Accounting for Not-for-Profit Organizations

Transcription

1 Razek-Ch.12 12/12/02 12:35 PM Page Accounting for Not-for-Profit Organizations Chapter Chapter Outline Learning Objectives Description of Not-for-Profit Organizations Accounting Standards Jurisdiction Examples of Not-for-Profit Entities Overview of Internal Accounting versus External Reporting Financial Statements Statement of Financial Position Statement of Activities Statement of Functional Expenses Statement of Cash Flows Contributions General Rule for Contributions Other Than Services and Collections Contributions Received with Donor-Imposed Restrictions Unconditional and Conditional Promises to Give Unconditional Promises Conditional Promises Contributed Services Contributions to Collections Not-for-Profit Financial Reporting in Practice: Financial Statements of a Rescuer and Distributor of Donated Food

2 Razek-Ch.12 12/12/02 12:35 PM Page 497 Accounting for Reclassifications Illustrations of Contributions Transactions Other Accounting Matters Investments: Valuation, Income, Gains, and Losses Depreciation Subscription and Membership Income Revenues and Receivables from Exchange Transactions Fund-Raising Activities Funds Used Interfund Transfers Fund Accounting Transactions and Financial Reporting by Not-for-Profit Organizations Preparing Financial Statements from Fund Records Statement of Activities Statement of Financial Position Review Questions Exercises Problems Appendix 12-A Not-for-Profit Colleges and Universities Financial Statements of Not-for-Profit Colleges and Universities Notes to the Financial Statements After completing this chapter, you should be able to: Describe the characteristics that distinguish not-for-profit organizations (NFPOs) from for-profit organizations and from governmental entities. Identify the types of organizations classified as voluntary health and welfare organizations (VHWOs) and as other not-for-profit organizations (ONPOs). Name and discuss the financial statements prepared by NFPOs. Discuss the characteristics of the three classifications of net assets reported on the statement of financial position. Describe the nature of donor-imposed restrictions and how they are reported. Discuss the nature of and the difference in accounting for unconditional and conditional promises to give. Discuss accounting for contributed services. Discuss accounting for collections of works of art, rare books, and similar assets. Discuss how investments are measured for financial reporting purposes. Chapter 12 Accounting for Not-for-Profit Organizations 497

3 Razek-Ch.12 12/12/02 12:35 PM Page 498 Discuss the journal entries needed when resources are released from restrictions. Prepare journal entries to record the activities of VHWOs and ONPOs. Describe the major types of funds used by NFPOs. Prepare financial statements for VHWOs and ONPOs. DESCRIPTION OF NOT-FOR-PROFIT ORGANIZATIONS The distinction between not-for-profit, for-profit, and governmental organizations is not always clear. Hospitals, for example, can be organized as not-for-profit, forprofit, or governmental entities, as can colleges and universities. Whether an organization is not-for-profit, for-profit, or governmental depends not on the activities they perform, but rather on such factors as the source of their revenues, their intention to earn profits, and their ownership. Generally, the major characteristics that distinguish not-for-profit from for-profit entities are that not-for-profit entities (1) receive significant amounts of resources in the form of contributions from providers who do not expect to receive monetary benefits in return; (2) operate for purposes other than to earn profits; and (3) lack defined ownership interests that can be sold, transferred, or redeemed. 1 Not-forprofit entities possess these characteristics in varying degrees. Entities such as states, cities, counties, and towns (including public corporations and bodies corporate and politic ) are clearly governmental, rather than not-forprofit. However, some entities created by charter under state corporation or not-forprofit corporation laws perform activities so closely related to what governments do that it may not be clear what kind of entity they are. As distinguished from notfor-profit entities, governmental entities have one or more of these characteristics: (1) their officers are either popularly elected or a controlling majority of their governing boards are appointed or approved by entities that are clearly governmental; (2) they may have the power to tax; (3) they may have the power to issue tax-exempt debt; or (4) they can be dissolved unilaterally by a government and their net assets assumed by it without compensation. 2 Accounting Standards Jurisdiction For accounting purposes, the distinctions among not-for-profit, for-profit, and governmental organizations are important. As discussed in Chapter 1, jurisdiction for setting accounting and financial reporting standards is shared by several organiza- 1 FASB Concepts Statement No. 4, Objectives of Financial Reporting by Nonbusiness Organizations, (Norwalk, CT: FASB, 1980), para AICPA Audit and Accounting Guide Health Care Organizations (New York: AICPA, 2001), para c. 498 Chapter 12 Accounting for Not-for-Profit Organizations

