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Focus on the Mission:Not-for-Profit Accountingand Reporting Today andTomorrow

FMIS/16/01

This product is intended to serve solely as an aid in continuing professional education. Due to the constantly changing nature of the subject of the materials, this product is not appropriate to serve as the sole resource for any tax and accounting opinion or return position, and must be supplemented for such purposes with other current authoritative materials. The information in this manual has been carefully compiled from sources believed to be reliable, but its accuracy is not guaranteed. In addition, Surgent McCoy CPE, LLC, its authors, and instructors are not engaged in rendering legal, accounting, or other professional services and will not be held liable for any actions or suits based on this manual or comments made during any presentation. If legal advice or other expert assistance is required, seek the services of a competent professional. April 2016 cpenow.com / [email protected] Copyright © 2016 Surgent McCoy CPE, LLC – FMIS/16/01

Table of Contents

Focus on the Mission ...................................................... 1 Distinguishing Contributions from Exchange Transactions .................................................................... 2 Conditional and Unconditional Promises to Give ........ 3 Contributed Services, Collection Items and Other Unique Items .................................................................... 4 Special Events ................................................................. 5 Classification of Expenses ............................................. 6 Financial Reporting Today ............................................. 7 Financial Reporting Tomorrow ...................................... 8 Latest Developments ...................................................... 9

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Focus on the Mission

Learning Objectives 1 I. A mission focus 1

A. Exercise 1-1 2 II. Using the proper lens to focus on the mission 2

A. A unique accounting lens 2 1. Accounting for contributions 2 2. Accounting for certain expenses 2 3. Accounting for net assets 3 4. Exercise 1-2 3 5. Exercise 1-3 3

B. A unique reporting lens 4 1. The statement of financial position 5 2. The statement of activities 5 3. Exercise 1-4 5 4. The statement of cash flows 6 5. The statement of functional expenses 6

III. An increased need to focus on the mission 6 A. Increased attention from the media 7

1. The Wounded Warrior Project 7 2. The American Red Cross 7 3. The ALS Association 8

B. A more competitive and ever changing fundraising environment 8 1. Exercise 1-5 9

IV. Our approach for this course 9 V. Suggested solutions to exercises 10

A. Suggested solution to Exercise 1-1 10 B. Suggested solution to Exercise 1-2 11 C. Suggested solution to Exercise 1-3 12 D. Suggested solution to Exercise 1-4 13 E. Suggested solution to Exercise 1-5 13

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Focus on the Mission

Learning Objectives

Upon completing this chapter, you will be able to:

Perceive the three defining characteristics of not-for-profit entities and how

they directly affect not-for-profit accounting and reporting; and

Identify some of the key pressures that not-for-profit entities are experiencing.

I. A mission focus

This course is on not-for-profit (NFP) accounting and reporting. When we are talking about the

accounting and reporting requirements for NFPs, it is obviously important to know what types of entities

the FASB considers to be NFPs. The following chart contains the definition of an NFP found in FASB

ASC 958, Not-for-Profit Entities.

The FASB ASC 958 definition of an NFP

An NFP is an entity that possesses the following characteristics, in varying

degrees, that distinguish it from a business entity: (1) contributions of

significant amounts of resources from resource providers who do not expect

commensurate or proportionate pecuniary return; (2) operating purposes

other than to provide goods or services at a profit; and (3) absence of

ownership interests like those of business entities.

In looking at the above definition, the FASB has identified three primary characteristics that NFPs have (in

varying degrees) that distinguish them from business entities. These characteristics are important as they

directly and indirectly get to the fact that NFPs are focused on mission fulfillment instead of profitability.

The following chart illustrates the contrast between NFPs and business entities (e.g., Taco Bell) using the

three characteristics.

Contrasting NFPs from business entities (e.g., Taco Bell)

NFP characteristic: An illustration of how NFPs differ from business entities:

Contributions of significant amounts of resources from

resource providers who do not expect commensurate or

proportionate pecuniary return

Individuals often hand NFPs cash without receiving or expecting

anything in return. However, individuals never go to Taco Bell and

hand Taco Bell cash without expecting something of commensurate or

proportionate pecuniary return.

Operating purposes other than to provide goods or

services at a profit

NFPs often provide goods or services without receiving anything in

return (i.e., goods or services are being provided without regard to

profitability). However, Taco Bell does not exist to serve tacos (e.g., it

does not make a practice of handing out tacos for free just for the

sake of making tacos). Instead, Taco Bell exists to make a profit.

Absence of ownership interests like those of

business entities

NFPs exist to serve the interests of society at large or aspects of

society. However, Taco Bell ultimately serves the interests of the

stockholders of its parent company (i.e., Yum! Brands, Inc.).

Not-For-Profit Entity

(NFP)

HELLO my name is


A. Exercise 1-1

Please answer the following true or false questions.

True or False

1 Under the FASB definition of an NFP, a credit union would be considered to be an

NFP.

2

Entity X is an NFP business-oriented health care entity (i.e., it has no ownership

interests and is essentially self-sustaining from fees charged for goods and

services). Entity X would be considered to be an NFP and follow guidance in

FASB ASC 958, Not-for-Profit Entities.

II. Using the proper lens to focus on the mission

In the prior section, we discussed that the FASB has identified three primary characteristics that NFPs

have (in varying degrees) that distinguish them from business entities. We also discussed that these

characteristics are important as they directly and indirectly get to the fact that NFPs are focused on

mission fulfillment instead of profitability. Thus, it only makes sense that the FASB has developed

different accounting and reporting requirements for NFPs that help measure: (1) the NFP’s progress in

the current period towards the mission; and (2) the NFP’s ability to make progress towards the mission in

the future. In this section, we will briefly overview the unique accounting and reporting lens (i.e.,

requirements) that the FASB has developed for NFPs.

A. A unique accounting lens

NFPs are involved in certain transactions that business entities simply are not engaged in. As illustrated

below, the FASB has developed specialized accounting requirements for the treatment of such

transactions.

Unique accounting requirements for a unique animal (i.e., NFPs)

The FASB has developed specialized accounting requirements for the treatment of

transactions/accounts that are found in NFPs but not business entities [e.g., the

accounting for: (1) contributions, (2) certain expenses, and (3) net assets].

1. Accounting for contributions

NFPs often receive contributions of significant amounts of resources from resource providers who do not

expect commensurate or proportionate pecuniary return. Contributions are transactions which are unique

to the NFP sector. Contributions are also unique in that they may come in many different forms which

affect how and if they are reported [e.g., are the contributions: (1) conditional or unconditional,

(2) restricted or unrestricted, (3) cash or noncash]. The FASB has developed requirements for these

unique transactions which we will discuss in Chapters 2, 3, 4, and 5.

2. Accounting for certain expenses

NFPs have certain types of expenses (e.g., fundraising expenses) that are unique to the NFP sector and

sometimes the accounting issues can become complicated (e.g., joint activities). Also, due to the

emphasis on mission fulfillment, NFPs are required to be able to categorize their expenses by function

(e.g., program services, management and general, fundraising, and membership development). The

FASB has developed requirements related to these unique expenses that we will discuss in Chapter 6.


3. Accounting for net assets

Because NFPs have an absence of ownership interests like those of business entities, they do not have

traditional equity accounts like retained earnings and common stock. Instead, NFPs utilize net assets to

account for the equity portion of their statement of financial position. Currently, NFPs break down their

total net assets into three classifications based on the presence or absence of donor restrictions. We will

discuss net assets in further detail in Chapter 7. However, the following provides a summarized overview

of the three classifications of net assets.

