting can be challenging, especially for growing organizations with limited resources. Timely reporting is a must, but complex regulations and detailed grant guidelines can make compliance a real slog. To add to the difficulty, grant guidelines differ, depending on the grant and grantor, and unless the grant is unrestricted, each grant must adhere to specific usage conditions, limiting financial flexibility. Here’s an overview of common grant accounting challenges.
Nonprofits are, by nature, restricted in how they can use much of their funding. As a result, they commonly operate with tight budgets and lean staffing. These limitations can hinder the organization’s ability to effectively handle the intricacies and subsequent challenges of grant accounting — such as parsing the grant-specific guidelines that often restrict funding in the first place.
Nonprofits commonly ease the issue by outsourcing certain accounting functions or taking advantage of grant accounting software, both of which can help organizations streamline the grant accounting process and make the most of available resources.
Red tape can present a significant challenge for nonprofits, as every grant comes with its own set of rules and guidelines set out by the grantor. These rules dictate how the money can be spent, when and how progress should be reported and other specifics that render required tracking and reporting a complex and time-consuming, albeit essential, task. In addition, some grants, especially those from government sources, may also require compliance with broader financial management principles, such as the GAAP rules for nonprofits. And any 501(c)(3) nonprofit needs to adhere to the IRS’s ongoing compliance rules for tax exemption.
Understanding these regulations — be they grantor guidelines or broader compliance requirements — requires specialized knowledge, which can be a strain on nonprofit organizations without the resources to hire dedicated accounting or legal personnel.
Meeting reporting requirements is a significant aspect of grant accounting, but the time and effort involved can be burdensome because there’s no single script or format for a nonprofit to use. Rather, each grant, especially those from different grantors, can have its own unique set of reporting requirements, each with its own degree of granular financial detail to delineate how each dollar was spent. Gathering and presenting this data in a clear and understandable manner that aligns with the grantor’s requirements is a time-consuming effort.
In addition, many funders want to see the impact their grant has made. This means nonprofits must not only track cash inflows and outflows but also measure and report on qualitative factors, such as the number of people served or the improvement in quality of life, which can be complex and require additional resources to effectively track.
Grant compliance often comes with strict time constraints, from financial reporting deadlines to milestones that need to be hit before funds can be released. Nonprofits must establish efficient grant accounting processes to meet these deadlines; otherwise, they face noncompliance and risk losing eligibility for current and future funding. Some grants might also have time constraints on when the funds must be used by, necessitating timely allocation and expenditure.
It’s also worth noting that the entire financial health of a nonprofit can be directly affected by the organization’s ability to manage its grant cycle. Identifying grant opportunities, applying for them, receiving them, implementing the initiative and eventually reporting on funding usage and program effectiveness create a time-consuming process that needs ongoing attention and precise scheduling abilities. Grant applications often have fixed deadlines, for example, and missing even one might not only limit the nonprofit’s revenue and cause cash flow issues but could even jeopardize grantor relationships.
Changes in Grant Guidelines
Grant guidelines can change over time, and nonprofits must stay informed and adapt to any changes. Although guidelines for a specific grant are unlikely to change once an agreement has been reached for a particular grant cycle, it’s common for the guidelines to change from one grant cycle to the next, or from one year to the next. Grantors can reevaluate their focus areas, objectives and strategies, depending on factors related to grantees, previous grant impacts, changes to societal contexts or even shifts in their preferred mission.
It’s important that nonprofits don’t assume grant guidelines will always be the same. Staying abreast of changes — and carefully reviewing every grant’s guidelines — can help nonprofits avoid banking on certain funding or stipulations that may cease to be the norm.
Difficulties in Cost Allocation
Allocating costs accurately among multiple programs and grants can be challenging, especially when it comes to managing expenses that are not directly attributable to a single project or grant. For instance, a nonprofit may have costs for rent, utilities, administrative salaries, office supplies or IT support that are necessary for the organization to function as a whole but can’t be directly linked to one particular program or grant-funded activity. These costs are typically spread out, or “shared,” among all the programs or projects that benefit from them, perhaps by measuring the number of employees or every square foot of space involved in each program. To complicate matters further, the planned allocation methodology often needs to be spelled out in advance — either by the grantor or within the nonprofit’s grant proposal — leaving the nonprofit little room for deviation.