4 Razek-Ch.12 12/12/02 12:35 PM Page 499 tions. The Governmental Accounting Standards Board (GASB) sets the standards that apply to state and local governmental entities, and the Financial Accounting Standards Board (FASB) sets the standards for for-profit and not-for-profit entities. The GASB s standards are not always the same as the FASB s standards. Until recently, not-for-profit organizations followed the accounting principles and reporting practices recommended by industry audit and accounting guides issued by the American Institute of Certified Public Accountants (AICPA) for transactions not covered in FASB pronouncements. The FASB, which has final authority over accounting and financial reporting principles used by not-for-profit organizations, recognized that inconsistencies had developed over the years among the guides and that the guides were not always followed. To provide consistency in accounting and financial reporting among all not-for-profit organizations, it addressed the major issues in three documents effective in 1995 and They are FASB Statement No. 116, Accounting for Contributions Received and Contributions Made, FASB Statement No. 117, Financial Statements of Not-for-Profit Organizations, and FASB Statement No. 124, Accounting for Certain Investments Held by Not-for-Profit Organizations. The AICPA updates its guides periodically to conform to the FASB requirements. Examples of Not-for-Profit Entities Four broad categories of not-for-profit organizations include voluntary health and welfare organizations, health care organizations, colleges and universities, and other not-for-profit organizations. This chapter covers basic accounting and financial reporting principles applicable to all four not-for-profit categories. When referring to principles that apply to all four, the acronym NFPOs will be used. However, the illustrations in this chapter relate primarily to voluntary health and welfare organizations (VHWOs) and other not-for-profit organizations (ONPOs). Not-for-profit colleges and universities are discussed in an appendix to this chapter. Health care entities, as well as discussions of accounting and reporting matters unique to them, are covered in Chapter 13. VHWOs are entities formed for the purpose of providing voluntary services for various segments of society, in the fields of health, welfare, and other social services. They obtain resources primarily from voluntary contributions from the general public. They may also receive grants and contracts from governmental agencies to provide specific social services. Because they are organized for the benefit of the public, they are exempt from many taxes. Well-known examples of VHWOs are the American Cancer Society, the Boy Scouts of America, the National Urban League, and the Young Women s Christian Association of the U.S.A. A VHWO may provide such services as family counseling, recreation and work for youth, and meals for the elderly, often at no charge or low charge to the service recipients. The category ONPOs includes other types of not-for-profit organizations that are not VHWOs, colleges and universities, or health care entities. Some of them provide services similar to those provided by VHWOs, and charge user fees. Many of them, Chapter 12 Accounting for Not-for-Profit Organizations 499

5 Razek-Ch.12 12/12/02 12:35 PM Page 500 however, are organized to provide benefits to their members, and hence derive their revenues primarily from membership dues and fees. Examples of ONPOs include the following: Cemetery organizations Civic and community organizations Labor unions Nongovernmental libraries and museums Performing arts organizations Political parties Private foundations Private not-for-profit elementary and secondary schools Professional associations and trade associations Religious organizations Research and scientific organizations Social and country clubs OVERVIEW OF INTERNAL ACCOUNTING VERSUS EXTERNAL REPORTING Though not required to do so, NFPOs generally use fund accounting for internal accounting purposes. They normally have resources whose use is restricted by donors as well as resources whose use is unrestricted. Maintaining separate funds for resources whose use is restricted helps to ensure that the resources are used in accordance with donor restrictions. External financial reporting for NFPOs, however, focuses on the organization as a whole, rather than on the individual funds. To prepare financial statements for these organizations, you must aggregate the resources of the individual funds and classify the net assets (that is, the difference between the assets and liabilities) as either unrestricted, temporarily restricted, or permanently restricted. (For example, if a donor contributes $1,000 with the stipulation that it must be used for a specific purpose, the resulting net asset is classified as temporarily restricted until it is used for that purpose.) All expenses are reported in the financial statements as if financed from unrestricted net assets. To facilitate financial reporting, accounting within the funds is designed to accommodate the three classifications of net assets, as well as the reclassifications among the three. FASB Statement No. 117 permits disclosure of fund-type data in external financial reports, provided the required organization-as-a-whole data are also reported. To simplify the presentation in this chapter, we will first discuss the general principles of accounting and financial reporting for NFPOs, without reference to fund accounting. We will then discuss the funds generally used by NFPOs and illustrate accounting within the funds. 500 Chapter 12 Accounting for Not-for-Profit Organizations

6 Razek-Ch.12 12/12/02 12:35 PM Page 501 FINANCIAL STATEMENTS Due to the intangible nature of many of the services offered by VHWOs and ONPOs, it is practically impossible to place a monetary value on them. Thus it is impossible to prepare financial statements that can measure the results of operations in the same sense as those used for business enterprises. The basic functions of the financial reporting process for VHWOs and ONPOs are therefore limited to (1) providing information on how the resources of the organization were obtained and used during the period, (2) presenting the resources available for future use at the end of the period, and (3) reporting on the organization s ability to continue to supply services in the future. The financial statements of VHWOs and ONPOs are prepared for four general types of users of financial information: (1) the management group of the organization (e.g., directors and other individuals who are responsible for carrying out dayto-day operations of the organization); (2) government officials who have oversight responsibility for such organizations; (3) individuals who contribute resources to the organization; and (4) constituents of the organization. 3 To provide financial information to this diverse group, three basic financial statements are prepared: (1) a statement of financial position, (2) a statement of activities, and (3) a statement of cash flows. 4 In addition, VHWOs are required to provide information in a separate financial statement about expenses by their natural classifications. 5 (Such information breaks down the broad functional categories, such as major programs and administrative support expenses, into components, such as salaries, supplies, and depreciation.) Statement of Financial Position A statement of financial position provides important information about the assets, liabilities, and net assets of the organization and their relationship to each other (see Table 12-1). This information, when used with information on other financial statements and related disclosures, helps interested parties to assess the organization s ability to continue operations and its liquidity, financial flexibility, ability to meet obligations, and future financing needs. 6 It focuses on the organization as a whole, as opposed to individual funds, and reports total assets, total liabilities, and net assets. Because of the emphasis on the organization as a whole, the term net assets is used rather than the term fund balance. 3 An in-depth discussion of these objectives and users is included in Statement of Financial Accounting Concepts No. 4, Objectives of Financial Reporting by Nonbusines Organizations (Norwalk, CT: FASB, 1980). 4 FASB Statement No. 117, Financial Statements of Not-for-Profit Organizations (Norwalk, CT: FASB, 1994), para Ibid., para Ibid., para. 9. Chapter 12 Accounting for Not-for-Profit Organizations 501

