With so much money at stake, the need for not-for-profit organizations to provide adequate and fairly presented financial information is understandable. Current and potential contributors and other interested parties want to know how financially stable these organizations are and how they use the monies they receive.
Future gifts or grants are often based, at least in part, on the organization’s ability to convince donors that it uses its resources wisely to accomplish stated goals. Financial statements are vital to this objective because they report both the resources generated and the spending decisions that have been made.
The Governmental Accounting Standards Board (GASB) has the authority to establish accounting standards for state and local governments and any organization that these governments control, such as governmental not-for-profit organizations. In contrast, the Financial Accounting Standards Board (FASB) sets accounting standards used by for-profit business organizations and private not-for-profit organizations.
Here the appropriate accounting for private not-for-profit organizations is presented. However, an occasional comparison with the statements for a public college or university can be helpful in visualizing the differences that have evolved in the two sets of standards.
ADVERTISEMENTS:
Prior to 1993, private not-for-profit organizations utilized a wide array of financial reporting practices. Statements often varied significantly, depending on the specific type of organization. In that year, the FASB standardized much of the reporting for private not-for-profit organizations with the issuance of two official standards.
FASB Statement (SFAS) 116, “Accounting for Contributions Received and Contributions Made,” established guidelines for determining when and how donations should be recognized and reported. FASB Statement 117, “Financial Statements of Not-for-Profit Organizations,” specified the required financial statements and the format to be used by these organizations.
Several basic goals form the framework for the FASB’s standards for private not-for-profit organizations, including these:
1. The financial statements should focus on the entity as a whole.
ADVERTISEMENTS:
2. Reporting requirements for private not-for-profit organizations should be similar to those for business entities unless critical differences in the information needs of financial statement users exist.
The first of these goals is important because it asserts that the organization’s financial statements should not be structured around the individual funds that many not-for-profit organizations use for internal recordkeeping. Prior to 1993, the reporting of not-for-profit organizations was often patterned after traditional government accounting with a heavy emphasis on separate fund types. The FASB eliminated this approach in order to emphasize reporting the operations and financial position of the entire entity.
The second goal is significant because it allows the use of many of the same accrual basis techniques utilized by for-profit business entities in recording and reporting transactions. Consequently, existing FASB standards for capital leases, pensions, contingent liabilities, and many other issues do not have to be rewritten for private not-for-profit organizations.
Financial Statements for Private Not-for-Profit Organizations:
Although private not-for-profit organizations have much in common with for-profit business entities, the FASB identified three critical differences. First, the donations that private not-for-profit organizations receive create transactions that have no counterparts in commercial accounting.
ADVERTISEMENTS:
Second, these contributions often have donor-imposed restrictions that require their use for a specified purpose or not until a specified time. Third, no single indicator can describe performance as effectively as net income does for commercial entities; thus, other indicators are necessary.
These differences suggest the need for a somewhat different set of financial statements for not-for-profit organizations.
As a result, FASB SFAS 117 requires that three financial statements be presented:
1. The statement of financial position reports the assets, liabilities, and net assets of these private not-for-profits. The final category, net assets, replaces owners’ equity or fund balance. The amount of net assets the organization holds must be classified as unrestricted, temporarily restricted, or permanently restricted.
ADVERTISEMENTS:
2. The statement of activities and changes in net assets reports revenues, expenses, gains, and losses for the period. Revenues and expenses are determined using the accrual basis of accounting, and includes depreciation of fixed assets. This statement is structured to present the change in each category of net assets for the period.
3. The statement of cash flows uses the standard FASB classifications of cash flows from operations, investing activities, and financing activities. Cash flows from operating activities may be prepared on either the direct or indirect basis. Because this statement follows the traditional format for a for-profit business, it will not be discussed here.
In addition to these three statements, voluntary health and welfare organizations are required to prepare a statement of functional expenses. Other types of non-for-profit organizations can provide this statement but are not required to do so. Voluntary health and welfare organizations are entities that promote humanitarian activities, such as public health clinics, homeless shelters, the cure of disease, and the like.