And, unlike a for-profit business that can use its revenue however it chooses, the nonprofit version of allocating shared costs is complex and needs to be done systematically, in a way that upholds grant requirements and regulations — especially when it comes to managing restricted grants that can’t be used for shared costs. In addition to methodically tracking where each dollar goes, nonprofits need to make sure they have a revenue stream that can be allocated to necessary operating expenses while adhering to the grantor’s requirements or the nonprofit’s initial proposal, if relevant.
Grants often come with certain restrictions and limitations on fund usage. Nonprofits must plan their activities and budgets within these constraints, leaving limited room for adjustments or reallocations. This necessitates thorough project planning, budgeting and continuous monitoring to ensure adherence to grant guidelines while maximizing the impact of available funds.
Take, for instance, a nonprofit that needs to pay rent next month. It just received a $50,000 grant to develop and host community CPR and first-responder training sessions. A traditional business would be able to use a similar $50,000 revenue boost to cover whatever it wants: rent, salaries, new product development, marketing, etc. But the nonprofit cannot use a penny of that grant to pay for anything but approved expenses directly related to the training sessions. Instead, it will need to acquire other, unrestricted funding, such as through donations or operating grants, to prevent a cash flow crunch.
Best Accounting Methods for Grants
Grant accounting is best approached using accrual accounting and its various subsets, such as fund accounting, program-based accounting and grant-specific accounting. Each of these methods has its own characteristics and can be used in different contexts. Depending on the size of the organization, the complexity of its grant portfolio and other regulatory requirements, a nonprofit might choose to adopt one or a combination of these accounting methods. Here’s a brief explanation of each.
Accrual accounting is a widely used method that records financial transactions — revenues and expenses — when they occur, regardless of when the cash is received or paid. Rather than waiting for cash to change hands, which can take months, the recording of revenue and expenses as they occur gives the nonprofit a more comprehensive and accurate picture of its financial activities. This differs from cash-basis accounting, where revenue and expenses are recorded only when cash is actually exchanged. Accrual accounting is required for any nonprofit — or business, for that matter — that adheres to GAAP guidelines, which in itself is necessary for a nonprofit looking to maintain its tax-exempt status. Plus, many grantors won’t grant funds to a nonprofit that isn’t using accrual accounting.
Those requirements aside, the accrual method is ideal for grant accounting purposes because it precisely records grant revenue and associated expenses over time, making it easier to monitor which funds are going where and why. The built-in stringency of this method puts the nonprofit in a better position to understand its financial health, prepare necessary financial reports and demonstrate fiscal responsibility to grantors.
Though fund accounting can technically be achieved with cash-basis accounting, it more commonly refers to a specialized version of accrual accounting. It’s also a perfect fit for most nonprofits because it segregates financial resources into separate “funds,” each dedicated to a unique purpose or program. Each fund is essentially a “pool” of money with its own budget, financial statements, revenue, expenses, liabilities and net assets. For example, a nonprofit might create discrete pools for research grant funds, operational grant funds, capacity-building grant funds and general donations without specific donor instructions. This method allows nonprofits to ensure and demonstrate that they are using their resources in compliance with donor restrictions. Nonprofits can also give each individual program or grant its own distinct fund, as outlined below.
Program-based accounting focuses on tracking and reporting financial information related to individual programs or projects. It’s essentially a distinct variation of fund accounting in which each project gets its own fund; but it’s still important to be able to clearly identify each individual grant within the overall fund.
For example, say a nonprofit is chartering an initiative to create a community garden by repurposing unused urban space. It creates a fund to track this project. Into the fund goes a federal government grant earmarked for clearing the space, plus a separate local government grant to cover planting and tending to the garden. However, the nonprofit has leftover federal grant funds that, according to the grant’s guidelines, can be used to clear additional unused urban spaces. Rather than return the funds, the organization moves them into a separate “clean-up” project fund that’s dedicated to cleaning up as many alleyways as it can afford.
Program-based accounting can also help the organization assess the financial performance and impact of each individual program by shedding light on its financial sustainability, ROI and cost effectiveness.
Grant-specific accounting is another variation of fund accounting. Rather than tracking and reporting financial information related to different programs, this approach delineates each individual grant. It involves separately recording each grant’s revenue, related expenses and compliance requirements. This approach makes it easier to track and report the particular resources and expenditures associated with each individual grant, ensuring that grant funds are used only for their designated purposes.