A summarized overview of the three classifications of net assets

Unrestricted net assets (i.e., the net

assets of the NFP that are free of donor imposed

restrictions)

+

Temporarily restricted net assets (i.e., the net assets of

the NFP that are subject to donor imposed

restrictions that are temporary in nature)

+

Permanently restricted net assets (i.e., the net assets of

the NFP that are subject to donor imposed

restrictions that are permanent in nature)

=

Total net assets

Note. Currently, NFPs may provide information about board designations of unrestricted net assets on the face of the financial statements or in the notes.

4. Exercise 1-2

Please answer the following question related to net assets.

Can you explain this to me?

You are attending the annual board meeting for NFP Z. The CEO of NFP Z has just given a glowing

five-minute report on the annual financial statements and has opened the floor to questions. Dr. Brown

is new to NFP Z’s board and does not have a financial background or a background in working with

NFPs. She asks for someone to explain net assets to her. She is particularly curious about

unrestricted net assets as the CEO just said that in a moment the board needs to make some

designations regarding how they want to spend those amounts. Silence fills the room and all eyes turn

to the lone CPA in the room (i.e., you). How would you explain the terms net assets and

unrestricted net assets in plain English to Dr. Brown?

5. Exercise 1-3

Please answer the following question related to net assets.

What do you think of this?

Recently, the course author observed the following in the net assets section of an NFP’s statement of

financial position. What do you think of this presentation?

Net assets:

Unrestricted (Note 8):

Operating fund (732,149)

Board designated fund 6,348,338

Total unrestricted net assets 5,616,189

Temporarily restricted net assets 7,581,594

Permanently restricted net assets 28,027,354

Total net assets 41,225,137


B. A unique reporting lens

The basic purpose of all financial reporting is to provide meaningful financial information to the financial

statement user. The user of the financial statements should be able to utilize the information provided

within the financial statements to answer basic questions they have about the financial performance of

the entity. The financial statements of an NFP look different from those of a business entity because:

(1) an NFP has a different set of financial statement users than a business entity does; and (2) the users

of an NFP’s financial statements have different questions about the NFP’s financial performance than

those of a business entity. The following discusses the common users of an NFP’s financial statements

and the questions that they typically have.

An NFP’s financial statements need to provide relevant information to meet the common interests of donors, members, creditors, and others who provide resources to NFPs. Users of NFP financial statements typically have the following questions:

?

What are the services that the NFP provides in attaining its mission, what efforts has it made in

providing those services, and what is the NFP’s ability to continue to provide those services?

?

How has the NFP’s management satisfied its stewardship responsibilities and other aspects of

its performance?

? What are the amounts and nature of the NFP’s assets, liabilities, and net assets?

?

What are the effects of transactions and other events and circumstances that change the

amount and nature of net assets?

?

What are the amounts and kinds of inflows and outflows of economic resources during the

period and the relationship between the inflows and outflows?

?

How does the NFP obtain and spend cash, its borrowing and repayment of borrowing, and

other factors that may affect its liquidity?

In addition to resource providers, NFPs have additional users of their financial statements. Examples of such users include regulatory bodies, governing boards, NFP management, and affiliated organizations. These users are also interested in the above questions.

NFPs attempt to answer the above questions through their financial statements. The following illustrates

the financial statements prepared by NFPs.

The financial statements prepared by NFPs include:

In addition, voluntary health and welfare entities prepare:

In the following sections, we will discuss how each of the above financial statements assist financial

statement users in understanding the NFP and in Chapter 7 we will look at the current requirements

related to each of the statements.

The Statement of Financial Position or

Balance Sheet

The Statement

of Activities

The Statement

of Cash Flows

The Statement of Functional

Expenses


1. The statement of financial position

A statement of financial position is the financial statement of an NFP that resembles the balance sheet of

a business entity. While the statement of financial position may resemble the balance sheet of a

business entity there certainly are some differences particularly in the equity section. The statement of

financial position provides relevant information about an NFP’s assets, liabilities, and net assets and

about their relationships to each other at a moment in time (i.e., it is really a point in time measurement

instead of a period of time measurement).

How much fuel does the NFP have in its tank?

The information provided in a statement of financial position helps donors,

members, creditors, and others to assess: (1) the NFP’s ability to continue to

provide services; and (2) the NFP’s liquidity, financial flexibility, ability to meet

obligations, and needs for external financing. This information is essential in

assessing the NFP’s resources or fuel on hand to be able to fulfill its mission

going forward.

Note. Some NFPs prefer to use the title balance sheet instead of statement of financial position as that

terminology is more comfortable to some board members.

2. The statement of activities

A statement of activities for an NFP is the financial statement that an NFP issues in lieu of a business

entity’s income statement. However, while the primary focus of a business entity’s income statement is

the entity’s net income or bottom line, the primary focus of an NFP’s statement of activities is how the

NFP’s activities related to mission fulfillment. Unlike the statement of financial position, the statement of

activities is more of a period of time measurement of the NFP instead of a point in time measurement.

Which direction did the NFP go last year?

The information provided in a statement of activities helps donors, members,

creditors, and others to: (1) evaluate the NFP’s performance during a period;

(2) assess an NFP’s service efforts and its ability to continue to provide services;

and (3) assess how an NFP’s managers have discharged their stewardship

responsibilities and other aspects of their performance. This information is

essential in assessing how an NFP used its resources towards mission

fulfillment during the period and how successful the NFP was in attaining

resources.

3. Exercise 1-4

Please answer the following true or false question.

True or False

1

The best way to measure how an NFP used its resources during the period is to

compare the percentages that the NFP spent on program services, management

and general activities, and fundraising activities to those percentages for all

NFPs.

Gasoline

N

S

E W


4. The statement of cash flows

A statement of cash flows is one of the required financial statements for NFPs. The statement of cash

flows for an NFP is very similar to the statement of cash flows prepared for a business entity.

Where did all the cash go (and come from)?

The information provided in a statement of cash flows helps donors,

members, creditors, and others to assess: (1) the NFP’s ability to generate

positive future net cash flows; (2) the NFP’s ability to meet its obligations,

its ability to provide resources, and its needs for external financing; (3) the

reasons for differences between the change in net assets and associated

cash receipts and payments; and (4) the effects on an NFP’s financial

position of both its cash and noncash investing and financing transactions

during the period. While the statement of cash flows may not be used as

heavily as the other financial statements to measure an NFP’s progress

towards its mission, it nevertheless provides useful information about the

NFP’s operations to certain user groups.

5. The statement of functional expenses

The statement of functional expenses is an additional financial statement that voluntary health

and welfare entities are required to present. As we will see in Chapter 7, the statement of functional

expenses provides information about the functional and natural classification of expenses. Other NFPs

are encouraged, but not required, to provide information about expenses by their natural classification.

Helping to put the pieces of the puzzle together

The information provided in a statement of functional expenses helps donors,

members, creditors, and others in associating expenses with service efforts and

accomplishments. The statement of functional expenses does this by breaking down

the functional expense categories (e.g., program services) into natural categories (e.g.,

salaries, travel, utilities). This information helps users put the pieces of the puzzle

together in terms of understanding how the NFP prioritizes and allocates its resources

within natural expense categories to fulfill its mission.

III. An increased need to focus on the mission

In this chapter, we have discussed that the FASB has identified three primary characteristics that NFPs

have (in varying degrees) that distinguish them from business entities and that these characteristics are

important as they directly and indirectly get to the fact that NFPs are focused on mission fulfillment

instead of profitability. We have also discussed that the FASB has developed unique mission-related

accounting and reporting requirements for NFPs. For at least a couple of reasons, NFPs are facing an

increased need for financial reporting that successfully communicates mission fulfillment.

An increased need to focus on the mission

Increased attention from the media

+ A more competitive and ever changing fundraising environment

An increased need for financial reporting that successfully communicates mission fulfillment

$

$

$ $

$

$ $ $ $


A. Increased attention from the media

As discussed in the following chart, NFPs are now operating in an environment which includes

increasingly more attention from the media.