These organizations might receive some revenues from their activities but, in most cases, rely heavily on support from gifts made by individuals, foundations, government grants, United Way allocations, and similar sources to support their work. These not-for-profit organizations are different from other types such as private universities or hospitals that generate a considerable amount of revenue from services rendered.
ADVERTISEMENTS:
Normally, voluntary health and welfare organizations depend more on donations, so the wise utilization of these resources is of special importance. The statement of functional expenses provides a detailed schedule of expenses by function (such as various programs and administrative activities) and by object (salaries, supplies, depreciation, etc.).
Statement of Financial Position:
Exhibit 18.1 presents the 2006 statement of financial position for Christian Children’s Fund, Inc. The asset and liability sections resemble those of for-profit enterprises. However, unlike businesses, individuals and organizations often provide resources to not-for-profit organizations without the expectation of earning a return on their investment.
As a result, the concept of owners’ equity does not apply. In the place of paid-in-capital and retained earnings, the final section of this statement presents “total net assets,” which is the excess of the organization’s assets over liabilities.
ADVERTISEMENTS:
Net assets are presented in three categories- unrestricted, temporarily restricted, and permanently restricted. Restrictions must be imposed by donors from outside the organization before an asset amount is classified as restricted. For that reason, board-designated or internally restricted assets continue to be classified as unrestricted for financial statement purposes.
Temporarily restricted assets are designated by an external party for a particular purpose or for use in a future time period. For example, a private college could receive a grant for medical research. The amounts received from the grant are reported as being temporarily restricted for that particular use. Alternatively, the college could receive a grant supporting general education programs over the next three years.
The amounts received or promised for future periods also are viewed as temporarily restricted. Assets that are temporarily restricted represent resources that are expected to be released from restriction based on performance of a specific act or the passage of time. The statement of financial position published for Christian Children’s Fund discloses that outside donors had restricted $31,950,348 of its net assets as of June 30, 2006, for a particular purpose or until a specific point in time.
Likewise, the statement of financial position for the University of Notre Dame as of June 30, 2006, indicates temporarily restricted net assets of more than $1.68 billion.
ADVERTISEMENTS:
In contrast, permanently restricted assets are those that are expected to remain restricted for as long as the organization exists, although some or all of the income is available for general or specified use. A note to the 2006 financial statements of Yale University explains its permanently restricted net asset total as “net assets that are subject to explicit donor-imposed stipulations that they be maintained permanently by the University.
Generally, the donors of these assets permit the University to use the returns on the related investments over time for general or specific purposes.” In the same manner, a footnote to the financial statements of the Christian Children’s Fund indicates that “permanently restricted net assets were $7,130,539 and $5,616,263 at June 30, 2006 and 2005, respectively. The principal of these net assets must be invested in perpetuity; however, the income is expendable to support subsidy for children and other restricted program activities.”
Statement of Activities and Changes in Net Assets:
Exhibit 18.2 presents the statement of activities and changes in net assets for Christian Children’s Fund. Note the format adopted here- A separate column is used to present the increases and decreases in each of the three categories of net assets- unrestricted, temporarily restricted, and permanently restricted. The final totals agree with the net asset balances presented on the statement of financial position.
Not-for-profit organizations receive a significant portion of their resources from contributions. One main purpose of the statement of activities is to provide a clear picture of those donations and any restrictions that might have been attached. As in Exhibit 18.2, public support (sponsorships, contributions, and grants) is reported separately from revenues such as investment income for which an earning process exists.
For the year ending June 30, 2006, Christian Children’s Fund reports that it received $45 million of public support that was unrestricted, $156 million that was temporarily restricted, and $1.5 million that was permanently restricted.
ADVERTISEMENTS:
Many not-for-profit organizations seek pledges of support that will be followed eventually (it is hoped) by actual giving. A question as to whether such pledges represent receivables that should be reported as assets has always existed. Private not-for- profit organizations do recognize unconditional promises to give as both a receivable and a contribution revenue in the period promised. For example, as of June 30, 2006, Wake Forest University reported contributions receivable (net) of more than $43 million.