Suppose a small nonprofit receives a grant to provide free health care services in an underserved area. The organization decides to use grant-specific accounting to effectively manage the grant, following its guidelines and reporting requirements. This approach enables the nonprofit to track the financial transactions and expenses related only to the specific grant, thus increasing transparency and simplifying financial reporting because there’s no need to weed through transactions to determine which dollar went where and why.
Worst Accounting Methods for Grants
While accrual accounting and its various fund accounting-related subsets offer comprehensive frameworks for tracking, reporting and managing grant funds, other accounting approaches limit a nonprofit’s ability to guarantee compliance and provide transparency. Here are a few less-than-favorable options.
In cash-basis accounting, transactions are recorded when money changes hands. This method documents when funds are received and disbursed, but it doesn’t reflect pending financial obligations or anticipated revenues, both of which are vital in grant accounting. This is because grant funds often aren’t immediately accessible upon award confirmation — the actual cash can take months to arrive. This delayed income isn’t captured in cash-basis accounting, which can distort the true financial picture of a nonprofit, especially those that heavily rely on grants.
Cash-basis accounting is also problematic from a compliance perspective. Its dearth of detail doesn’t conform to GAAP guidelines, which many nonprofits are required to follow. Moreover, grantors often mandate use of more rigorous accounting standards, such as accrual accounting and its more explicit alternatives, like fund accounting, which most nonprofits are required to follow. In other words, cash-basis accounting isn’t just a subpar grant accounting method; it’s often verboten.
Mixed Accounting Methods
Also known as hybrid accounting, mixed accounting combines elements of both accrual accounting and cash-basis accounting, with no consistent, universally agreed-upon framework. For example, a company might track income using the cash-basis approach (recording revenue when cash is actually received) and expenses using the accrual-basis version (recording expenses when they are incurred, not necessarily when they are paid), or vice versa. Another company might use accrual accounting for overhead expenses but cash-basis for revenue.
While this flexibility could seem advantageous, inconsistency in accounting methods — especially across grants — can lead to confusion, reporting discrepancies and challenges in monitoring and evaluating financial performance. Like strict cash-basis accounting, mixed accounting generally isn’t permitted in the world of grant accounting.
General accounting refers to the broad, overarching process of systematically recording, categorizing and interpreting all financial transactions within an organization. For a for-profit business, this includes everything from recording daily transactions in the general ledger to producing crucial financial reports, such as the balance sheet, income statement and statement of cash flows. In a nonprofit organization, the crucial financial reports are the statement of financial position, statement of activities, statement of cash flows and statement of functional expenses. Grant accounting falls under the general accounting umbrella, but it’s important to note that grant accounting is a specialized area within general accounting that deals with managing and reporting of funds received through grants. It requires its own special knowledge and skill set to keep up with compliance requirements, whereas general accounting — as a general concept — may not provide the level of granularity or transparency required for effective grant management and reporting.
Excel-based accounting relies on spreadsheets for financial management. Though Excel can be a useful tool for companies using accrual accounting, it may not provide the robust details required for comprehensive grant accounting — nor does it have the same data security features or scalability capabilities. Grant accounting is highly complex as it is, and relying solely on spreadsheets can increase the risk of human error while limiting an organization’s ability to generate appropriately sophisticated financial reports and effectively track multiple grants and their individual conditions. Accounting software specifically designed with nonprofits in mind is a more suitable alternative that can save time and resources, promote transparency and minimize errors.
Grant Management Accounting Tips for Nonprofits
Following grant management best practices can help nonprofits overcome the many challenges and intricacies of grant accounting. By putting the following processes into place, an organization can increase accountability, use funds more effectively and, ultimately, better support its mission.
Develop clear policies and procedures.
Establishing clear and well-defined policies and procedures paves the way for consistency, clarity and accountability. Set policies that guide staff toward proper accounting practices, grant compliance and reporting requirements. For example, develop guidelines for expense tracking, revenue recognition, documentation and reporting formats, and be sure to explain the importance of each operating procedure; eschewing well-defined methods will only make it harder for a nonprofit to track financial data, receive grants and achieve its mission.
Use accounting software.