Getting more attention from the media

Not all that long ago, NFPs operated in a media environment that rarely questioned

how they operated or their progress towards their mission. Barring an incident of

fraud, NFPs seldom made the news except for perhaps some localized reporting

about good works being done in the community. However, in recent years, the

media has become much more inclined to question NFPs and their operations.

To illustrate how things have changed, we will now look at recent media reports related to three nationally

known NFPs. It is interesting to note that in none of the reporting we will discuss was the media alleging

that fraud had occurred at the NFP. However, for good or bad the media was certainly questioning the

NFPs and their operations. Please note that the intention of this is not to pile onto the media reports but

rather to illustrate the media environment that NFPs are now operating in. The NFPs discussed are:

(1) the Wounded Warrior Project; (2) the American Red Cross; and (3) the ALS Association.

1. The Wounded Warrior Project

In early 2016, The New York Times published a rather long article entitled “Wounded Warrior Project

Spends Lavishly on Itself, Insiders Say.” The story began by stating “In 2014, after 10 years of rapid

growth, the Wounded Warrior Project flew its roughly 500 employees to Colorado Springs for an all hands

meeting at the five-star Broadmoor hotel. They were celebrating their biggest year yet: $225 million

raised and a work force that had nearly doubled. On the opening night, before three days of strategy

sessions and team-building field trips, the staff gathered in the hotel courtyard. Suddenly, a spotlight

focused on a 10-story bell tower where the chief executive stepped off the edge and rappelled toward the

cheering crowd.” The story went on to say that in its rapid growth since its inception in 2003 the

Wounded Warrior Project has “embraced aggressive styles of fundraising, marketing and personnel

management that have many current and former employees questioning whether it has drifted from its

mission” and added that “it has spent millions a year on travel, dinners, hotels and conferences that often

seemed more lavish than appropriate, more than four dozen current and former employees said in

interviews.” In the article, the Wounded Warrior Project countered by saying that spending on fundraising

and other expenses not directly related to veterans programs has enabled the Wounded Warrior Project

to grow faster and serve more people and that it estimated that 80,000 veterans have used its services.

2. The American Red Cross

In 2015, NPR published a report entitled “In Search of the Red Cross’ $500 Million in Haiti Relief.” The

report began by stating “When a devastating earthquake leveled Haiti in 2010, millions of people donated

to the American Red Cross. The charity raised almost half a billion dollars. It was one of its most

successful fundraising efforts ever. The American Red Cross vowed to help Haitians rebuild, but after

five years the Red Cross’ legacy in Haiti is not new roads, or schools, or hundreds of new homes. It’s

difficult to know where all the money went.” The report went on to say that the “Red Cross says it has

provided homes to more than 130,000 people, but the number of permanent homes the charity has built

is six.” In the report, the American Red Cross countered by saying that it has provided clean water,

sanitation, vaccinations, disaster preparedness, cholera prevention and that all of the money that has

been spent has been focused on benefiting the people of Haiti.

I didn’t expect so much attention!


3. The ALS Association

In 2015, CNN ran a story entitled “One year later, your ALS Ice Bucket money goes to...” The story

began by stating that “More than 17 million people participated in the Ice Bucket Challenge to support

ALS and other causes. Nationally, 2.5 million people donated $115 million to the ALS Association. The

organization says the event was probably the single largest episode of giving outside of a disaster or

emergency. So, whatever happened to all that money?” After the story’s beginning, the story went on to

primarily detail out how the ALS Association has either spent the Ice Bucket Challenge funds to date or

intends to spend the funds in the future. This story was much more favorable to the NFP than the prior

two we have discussed. The story is interesting in that it displays the high level of focus that NFPs may

be subject to today. The story also had an interesting statement at the end ascribed to the president of

the Center for Effective Philanthropy who expressed a concern that donors will pay attention only to

diseases with the cleverest social media marketing campaigns.

B. A more competitive and ever changing fundraising environment

As discussed in the following chart, NFPs are now operating in a more competitive and ever changing

fundraising environment. In this environment, financial reporting which communicates an NFP’s progress

towards the mission is critical.

NFPs are operating in a more competitive and ever changing fundraising environment

Different fundraising tools are being used

and nationalized competition for donor dollars

exists

20 years ago the NFP landscape looked much different. There were some large

national NFPs (e.g., the American Cancer Society, MDA, March of Dimes) and

many smaller more localized NFPs. The fundraising tools that NFPs used differed

between the two groups. The larger national NFPs used tools like television ads

and mail solicitations and the smaller more localized NFPs used tools like golf

outings, dinners, walk-a-thons, etc. Today, NFPs still use these fundraising tools

while also using tools like their websites, email campaigns, crowd-funding sites,

texting campaigns, and partnerships with retailers asking customers to donate at

checkout. These newer fundraising tools simply did not exist 20 years ago and they

have made the fundraising environment more competitive as an NFP in Savannah,

Georgia may now be competing with an NFP in Spokane, Washington for donor

dollars in these types of campaigns.

The growth of NFP rating agencies

The fundraising environment has also been affected by the growth of websites like

Charity Navigator (www.charitynavigator.org), GuideStar (www.guidestar.org), and

Charity Watch (www.charitywatch.org), that rate and/or provide information on

NFPs. The upside to such websites is that they provide more information to donors.

The downside to such websites is that to some degree they can overly simplify how

donors look at NFPs (e.g., some websites assign ratings and/or post lists like “10

consistently low rated charities” or “10 inefficient fundraisers”). These websites tend

to focus on numbers from the IRS Form 990 or analytics based on those numbers

instead of numbers from audited financial statements. Also, the progress that the

NFP has made towards its mission is often ignored due to the emphasis on the IRS

Form 990.

An ever changing economy

Since 2008-09 the economy has not been as robust as many NFPs would like.

While some improvement may have occurred in recent years, the stock market is

still very unpredictable which can cause donors to be more reluctant to give.


1. Exercise 1-5

Please answer the following question.

How might this change affect NFPs?

NFPs that have expenditures of federal awards of $750,000 or more during the year are required to

have a single audit. At the end of a single audit a reporting package is submitted to the Federal Audit

Clearinghouse. One change contained in the Uniform Guidance for Federal Awards (i.e., the new

single audit requirements) is that the Federal Audit Clearinghouse is required to make all submitted

reporting packages available to the public (with the exception of certain Indian tribes). The Federal

Audit Clearinghouse will achieve this through a website so users can readily search for the reporting

packages of various entities. How might this change affect NFPs?

IV. Our approach for this course

In this chapter, we have discussed the importance of communicating mission fulfillment in financial

reporting. In the remainder of the course, we will examine the key accounting and reporting rules that

NFPs follow to tell their story of mission fulfillment today. Then, in Chapter 8, we will discuss how some

of these rules will change in the future with the FASB’s Financial Statements of Not-for-Profit Entities

project.


V. Suggested solutions to exercises

This section contains the suggested solutions to the exercises presented in the chapter.

A. Suggested solution to Exercise 1-1

True or False

1 Under the FASB definition of an NFP,

a credit union would be considered to

be an NFP.

False. FASB ASC 958 states that entities which clearly

fall outside the definition of an NFP include: (1) all

investor-owned entities; and (2) entities that provide

dividends, lower costs, or other economic benefits directly

and proportionately to their owners, members, or

participants, such as mutual insurance entities, credit

unions, farm and rural electric cooperatives, and

employee benefit plans.

2

Entity X is an NFP business-oriented

health care entity (i.e., it has no

ownership interests and is essentially

self-sustaining from fees charged for

goods and services). Entity X would

be considered to be an NFP and

follow the guidance in FASB ASC

958, Not-for-Profit Entities.