In an accompanying footnote, the school explained that “contributions, including unconditional promises to give, are recognized as revenues in the period received. Conditional promises to give are not recognized until they become unconditional, that is, when the conditions on which they depend are substantially met.”
Expenses and Release of Temporarily Restricted Net Assets:
All expenses are reported in a statement of activities (as in Exhibit 18.2) solely within the Unrestricted Net Assets column. In that way, this first column can be viewed as a reflection of current operations for the not-for-profit organization. For Christian Children’s Fund, total unrestricted public support and revenues totaled $206.4 million while the organization’s expenses amounted to $211.3 million.
Recording all expenses solely within the unrestricted net assets causes a problem in that some expenses are incurred in connection with temporarily restricted net assets. A gift, for example, could be made specifically to support the salaries of the organization’s employees. If the contribution is reported as temporarily restricted, how can the eventual salary expense be presented as unrestricted? Mechanically, that does not match.
When a temporary restriction (either time or usage) is fulfilled, that amount is reclassified as unrestricted at that time. Therefore, if an expense is incurred to meet that stipulation, both the expense and the contribution appear in the statement of activities in the unrestricted column in the same time period.
As in Exhibit 18.2, this reclassification is reflected in the statement of activities by a line at the bottom of the Public Support and Revenue section that increases unrestricted net assets and decreases temporarily restricted net assets. Christian Children’s Fund shows more than $158 million reclassified as “net assets released from restrictions.”
Thus, that amount of temporarily restricted net assets was no longer restricted because of one or more of the following:
1. Money was appropriately expended for an expense as designated by the donor.
2. Money was appropriately expended for an asset as designated by the donor.
3. A donor restriction based on time was satisfied.
To illustrate, assume that in Year 1, a private not-for-profit organization receives three cash gifts of $10,000 each. The donor has specified that the first gift is for employee salaries, the second gift is for the purchase of equipment, and the third gift must be held until Year 2 before being expended. In Year 1, the statement of activities will show all three gifts as increases in Temporarily Restricted Net Assets.
Assume that this example is extended into Year 2 when the first two gifts are properly spent and the time restriction on the third gift is satisfied. For the first gift, cash is decreased and a salary expense is recorded in the Unrestricted Net Asset column. In addition, $10,000 is reclassified on the statement of activities from the Temporarily Restricted column to the unrestricted column in the same manner as the $158 million in Exhibit 18.2.
For the second gift, equipment (an asset) is increased and cash is decreased, but the same reclassification is made to indicate that this restriction has been met. A $10,000 reclassification must also be made for the third gift even though it has not been spent. It was restricted only as to time, and the required time has passed. The statement of activities will show a total of $30,000 in Net Assets Released from Restriction as an increase in unrestricted net assets with an equal decrease in temporarily restricted net assets.
An alternative in accounting for the equipment bought with the restricted gift exists. A time restriction can be specified by the donor or assumed by the organization for the use of the asset. For example, the donor might require the organization to hold the equipment for its entire expected life or for a specific number of years. In that case, no immediate reclassification is made from temporarily restricted net assets to unrestricted net assets. Instead, a gradual reclassification equal to the depreciation of the asset is made each year.
Detailed information about the expenses incurred by a not-for-profit organization is considered important to contributors. One primary concern of contributors is the extent to which the not-for-profit is using the resources provided to fulfill the organizational mission. Is money used, for example, to cure disease or wasted on bloated fund-raising campaigns or executive salaries? For this reason, expenses must be presented in two broad categories-program services and supporting services. Program services are the organization’s activities relating to its mission.
Within this category, several programs may be reported or only one. Christian Children’s Fund discloses six program categories: basic education, health and sanitation, nutrition, early childhood development, micro enterprise, and emergencies. Supporting service costs consist of administrative costs (management and general costs) and fund-raising expenses. These activities generally are not regarded as directly related to any of the organization’s stated missions.