Nonprofit organizations have unique accounting requirements that neither spreadsheets nor general-purpose accounting software can be expected to fully accommodate. Specialized nonprofit accounting software, on the other hand, is capable of producing GAAP-compliant financial statements, tracking restricted and unrestricted contributions and verifying compliance with grant conditions. It can also aid in budgeting, expenditure tracking, accurate recordkeeping and rapid, customized report generation — all at a granular level. When able to quickly access vital financial information in a genuine nonprofit accounting software solution, even understaffed nonprofits can track expenses, manage grants and adhere to compliance requirements with greater accuracy and fewer mistakes.
Maintain accurate records.
Accurate recordkeeping is central to grant accounting. As part of transparency expectations, nonprofits can’t afford to neglect organized and detailed records of all financial transactions, invoices, receipts and grant-related documentation. Rather, diligent and precise records are needed to provide a reliable trail of financial activities that supports transparency and accountability. Better yet, nonprofits that employ a centralized recordkeeping system — for example, within a nonprofit grant accounting software solution — are able to quickly access key financial information to swiftly meet auditing and reporting requirements.
Monitor grant performance.
Regularly monitoring grant performance paves the way for proactive management and tracking of outcomes, expenses and progress. Monitoring enables timely identification of issues and facilitates adjustments to strategies, as well as effective resource allocation, to maximize the impact of grant funds. Nonprofits can track key performance indicators, such as grant revenue, program revenue and program expenses, to identify potential issues proactively, make timely adjustments to strategies or budgets and ensure that resources are used effectively to achieve desired — or required — outcomes.
Allocate costs appropriately.
Correct cost allocation is paramount for any nonprofit because it ensures accurate, traceable financial reporting and compliance with grantor stipulations and other regulations. To make cost allocation easier, it’s important to devise a clear and consistent method that equitably and transparently distributes shared costs across various programs or grants. For example, if a staff member splits their time among multiple programs, their salary should be allocated proportionally, based on the time spent on each program. Setting predefined criteria, such as percentage of resources used or the amount of time dedicated to a particular program, can help prevent misallocation.
Train staff and volunteers.
Though it’s unlikely that all staff or volunteers will be actively involved in the grant accounting process, the better they understand the inner workings of a nonprofit, the better they’ll be able to support the organization’s vision — be it by truthfully logging their work hours or assiduously keeping receipts. For the workers who will be involved in grant management and/or grant accounting, training is critical, given the specialized knowledge and skill prerequisites. For example, employees and volunteers need to understand compliance requirements to ensure that funds are spent correctly and that all necessary information is accurately reported. Otherwise, the nonprofit runs the risk of important financial data slipping through the cracks, hurting its accountability.
Transparency at an organizational level is also vital, as these traits are the backbone of any nonprofit and are key to building trust with grantors, other donors, lenders and the overall public. Cultivating a culture of authenticity and integrity not only helps build trust but can help make sure the entire team is on the same page and willing to uphold consistent expectations that support the nonprofit’s mission.
Communicate regularly with funders.
Even if it’s not stipulated in the grant’s guidelines, it’s still a good idea to keep funders informed about progress, challenges and successes of their grant-funded programs. If you have questions, it’s always better to ask than assume. For example, if something is unclear in the grant requirements, or if your team suspects it might face issues with the project timeline, speak to the funder as soon as possible. Proactive communication builds trust, aligns expectations, fosters potential collaborations and strengthens the relationship between the nonprofit and its funders.
Regulations can change. For example, FASB didn’t standardize nonprofit financial statement requirements until 1993. Since then, guidelines have been periodically updated, with new guidance on the presentation of financial statements released in 2016. Similarly, IRS rules are subject to change each year, though they don’t always change. Still, grant accountants need to keep their fingers on the pulse and be prepared for possible shifts — or face preventable setbacks, like noncompliance penalties or losing tax-exempt status.
Nonprofits also need to monitor and ensure compliance with grantor requirements, reporting deadlines and regulations. Even organizations that regularly win grants from the same grantor can’t expect that every grant will have the same compliance guidelines. It can help to establish a compliance calendar that outlines important reporting deadlines, as well as other grantor requirements. Regularly reviewing this calendar can help nonprofits consistently adhere to compliance requirements for all grants received.
Seek professional advice.