True. The guidance in FASB ASC 958 applies to all

NFPs regardless of whether the entity is essentially self-

sustaining from fees charged for goods and services.

NFP business-oriented health care entities also follow the

incremental guidance in FASB ASC 954, Health Care

Entities (Note. NFP non-business-oriented health care

entities are voluntary health and welfare entities and

follow FASB ASC 958 but not FASB ASC 954).


B. Suggested solution to Exercise 1-2

Can you explain this to me?

You are attending the annual board meeting for NFP Z. The CEO of NFP Z has just given a glowing

five-minute report on the annual financial statements and has opened the floor to questions. Dr. Brown

is new to NFP Z’s board and does not have a financial background or a background in working with

NFPs. She asks for someone to explain net assets to her. She is particularly curious about

unrestricted net assets as the CEO just said that in a moment the board needs to make some

designations regarding how they want to spend those amounts. Silence fills the room and all eyes turn

to the lone CPA in the room (i.e., you). How would you explain the terms net assets and

unrestricted net assets in plain English to Dr. Brown?

In a situation like this, the author recommends taking a simplified approach rather than getting caught

up in the FASB’s terminology. Net assets can be explained as either: [1] the difference between what

the NFP owns (i.e., its assets) and what it owes (i.e., its liabilities); or [2] the cumulative difference

between the NFP’s revenues and expenses since inception. You can then explain that the FASB

requires NFPs to break nets assets down into three classifications based on the presence or absence

of existing donor restrictions. Unrestricted net assets can simply be explained as the portion of net

assets that are free and clear of donor restrictions. Sometimes board members (and others!)

incorrectly interpret unrestricted net assets as being “cash in the bank” that the NFP can go out and

spend today. It is important for board members to understand that this is not the case and that much of

an NFP’s unrestricted net assets are tied up in assets that are not available to be spent (e.g., property

and equipment). Thus, an NFP could not really spend all of the unrestricted net assets balance unless

it liquidated all of its assets and paid all of its liabilities. This is an important concept for governing

boards to understand particularly when it comes to making internal board designations.


C. Suggested solution to Exercise 1-3

What do you think of this?

Recently, the course author observed the following in the net assets section of an NFP’s statement of

financial position. What do you think of this presentation?

Net assets:

Unrestricted (Note 8):

Operating fund (732,149)

Board designated fund 6,348,338

Total unrestricted net assets 5,616,189

Temporarily restricted net assets 7,581,594

Permanently restricted net assets 28,027,354

Total net assets 41,225,137

The interesting item about the above presentation is that the NFP’s board has designated more

unrestricted net assets than it presently has (that is why we see a negative amount in the “operating

fund”). Such a presentation may raise questions on the part of financial statement users as to whether

the board is perhaps overly aggressive in designating amounts or perhaps lacks confidence in day to

day management. The NFP did provide some rationale for this presentation in Note 8 to the financial

statements. Part of Note 8 stated that:

The Board of Trustees approved lending $3,220,000 from the Board Designated Fund to assist in

financing operating deficits between December 2008 and November 2011. On November 20, 2013,

the board amended the original terms of the loan. Currently the loan is non-interest bearing and is

required to be repaid in 10 equal annual installments beginning August 31, 2019. For the year

ended August 31, 2015 the board designated a $150,600 gift to pay down the board loan. The

balance of the loan as of August 31, 2015 was $2,669,400.

The Board Designated Fund consists of funds with no donor or legal restrictions, but through Board

resolutions it has been set aside for specific purposes. As of August 31, the fund consists of the

following:

2015 Board Designated Reserve Fund $4,058,528 NFP X Surplus Endowment Fund 2,287,656 Guild Operations 2,154

$6,348,338


D. Suggested solution to Exercise 1-4

True or False

1

The best way to measure

how an NFP used its

resources during the

period is to compare

the percentages that the

NFP spent on program

services, management

and general activities,

and fundraising activities

to those percentages for

all NFPs.

False. It is not fair to lump all NFPs together in using simple across

the NFP sector expense ratios. Three examples of how such ratios

may be unfair just in the area of fundraising are: [1] an NFP that relies

primarily on contributions will naturally spend more on fundraising than

an NFP that primarily relies on fees from services it provides or

investment earnings; [2] some NFPs support causes that affect fewer

people (e.g., it has been estimated that well less than 1% of

Americans will be diagnosed with ALS during their lifetimes) so it may

cost them more in fundraising per dollar raised than a disease that

affects more people (e.g., it has been estimated that approximately

40% of Americans will be diagnosed with a type of cancer during their

lifetimes); and [3] an NFP may have been blessed with an unusually

large gift from an individual which will naturally make its ratio of

contributions to fundraising expenses appear better than an NFP that

did not receive such a gift.

E. Suggested solution to Exercise 1-5

How might this change affect NFPs?

NFPs that have expenditures of federal awards of $750,000 or more during the year are required to

have a single audit. At the end of a single audit a reporting package is submitted to the Federal Audit

Clearinghouse. One change contained in the Uniform Guidance for Federal Awards (i.e., the new

single audit requirements) is that the Federal Audit Clearinghouse is required to make all submitted

reporting packages available to the public (with the exception of certain Indian tribes). The Federal

Audit Clearinghouse will achieve this through a website so users can readily search for the reporting

packages of various entities. How might this change affect NFPs?

There are at least a couple of key impacts to NFPs that undergo single audits as a result of this change

including: [1] the ease of public access to single audit information and the audited financial statements

(which are part of the reporting package) will greatly expand particularly as many NFPs have

previously not made their audited financial statements readily available to the public online; and

[2] under the Uniform Guidance for Federal Awards, subrecipients (e.g., an NFP that receives a federal

award from a state or local government) are no longer required to submit a copy of the reporting

package to pass-through entities since the reporting package will be available to pass-through entities

via the Federal Audit Clearinghouse website. (Note. As discussed in §200.512 of the Uniform

Guidance for Federal Awards, certain Indian tribes will continue to have submission requirements

related to pass-through entities. Also, some pass-through entities may impose notification/submission

requirements on subrecipients that go beyond what the Uniform Guidance for Federal Awards

requires.)


Distinguishing Contributions from Exchange Transactions

Learning Objectives 1 I. What are we talking about? 1 II. So why is this important? 1 III. How do we tell the difference? 2

A. Difficult determinations 3 1. Exercise 2-1 3

B. Part contribution, part exchange transaction 4 1. Exercise 2-2 4 2. Some special guidance related to premiums 4 3. Some special guidance related to items donated for use in fundraising 5 4. Exercise 2-3 5

C. Helpful indicators in distinguishing contributions from exchange transactions 5 1. Exercise 2-4 6

D. Membership dues 6 1. Exercise 2-5 8 2. Exercise 2-6 8

IV. What about agency transactions? 9 V. An issue on the horizon: revenue recognition 9

A. A brief look at how the new revenue recognition standard works 10 1. The 1st hurdle: Identifying the contract with a customer 10 2. Exercise 2-7 10 3. The 2nd hurdle: Identifying the performance obligations in the contract 11 4. The 3rd hurdle: Determining the transaction price 11 5. The 4th hurdle: Allocating the transaction price to the performance obligations in the contract 11 6. The 5th hurdle: Recognizing revenue when (or as) each performance obligation is satisfied 11

B. A developing area 12 VI. Suggested solutions to exercises 13

A. Suggested solution to Exercise 2-1 13 B. Suggested solution to Exercise 2-2 13 C. Suggested solution to Exercise 2-3 14 D. Suggested solution to Exercise 2-4 15 E. Suggested solution to Exercise 2-5 16 F. Suggested solution to Exercise 2-6 17 G. Suggested solution to Exercise 2-7 17


Distinguishing Contributions from Exchange Transactions

Learning Objectives


Perceive the importance of properly distinguishing contributions from

exchange transactions;

Differentiate contributions from exchange transactions.

