Chapter 14: Accounting for Not-for-Profit Organizations

Chapter 14: Accounting for Not-for-Profit Organizations

Learning Objectives

  • 14-1 Identify the authoritative standards-setting body for establishing GAAP for nongovernmental not-for-profit organizations (NFPs) and determine whether an NFP organization is governmental.

  • 14-2 Identify and explain financial reporting for NFPs, including required financial statements and classification of net assets.

  • 14-3 Explain accounting for NFPs, including accounting for revenues, gains, support, expenses, and assets.

  • 14-4 Explain accounting for NFP consolidations and combinations.

  • 14-5 Prepare journal entries and financial statements in accordance with the generally accepted accounting principles governing NFP organizations.

Government or Not?

  • The AICPA provides a not-for-profit audit and accounting guide that, with tacit approval from both the Financial Accounting Standards Board (FASB) and the Governmental Accounting Standards Board (GASB), offers guidance on differentiating governmental and nongovernmental organizations. AN NFP is are governmental organizations if its aPublic corporations and bodies corporate and politic, others are governmental if

    • Popular election of officers

    • Potential for unilateral dissolution by a government

    • Power to enact and enforce a tax levy

    • Ability to directly issue debt that pays interest exempt from federal taxation

  • Examples of organizations that may be classified as governmental or nongovernmental include:

    • Colleges

    • Universities

    • Hospitals

    • Museums

    • Social service agencies

GAAP for Nongovernmental NFP Organizations

  • The FASB has been responsible for providing guidance on generally accepted accounting principles (GAAP) for not-for-profit organizations since 1979.

  • The GASB oversees government organizations including governmental not-for-profit organizations.

Objectives of Financial Reporting for NFPs

Financial reporting for NFPs aims to:

  • Assist in making resource allocation decisions

  • Facilitate evaluation of services and ability to provide services

  • Provide assessment of management stewardship and performance

  • Provide information about economic resources, obligations, net resources, and changes in them

  • FASB’s objectives of financial reporting for NFPs are centered around these factors.

Stakeholders of NFP Organizations

Key stakeholders include:

  • Donors

  • Grantors

  • Members

  • Lenders

  • Consumers

  • Other resource providers

Financial Reporting

GAAP for not-for-profit organizations includes the following components:

  • Accrual basis accounting

  • Statement of Financial Position (Balance sheet)

  • Statement of Activities

  • Statement of Cash Flows

  • Comparative statements are encouraged but not mandatory.

Statement of Financial Position

  • This document, also known as a balance sheet, illustrates the organization’s total assets, liabilities, and net assets.

  • Net assets must be reported in the following categories:

    • Net assets without donor restrictions

    • Net assets with donor restrictions: for use in a future period, particular purpose, or endowment.

    • Endowments: A gift whose principal is preserved in perpetuity or a period of timewith the income generated from the investment used to support the organization's mission.

  • FASB standards require at least totals for

    • total assets

    • total liabilities

    • total net assets

    • totals for each classification of net assets.

Statement of Activities

  • An operating statement that shows changes in:

    • net assets without donor restrictions

    • net assets with donor restrictions

    • total net assets during the reporting period

  • Uses a three-column format to present the changes in net assets.

Reclassification

  • The term “Net Assets Released from Restrictions” indicates support with donor restrictions that turns into support without donor restrictions when donor stipulations are met.

  • Reclassifications can occur due to:

    • Satisfaction of program or purpose restrictions

    • Satisfaction of equipment acquisition restrictions

    • Satisfaction of time restrictions, either actual or implied by the donor.

Statement of Cash Flows

  • Cash flows are categorized into:

    • Operating activities

    • Investing activities

    • Financing activities

  • Either the direct method or indirect method may be utilized to report operating cash flows.

  • A reconciliation of change in total net assets to net cash used for operating activities is optional with the direct method.

Statement of Cash Flows Classifications

Examples of transactions and their classifications include:

  • Receipt of gifts without donor restrictions: Operating activities

  • Receipt of and earnings on net assets restricted for long-term purposes: Financing activities

  • Sale of donated financial asset with no restrictions: Operating activities

  • Acquisition of building or equipment using restricted net assets: Investing activities

  • Noncash or in-kind contributions: Noncash investing and financing activities.

Reporting of Expenses by Nature and Function

  • NFPs must report expenses based on functional classification (e.g., programs or support activities) and natural classification (e.g., salaries, rent, interest expense, supplies, and depreciation).

  • This can occur within the statement of activities, in the notes to the financial statements, or as a separate financial statement.

Notes to the Financial Statements

  • Disclosures must include accounting principles applicable to investor-owned organizations.

  • Must disclose the nature and amounts of:

    • net assets without donor restrictions

    • net assets with donor restrictions (if not displayed on the face of the financial statements)

  • Information regarding the sufficiency of liquid resources to meet general expenditures within one year of the balance sheet date is also required.

  • Certain policy statements should be incorporated in the notes.

Revenues, Gains, and Support

Definitions include:

  • Revenues: Increases in net assets arising from exchange transactions where the other party receives direct tangible benefits.

  • Gains: Increases in net assets occurring from peripheral or incidental transactions, generally beyond management's control.

  • Support: A category of revenues deriving from contributions of resources or non-exchange transactions where the donor does not gain tangible benefits.

Contributions and Gifts

  • A contribution is defined as a voluntary, unconditional, nonreciprocal transfer of assets or cash to an NFP from an external entity.

Conditional or Unconditional Contributions

  • Unconditional contributions can only be recognized as revenue if they are not conditional.