7 Razek-Ch.12 12/12/02 12:35 PM Page 502 Table 12-1 Statement of Financial Position NOT-FOR-PROFIT ORGANIZATION STATEMENT OF FINANCIAL POSITION JUNE 30, 2005 AND 2004 (AMOUNTS IN THOUSANDS) Assets Cash and cash equivalents $ 75 $ 460 Accounts and interest receivable 2,130 1,670 Inventories and prepaid expenses 610 1,000 Contributions receivable 3,025 2,700 Short-term investments 1,400 1,000 Assets restricted to investment in land, buildings, and equipment 5,210 4,560 Land, buildings, and equipment 61,700 63,590 Long-term investments 218, ,500 Total assets $292,220 $278,480 Liabilities and Net Assets Liabilities: Accounts payable $ 2,570 $ 1,050 Refundable advance 650 Grants payable 875 1,300 Notes payable 1,140 Annuity obligations 1,685 1,700 Long-term debt 5,500 6,500 Total liabilities 10,630 12,340 Net assets: Unrestricted 115, ,670 Temporarily restricted (Note B) 24,342 25,470 Permanently restricted (Note C) 142, ,000 Total net assets 281, ,140 Total liabilities and net assets $292,220 $278,480 Accompanying notes to financial statements not included. Source: Adapted from FASB Statement No. 117, Financial Statements of Not-for-Profit Organizations (Norwalk, CT: FASB, 1994), para Under FASB Statement No. 117, net assets must be reported as permanently restricted, temporarily restricted, and unrestricted, depending on the existence and nature of donor-imposed restrictions. The existence and nature of these restrictions must be reported on the face of the statement of financial position or in the notes to the financial statements or both. 502 Chapter 12 Accounting for Not-for-Profit Organizations

8 Razek-Ch.12 12/12/02 12:35 PM Page 503 Permanently restricted net assets are ones resulting (a) from contributions and other inflows of assets whose use by the organization is limited by donor-imposed stipulations that neither expire by passage of time nor can be fulfilled or otherwise removed by actions of the organization, (b) from other enhancements and diminishments subject to the same kinds of stipulations, and (c) from reclassifications from (or to) other classes of net assets as a consequence of donor-imposed stipulations. 7 Temporarily restricted net assets are ones resulting (a) from contributions and other inflows of assets whose use by the organization is limited by donor-imposed stipulations that either expire by passage of time or can be fulfilled and removed by actions of the organization pursuant to those stipulations, (b) from other asset enhancements and diminishments subject to the same kinds of stipulations, and (c) from reclassifications to (or from) other classes of net assets as a consequence of donor-imposed stipulations, their expiration by passage of time, or their fulfillment and removal by actions of the organization pursuant to those stipulations. 8 Unrestricted net assets are ones that are neither permanently nor temporarily restricted. The only limits on their use are ones resulting from the nature of the organization and the environment in which it operates and contractual agreements with creditors, suppliers, and others entered into in the ordinary course of business. Information about such limits should be disclosed in the notes to the financial statements. Because they are not donor-imposed, those limitations do not meet the FASB s definition of restrictions. FASB Statement No. 117 does not specify or preclude any one format of financial statement. As a result, both vertical and horizontal formats are permitted, as are single and multicolumn and single and multipage formats. Notice that assets in Table 12-1 are presented in order of liquidity, whereas liabilities are presented in order of anticipated liquidation. The refundable advance shown on this statement refers to a donor s conditional promise to give, whose conditions have not been met. Net assets are presented by type and are disclosed in detail in the notes to the financial statements (not included in Table 12-1). Statement of Activities A statement of activities provides information about (a) the effects of transactions and other events and circumstances that change the amount and nature of net assets, 7 Ibid., para Ibid. Chapter 12 Accounting for Not-for-Profit Organizations 503