Assess the proper classification of membership dues.

I. What are we talking about?

In this chapter, we are going to discuss the importance of properly distinguishing contributions from

exchange transactions and key aspects of the current guidance provided for how this is done. Note.

Distinguishing contributions from exchange transactions is really not an area that the FASB chose to

address/change in the Financial Statements of Not-for-Profit Entities project.

II. So why is this important?

Contributions are a significant source of revenue for many if not most NFPs. Many NFPs also rely heavily

on revenue from exchange transactions. NFPs may even be involved in transactions that consist of both

contribution and exchange transaction components. It might be tempting to just say that revenue is

revenue. However, for NFPs the categorization of a transaction as: (1) contribution revenue;

(2) exchange transaction revenue; or (3) a transaction with components of both contribution and

exchange transaction revenue is important. As reflected below, the accounting and reporting for

contributions differs from the accounting and reporting used for exchange transactions.

Distinguishing contributions from exchange transactions is important because…

Except for certain contributed services and collection items, contributions received are

recognized as revenues or gains in the period received and as assets, decreases of

liabilities, or expenses depending on the form of the benefits received. The classification

of contributions received as revenues or gains depends on whether the transactions are

part of the NFP’s ongoing major or central activities (revenues), or are peripheral or

incidental to the NFP (gains). NFPs distinguish between contributions received with

permanent restrictions, those received with temporary restrictions, and those received

without donor-imposed restrictions.

Revenue from exchange transactions follow traditional accrual generally accepted

accounting principles (e.g., revenue derived from membership dues in exchange

transactions is recognized over the period to which the dues relate). Resources

received in exchange transactions are classified as unrestricted revenues and net

assets, even in circumstances in which resource providers place limitations on the use

of the resources (although there are some disclosure considerations see FASB ASC

958-210-50-2).

Contribution

$

$

$ $

$ $

$

$

$


Whether an NFP considers a transaction to be a contribution or an exchange transaction can have a

dramatic impact on its financial statements as reflected below.

III. How do we tell the difference?

The distinction between a contribution and an exchange transaction can be found in the FASB ASC

definitions of the terms contribution and inherent contribution.

Contribution - An unconditional transfer of cash or other assets to an entity or a

settlement or cancellation of its liabilities in a voluntary nonreciprocal transfer by

another entity acting other than as an owner. Those characteristics distinguish

contributions from exchange transactions, which are reciprocal transfers in which each

party receives and sacrifices approximately equal value; from investments by owners

and distributions to owners, which are nonreciprocal transfers between an entity and

its owners; and from other nonreciprocal transfers, such as impositions of taxes or

legal judgments, fines, and thefts, which are not voluntary transfers. In a contribution

transaction, the value, if any, returned to the resource provider is incidental to potential

public benefits. In an exchange transaction, the potential public benefits are

secondary to the potential proprietary benefits to the resource provider. The term

contribution revenue is used to apply to transactions that are part of the entity’s

ongoing major or central activities (revenues), or are peripheral or incidental to the

entity (gains).

If NFP A determines the grant to be an

exchange transaction its 6/30/X1

statement of activities will likely reflect

$100,000 in revenues and the statement

of financial position will reflect $100,000 in

deferred revenues (a liability). This is

because revenues from exchange

transactions are generally recognized

based on accrual accounting principles.

If NFP A determines the grant to be a contribution

its 6/30/X1 statement of activities will likely reflect

$200,000 in revenues (either as $100,000 in

unrestricted revenues and $100,000 in temporarily

restricted revenues or $200,000 in temporarily

restricted revenues and a reclassification of $100,000

to unrestricted net assets depending on the NFP’s

policy). This is because revenues from contributions

are generally recognized when received.

NFP A has a 6/30 year end. On 1/1, NFP A received $200,000 from a grant to support program X

for the calendar year 20X1. At 6/30/X1, NFP A had incurred $100,000 in expenses related to

program X which were not funded by other sources.

A dramatic impact

In the above example, the NFP’s classification of the grant as either a contribution or an exchange

transaction results in a $100,000 difference one way or the other in the revenues reported at

6/30/X1. The NFP’s decision would hinge on whether reciprocity occurred or did not occur as part of

the grant.


Inherent Contribution - A contribution that results if an entity voluntarily transfers

assets (or net assets) or performs services for another entity in exchange for either no

assets or for assets of substantially lower value and unstated rights or privileges of a

commensurate value are not involved.

A. Difficult determinations

It is not always easy to distinguish between a contribution and an exchange transaction. Certain transfers

of assets that are exchange transactions may appear to be contributions if the services or other assets

given in exchange are perceived to be a sacrifice of little value and the exchanges are compatible with

the recipient’s mission. NFPs may receive resources under grants, awards, or sponsorships from

foundations, business entities, and other types of entities. Those asset transfers are contributions if the

resource providers receive no value in exchange for the assets transferred or if the value received by the

resource providers is incidental to the potential public benefit from using the assets transferred. A careful

assessment of the characteristics of the transaction, from the perspectives of both the resource provider

and the recipient, is necessary to determine whether a contribution has occurred.

An illustration of assessing the characteristics of the transaction

A grant made by a resource provider to an NFP would likely be a

contribution if the activity specified by the grant is to be planned and

carried out by the NFP and the NFP has the right to the benefits of

carrying out the activity.

If, however, the grant is made by a resource provider that provides

materials to be tested in the activity and that retains the right to any

patents or other results of the activity, the grant would likely be an

exchange transaction.

1. Exercise 2-1

Please review and complete the below.

Is this a contribution or an exchange transaction?

University A’s school of veterinary medicine recently received $75,000 from a dog food company to

perform a clinical trial of an experimental dog food product. The dog food company specified the

protocol for testing and requires a detailed report within 12 months. University A immediately recorded

the $75,000 cash received and temporarily restricted contribution revenue for $75,000. If you were the

auditor of University A would you agree or disagree with this treatment? If you disagree, how

would you record the receipt of the $75,000?


B. Part contribution, part exchange transaction

As illustrated below, a single transaction may be in part an exchange transaction and in part a

contribution.

What is this?

A single transaction may be in part an exchange transaction and in part a contribution.

An example of this would be where a donor transfers property to an NFP at a price

significantly lower than its market value and no unstated rights or privileges are

involved. In this scenario, the transaction is in part an exchange of assets and in part

a contribution and accounted for as such.

1. Exercise 2-2

Please answer the following question related to transactions that are part contribution and part exchange.

Is this a contribution and/or an exchange transaction?

NFP Z holds a golf outing as a fundraising event. Each player gives NFP Z $250 to play in the event.

NFP Z pays the golf course $50 per player in greens fees plus an additional $25 per player for meals

and beverages. NFP Z also provides each player with a golf shirt worth $25. Do you believe that

this transaction is in part an exchange transaction and in part a contribution? If so, how would

you allocate the $250 paid per player between the contribution and exchange transaction

components?

2. Some special guidance related to premiums

NFPs may provide potential donors and resource providers small rewards (premiums) for donating or

potentially donating to the NFP. FASB ASC 958-720-45 provides special guidance in this area.

Premiums

The cost of premiums (e.g., postcards or calendars) given to potential donors as

part of a mass fundraising appeal is fundraising expense, and the classification of

the donations received from the appeal as contributions is unaffected by the fact

that premiums were given to potential donors. The premiums are not provided to

potential donors in exchange for the assets contributed; they can be kept by all

those from whom funds are solicited, irrespective of whether a contribution is

made.

