Accounting for Not-for-Profit Organisations

The full picture

A Not-for-Profit Organisation (NPO) is formed to serve a public cause rather than to make money for its owners. Schools, charitable hospitals, sports clubs, temples, and NGOs are all NPOs. Instead of share capital, they rely on membership fees, donations, government grants, and subscriptions. Because there are no shareholders expecting dividends, any surplus at the end of the year must be ploughed back into the mission — it cannot be distributed. This single rule drives the entire difference in how NPOs report their finances.

Every NPO maintains three core financial statements. The Receipt and Payment Account is a simple cash summary — it lists every rupee received (donations, fees, grants) on the left and every rupee paid out (salaries, rent, asset purchases) on the right. The closing balance is the cash in hand at year-end. Think of it as the NPO's bank passbook for the year. The Income and Expenditure Account is the NPO's version of a Profit & Loss Account. It converts the cash figures to an accrual basis — recording income when it is earned and expenses when they are incurred, not just when cash moves. The resulting figure is called a surplus (income > expenditure) or deficit (expenditure > income), never profit or loss. Finally, the Balance Sheet shows accumulated funds (the NPO's version of capital), fixed assets, current assets, and liabilities on a specific date.

The key skill in this chapter is converting cash figures from the Receipt and Payment Account into accrual figures for the Income and Expenditure Account. Four adjustments come up repeatedly. First, prepaid expenses: if you paid ₹12,000 rent in January for March, April, and May, only one month (₹4,000) is this year's expense — the remaining two months (₹8,000) are an asset (prepaid rent) because they cover the next financial year. Second, outstanding expenses: if salaries of ₹5,000 are owed but unpaid at year-end, you must still charge them as an expense this year. Third, accrued income: if the club earned ₹8,000 in locker fees but hasn't collected the cash, the income still belongs to this year. Fourth, depreciation: assets like computers and vehicles wear out; you must charge a non-cash depreciation expense each year even though no new cash leaves the bank.

Donations and subscriptions need careful classification. A donation earmarked for a specific fixed asset — 'for building a new library' or 'for purchasing an ambulance' — is a capital receipt. It goes directly to the Balance Sheet as part of Accumulated Funds and does not appear in the Income and Expenditure Account at all. A general donation with no strings attached, or a recurring annual donation for running costs, is a revenue receipt and is credited to the Income and Expenditure Account as income. Life membership fees are treated as capital receipts because they cover the member's lifetime — they go to the Balance Sheet. Annual subscriptions are revenue income. Getting this classification right is one of the most common places marks are lost in board exams.

The Accumulated Funds (or Capital Fund) on the Balance Sheet is the NPO equivalent of owner's equity in a business. It starts with whatever the NPO has built up over its life and grows each year by adding the surplus (or shrinks by adding the deficit). Restricted funds — amounts donated for a specific purpose like a 'Building Fund' or 'Scholarship Fund' — must be shown separately on the Balance Sheet. Spending them for any other purpose violates the donor's trust and, under Indian law, can attract legal action under the Societies Registration Act, 1860 or the Indian Trusts Act, 1882.

In India, NPOs must meet several legal requirements. They must register with the Registrar of Societies or as a Trust, file annual returns, and get their accounts audited. An NPO can voluntarily obtain an 80G certificate from the Income Tax Department, which allows its donors to claim a tax deduction on their donations — making the NPO more attractive to contributors. Registration under Section 12A/12AB of the Income Tax Act gives the NPO itself exemption from income tax on its surplus. NPOs must maintain separate records for foreign donations under the Foreign Contribution (Regulation) Act (FCRA), 2010, and organisations receiving foreign funds need a separate designated FCRA bank account. Many Kerala NPOs — including hospital trusts, aided school committees, and cultural organisations like Kalamandalam — follow these rules under both central law and the Kerala Charities Act. Understanding these compliance requirements tells you that NPO accounting is not just bookkeeping theory; it is the legal backbone of civil society.

An Indian example

Consider Sneha Bhavan, a children's home in Thrissur run by a registered charitable trust. In the year 2023–24, Sneha Bhavan received ₹18 lakhs in government grants, ₹6 lakhs in public donations, and collected ₹1.2 lakhs in annual subscriptions from its 60 patron members at ₹2,000 each. It spent ₹14 lakhs on staff salaries, ₹3 lakhs on food and medicines, and paid ₹1.5 lakhs as one year's rent. A donor gave ₹4 lakhs specifically 'to build a new classroom block.' At year-end, ₹50,000 rent for April was prepaid and ₹30,000 in supplier invoices for medicines were still unpaid. The Receipt and Payment Account would show total receipts of ₹29.2 lakhs (18 + 6 + 1.2 + 4) and total payments of ₹18.5 lakhs, giving a closing cash balance of ₹10.7 lakhs. But the Income and Expenditure Account tells a different story: the ₹4 lakh classroom donation is excluded (it is capital, going to Accumulated Funds on the Balance Sheet). Rent expense is reduced by the ₹50,000 prepaid portion to ₹1 lakh, and the ₹30,000 unpaid medicine bill is added to give medicines expense of ₹3.3 lakhs. The I&E Account shows income of ₹25.2 lakhs and expenses of ₹18.30 lakhs — a surplus of ₹6.90 lakhs. That surplus stays inside Sneha Bhavan, growing the Accumulated Funds so the trust can one day replace its ageing kitchen equipment. Not a single rupee goes to the trustees personally.

Common misconceptions to watch for

• Many students think 'surplus' in an NPO is just another word for profit and can be shared with the management committee. Wrong — surplus belongs to the organisation, not to its office-bearers. Distributing it would violate the Societies Registration Act and cause the NPO to lose its charitable status and tax exemptions.
• Students often put every donation straight into the Income and Expenditure Account as income. The rule is: only unrestricted or recurring donations are revenue income in the I&E Account. A donation tied to a specific asset (e.g., 'for buying a school bus') is a capital receipt and goes to the Balance Sheet under Accumulated Funds — it never appears in the I&E Account.
• A very common error is treating the Receipt and Payment Account as the finished product and ignoring the need for an Income and Expenditure Account. The R&P Account is only a cash summary — it misses prepaid expenses, outstanding payables, accrued income, and depreciation. The I&E Account, not the R&P, shows whether the NPO truly covered its costs for the year.