9 Razek-Ch.12 12/12/02 12:35 PM Page 504 (b) the relationships of those transactions and other events and circumstances to each other, and (c) how the organization s resources are used in providing various programs or services. 9 Like the statement of financial position, it focuses on the organization as a whole and reports the change in net assets, by level of restriction, for the period. Year-end net assets reported for each net asset classification in this statement should be the same as that reported in the statement of financial position. A statement of activities can be prepared in a single column or a multicolumn format. The latter is preferred because it enables the reader to observe, at a glance, the effects of revenues, gains, other support, expenses, and losses on each category of net assets. It also enables the reader to observe, at a glance, the effect on net assets of changes in levels of restrictions. A statement of activities prepared in a multicolumn format is shown in Table Notice that the first caption in Table 12-2 is Revenues, Gains, and Other Support. What is the distinction among those terms from the perspective of an NFPO? Revenues are inflows from selling goods and providing services that constitute the organization s ongoing major or central operations, such as fees for providing child care services, college and university tuitions, and services to hospital patients. Gains are inflows from peripheral or incidental transactions, such as profits from selling securities or operating a parking lot in conjunction with an NFPO s major activities. It is possible that an activity considered by one organization to produce revenues will be considered by another organization to produce gains. Donor contributions received by NFPOs may be considered revenues or gains, depending upon whether they are actively sought and frequently received, but support is a more descriptive term and is used throughout the FASB s literature on NFPOs. Expenses incurred by NFPOs must be reported on the statement of activities or in the notes to the financial statements by their functional classification such as major classes of program services and supporting activities. 10 When functional classifications are used, individual expenses are reported by function or program. Thus, such items as salaries and supplies used by each program are reported as expenses of those activities. Functional classifications are required because they enable the reader to determine the cost of various programs offered by the organization. The organization s programs should also be described in the notes to the financial statements. For financial reporting purposes, a program is considered to be an activity that is directly related to the purpose(s) for which the organization was established. Although most organizations are involved in many programs, it is possible that an organization may have only one such activity. Expenses identified as management and general are those associated with the overall direction and management of the organization, in addition to those associated with record keeping, the annual report, and so forth. Fund-raising and other supporting services are associated with the solicitation of money, materials, and the like, for which the individual or organization making the contribution receives no direct economic benefit. 9 Ibid., para Ibid., para Chapter 12 Accounting for Not-for-Profit Organizations

10 Razek-Ch.12 12/12/02 12:35 PM Page 505 Table 12-2 Statement of Activities NOT-FOR-PROFIT ORGANIZATION STATEMENT OF ACTIVITIES YEAR ENDED JUNE 30, 2005 (AMOUNTS IN THOUSANDS) TEMPORARILY PERMANENTLY UNRESTRICTED RESTRICTED RESTRICTED TOTAL Revenues, Gains, and Other Support Contributions $ 8,640 $ 8,110 $ 280 $ 17,030 Fees 5,400 5,400 Income on long-term investments (Note E) 5,600 2, ,300 Other investment income (Note E) Net unrealized and realized gains on long-term investments (Note E) 8,228 2,952 4,620 15,800 Other Net assets released from restrictions (Note D): Satisfaction of program restrictions 11,990 (11,990) Satisfaction of equipment acquisition restrictions 1,500 (1,500) Expiration of time restrictions 1,250 (1,250) Total revenues, gains, and other support 43,608 (1,098) 5,020 47,530 Expenses and Losses Program A 13,100 13,100 Program B 8,540 8,540 Program C 5,760 5,760 Management and general 2,420 2,420 Fund-raising 2,150 2,150 Total expenses (Note F) 31,970 31,970 Fire loss Actuarial loss on annuity obligations Total expenses and losses 32, ,080 Change in net assets 11,558 (1,128) 5,020 15,450 Net assets at beginning of year 103,670 25, , ,140 Net assets at end of year $115,228 $24,342 $142,020 $281,590 Accompanying notes to financial statements not included. Source: Adapted from FASB Statement No. 117, Financial Statements of Not-for-Profit Organizations (Norwalk, CT: FASB, 1994), para Chapter 12 Accounting for Not-for-Profit Organizations 505

11 Razek-Ch.12 12/12/02 12:35 PM Page 506 They include such items as printing, personnel, the cost of maintaining a mailing list, and the cost of any gifts that are sent to prospective contributors. The distinction between program expenses and other expenses is useful to those interested in knowing the percentage of total expenses that an NFPO devotes to program activities. In the statement of activities, notice that revenues, gains, and other support are reported as increases in either unrestricted or restricted assets, depending on whether the use of assets is limited by donor-imposed restrictions. However, all expenses are reported as decreases in unrestricted net assets, even if they were financed with restricted resources. This is accomplished by means of journal entries that reduce restricted assets and increase unrestricted assets, as resources are released from restrictions through their satisfaction (such as incurring program expenses) or the expiration of time. (See the activity reported under Net assets released from restrictions in Table 12-2.) Statement of Functional Expenses All VHWOs are required to prepare both a statement of activities and a statement of functional expenses. The statement of functional expenses is presented in matrix format. For each program or function, this statement identifies the expenses by natural or object classification (e.g., salaries, grants to other organizations, supplies, depreciation, and occupancy expense). A statement of functional expenses is shown in Table Notice how the expenses by natural classification are associated with each of the programs and functions shown in the statement of activities. Although Table 12-3 Statement of Functional Expenses NOT-FOR-PROFIT ORGANIZATION STATEMENT OF FUNCTIONAL EXPENSES YEAR ENDED JUNE 30, 2005 (AMOUNTS IN THOUSANDS) MANAGEMENT FUND- TOTAL A B C AND GENERAL RAISING Salaries, wages, and benefits $15,115 $ 7,400 $3,900 $1,725 $1,130 $ 960 Grants to other organizations 4,750 2, ,925 Supplies and travel 3, , Services and professional fees 2, , Office and occupancy 2,528 1, Depreciation 3,200 1, Interest Total expenses $31,970 $13,100 $8,540 $5,760 $2,420 $2,150 Source: Adapted from FASB Statement No. 117, Financial Statements of Not-for-Profit Organizations (Norwalk, CT: FASB, 1994), para Chapter 12 Accounting for Not-for-Profit Organizations