The cost of premiums (e.g., coffee mugs) that are given to resource providers to

acknowledge receipt of a contribution is also reported as fundraising expense if

those costs are nominal in value compared with the value of the goods or services

donated by the resource provider. As an example, an NFP may provide a coffee

mug to people making a contribution of $100 or more; the mug costs the NFP $2.

The NFP recognizes contributions for the total amount contributed and fundraising

expense of $2 for each mug provided to donors. The cost of premiums that are

greater than nominal in value are reported as cost of sales. If premiums are

greater than nominal in value, transactions are reported as part exchange

transaction and part contribution.

Enclosed are your mailing labels!

We’re wild about our donors!

Thank

you!


3. Some special guidance related to items donated for use in fundraising

The FASB ASC also carves out special guidance for items donated for use in fundraising. FASB ASC

958-605-25 discusses that NFPs occasionally receive items (e.g., tickets, gift certificates, works of art,

and merchandise) that are to be used for fundraising purposes by transferring them to other resource

providers (the ultimate resource provider or recipient) during fundraising events. Those gifts in kind can

be linked to asset transfers from the original resource providers to the ultimate resource providers

(recipients) because they are, in substance, part of the same transaction; those gifts in kind are reported

as contributions and measured at fair value when originally received by an NFP. The difference between

the amount received for those items from the ultimate resource providers (recipients) and the fair value of

the gifts in kind when originally contributed to the NFP are recognized as adjustments to the original

contributions when the items are transferred to the ultimate resource providers (recipients).

4. Exercise 2-3

Please answer the following related to items donated for use in fundraising.

All I have to give

NFP Z is holding its annual 1990s themed fundraiser. As part of the fundraiser, NFP Z requests and

receives donated items which it auctions off to the highest bidder. This year, NFP Z received a ticket to

a future concert that former pop icons Backstreet Ice are holding in the area. The fair value of the ticket

is believed to be $100. Thus, when NFP Z received the ticket it recorded a $100 contribution and an

asset for $100. Please answer the following questions related to the results of the auction under

two different scenarios.

The auction goes well

Many attendees at the auction are Backstreet Ice

fans and a bidding war erupts. The ticket is

auctioned off for $150. What entry would NFP Z

record?

The auction does not go well

Few attendees at the auction are Backstreet Ice

fans (or they are afraid to publicly admit it by

bidding on the ticket). The ticket is auctioned off

for $50 to the cleaning crew which wants to turn off

the lights and go home. What entry would NFP Z

record?

C. Helpful indicators in distinguishing contributions from exchange transactions

The following chart discusses indicators that may be helpful in determining whether individual asset

transfers are contributions, exchange transactions, or a combination of both.

Helpful indicators

Indicators that may be helpful in determining whether individual asset transfers are

contributions, exchange transactions, or a combination of both include: (1) the

resource provider’s expressed intent about the purpose of the asset or service to be

provided by the recipient NFP; (2) the recipient NFP’s intent in soliciting the asset or

service; (3) the method of delivery; (4) the method of determining the amount of

payment; (5) whether penalties are assessed if the NFP fails to make timely delivery of

assets; and (6) the delivery of assets or services to be provided by the recipient NFP.

Exchange Transaction Contribution


Some indicators may be more significant than others depending on the facts and circumstances. No

single indicator is determinative of the classification of a particular transaction. Indicators of a contribution

tend to describe transactions in which the value, if any, returned to the resource provider is incidental to

potential public benefits. Indicators of an exchange tend to describe transactions in which the potential

public benefits are secondary to the potential proprietary benefits to the resource provider.

1. Exercise 2-4

Please read the fact presented in the left column below and place an X in the right column as to whether

the fact presented is indicative of a contribution or an exchange transaction.

Contribution

Exchange transaction

1 Resource Provider A asserts that it is making a donation to support NFP B’s programs.

2 Resource Provider A asserts that it is transferring resources in exchange for specified benefits.

3 Recipient NFP B asserts that it is soliciting an asset as a contribution.

4 Recipient NFP B asserts that it is seeking resources in exchange for specified benefits.

5 The method of delivery of the asset to be provided by Recipient NFP B to third-party recipients is specified by Resource Provider A.

6 The time or place of delivery of the asset to be provided by Recipient NFP B to third-party recipients is at the discretion of Recipient NFP B.

7 Resource Provider A determines the amount of the payment.

8 Payment by Resource Provider A equals the value of the assets to be provided by Recipient NFP B, or the assets’ cost plus markup; the total payment is based on the quantity of assets to be provided.

9 Penalties are limited to the delivery of assets already produced and the return of the unspent amount. NFP B is not penalized for nonperformance.

10 Provisions for economic penalties exist beyond the amount of payment. NFP B is penalized for nonperformance.

11 Assets are to be delivered to Resource Provider A or to individuals or organizations closely connected to Resource Provider A.

12 Assets are to be delivered to individuals or organizations other than Resource Provider A.

D. Membership dues

Some NFPs use the term members to refer to their donors and other NFPs use the term to refer to

individuals or other entities that pay dues in exchange for a defined set of benefits. The determination of

whether membership dues are contributions, exchange transactions, or a combination of both is important

and sometimes difficult for the reasons we have been discussing. The illustration on the following page

discusses membership dues.


Membership dues

NFPs may receive dues from their members. These transfers often have elements of

both a contribution and an exchange transaction because members receive tangible or

intangible benefits from their membership in the NFP. Usually, the determination of

whether membership dues are contributions rests on whether the value received by

the member is commensurate with the dues paid. As an example, NFP Z has annual

dues of $200 and the only benefit members receive is a year-long, unrestricted access

to an informational website with a fair value of $50. For NFP Z, $50 of the dues are

received in an exchange transaction and are recognized as revenue as the earnings

process is completed and $150 of the dues are a contribution.

As discussed earlier, revenue derived from membership dues in exchange transactions is recognized

over the period to which the dues relate. Nonrefundable initiation and life membership fees received in

exchange transactions are recognized as revenues in the period in which the fees become receivable if

future fees are expected to cover the costs of future services to be provided to members. If

nonrefundable initiation and life membership fees, rather than future fees, are expected to cover those

costs, nonrefundable initiation and life member fees received in exchange transactions are recognized as

revenue over the average duration of membership, the life expectancy of members, or other appropriate

time periods.

Must member benefits be used to have value?

Regardless of how often (or whether) the benefits are used, member benefits

generally have value. For example, a health club membership is an exchange

transaction, even if the member stops using the facilities before the completion

of the membership period.

The following chart discusses indicators that may be helpful in determining whether membership dues are

contributions, exchange transactions, or a combination of both.

Helpful indicators

Indicators that may be helpful in determining whether membership dues are

contributions, exchange transactions, or a combination of both include: (1) the

recipient NFP’s expressed intent concerning the purpose of the dues payment; (2) the

extent of benefits to members; (3) the NFP’s service efforts; (4) the duration of

benefits; (5) the expressed agreement concerning refundability of the payment; and

(6) the qualifications for membership.

Depending on the facts and circumstances, some of the above indicators may be more significant than

others. However, no single indicator is determinative of the classification of a particular transaction.

Join us!

I had good intentions!

Exchange Transaction Contribution


1. Exercise 2-5

Please read the fact presented in the left column below and place an X in the right column as to whether

the fact presented is indicative of a contribution or an exchange transaction.

Contribution


1 NFP A’s request for dues payment describes the dues as providing economic benefits to members or to other organizations or individuals designated by or related to the members.

2 NFP A’s request for dues payment describes the dues as being used to provide benefits to the general public or to NFP A’s service beneficiaries.

3 The benefits to members are negligible.

4 The substantive benefits to members (e.g., publications, admissions, educational programs, and special events) may be available to nonmembers for a fee.

