Top 5 Mistakes Nonprofits Make During Year-End Financial Reporting

7 min read

December 18th, 2024

The process of closing out financial records is complex, and there are lots of places where nonprofit financial mistakes can occur. However, your final financial reports and records must be accurate and compliant.

You'll be using your financial data to make decisions about how your nonprofit is run in the coming year. You will also be sharing your year-end financial reports with your board of directors and stakeholders, and any misstatements or misrepresentations of your organization's finances would be undesirable (in the best case) and disastrous (in the worst case).

5 Common Year-End Financial Reporting Mistakes Nonprofits Should Avoid

Be on the lookout and vigilant to avoid the following top five year-end reporting errors that commonly occur in nonprofits:

1. Unrecognized Revenue

Nonprofit organizations are required to use the accrual accounting method for compliance purposes, and this method requires a specific process for recognizing and recording revenue. Accrual accounting requires nonprofit organizations to recognize revenue when it is earned (or pledged or awarded) and not when it is received.

For example, if a donor makes a commitment, pledge, or promise to donate a certain amount to your organization, you must record the pledge as assets and contributions at the time the promise is made - not when your organization receives the money.

At year-end, this can cause some confusion because donors might make pledges at the end of the year that won't be received until the next year. These pledges need to be recorded as contributions during the calendar year when the promise is made.

Read More: How Much Do Bookkeeping & Accounting Services for Nonprofits Cost?

2. Incorrectly Categorized Revenue

In addition to recognizing pledged contributions at the correct time, nonprofits must also separate the revenue they receive into distinct categories. (Note that these categories can also impact the timing of compliant revenue recognition, so proper categorization is twice as important.)

Correct revenue categorization is essential to good compliance. The Internal Revenue Service and the Generally Accepted Accounting Principals (GAAP) require that nonprofits categorize all revenue into separate categories which include:

• Conditional - Donor only provides funds if specific conditions are met. Revenue should be recognized when the conditions have been met.
• Unconditional - No conditions are provided, and revenue should be recognized fully when the contribution is pledged or received (whichever occurs first).
• Unrestricted - Funds that the nonprofit can spend and use at its discretion with no limitations.
• Restricted - Funds can only be used for a specific purpose set for by the donor.

Categorizing and tracking these various types of funds can become complicated for organizations - especially those with multiple funding sources. A fund accounting system can help to alleviate the burden of keeping track of the different categories of funds, but it won't do much good if funds are separated into the proper categories as they are recorded.

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3. Unreported In-Kind Donations

Nonprofit organizations often require specific types of goods to carry out their missions, and they can be highly successful in requesting donations of these specific goods, instead of money. Additionally, nonprofit organizations often benefit from receiving professional services for free. These types of contributions are called in-kind donations, and they must be properly documented and recorded in your financial reports. The donations of goods and services must be assigned a fair market value and recorded as donations received and expenses associated with operating.

Nonprofits should have in-kind donation policies in place to help streamline the recording and valuation of these contributions. These records should be maintained throughout the year, rather than trying to round up a list at the end of the year.

Read More: Why Your Nonprofit Needs a Sustainer Program (And How To Get Started)

4. Expenses Recorded in the Wrong Period

In the accrual accounting system, revenue must be recorded in the proper year (when it is earned), and expenses must also be recorded when they are incurred - not when they are paid.

At the end of the year, this can get complicated because invoices received in mid or late-December might not be paid until January. These invoices, however, need to be recorded in the year they are received and not when the bills are actually paid. Improperly recording expenses can have a big impact on your financial reports because they cause net income to be inflated and liabilities to be understated, making your year-end financial position look stronger than it actually is.

5. Improper Functional Expense Categorization

In addition to regular expense classification (such as rent, salaries, supplies, etc.), nonprofits are also required to categorize all of their expenses into separate functional categories such as fundraising, programs, membership development, management, and general operations. Functional expense categorization is required for compliance purposes, but it also helps your organization understand how it uses its funds while increasing transparency and building donor trust.

Functional expense categorization can become complex and challenging to get right (and maintain consistency) when organizations attempt to allocate overhead costs to multiple functions. Additionally, it can be challenging to determine how to categorize expenses that might serve multiple purposes. Plus, defining an expense's purpose can prove to be a fairly subjective practice.

Read More: Raise More Money By Showing The Donors The ROI Of Their Gift

How to Identify and Fix Year-End Reporting Errors in Nonprofits

Before finalizing your year-end financial reports, you should scan through them carefully. Make sure that all of your accounts (bank, credit card, and loan) have been reconciled to their statements. Then, review your financial statements (Statement of Financial Position, Statement of Activities, Statement of Cash Flow, and Statement of Functional Expenses). During this review, you should be looking for:

• Inconsistencies
  • Differences between supporting documents and financial statements
  • Discrepancies between related data points
  • Mismatched totals
  • Abnormally small or large entries
• Unexplained Fluctuations
  • Sudden increase or decrease in balances (assets or liabilities)
  • Significant changes in expenses or revenue compared to the previous year or period
• Missing Information
  • No receipts, invoices, or supporting documentation for transactions
  • Lack of details on donor designations or fund accounts
• Classification Errors
  • Expenses or revenue sources not properly classified
• Accounting Errors
  • Incorrect calculations
  • Duplicate entries

Another way to identify financial reporting mistakes and ensure your year-end financial reports are accurate is to hire a third-party accountant with nonprofit experience to perform an audit of your books, records, and reports.

Of course, the best way to handle year-end reporting errors is to avoid them altogether with a better back-office system. We recommend instilling policies, procedures, accounting software, and integrated applications to automate data collection, reduce manual error, and improve your ability to detect anomalies, duplicated entries, and inconsistencies that could point to problems.

Supercharge Your Back Office and Be Year-End-Ready Year-Round With Outsourced Accounting for Nonprofits

Yes, nonprofit financial reporting is complex. No, you don't have to shoulder the responsibility on your own.

The key to accurate, complete, and compliant year-end financial reports is a well-run back office. In a nonprofit, however, it can be difficult to simultaneously focus on achieving your mission while also maintaining sound financial records throughout the year. An excellent solution for nonprofit leaders who don't have time to keep up with the back office while also running their organizations is outsourcing.

Outsourced accounting for nonprofit organizations is designed to automate processes, increase efficiency, and free up your time and resources so that you can work to maximize your impact and achieve your mission while leaving the back office, its systems, and its regulations to the experts. Plus, with outsourcing, nonprofits can do all of this at a fraction of the cost of hiring an in-house back-office team. So, you can save money, achieve your mission, and do a better job of being ready for year-end, year-round.