Accounting for nonprofit organizations (NfPs) is governed by a unique set of rules that prioritize stewardship over profit. While for-profit accounting focuses on the bottom line, nonprofit accounting—specifically ASC 958—focuses on the “restriction” of assets and the “functional” use of every dollar.

For CFOs, Board Members, and Auditors, navigating the complexities of donor restrictions and functional expense reporting is critical for maintaining tax-exempt status and donor trust. In 2026, with increased IRS and public scrutiny of nonprofit transparency, getting these disclosures right is more important than ever.

1. The Core Pillar: Net Asset Classification

The most significant change in recent nonprofit history came with ASU 2016-14, which simplified net asset classification into just two categories.

I. Net Assets Without Donor Restrictions

These are funds available for the general use of the nonprofit to support its core mission.

  • Board-Designated Funds: Funds that the Board of Directors has set aside for a specific purpose (e.g., an “Emergency Reserve” or a “Building Fund”) are still classified as “Without Donor Restrictions” because the Board has the power to un-designate them at any time.

II. Net Assets With Donor Restrictions

These are funds subject to donor-imposed stipulations. These restrictions can be:

  • Purpose-Restricted: “This money can only be used for the After-School Program.”
  • Time-Restricted: “This money can only be used after January 1st, 2027.”
  • Perpetual (Endowment): “This principal can never be spent; only the investment income can be used.”

BATO Warning: When a restriction is met (e.g., the program is completed or the time passes), you must record a “Release from Restriction.” This is one of the most common areas for audit adjustments.

2. The Statement of Functional Expenses

Nonprofits are unique in that they must tell the story of their spending across two dimensions: Nature and Function.

Dimensions of Reporting:

  1. Nature (The “What”): Salaries, utilities, advertising, office supplies, depreciation.
  2. Function (The “Why”):
    • Program Services: Costs directly related to carrying out the mission.
    • Management & General (Admin): Executive oversight, accounting, legal, and board costs.
    • Fundraising: Costs of soliciting contributions, grants, and gala events.

The Allocation Problem:

Auditors pay close attention to how you allocate “Shared Costs” (like the salary of an Executive Director or the rent for an HQ).

  • Requirement: You must use a “reasonable and consistent” method for allocation (e.g., square footage for rent, or time-tracking for staff).
  • The KPI: Donors often look at the “Program Ratio” (Program Service Expenses / Total Expenses). A high Program Ratio (75%+) is generally seen as a sign of financial health.

3. Liquidity and Availability Disclosures

ASC 958 introduced a mandatory requirement for nonprofits to disclose their “Liquidity and Availability”. This is a footnote that summarizes:

  1. Total Financial Assets: Cash, receivables, and investments.
  2. Less: Amounts Not Available for General Use: This includes donor-restricted funds, board-designated reserves, and cash held for long-term construction.
  3. Net Financial Assets Available for General Expenditure within One Year: The final “Liquid” number.

Why this matters: This disclosure is designed to help donors and lenders understand if a nonprofit is $2 million “rich” in restricted assets but $50,000 “poor” in cash needed to pay next month’s rent.

4. Accounting for Contributions (Gift Revenue)

Nonprofit revenue recognition is distinct from the 5-step model in ASC 606. Instead, it follows the “Contribution” model:

  • Conditional vs. Unconditional: If a donor says “I will give you $10k if you raise another $10k,” that is a Conditional gift. You cannot record the revenue until the condition (the “barrier”) is overcome.
  • Contributed Nonfinancial Assets (Gifts-in-Kind): If a lawyer provides $5,000 worth of free legal services or a company donates laptops, these must be recorded at Fair Value with a corresponding expense, provided they require specialized skills or create/enhance a nonfinancial asset.

5. Audit Preparedness: Top 3 Red Flags

  1. Underwater Endowments: When the fair value of an endowment fund falls below the original gift amount. ASC 958 requires specific disclosures for these “underwater” funds.
  2. Inconsistent Allocation Methodology: If you change your method for allocating salaries from “50/50” to “90/10” in a single year to make the Program Ratio look better, expect a heavy audit inquiry.
  3. Restricted Cash Mismatches: If your Balance Sheet shows $100,000 in “Net Assets with Donor Restrictions” but your Bank Balance is only $60,000, you have “spent” restricted funds on general operations—a major compliance violation.

6. Accounting for Endowments and UPMIFA

For organizations with long-term investments, the Uniform Prudent Management of Institutional Funds Act (UPMIFA) dictates how you can spend from restricted endowments.

The “Spending Rate” Rule:

Most nonprofits adopt a spending rate (e.g., 4% of the average balance) rather than spending actual income (interest/dividends). ASC 958 requires you to disclose the “Spending Policy” and how you determined that rate.

Underwater Disclosures:

If the market drops and an endowment’s value falls below the original gift (the “Historical Dollar Value”), the fund is underwater. You must disclose:

  • The fair value of the fund.
  • The original gift amount.
  • The amount of the deficiency (the “underwater” amount).
  • The Board’s policy on spending from underwater funds.

Summary

Nonprofit financial reporting under ASC 958 is a balancing act between technical accuracy and mission-focused storytelling. By mastering net asset classifications, maintaining rigorous functional expense allocations, and providing clear liquidity disclosures, nonprofit finance leaders can ensure their organization remains both compliant and credible in the eyes of donors and regulators.

Disclaimer: This guide is for informational purposes only and does not constitute professional accounting or audit advice.