5 NFP A provides service to members and nonmembers.

6 NFP A’s benefits are provided to members only.

7 Membership benefits are provided for a defined period; additional payment of dues is required to extend benefits.

8 The duration of membership benefits is not specified.

9 The dues payment is fully or partially refundable if the resource provider withdraws from membership.

10 The dues payment is not refundable to the resource provider.

11 Membership in NFP A is available to the general public.

12 Membership in NFP A is available only to individuals who meet certain criteria (e.g., requirements to pursue a specific career or to live in a certain area).

2. Exercise 2-6

Please answer the following question related to membership dues.

What should I record at year end?

Trade Association X believes that all of its annual membership dues are exchange transaction revenue.

So, Trade Association X originally records a deferred revenue amount and then recognizes the revenue

on a monthly basis throughout the year for which the dues relate. Trade Association X has a 9/30 year

end and bills its members for the upcoming year (i.e., 10/1 to 9/30) around 7/31 each year. This year at

7/31, Trade Association X invoiced its existing members in total for $10,000,000 for the upcoming year

which it recorded in its subsidiary ledger as accounts receivable (dr.) and deferred revenue (cr.).

Between 7/31 and 9/30 members paid $7,000,000 in dues for the upcoming year for which Trade

Association X recorded cash (dr.) and reduced the receivable (cr.). In its 9/30 financial statements,

what amount of deferred revenue and accounts receivable would you suggest that Trade

Association X report related to these dues on its statement of financial position?


IV. What about agency transactions?

In this chapter we have discussed how to distinguish a contribution from an exchange transaction. Some

NFPs also receive transfers of resources in an agency, trustee, or intermediary role. Federated

fundraising organizations, community foundations, and institutionally related entities are examples of

NFPs that ordinarily serve as agents, trustees, or intermediaries, but any NFP can function in those roles.

Just passing through

A transfer of assets may appear to be a contribution when a donor uses an agent, a trustee, or an

intermediary to transfer assets to a donee. Receipts of resources as an agent, trustee, or

intermediary of a donor are not contributions received to the agent because the recipient of

assets who is an agent or trustee has little or no discretion in determining how the assets

transferred will be used. For the same reason, deliveries of resources as an agent, trustee, or

intermediary of a donor are not contributions made by the agent. Similarly, contributions of

services (time, skills, or expertise) between donors and donees that are facilitated by an intermediary

are not contributions received or contributions made by the intermediary. FASB ASC 958-605 contains

guidance for NFPs or charitable trusts that raise or hold contributions for others.

V. An issue on the horizon: revenue recognition

In this chapter, we have discussed the importance of and some of the key determinations involved in

distinguishing contributions from exchange transactions. Before ending the chapter, we also want to

touch on a potentially significant issue on the horizon for NFPs. FASB ASU No. 2014-09, Revenue from

Contracts with Customers (Topic 606), (i.e., the new revenue recognition standard) will impact most NFPs

for annual reporting periods beginning after December 15, 2018. Certain NFPs with public debt will be

impacted for annual reporting periods beginning after December 15, 2017. While we are still a few years

from implementing the standard, and the implementation guidance for NFPs is still very much in the

developmental stage, it is not too early to begin thinking about the new revenue recognition standard.

The degree to which the new revenue recognition standard will impact an NFP depends upon the types of

revenues that the NFP receives and the timing of when the revenues are received (i.e., to some degree,

the closer the revenue stream aligns to the fiscal year of the NFP the lesser the potential impact may be).

The good news and bad news for NFPs

The main good news related to the new revenue recognition standard for NFPs is that

contributions and investment income are not subject to the standard. The bad news is

that many other revenues will be covered by the new revenue recognition standard (e.g.,

membership dues, subscriptions, tuition, fees for services, retail sales, licensing, and

potentially government grants and contracts).

$ Resource provider or donor Recipient entity Specified beneficiary

$ $ $ $ $ $

I made it here!

I’m just passing through.

Wait for me.


A. A brief look at how the new revenue recognition standard works

As illustrated below, under the new revenue recognition standard, revenue will be recognized after five

hurdles are cleared.

Under the new revenue recognition standard revenue will be recognized after five hurdles are cleared:

The 1st hurdle The NFP will identify the contract with a customer.

The 2nd hurdle The NFP will identify the performance obligations in the contract.

The 3rd hurdle The NFP will determine the transaction price.

The 4th hurdle The NFP will allocate the transaction price to the performance obligations in the contract.

The 5th hurdle The NFP will recognize revenue when (or as) each performance obligation is satisfied.

In the following sections, we will look at aspects of each of the five hurdles.

1. The 1st hurdle: Identifying the contract with a customer

When the new revenue recognition standard refers to a contract with a customer it does not have to be a

written contract. A contract may be oral or even implied by the entity’s customary business practices, but

it needs to create rights and obligations that are legally enforceable against the parties. A contract does

not exist if a party can terminate the contract prior to any performance occurring without compensating

the other party. A critical part of the 1st hurdle for some NFPs will be distinguishing transactions that are

part exchange transaction and part contribution between the two components. This will be important

because the exchange transaction component will likely be considered to be a contract with a customer

(and thus subject to the new revenue recognition standard) while the contribution component will not (and

thus not subject to the new revenue recognition standard).

An illustration related to the 1st hurdle

Zoo X offers memberships to its supporters. The annual memberships go for $250

each. Zoo X has determined that $100 of this amount is a contribution and that $150 is

an exchange transaction for benefits that members receive. In applying the 1st hurdle,

Zoo X will likely conclude that $100 of the membership is a contribution and thus not

subject to the new revenue recognition standard and $150 of the membership is an

exchange transaction (i.e., a contract) subject to the new revenue recognition standard.

2. Exercise 2-7

Please review and answer the following question.

When do I have a contract?

In Exercise 2-6 we discussed Trade Association X which believes that all of its annual membership

dues are exchange transaction revenue. We also saw that Trade Association X has a 9/30 year end

and bills its members for the upcoming year (i.e., 10/1 to 9/30) around 7/31 each year. Under the new

revenue recognition standard do you believe Trade Association X would say it has a contract

with the customer on: (1) 7/31 when it bills the customer; or (2) when it actually receives the

renewal payment?


3. The 2nd hurdle: Identifying the performance obligations in the contract

A performance obligation is a promise in a contract with a customer to transfer a good or service to the

customer. At the inception of a contract, the entity will assess the goods or services promised to be

transferred to the customer and identify as a performance obligation each promise to transfer to the

customer either: (1) a good or service, or bundle of goods or services, that is distinct; or (2) a series of

distinct goods or services that are substantially the same and that have the same pattern of transfer to the

customer.

An illustration related to the 2nd hurdle

The annual memberships at Zoo X go for $250 each. Zoo X has determined that $100

of this amount is a contribution and that the remaining $150 is a contract for benefits

that members receive (i.e., the performance obligations). In the 2nd hurdle, Zoo X will

identify the specific performance obligations and their characteristics. For example,

Zoo X determines that the benefits provided consist of: (1) an annual pass to Zoo X;

(2) a monthly newsletter; and (3) attendance at the annual Zoofest Gala.

4. The 3rd hurdle: Determining the transaction price

The transaction price is the amount of consideration that the entity expects to be entitled to in exchange

for transferring the promised goods or services to the customer.

An illustration related to the 3rd hurdle

Zoo X determines that the benefits provided (i.e., the annual pass to Zoo X; the monthly

newsletter; and attendance at the annual Zoofest Gala) are valued at $150.

5. The 4th hurdle: Allocating the transaction price to the performance obligations in the contract

When a contract has only one performance obligation, the entire transaction price is attributed to that

performance obligation. If the contract has more than one performance obligation, the transaction price

will be allocated among the individual performance obligations. That allocation is done based on the

stand-alone selling price of each of the distinct goods or services underlying the performance obligations.