12 Razek-Ch.12 12/12/02 12:35 PM Page 507 they are not required to prepare a statement of functional expenses, many ONPOs elect to do so because the statement is useful to managers and others concerned with the way resources are spent. Statement of Cash Flows A statement of cash flows provides the user of the financial statements with information on cash receipts and cash payments of the organization during the same period as the statement of activities. The statement is organized so that the effect of operating, investing, and financing activities on cash flows is clearly shown. Such a statement is shown in Table CONTRIBUTIONS General Rule for Contributions Other Than Services and Collections Not-for-profit organizations may receive contributions in many forms, such as cash, pledges of cash, investments, materials, supplies, facilities, use of facilities or utilities, personal services, and collections. The general rule for contributions other than services and collections is that they must be (a) reported as revenues or gains in the period received, (b) reported as assets, decreases of liabilities, or expenses, depending on the form the benefits take, (c) measured at the fair value of the contribution received, and (d) reported as either restricted support or unrestricted support. 11 For example, if an NFPO receives free use of a building that normally leases for $15 per square foot, the NFPO would recognize the fair value of the contribution ($15 per square foot) as a revenue and as an expense. If a utility provides free electricity, the NFPO would also recognize the fair value of the electricity as a revenue and as an expense. If a pharmaceutical company provides free drugs, the NFPO would recognize the fair value of the drugs as a revenue and as an asset. All three are forms of contributed resources. Contributions may be received with or without donor-imposed restrictions. Unrestricted contributions should be reported on the statement of activities as unrestricted revenues or gains (unrestricted support), which increase unrestricted net assets. Expenses incurred from unrestricted net assets are reported as decreases in those assets. Contributions Received with Donor-Imposed Restrictions A donor-imposed restriction limits the use of contributed assets beyond the broad limits resulting from the nature of the organization and the purposes for which it was organized. For example, a contributor to a performing arts entity may stipulate that 11 FASB Statement No. 116, para. 8. Chapter 12 Accounting for Not-for-Profit Organizations 507

13 Razek-Ch.12 12/12/02 12:35 PM Page 508 Table 12-4 Statement of Cash Flows NOT-FOR-PROFIT ORGANIZATION STATEMENT OF CASH FLOWS YEAR ENDED JUNE 30, 2005 (AMOUNTS IN THOUSANDS) Cash flows from operating activities: Change in net assets $15,450 Adjustments to reconcile change in net assets to net cash used by operating activities: Depreciation 3,200 Fire loss 80 Actuarial loss on annuity obligations 30 Increase in accounts and interest receivable (460) Decrease in inventories and prepaid expenses 390 Increase in contributions receivable (325) Increase in accounts payable 1,520 Decrease in refundable advance (650) Decrease in grants payable (425) Contributions restricted for long-term investment (2,740) Interest and dividends restricted for long-term investment (300) Net unrealized and realized gains on long-term investment (15,800) Net cash used by operating activities (30) Cash flows from investing activities: Insurance proceeds from fire loss on building 250 Purchase of equipment (1,500) Proceeds from sale of investments 76,100 Purchase of investments (74,900) Net cash used by investing activities (50) Cash flows from financing activities Proceeds from contributions restricted for: Investment in endowment 200 Investment in term endowment 70 Investment in plant 1,210 Investment subject to annuity agreements 200 1,680 Other financing activities: Interest and dividends restricted for reinvestment 300 Payments of annuity obligations (145) Payments on notes payable (1,140) Payments on long-term debt (1,000) (1,985) Net cash used by financing activities (305) Net decrease in cash and cash equivalents (385) Cash and cash equivalents at beginning of year 460 Cash and cash equivalents at end of year $ 75 Accompanying notes to financial statements not included. Source: Adapted from FASB Statement No. 117, Financial Statements of Not-for-Profit Organizations (Norwalk, CT: FASB, 1994), para. 160.