Nonprofits can benefit from engaging with accounting professionals or consultants who specialize in grant accounting, especially if the organization has limited resources to handle grant complexities. These professionals can provide guidance on complicated accounting matters and help address unexpected challenges or compliance issues, from revenue recognition rules and cost allocation methodologies to compliance with special grantor regulations and choosing the best accounting method for the nonprofit’s needs. Professional advice can also help ensure that the organization adheres to best practices and stays updated with regard to accounting standards.
Nonprofit Grant Accounting Software
Nonprofit grant accounting software is a specialized tool designed to meet the unique financial and grant management needs of nonprofits. In short, it streamlines sophisticated grant-related tracking, compliance and reporting activities. For example, nonprofit grant accounting software can typically centralize and automate key financial tasks, such as advanced planning and budgeting, cost allocation, real-time expenditure tracking and grantor compliance. It can also track deadlines, helping nonprofits make sure they use funds within designated time frames. And the software, by its very nature, emphasizes transparency to support reporting and auditing requirements.
For most nonprofits, this type of software plays a critical role in enhancing operational efficiency. It takes challenging tasks off people’s plates, freeing up time so they can promote the organization’s mission.
Grant Accounting Made Easier With NetSuite
Nonprofits, particularly small ones, face accounting challenges, many due to their limited resources. NetSuite addresses these difficulties by simplifying grant accounting tasks, ensuring compliance and supporting better decision-making. For example, real-time grant revenue and expense reporting allows for better financial visibility, which, in turn, supports transparency and provides insights that can lead to more efficient actions.
NetSuite makes it easy for nonprofits to set up discrete grant projects or funds within its Cloud Accounting Software system. Customizable templates generate detailed reports, tailored to individual grantor requirements. The software automatically handles restrictions, sets up reminders and notifications for important deadlines, ensures timely submission of grant reports and complies with specific grantor and regulatory body guidelines. NetSuite also streamlines cost allocation complexities by allowing organizations to split payroll costs or other labor expenses across multiple grants or projects.
Grants are a vital financial lifeline for nonprofits, giving them much-needed funds to promote their causes, support expansion projects or launch new initiatives. Adhering to robust grant accounting practices ensures the appropriate use of these funds, minimizes the risk of incurring penalties, fosters enduring, positive relationships with grantors and opens doors to future funding opportunities. Yet, grant accounting requires meticulous attention to detail, comprehensive documentation and financial expertise. Fortunately, with the assistance of nonprofit grant accounting software, these complexities can be simplified, freeing up much-needed time for organizations to focus on making a meaningful impact.
Grant Accounting FAQs
How do you record grant money in accounting?
The way grant money is recorded depends on whether the nonprofit is following U.S. Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS) guidelines. In GAAP accounting, the way a nonprofit recognizes grant revenue depends on whether it’s a contribution (e.g., a grant that aims to further the nonprofit’s mission) or an exchange transaction (e.g., a grant given in exchange for research that directly benefits the grantor). If it’s a contribution, the grant must then be classified as conditional or unconditional. Conditional contributions can be recognized when the grant’s stipulations are met. Unconditional contributions can be recognized as revenue as soon as the grant is committed. If an exchange transaction, the grant is recorded when goods or services are provided. In IFRS accounting, grants can be recognized as revenue when their conditions are met.
In either case, grant money is typically recorded as its own line item that specifies the grant’s source, amount and purpose.
What is the role of a grant accountant?
The role of a grant accountant is to manage the financial aspects of grants received by an organization. This includes tracking grant funds, ensuring compliance with grantor requirements, preparing financial reports and overseeing proper allocation and expenditure of grant money.
What do I need to know about grant accounting?
In grant accounting, it’s important to understand the specific terms and conditions of each grant, as well as proper revenue recognition requirements, cost allocation methodologies and regulatory compliance requirements. Furthermore, good grant accounting practices depend on accurate recordkeeping, timely reporting and utmost transparency and accountability.
How do you record government grants in accounting GAAP?
In Generally Accepted Accounting Principles (GAAP), how government grants are recorded as revenue depends on whether the grant is classified as a contribution or an exchange transaction. If it’s a contribution, which most grants are, the grant is recorded as revenue when it’s committed, or, if conditional, once the grant’s stipulations have been met. If it’s an exchange transaction, the grant is recorded as revenue when the goods or services are provided. Generally, the grant is clearly recorded on the nonprofit’s income statement.