LECTURE 18 ACCOUNTING AND AUDITING

NPO (Non Profit Organisation)

A non-profit organization is a legal accounting entity that is operated for the benefit
of the society as a whole, rather than for the benefit of a sole proprietor or a group of
partners or shareholders. The main motive behind the non-profitable organization is
to render service to the society or the members of the organisation.
Non-profit making organisations such as public hospitals, public educational
institutions, clubs, Temples, churches etc., as a part of their final accounts prepare
Receipts and Payments Account and Income and Expenditure Account to show
periodic performance (either surplus or deficit) and Balance Sheet to show financial
position at the end of the period.

The Income and Expenditure Account (non- profitable organisation) is just similar
to Profit and Loss Account prepared for the profit making organisations but there
has been different terminology employed for the word Profit as SURPLUS – excess of
income over expenditure or loss as DEFICIT – excess of expenditure over
income. In non-profit making organisations, total cash receipts and total cash
payments are highlighted through Receipts and Payments Account.

NATURE OF RECEIPTS AND PAYMENTS ACCOUNT

It is the summary of the cash and bank transactions like cash book, all the receipts
(capital or revenue) are debited, similarly, all the expenditures (capital or revenue)
are credited.

It starts with opening cash and bank balances and also ends with their closing
balances. This account is usually not a part of the double entry system as it includes
all cash and bank receipts and payments, whether they are related to present, past
or future periods.

Surplus or deficit for an accounting period cannot be ascertained from this account,
since, it shows only the Cash/Bank position and excludes all non cash items.

Important drawback is that the Receipts and Payments Account includes items
relating to all periods and of all types whether capital or revenue.

INCOME AND EXPENDITURE ACCOUNT

The income and expenditure account is equivalent to the Profit and Loss Account of
a Profit making business enterprise. It is an account which is widely adopted by most
of the Non-profit making concerns and is prepared by following accrual principle.
Only items of revenue nature pertaining to the current period of account are
included. The preparation of the account, therefore, requires adjustments in both
outstanding and advances items of income and expenditure.
The only difference is in the terms used to represent the profit and loss. Profit
is termed as Surplus- Excess of income over expenditure and loss is termed as
Deficit- Excess of expenditure over income.

FINANCIAL STATEMEMTS

Non-profit organizations registered under section 8 of the Companies Act, 2013

are required to prepare their Income and Expenditure account and Balance
Sheet as per the Schedule III to the Companies Act, 2013.

FEATURES OF I&E ACCOUNT

It is a revenue account prepared at the end of the accounting period for finding out
the surplus or deficit of that period.
It is prepared by matching expenses against the revenue of that period concerned.
Both cash and non-cash items, such as depreciation, are taken into consideration.
All capital expenditures and incomes are excluded.
Only current years’ income and expenses are considered. This Surplus/deficit is
taken to the balance sheet and is added / deducted respectively with the capital fund
(opening balance).

MAIN SOURCE OF INCOME

For a non profit organisation, the sources of income, largely depend on the nature of
the activity carried on by them. The income for a charitable hospital is different from
that of a income received by a sports club. Broadly for the purposes of solving the
illustrations, we can classify the sources of income as subscriptions, ordinary
donations, membership fees or entrances fees (if the amount is normal or provided
according to bye-laws of the society), recurring grants from local authorities and
income from investments, etc.

Any amount raised for a special activity, e.g. on sale of match tickets, is deducted
from the expenditure of that activity and net amount is shown in the income and
expenditure account. Any receipt of capital nature shall not be shown as income but
will be credited to the Capital Fund or special purpose fund e.g. "Building Fund' or
if the receipts is on account of sale of a fixed asset, it shall be credited to the asset
account. This system of showing the donation towards specific purposes separately
is termed as fund accounting.

Examples:
Hospital - medicines and cost of tests and investigations.
Sports Club - sports materials, tournament expenses, etc.
Drama Club - expenses of staging plays, rent of the hall, payment to artists, etc.
Educational Societies - award of scholarships, organisation of seminars, etc.
Library Societies - newspapers and magazines.