14 Razek-Ch.12 12/12/02 12:35 PM Page 509 his or her contribution be used only for a clarinet and flute duet. This type of restriction, a temporary restriction, is satisfied by the action of the performing arts entity in giving the concert. Another donor may require that his or her contribution to the performing arts entity be maintained permanently, with the income from the contribution used to train future ballet artists. The permanent restriction can never be removed by action of the entity, but the income from the contribution is classified as temporarily restricted until it is used for the training program. Contributions received with donor-imposed restrictions must be reported as restricted support. These contributions will increase either temporarily restricted or permanently restricted net assets. As an option, however, in the case of donor-restricted contributions whose restrictions are met in the same reporting period the contributions are received, the contribution may be reported as unrestricted support, provided the entity reports similar types of contributions that way consistently from one period to another. An NFPO must recognize the expiration of a donor-restricted contribution in the period that the restriction expires. This expiration occurs when the stipulated purpose for which the contribution was made has been fulfilled, when the stipulated time period has elapsed, or both. FASB Statement No. 117 requires that all expenses be reported in the statement of activities as decreases in unrestricted net assets, even though the original contribution that financed the expense was reported as an increase in temporarily or permanently restricted net assets. Through journal entries, restricted net assets are reclassified as unrestricted net assets. Unconditional and Conditional Promises to Give Unconditional Promises A promise to give (sometimes called a pledge or a charitable subscription) is a written or oral agreement to contribute cash or other assets to another entity. The FASB concluded that unconditional promises to give those that depend only on the passage of time or demand by the receiver of the promise meet the definition of assets because promise makers generally feel bound to honor them. Therefore, unconditional promises to give should be recognized in the financial statements as receivables and as revenues or gains when the promises are received. An appropriate allowance for uncollectible promises should be established. Receipts of unconditional promises to give, whose payments are due in future periods, must be reported as restricted support, generally as temporarily restricted assets. However, a promise should be reported as unrestricted if explicit donor stipulations or circumstances surrounding the receipt of a promise make clear that the donor intended it to be used to support activities of the current period. 12 When reporting pledges, the following must be disclosed: (a) Amounts of promises receivable within one year, from one to five years, and in more than five years, and (b) The allowance for uncollectible pledges Ibid., para Ibid., para. 24. Chapter 12 Accounting for Not-for-Profit Organizations 509

15 Razek-Ch.12 12/12/02 12:35 PM Page 510 Conditional Promises Conditional promises to give are promises that bind the promisor on the occurrence of a specified future and uncertain event. For example, a donor promises to give $15,000 in cash to an NFPO provided the NFPO raises an equal amount from other contributors by a specific date. As another example, a donor promises to contribute $20,000 as soon as the NFPO establishes a daycare center and starts admitting children. Conditional promises to give are not recognized as receivables and as revenues (or gains) until the conditions on which they depend are substantially met. At that point, the conditional promise becomes unconditional and should be recognized as a receivable and a revenue. When an NFPO receives conditional promises to give, it must disclose the total amount promised, and describe each group of promises having similar characteristics, such as amounts of promises conditioned on completing a new building and raising matching gifts by a specified date. If a donor were to actually transfer assets to an NFPO simultaneously with a conditional promise, the NFPO could not recognize revenues. Instead, the receipt of the assets would be accounted for as a refundable advance (deferred revenue) until the conditions were substantially met. Notice how the accounting treatment of conditions differs from that regarding restrictions. Conditions may involve significant uncertainty, including events outside the organization s control. Recognizing assets before the uncertainty is sufficiently resolved may cause the information to be unreliable. Therefore, judgment must be exercised in determining when a condition is substantially met. Suppose, for example, a donor promised a gift of $50,000 in the year 2004 on condition that the entity raises matching gifts totaling $50,000. The NFPO wants to recognize the gift in its year 2004 financial statements. Would the condition be substantially met if the NFPO raised $25,000 by year-end and the matching gifts were dwindling? Not likely. Would the condition be substantially met if it had raised $45,000 by year-end and matching gifts were being received at a strong pace? Perhaps. If a promise is received with ambiguous donor stipulations, the promise should be presumed to be conditional until the ambiguities are resolved. On the other hand, if a donor attaches a condition to a promise and the possibility that the condition will not be met is remote, the promise should be considered to be unconditional. (An example of the latter is an administrative requirement to file a routine annual report.) Contributed Services The rule regarding contributed services is somewhat different from the general rule regarding contributions. An NFPO must record the fair value of contributed services, provided the services received (1) create or enhance nonfinancial assets or (2) require specialized skills, and are provided by individuals who possess those skills, and would typically need to be purchased if the services were not donated. Services requiring specialized skills are those provided by professionals and craftspeople, such as accountants, architects, carpenters, doctors, electricians, lawyers, nurses, plumbers, and teachers. 14 When these criteria are met, a contribu- 14 Ibid., para Chapter 12 Accounting for Not-for-Profit Organizations