Analysts frequently use the ratio of program service expenses to total expenses as one way to evaluate the efficiency of not-for-profits. The Better Business Bureau has suggested that ratio values of less than 60 percent are not desirable. Christian Children’s Fund reports a ratio of 80.6 percent ($170.32 million/$211.30 million) for the year ended June 30, 2006.
Below the Expenses and Supporting Services sections in Exhibit 18.2, Christian Children’s Fund reports “Non-operating Revenues.” FASB SFAS 124, “Accounting for Certain Investments Held by Not-for-Profit Organizations,” requires that investments in equity securities with readily determinable market values and all debt investments be reported at fair value.
A not-for-profit entity reports the resulting unrealized gains and losses in the statement of activities. These entities report gains and losses on investments, along with dividend and interest income, as increases or decreases in unrestricted net assets unless the donor explicitly restricted this income or a law extends a donor’s restrictions to it. Christian Children’s Fund separately reports these gains and losses in a non-operating section. Here, the organization shows a realized gain on the sale of investments of $848,165, along with an unrealized gain on adjusting investments to fair value of $2,350,458.
Statement of Functional Expenses:
Exhibit 18.3 presents the statement of functional expenses for the Christian Children’s Fund. Because contributors are concerned with how their gifts are used, this statement provides a detailed analysis of expenses by both function and object. The columns represent functions and include the six identified programs and the supporting services of management and general expenses as well as fund-raising.
These are the same categories reported on the statement of activities, and column totals here agree with operating expenses reported on that statement. The rows list expenses according to their nature—for example, subsidy for children, travel, supplies, and professional services.
As a result of the scrutiny placed on the amount that a private not-for-profit organization spends on fund-raising, the allocation of costs is quite important. At one time, joint costs expended for fund-raising appeals that also contained educational literature were routinely divided between fund-raising and program services. Thus, most direct mail solicitations for contributions were accompanied by informational pamphlets and the like so that some portion of the cost of the mailing could be reflected as a program service expense such as educating the public.
To strengthen reporting in this area, the American Institute of Certified Public Accountants issued Statement of Position (SOP) 98-2, “Accounting for Costs of Activities of Not-for-Profit Organizations and State and Local Governmental Entities That Include Fund-Raising.” A full description of SOP 98-2 is beyond the scope of this; however, a portion of the costs of such fund-raising campaigns can still be assigned to program service costs but only if several identified criteria are met.
The literature that is mailed or otherwise distributed must include a specific call for action that would have been made even without the fund-raising request. This appeal cannot be directed purely at potential contributors, and the desired action must be specific and help accomplish the entity’s overall mission. If all of these criteria are met, some or all of the costs associated with this call for action campaign should be reported under program services rather than fund-raising.
For this reason, the June 30, 2006, financial statements of the American Heart Association, Inc., included the following note:
The Association conducts joint activities (activities benefiting multiple programs and/or supporting services) that include fund-raising appeals. Those activities primarily include direct mail campaigns and special events.
The costs of conducting those joint activities were allocated as follows in 2006 and 2005:
The Association allocates joint costs using the physical units methodology.
Evolution of Standard-Setting Authority:
Hospitals as well as colleges and universities can function as private not-for-profit organizations, as part of a government, or as for-profit businesses. A municipal hospital, for example, may be in direct competition with either a private not-for-profit hospital or a for-profit hospital.
After the creation of the Governmental Accounting Standards Board (GASB) in 1984, questions of standard setting for governmental not-for-profit organizations and private not-for-profit organizations began to be raised:
i. Should two sets of accounting principles or just one be developed?
ii. If only one set of principles was to be applied to all not-for-profit organizations, which body should create these principles?
A crisis eventually arose in connection with the recording of depreciation expense by not- for-profit organizations that led to an official division of authority for standard setting.
Prior to 1987, not-for-profit organizations, especially colleges and universities, had been permitted but not required to report depreciation expense. Not surprising, because of the impact on current balances (and the work necessary to compute the amounts), few institutions chose to include annual depreciation figures voluntarily.