Distinction between Receipts and Payments Account and Income and

Expenditure Account

Not for profit organizations such as public hospitals, public educational institutions,
clubs,Temples, churches etc., conventionally prepare Receipt and Payment Account
and Income and Expenditure Account to show periodic performance for a particular
accounting period. The distinguishing features of both the accounts can be
summarized as:
Receipt and Payment Account is an elementary form of account consisting of a
classified summary of cash receipts and payments over a certain period together with
cash balances at the beginning and close of the period. The receipts are entered on
the left hand side and payments on the right hand side i.e. same sides as those
on which they appear in cash book. All the receipts and payments whether of
revenue or capital nature are included in this account. The receipts and payments
pertaining to the current, previous or future periods are also considered here. The
balance of the account at the end of a period represents the difference between the
amount of cash received and paid up. It is always in debit since it is made up of cash
in hand and at bank.

Income and expenditure account resembles and is drawn in the same form of a Profit
and loss account in case of profit-making organisations. Expenditure of revenue
nature is shown on the debit side, income and gains of revenue nature are shown on
the credit side. Income and Expenditure Account contains all the items of income
and expenditure relevant to the current accounting period only, whether received
or paid as well as that which have fallen due for recovery or payment. Capital
Receipts, prepayments of income and capital expenditures, prepaid expenses are
excluded. It does not start with any opening balance. The balancing figure
represents the amount by which the income exceeds the expenditure or vice
versa.

Preparation of Income and Expenditure Account from Receipts and Payments

Account

Situations may require compilation of Income and Expenditure Account and the
Balance Sheet from the Receipts and Payments Account after making adjustments
in respect of Income accrued but not collected and expenses outstanding. The
preparation of Balance Sheet in such a case is also necessary since an Income and
Expenditure Account must always be accompanied by a Balance Sheet. The
procedure which should be followed in this regard is briefly outlined below.

1) Opening Capital Fund balance

2) Open ledger accounts in respect of various items of income and expenditure
 3) Post from the debit of the Receipts & Payments Account to the credit of the
Income and Expenditure Account other items of income wherein accruals and
outstanding amount have to be adjusted. Likewise, post item of expenses in
which no adjustment is to be made directly to debit of income and Expenditure
Account.
4) Transfer the balance of Income and Expenditure Account to the Accumulated
Fund/Capital Fund Account.
5) Post the receipts and payments of capital nature from the Receipts and
Payments Account to the appropriate asset or liability account for
incorporating in the Balance Sheet. If a part or whole of an asset has been
sold, the capital profit/loss, if any, is credited / debited in the Income and
Expenditure Account. The balance of Income and Expenditure Account should
be transferred to the Accumulated Fund/Capital Fund Account.
6) Prepare a Balance Sheet by including therein all the balances left over after
transfers to the Income and Expenditure Account have been made.

BALANCE SHEET

A Balance Sheet is the statement of assets and liabilities of an accounting unit at a

given date. It is generally prepared at the end of an accounting period after the
Income and Expenditure Account has been prepared. It is classified summary of the
ledger balances left over, after accounts of all the revenue items have been closed by
transfer to the Income and Expenditure Account. In not for profit organizations, the
excess of total assets over total outside liabilities is known as Capital Fund. The
Capital fund represents the amount contributed by members, through legacies,
special donations, entrance fees and accumulated surplus over the years. If however,
members have not contributed any amount, it shall be termed as "Accumulated fund"
instead of "Capital fund". The surplus or deficit, if any, on the year's working as
disclosed by the Income and Expenditure Account is shown either as an addition to
or deduction from the Capital / Accumulated Fund brought forward from the
previous period respectively.

Accounting Treatment of Some Special Items

Donations: These may have been raised either for meeting some revenue or capital
expenditure; those intended for the first mentioned purpose are credited directly to
the Income and Expenditure Account but others, if the donors have declared their
specific intention, then they are credited to special fund account and in the absence
thereof, to the Capital Fund Account. If any investments are purchased out of a
special fund or an asset is acquired therefrom, these are disclosed separately. Any
income received from such investments or any donations collected for a special
purpose are credited to an account indicating the purpose and correspondingly the
expenditure incurred in carrying out the purpose of the fund is debited to this
account. On no account any such expense is charged to the Income and Expenditure
Account. The term "Fund" is strictly applicable to the amounts collected for a
special purpose when these are invested, e.g. Scholarship Fund, Prize Fund etc.
In other cases, when the amounts collected are not invested in securities or assets
distinguishable from those belonging to the institution, the word "Account" is more
appropriate e.g. Building Account, Tournament Account etc.