  • A donor-imposed condition exists if a right of return or release exists, and if the agreement outlines barriers that must be overcome by the NFP.

  • Refundable advance liability should be recognized when assets are received prior to meeting the conditions.

Indicators of a Barrier

  • Indicators of conditions include:

    • Stipulations limiting the recipient's discretion

    • Inclusion of measurable performance-related barriers

    • Relevance of the condition to the donation’s purpose.

Donor Contributions

Donor contributions can be classified as:

  • Unrestricted

  • Restricted as to time

  • Restricted as to purpose.

Pledges

  • A pledge is a promise to donate assets to an organization.

  • A conditional promise to give is recorded only when conditional criteria are significantly met, while an unconditional promise depends on time or demand for performance.

  • Unconditional promises are reported as support in the year they are made but considered restricted until donor intent is confirmed.

Gifts in Kind

  • Gifts in kind refer to donations of materials or services.

  • Recognized at fair value.

  • Donated materials used in service provision should be reported as part of the service cost.

Contributed Services

  • FASB stipulates that contributed services should be recognized at fair value if they create or enhance non-financial assets, or if they require specialized skills provided by individuals with those skills.

  • A donation of advertising time is regarded as contributed asset rather than a service.

Land, Buildings, and Equipment

  • These assets are recorded at fair value at the time of donation and can be donor restricted or unrestricted.

  • For donor-restricted buildings and equipment, donor restrictions expire when assets are put into service unless there are specific, limitative restrictions.

Special Events

  • Expenses related to special events are recorded as fund-raising expenses.

  • Revenues from events should be reported at gross unless peripheral or incidental.

  • Direct expenses of providing benefits from special events should be reported separately.

Contributions with Intermediaries

  • An intermediary assists in transferring assets between donators and beneficiaries.

  • Generally, intermediaries record an asset and liability when receiving donations for another organization.

  • If the intermediary has variance power or is interrelated with the beneficiary, contribution revenue is recognized.

Financially Interrelated Organizations

  • Financially interrelated means one entity influences the operating and financial decisions of the other, with an ongoing economic interest in the other's net assets.

  • Variance Power: unilateral power of an organization to redirect donated assets another beneficiary different from the third party.

Accounting for Expenses

  • Under accrual basis accounting, expenses are recorded as decreases in net assets without donor restrictions.

Functional Expenses

  • Program classifications arise from goods or services that help achieve the organization's major purposes, such as:

    • Research

    • Information

    • Advocacy and public awareness

  • Support activities aid NFPs in their missions, including:

    • Fundraising

    • Management and general functions.

Joint Costs of Fund-Raising

  • NFPs may combine program or administrative activities with fundraising.

  • FASB guidelines for joint costs state that total costs must be reported as fund-raising unless a bona fide program has taken place alongside the appeal.

  • Joint costs should be allocated between the bona fide function and fundraising with an equitable base.

Criteria for Joint Costs

To determine if joint costs are appropriately allocated, criteria must be met regarding:

  • Purpose: The activity must advance a program or management function.

  • Audience: The audience must be chosen for program or management purposes rather than solely for fundraising abilities.

  • Content: The activity should motivate the audience toward advancing the mission or fulfilling a management duty.

Management and General Expenses

Includes costs for:

  • Budgeting

  • Accounting

  • Legal services

  • Office management

  • Purchasing

  • General publicity.

Restricted Assets

  • Restricted assets are not available for current operations as donors have limited their use for long-term purposes.

  • FASB mandates these assets be classified separately from current assets on the statement of financial position.

Investments

Items/issues pertaining to investments are treated as follows:

  • Purchase investments: Recorded at acquisition price

  • Donated investments: Fair market value on donation date

  • Fair market value at the measurement date reported at fiscal year-end

  • Category classification for investments: Not required

  • Realized and unrealized gains or losses must be reported on current period's statement of activities and affect corresponding net asset accounts (net assets with or without donor restrictions).

  • Detailed disclosures required in footnotes.

Collections

  • Defined as works of art, historical treasures, etc., held for public exhibition, education, or research, not for profit.

  • Must be protected, cared for, and preserved.

  • Organizations must have policies on proceeds from sale being allocated for new acquisitions or direct care for existing collections.

  • Collections can either be recognized or not as assets; selective capitalization is prohibited.

Collections Capitalization

  • Capitalized collections recognized as assets should be accounted for in the acquisition period.

  • Capitalized art/historical treasures do not require depreciation if they maintain long-term value and utility, as determined by:

    • Cultural/aesthetic/historic value worthy of perpetual preservation.

    • The organization's capability to protect and preserve their potential service without significant diminishment.

Consolidations and Combinations

  • Consolidations are necessary when:

    • Investments in for-profit entities exist

    • Organizations are financially interrelated

    • Entity is a component unit of government

  • Combinations may occur through merger or acquisition.

Optional Fund Accounting

  • Different funds in AICPA’s Audit:

    • Unrestricted

    • restricted

    • Plan funds

    • Loan funds

    • Endowment funds

    • Annuity and life income

    • Agency funds

    • Fund balance = difference between total assets and total liabilities

Conclusion

  • This chapter focuses on the accounting pertaining to not-for-profit organizations, covering significant characteristics, GAAP sources, and financial reporting requirements.

  • Various accounting issues concerning financial statements, consolidations, and combinations are introduced and addressed.

  • For further exploration, the discussion on accounting for not-for-profit organizations will continue in Chapter 15, particularly in relation to colleges and universities.