Regarding depreciation, the argument was frequently made that profitability is not a goal of these organizations so that calculating and recording this expense was not needed. Some college officials also contended that fund- raising campaigns (rather than operations) commonly financed new acquisitions so that ensuring the availability of adequate resources through the recognition of depreciation was not necessary.
However, in August 1987, the FASB issued SFAS 93, “Recognition of Depreciation by Not- for-Profit Organizations.” This pronouncement required all not-for-profit organizations (other than state and local governments) to recognize depreciation. The rule pertained to both purchased assets and properties acquired by donation. It was aimed at colleges and universities, religious institutions, and other not-for-profit organizations.
At that time, several types of public not-for-profit organizations (governmental colleges and universities, public benefit corporations and authorities, public employee retirement systems, governmental utilities, and governmental hospitals and other health care providers) had been directed to follow GASB pronouncements. However, according to the rules of the day, if the accounting treatment of a transaction or event was not explicitly covered by a GASB pronouncement, applicable FASB pronouncements were to be utilized.
Consequently, in January 1988, the GASB countered with a pronouncement of its own. Statement 8, “Applicability of FASB Statement No. 93, Recognition of Depreciation by Not- for-Profit Organizations (SFAS No. 93), to Certain State and Local Governmental Entities.” This standard exempted public colleges and universities (as well as the other governmental not-for-profit institutions) from recording depreciation.
Until that time, the FASB had focused on accounting for for-profit businesses and the GASB had concentrated on state and local governments. The lines of authority over not-for- profit organizations had not been subjected to intense scrutiny. Suddenly, colleges and other not-for-profits found themselves being guided by two different authoritative bodies. Public schools, such as The Ohio State University and The University of Texas, were to follow GASB so that recording depreciation was voluntary. Private institutions such as Harvard University and Duke University came under the auspices of the FASB and had to report depreciation expense.
A power struggle quickly resulted with the reporting organizations caught in the middle. Officials reacted with dismay at the dual set of rules that had been established. Debates arose as to whether depreciation was truly applicable to not-for-profit organizations.
Just before SFAS 93 was scheduled to take effect, the FASB postponed the effective date to allow time for a compromise to be developed. The Financial Accounting Foundation (FAF), which oversees and funds both the FASB and the GASB, stepped in to help mediate a solution to the territorial dispute. Numerous compromises were proposed. On October 30, 1989, the FAF voted to give the FASB jurisdiction over both governmental and private not-for-profit organizations. Thus, only one set of accounting standards would apply to all such entities.
However, that ruling only escalated the controversy. Ten different government groups threatened to stop supporting the GASB unless all public entities (such as state universities) remained under its jurisdiction. Faced with a problem having no end in sight, the FAF reversed itself and gave the GASB authority over governmental not-for-profit organizations.
Following that final assignment of authority in 1989, the differences in financial reporting for private and governmental not-for-profit organizations continued to become more numerous. Consequently, the financial statements produced by these two groups of organizations in the 1990s could hardly be considered comparable.
Accounting for public colleges and universities, however, became standardized in November 1999 when the GASB issued its Statement 35, “Basic Financial Statements—and Management’s Discussion and Analysis—for Public Colleges and Universities—An Amendment to GASB Statement 34,” which applied the reporting standards (including depreciation) established by GASB Statement 34 to public schools.
Many public schools have decided that they are solely proprietary funds so that only fund-based statements are needed. Thus, this pronouncement narrowed many of the distinctions between the two reporting models but certainly not all. Apparently, the need for precise comparability between public and private not-for-profit universities is not viewed as an essential objective.
The GAAP Hierarchy:
At some point in the development of accounting standards, the relationship between governmental not-for-profit organizations and FASB pronouncements almost had to be redefined. Even after its authority was reinstated, the GASB could not stop its ongoing work every time that the FASB issued a new statement to evaluate whether the standard should be voided for governmental not-for-profit organizations.