Instead of paying cash, a donor may sometimes give away or transfer a security or
some other readily realisable asset. In such a case, the value of asset on valuation,
must be credited to the fund for which the amount has been donated.

Crux
Donation: it is gift in cash or kind from some person. It may be of two types:
(a) Specific Donation: It is received for certain specific purpose like Building
Donation, Library Books donation etc. It should be capitalized and shown on the
liabilities side of the balance sheet.
(b) General Donation: It is not received for any specific purpose and shown on the
credit side of Income and Expenditure Account.

Entrance and Admission Fees: Such fees which are payable by a member on
admission to club or society are normally considered capital receipts and credited
to Capital Fund. This is because these do not give rise to any special obligation
towards the member who is entitled to the same privileges as others who have paid
only their annual subscription.

Nevertheless, where the amount is small, meant to cover expenses concerning

admission, or the rules of the society provided that such fees could be treated as
income of the society, these amounts may be included in the Income and
Expenditure Account

Subscription: Subscriptions being an income should be allocated over the period of

their accrual.

For example, if it is stated that subscriptions collected by a society during the year
2020 amounted to 1,850 out of which 200 represented subscription for the year
2019; 100 were subscriptions collected in advance for the year 2021, and
subscriptions amounting to 500 were outstanding for recovery at the end of 2020.

Life Membership Fee: Fees received for life membership is a capital receipt as it is
of non-recurring nature. It is directly added to capital fund or general fund.

For adjusting lump sum subscription collected from the life members, one of the
following methods can be adopted:

(1) The entire amount may be carried forward in a special account until the member
dies, after which the same may be transferred to the credit of the Accumulated Fund.

(2) An amount equal to the normal annual subscription may be transferred every
year to the Income and Expenditure Account and balance carried forward till it is
exhausted. If, however, the life member dies before the whole of the amount paid by
him has been transferred in this way, the balance should be transferred to
accumulated fund on the date of the death

(3) An amount, calculated according to the age and average life of the member, may
annually be transferred to the credit of Income and Expenditure Account.
Crux

It should be capitalized and shown on the liabilities side of the balance sheet.
If the question gives any specific treatment of Life membership Fees, then it
should be followed accordingly out of above 3

Legacy: It is an amount received by an organization as per the will of the person

after the death of the person. It should be capitalized and shown on the liabilities
side of the balance sheet by adding to the Capital Fund.

Endowment Fund Donation: It is a donation received and only income from that
donation is to be used for certain specific purpose. In such cases income relating to
special funds should be added to these funds on the liabilities side of the Balance
Sheet. All the expenses should be deducted from that fund on the liabilities side of
the Balance Sheet.

Treatment of Sale of Old Newspaper and Periodicals: The amount received on

such sale is shown as Income on the credit side of income and expenditure account.

Sale of old Fixed Assets: The Sale proceeds of old Fixed Assets are treated as capital
receipts. The profit or loss on sale of fixed asset is shown in the Income and
Expenditure A/c

Honorarium: It is paid to someone for receiving any services from person who are
not the employees of the Not-for-Profit Organisation.

Preparation of Balance Sheet

Preparation of opening balance sheet and calculation of surplus: If capital fund

or accumulated surplus in the beginning of the year is not given, it is calculated by
deducting liabilities from assets in the beginning of year. While calculating opening
capital fund, care should be taken to include prepaid expenses and accrued incomes
as assets and outstanding expenses and advance incomes as liabilities. Any surplus
earned during the year is added to the opening capital fund and deficit suffered
during the year is deducted from the opening capital fund.

Cash and bank balance: Closing cash and bank balance as disclosed in Receipt and
Payment Account is shown in the assets side of Balance Sheet. If there is a bank
overdraft, it is to be shown on the liabilities side of balance sheet.
Fixed assets: Opening balances of Fixed Assets (Furniture, building, equipment,
etc.) are increased by the amount of purchases and reduced by sales of the same and
depreciation on the same.

Liabilities: Opening balances of liabilities should be adjusted for any increase or

decrease in the same.