Lesson 4 in the course Intro to Nonprofit Accounting
A general ledger is a list of transactions by account. In this lesson, we are going to take a deeper look at transactions: what they are, how and when to record them, and how they impact your nonprofit’s accounting system. If you have set up your nonprofit’s chart of accounts and are ready to take the next step, this is the lesson for you!
What are Transactions?
In the previous lesson, “What is a Nonprofit Chart of Accounts?”, we learned what accounts are and how you create a chart of accounts for your nonprofit. This is the foundation to any nonprofit accounting system, and once established, it allows you to begin building on that foundation.
Accounts are created to represent the things your organization owns, owes, receives, and spends, and its overall worth. These accounts gain value through recording transactions, which essentially are the “happenings” within your organization. Receiving money, spending money, purchasing inventory, paying bills, and transferring money between your banks are all examples of transactions that happen on a daily basis in your nonprofit.
So how do you record these transactions using your chart of accounts? Before we take a look at some methods of recording these transactions, it is important to take a look at how your accounts work together. Once these relationships are understood, transactions begin to make a lot more sense.
The relationship between accounts plays a crucial role in recording transactions. This relationship is comprised of debits and credits. This is not referring to debit and credit cards, but rather how an account is increased or decreased. There are five types of accounts, and each one is increased or decreased by a debit or a credit. Below is a chart to help you visualize it.
As you can see in the chart, if you are increasing an asset or expense account, you would use the debit column, and for increasing liabilities, income, and equity you will use the credit column.
For every transaction there are always at least two “movements,” which means that at least two accounts are used. In a transaction, the debit and credit columns will always equal one another. Let’s take a look at an example.
Let’s say you purchase some supplies that cost $50. When recording this purchase, you are going to use one of your expense accounts, since they are used when recording money spent. So, you choose “Office Supplies.” What is the other movement to this transaction? Well, if you’ve purchased these supplies with money from your checking account, your checking balance is being reduced. Therefore, the other side of this transaction would be your asset account, “Checking.” Your expense account was increased and your checking account was decreased.
Welcome to recording transactions. This process of recording both sides of a transaction is called double-entry accounting, and is a necessary part of any accounting system. Take a look at another example:
Let’s say you’ve received a donation for $100. This is money that is being received by your organization, therefore it is income. The income account you want to use is “Contributions Income,” and since income accounts are increased by credits, you will put the value in the credit column. What is the other side? Well, if you are depositing this money into your bank account (i.e. checking), that would be the other side. Since assets are increased by debits, you can see that this works out in our transaction.
As you think through and record transactions, the debit and credit chart is going to help tremendously. Typically, if you can remember the relationships between accounts and their debit and credit columns, everything begins to fall into place.
How do I record Transactions?
Now that we have a general understanding of what a transaction is, let’s take a look at how these are recorded. Whether you’re keeping track of things by hand or with software, there will always be some form of the journal and the ledger.
The journal is where the transactions are first recorded, and will show the information like the examples above. In addition to the accounts used and the debit and credit values, the journal will also have information about the transaction. This additional information would be anything else that is relevant to the information you’re recording. For instance, using the above example of the $50 spent, it would be helpful to know the date of the purchase, where the purchase was made, and what was purchased with the recorded amount.
The ledger is a more detailed breakdown of each account and its balance. This is used as a running balance for each of your accounts. We won’t get into the ledger in this lesson, as both the journal and ledger are typically automated if you use bookkeeping software.
In the next section, we’re going to take a look at how software can help with the recording of transactions, and largely replace the need to know everything we just learned… kidding! But in all seriousness, time to take a breath – the hard part is done!
Like I mentioned above, software typically streamlines the journal and the ledger. Software allows you to record the details of your transactions, while automatically keeping your account balances up-to-date. Plus, software will automatically compile the information from your transactions into reports, which we will cover in the next lesson.
When choosing a software to use, you will want to make sure it has the following elements for a nonprofit:
- Fund accounting
- Nonprofit reporting
- Integration with donations
With the above elements, you will be able to set up a nonprofit chart of accounts, record transactions, and compile the reports necessary for your organization. Also, with integrated donation tracking, you will be able to enter donations and it will automatically keep your accounting up-to-date
Now that we have learned how to set up accounts and record transactions, it is time to take a look at how this information is compiled and shared through the use of reports. We will take a look at the most common reports, as well as the reports that are required of you and your nonprofit per the IRS guidelines.