16 Razek-Ch.12 12/12/02 12:35 PM Page 511 tion should be recorded for the fair value of the services donated, along with an offsetting expense. The rule regarding contributed services is intended to be restrictive, so that contributed services that do not meet the enumerated criteria may not be recognized. For example, assume a lawyer donates five hours of time to a performing arts center. She spends three hours preparing contracts with artists and two hours selling tickets at the box office. The fair value of the time she spends drawing up contracts should be recognized as a contribution and as an expense. The two hours she spends selling tickets should not be recognized, however, because the work even though needed by the center does not require specialized skills. An NFPO that receives contributed services must describe, in notes to its financial statements, the nature and extent of services received, programs or activities for which they were used, and the amount recognized as revenues. If practicable, the fair value of contributed services received but not recognized should also be disclosed. For example, a note to the financial statements of a performing arts center might say: Donated service revenues and program expenses include the fair value of professional services contributed by performing artists. During the year, performing artists contributed services valued at $60,000 for the free summer concert series. Contributions to Collections A museum in dire financial straits is about to receive a gift of a painting, valued at $1 million, that it plans to display. The museum thinks it would be misleading to report the contribution as a revenue and as an asset because other potential donors, noting the revenue, might conclude that the museum does not need financial support for day-to-day operating purposes. Must the museum recognize the contribution as a revenue and as an asset? The FASB resolved this controversial issue by giving NFPOs the option of not recognizing donated works of art, historical artifacts, rare books, and similar assets as revenues or gains and assets, provided the donated items are added to collections and the collections meet all of the following conditions: (a) Are held for public exhibition, education, or research in furtherance of public service rather than financial gain, (b) Are protected, kept unencumbered, cared for, and preserved, and (c) Are subject to an organizational policy that requires the proceeds from sales of collection items to be used to acquire other items for collections. 15 Thus, NFPOs, such as museums, art galleries, and similar entities that have collections meeting all three of these conditions, have a choice when new items are added. If they choose to capitalize their collections, they must recognize new items as revenues or gains. If they choose not to capitalize their collections, their revenues or gains cannot be recognized. Furthermore, they must follow a consistent policy. They cannot capitalize selected collections or items within a collection. 15 Ibid., para. 11. Chapter 12 Accounting for Not-for-Profit Organizations 511

17 Razek-Ch.12 12/12/02 12:35 PM Page 512 NOT-FOR-PROFIT FINANCIAL REPORTING IN PRACTICE Financial Statements of a Rescuer and Distributor of Donated Food City Harvest, Inc., a not-for-profit corporation, rescues and distributes surplus and donated food to social service agencies, soup kitchens, homeless shelters, and other agencies that provide free meals to the hungry and homeless in New York City. Its statement of activities for the year ended June 30, 2001, shows total public support and revenue of $17.2 million, which includes contributions of donated food ($8.7 million) as well as cash and in-kind contributions from corporations, foundations, and individuals ($6.7 million). Its expenses were $16.5 million $13.5 million for food distribution and operations and $3.0 million for supporting services. Its largest item of expense (which can be found in its statement of functional expenses) was Food rescued the same $8.7 million of donated food included in public support. As discussed previously in the text, contributions received by NFPOs need to be reported as revenues or gains and measured at the fair value of the contribution received. The notes to the financial statements describe how City Harvest measured the fair value of the food donated by restaurants, corporations, and individuals. These organizations contributed 12.6 million pounds of perishable and packaged food in fiscal year City Harvest valued the food at 69 cents a pound, a number derived from the average cost to feed an individual under the U.S. Department of Agriculture thrifty food plan. The notes to the statements also point out that City Harvest also received donations of prepared food, but did not report it on the face of the financial statements because it did not have a determinable market value. The notes also state that City Harvest s reported public support and expenses include the fair value of donated legal services ($84,000) and advertising services ($145,000), but the services of a substantial number of unpaid volunteers were not recognized in the financial statements because those services did not meet the FASB s recognition criteria. Source: City Harvest, Inc. (New York, NY) Financial statements, June 30, 2001 and On the other hand, contributions of works of art, historical treasures, and similar items that are not part of a collection must be recognized as revenues or gains and assets when received. For example, suppose an NFPO holds a collection of art that meets all three criteria for triggering the choice to either capitalize or not capitalize the collection. The NFPO chooses not to capitalize. However, it receives a donation of three works of art that it does not intend to add to its collection. In that situation, the NFPO must recognize the donation as revenues or gains and assets when the three works of art are received. If an organization does not capitalize its collections, it must report the following information on the face of its statement of activities, separately from revenues, expenses, gains, and losses: (a) Costs of collection items purchased as a decrease in the appropriate class of net assets 512 Chapter 12 Accounting for Not-for-Profit Organizations

18 Razek-Ch.12 12/12/02 12:35 PM Page 513 (b) Proceeds from sale of collection items as an increase in the appropriate class of net assets (c) Proceeds from insurance recoveries of lost or destroyed collection items as an increase in the appropriate class of net assets. 16 It must also describe its collections, including their relative significance, and its accounting and stewardship policies for collections. 17 If items in the collection are deaccessed (removed from the collection) during the period, the organization must also (a) describe the items given away, damaged, destroyed, lost, or otherwise deaccessed during the period or (b) disclose their fair value. 18 In addition, these disclosures must be referred to in a line item shown on the face of the statement of financial position. Accounting for Reclassifications As previously noted, reporting net assets as either unrestricted, temporarily restricted, or permanently restricted requires journal entries reclassifying net assets from one classification to another as resources are released from restrictions. Reclassifications have an effect similar to interfund transfers in governmental accounting. They increase net assets of one net asset class and correspondingly reduce net assets of another. As shown in the statement of activities (Table 12-2), reclassification transactions are reported as revenues, gains, and other support under the caption net assets released from restrictions. The journal entry to record these transactions should be prepared in sufficient detail to enable reporting the cause of the reclassification, such as satisfaction of program restrictions or expiration of time restrictions. To illustrate, assume an individual donated $5,000 in 2004, to be used only for a specific purpose. The gift is used in As discussed in the section Contributions Received with Donor-Imposed Restrictions, the contribution would be reported initially as temporarily restricted net assets. When the gift is used as intended, the purpose restriction has been satisfied. At that point, the resources are released from the restrictions and become unrestricted; at the same time, the expense is reported as a reduction of unrestricted net assets. Financial reporting of the reclassification transactions is shown in the statement of activities illustrated in Table 12-2 on page 505. The debit to Reclassifications out is reported as a negative amount under Net assets released from restrictions, in the temporarily restricted column. The credit to Reclassifications in is reported as a positive amount alongside the negative amount under Net assets released from restrictions in the unrestricted column. From an organization-wide perspective, the reclassifications cancel each other. Also, viewed organization-wide, the revenue is recognized at the time of the donation 16 Ibid., para Ibid., para Ibid. Chapter 12 Accounting for Not-for-Profit Organizations 513

