Intro To Nonprofit Accounting: Lesson 4
A general ledger is a list of transactions by account. In this lesson, we will take a deeper look at transactions. We’ll discuss 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 lesson is for you.
What Are Transactions?
In the previous lesson, we learned what accounts are and how to create a chart of accounts for your nonprofit. This is the foundation of any nonprofit accounting system, and once established, it allows you to begin building on that foundation.
Accounts 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 learn how your accounts work together. Once you understand these relationships, 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 does not refer to debit and credit cards, but rather how an account is increased or decreased. There are five types of accounts, and a debit or credit increases or decreases each one. See the chart below.
As you can see in the chart, if you are increasing an asset or expense account, you would use the debit column. For increasing liabilities, income, and equity, you will use the credit column.
For every transaction there are always at least two movements, which means at least two accounts are used. This is what is referred to as a double-entry system of accounting. In a transaction, the debit and credit columns will always equal one another.
For example, let’s say you purchase some supplies that cost $50. When recording this purchase, you will use one of your expense accounts, since they represent money spent. In this case you choose Office Supplies. What is the other movement to this transaction? If you 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 it is a necessary part of any accounting system.
Let’s look at another example. Suppose you receive a donation for $100. Because your organization receives this money, it is income. In this case you would use the Contributions Income account. Since income accounts are increased by credits, you will put the value in the credit column. What is the other movement? If you are depositing this money into your bank account (i.e. Checking), that would be the second movement. Since assets are increased by debits, you can see this works out in our transaction.
As you think through and record transactions, the debit and credit chart will help tremendously. Typically, if you can remember the relationships between accounts and their debit and credit columns, everything will begin to fall into place.
How Do You 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 your finances by hand or with software, there will always be some form of the journal and the general ledger.
The journal is where the transactions are first recorded. They 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 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, so it is a running balance for each of your accounts. We won’t get further into the general ledger in this lesson, since bookkeeping software typically automates both the journal and ledger.
Next we’ll take a look at how software can help with the recording of transactions, and largely replace the need to know everything you just learned. Just kidding! But in all seriousness, time to take a breath. The hard part is done.
Using Software For Your Journal And General Ledger
As mentioned previously, software typically streamlines the journal and the general ledger. Software allows you to record the details of your transactions, while automatically keeping your account balances up to date. It also automatically compiles the information from your transactions into reports, which we will cover in the next lesson.
When choosing a software, 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, the software will automatically keep your accounting up to date when you enter donations.
Now that you know what a general ledger is, and you have learned how to set up accounts and record transactions, let’s take a look at how to compile and share this information through reports. We will take a look at the most common reports, as well as reports that IRS guidelines require from nonprofits.