The AICPA Auditing Standards Board crafted a resolution in its Statement on Auditing Standards 69, “The Meaning of ‘Presents Fairly in Conformity with Generally Accepted Accounting Principles’ in the Independent Auditor’s Report,” issued in 1991. This standard created a hierarchy for determining whether an accounting treatment should be judged as in compliance with generally accepted accounting principles (GAAP). Accounting pronouncements and other potential guidelines for both nongovernmental entities as well as state and local governments are grouped into levels.
The GAAP hierarchy placed GASB statements and interpretations at the highest level for state and local governments. This same ranking is appropriate for AICPA and FASB pronouncements but only if a GASB statement or interpretation makes them applicable to state and local governments.
Thus, even though a GASB statement may not provide specific guidance in a particular area of financial reporting, FASB statements no longer become automatically appropriate for governmental not-for-profit organizations. Instead, the GASB can study and evaluate each new pronouncement and act if it believes that the guidelines should be followed.
For state and local governments, the GAAP hierarchy is structured as follows with the sources listed at higher levels having the most authority:
Level 1:
GASB statements and interpretations, plus AICPA and FASB pronouncements if made applicable to state and local governments by a GASB statement or interpretation.
Level 2:
GASB technical bulletins, and the following pronouncements if specifically made applicable to state and local governments by the GASB: AICPA industry audit and accounting guides and AICPA statements of position.
Level 3:
AICPA Accounting Standards Executive Committee practice bulletins if specifically made applicable to state and local governmental entities and cleared by the GASB. Also, consensus positions of a group of accountants organized by the GASB that attempts to reach consensus positions on accounting issues applicable to state and local governmental entities.
Level 4:
Implementation guides published by the GASB as well as industry practices widely recognized and prevalent.
Other Sources:
Other accounting literature including GASB concepts statements and AICPA and FASB pronouncements when not specifically made applicable to state and local governmental entities.
However, the GAAP hierarchy for nongovernmental entities is in transition. At the urging of the Securities and Exchange Commission (SEC), the FASB has taken steps to establish its authority in this area. At the present time, a “near final” FASB statement, The Hierarchy of Generally Accepted Accounting Principles, exists.
When issued, it will not create radical changes but will establish the FASB as the body that controls this particular hierarchy. According to paragraph A5 of the “near final” version- “The GAAP hierarchy set forth by the AICPA in SAS 69 was directed to the auditor although it is the enterprise, and not its auditor, that is responsible for selecting accounting principles for financial statements that are presented in conformity with GAAP. Therefore, the Board decided to issue this Statement and direct the GAAP hierarchy to the enterprise.”
According to this FASB statement, the sources of accounting principles that are generally accepted for nongovernmental entities would be categorized in descending order of authority as follows:
1. AICPA Accounting Research Bulletins and Accounting Principles Board Opinions that are not superseded by action of the FASB, FASB Statements of Financial Accounting Standards and Interpretations, FASB Statement 133 Implementation Issues, and FASB Staff Positions (also SEC rules, interpretive releases, and Staff Accounting Bulletins for SEC registrants).
2. FASB Technical Bulletins and, if cleared by the FASB, AICPA Industry Audit and Accounting Guides and Statements of Position.
3. AICPA Accounting Standards Executive Committee Practice Bulletins that have been cleared by the FASB and consensus positions of the FASB Emerging Issues Task Force (EITF).
4. Implementation guides (Q&As) published by the FASB staff, AICPA accounting interpretations, AICPA Industry Audit and Accounting Guides and Statements of Position not cleared by the FASB, and practices that are widely recognized and prevalent either generally or in the industry.
If these sources do not cover the issue in question for a nongovernmental entity, other accounting literature should be consulted including, for example, FASB concepts statements; AICPA issues papers; international financial reporting standards (IFRSs) of the International Accounting Standards Board (IASB); pronouncements of other professional associations or regulatory agencies; technical information service inquiries and replies included in AICPA Technical Practice Aids.