19 Razek-Ch.12 12/12/02 12:35 PM Page 514 and the expense is recognized when incurred. However, when viewed from the perspective of changes in unrestricted net assets, the inflow (reported by means of the reclassification) and the outflow (the expense) occur in the same accounting period. ILLUSTRATIONS OF CONTRIBUTIONS TRANSACTIONS An NFPO operates a clinic that provides services to substance abusers. It has the following transactions. 1. It receives cash donations of $15,000 that may be used for any purpose. Also, a pharmaceutical company donates medical supplies having a fair market value of $10,000. Cash 15,000 Inventory medical supplies 10,000 Unrestricted support contributions 15,000 Unrestricted support supplies 10,000 To record unrestricted contributions. 2. It receives two cash donations. One is for $5,000 from a donor who stipulates that it may be used only for research into a new method for treating substance abusers. The other is for $25,000 from a donor who stipulates the gift must be maintained in perpetuity, with the income from the gift to be used for any purpose. Cash 30,000 Temporarily restricted support contributions 5,000 Permanently restricted support contributions 25,000 To record temporarily and permanently restricted gifts. 3. In response to its annual fund-raising campaign, the NFPO receives pledges of $50,000 to be used during the current period for any purpose. Based on past experience, the NFPO expects to collect 90 percent of the pledges. Later in the year, the NFPO receives $10,000 of promises to give cash during the following year, all of which it expects to collect. Contributions receivable 50,000 Allowance for uncollectible contributions 5,000 Unrestricted support contributions 45,000 To record receipt of pledges to give cash this year, less provision for estimated uncollectible pledges. Contributions receivable 10,000 Temporarily restricted support contributions 10,000 To record receipt of pledges to give cash next year. 4. A donor promises to contribute $50,000 to the NFPO s new building fund, provided the NFPO raises an equal amount from other donors. No entry should be made until the donor s conditional promise is substantially met. 514 Chapter 12 Accounting for Not-for-Profit Organizations

20 Razek-Ch.12 12/12/02 12:35 PM Page A psychiatrist donates 10 hours counseling patients. She also spends 5 hours serving food at lunchtime. The NFPO would have purchased both services if the psychiatrist had not donated her time. She normally gets $150 an hour when counseling her patients. Expenses counseling services 1,500 Unrestricted support services 1,500 To record donation of professional services. (Note: No entry should be made for serving meals because it requires no specialized skills. ) 6. Research is conducted into a new method for treating substance abusers, using the gift made in transaction (2). Expenses special research programs 5,000 Cash 5,000 Temporarily restricted asset reclassifications out satisfaction of program restrictions 5,000 Unrestricted asset reclassifications in satisfaction of program restrictions 5,000 To record disbursement of cash for research program and satisfaction of program restrictions. OTHER ACCOUNTING MATTERS Investments: Valuation, Income, Gains, and Losses As a general rule, investments held by NFPOs in equity securities that have readily determinable fair values, and all investments in debt securities, must be reported at fair value (market price) in the statement of financial position. Thus, although investments are initially recorded at cost (if purchased directly by the NFPO) and at fair value (if received by the NFPO through a contribution), the carrying amount of the investments will usually need to be adjusted so that fair values are reported in the financial statements. Because investments must be reported at fair value, unrealized gains and losses resulting from changes in the market price of securities held need to be recognized in the statement of activities. If unrealized gains and losses have been recognized in previous reporting periods on investments sold in the current period, the amount of gain or loss reported in the current period should exclude the amount previously reported in the statement of activities. To illustrate, assume an NFPO purchased 100 shares of an equity security for $5,000 on March 1, On December 31, 2004, the date of its financial statements, the security had a market value of $5,600. On April 15, 2005, it sold the security for $5,800. In its 2004 financial statements, the NFPO should report a gain of $600 and value the security at $5,600. In its 2005 financial statements, the NFPO should report a gain of $200. The $200 gain may be reported either at the net amount of $200 or by its components; that is, as a realized gain of $800, less the previously recognized unrealized gain of $600. If the NFPO chooses to report both unrealized and realized gains and losses in a single account, it would credit both realized and unrealized Chapter 12 Accounting for Not-for-Profit Organizations 515