An illustration related to the 4th hurdle

Zoo X determines that the $150 exchange transaction (i.e., contract) component of the

membership consists of: (1) an annual pass to Zoo X valued at $50; (2) a monthly

newsletter valued at $25; and (3) attendance at the annual Zoofest Gala valued at $75.

6. The 5th hurdle: Recognizing revenue when (or as) each performance obligation is satisfied

The 5th hurdle in the new revenue recognition standard is to recognize revenue. Recognition of revenue

occurs when or as each performance obligation is satisfied by transferring the promised good or service

to the customer.

An illustration related to the 5th hurdle

In the example of Zoo X, the annual pass to the zoo and monthly newsletter would likely

be recognized as revenue over the 12 months and the amount allocated to the annual

Zoofest Gala would likely be recognized after the event.


B. A developing area

As we mentioned at the start of our discussion of the new revenue recognition standard, the

implementation guidance for NFPs is still very much in the developmental stage. The FASB, AICPA, and

others will hopefully be putting out a fair amount of implementation guidance over the next few years.

One area that NFPs will want to watch carefully is how the new revenue recognition standard will

potentially impact the accounting for government grants and contracts. This is an area of continuing

discussion.

A significant area to watch

Traditionally, most government grants and contracts received by NFPs have been

treated as exchange transactions instead of contributions. This is essentially based on

the concept that the government is not making a contribution. Instead, in receiving the

grant, the NFP is essentially fulfilling a function that the government has assigned to it.

However, deeming a government grant or contract to be an exchange transaction

in the future would likely result in that transaction being subject to the new revenue

recognition standard including its disclosure requirements. Many feel that this was not

the FASB’s intention and that applying the new revenue recognition standard to

government grants and contracts would be problematic. Some believe a possible

solution is for NFPs to treat government grants and contracts as conditional

contributions in the future. However, as this course was written in the spring of 2016,

the issue was still very much unresolved and NFPs should watch for additional

guidance to be issued in this and other areas.

Caution!

Contentious Area


VI. Suggested solutions to exercises



Is this a contribution or an exchange transaction?

University A’s school of veterinary medicine recently received $75,000 from a dog food company to

perform a clinical trial of an experimental dog food product. The dog food company specified the

protocol for testing and requires a detailed report within 12 months. University A immediately recorded

the $75,000 cash received and temporarily restricted contribution revenue for $75,000. If you were the

auditor of University A would you agree or disagree with this treatment? If you disagree, how

would you record the receipt of the $75,000?

In the author’s opinion, the transaction appears to be an exchange transaction instead of a contribution

based upon the reciprocity involved (e.g., the dog food company is getting a clinical trial of their product,

the trial is based upon the dog food company’s protocol, and the university is required to submit a

detailed report). The author would have recorded the transaction as a debit to cash for $75,000 and a

credit to a liability account (deferred revenue or refundable advance) for $75,000.


Is this a contribution and/or an exchange transaction?

NFP Z holds a golf outing as a fundraising event. Each player gives NFP Z $250 to play in the event.

NFP Z pays the golf course $50 per player in greens fees plus an additional $25 per player for meals

and beverages. NFP Z also provides each player with a golf shirt worth $25. Do you believe that

this transaction is in part an exchange transaction and in part a contribution? If so, how would

you allocate the $250 paid per player between the contribution and exchange transaction

components?

In this scenario, there certainly appears to be reciprocity involved as each player is paying $250 to play

in the event and is receiving a benefit in exchange worth $100 (i.e., the $50 per player in greens fees,

$25 per player for meals and beverages, and the golf shirt worth $25). Based on the level of reciprocity

involved, NFP Z would likely say that $150 is a contribution and $100 is an exchange transaction.

Note. Later in the course, we will discuss the presentation of special events in the statement of

activities.



All I have to give

NFP Z is holding its annual 1990s themed fundraiser. As part of the fundraiser, NFP Z requests and

receives donated items which it auctions off to the highest bidder. This year, NFP Z received a ticket to

a future concert that former pop icons Backstreet Ice are holding in the area. The fair value of the ticket

is believed to be $100. Thus, when NFP Z received the ticket it recorded a $100 contribution and an

asset for $100. Please answer the following questions related to the results of the auction under

two different scenarios.

The auction goes well

Many attendees at the auction are Backstreet Ice

fans and a bidding war erupts. The ticket is

auctioned off for $150. What entry would NFP Z

record?

NFP Z would credit an additional $50 in

contributions, credit the ticket asset for $100, and

debit cash for $150.

The auction does not go well

Few attendees at the auction are Backstreet Ice

fans (or they are afraid to publicly admit it by

bidding on the ticket). The ticket is auctioned off

for $50 to the cleaning crew which wants to turn off

the lights and go home. What entry would NFP Z

record?

NFP Z would debit (i.e., reduce) contributions by

$50, credit the ticket asset for $100, and debit

cash for $50.



Contribution


1 Resource Provider A asserts that it is making a donation to support NFP B’s programs.

X

2 Resource Provider A asserts that it is transferring resources in exchange for specified benefits.

X

3 Recipient NFP B asserts that it is soliciting an asset as a contribution. X

4 Recipient NFP B asserts that it is seeking resources in exchange for specified benefits.

X

5 The method of delivery of the asset to be provided by Recipient NFP B to third-party recipients is specified by Resource Provider A.

X

6 The time or place of delivery of the asset to be provided by Recipient NFP B to third-party recipients is at the discretion of Recipient NFP B.

X

7 Resource Provider A determines the amount of the payment. X

8 Payment by Resource Provider A equals the value of the assets to be provided by Recipient NFP B, or the assets’ cost plus markup; the total payment is based on the quantity of assets to be provided.

X

9 Penalties are limited to the delivery of assets already produced and the return of the unspent amount. NFP B is not penalized for nonperformance.

X

10 Provisions for economic penalties exist beyond the amount of payment. NFP B is penalized for nonperformance.

X

11 Assets are to be delivered to Resource Provider A or to individuals or organizations closely connected to Resource Provider A.

X

12 Assets are to be delivered to individuals or organizations other than Resource Provider A.

X



Contribution


1 NFP A’s request for dues payment describes the dues as providing economic benefits to members or to other organizations or individuals designated by or related to the members.

X

2 NFP A’s request for dues payment describes the dues as being used to provide benefits to the general public or to NFP A’s service beneficiaries.

X

3 The benefits to members are negligible. X

4 The substantive benefits to members (e.g., publications, admissions, educational programs, and special events) may be available to nonmembers for a fee.

X

5 NFP A provides service to members and nonmembers. X

6 NFP A’s benefits are provided to members only. X

7 Membership benefits are provided for a defined period; additional payment of dues is required to extend benefits.

X

8 The duration of membership benefits is not specified. X

9 The dues payment is fully or partially refundable if the resource provider withdraws from membership.

X

10 The dues payment is not refundable to the resource provider. X

11 Membership in NFP A is available to the general public. X

12 Membership in NFP A is available only to individuals who meet certain criteria (e.g., requirements to pursue a specific career or to live in a certain area).

X


F. Suggested solution to Exercise 2-6

What should I record at year end?

Trade Association X believes that all of its annual membership dues are exchange transaction revenue.

So, Trade Association X originally records a deferred revenue amount and then recognizes the revenue

on a monthly basis throughout the year for which the dues relate. Trade Association X has a 9/30 year

end and bills its members for the upcoming year (i.e., 10/1 to 9/30) around 7/31 each year. This year at

7/31, Trade Association X invoiced its existing members in total for $10,000,000 for the upcoming year

which it recorded in its subsidiary ledger as accounts receivable (dr.) and deferred revenue (cr.).

Between 7/31 and 9/30 members paid $7,000,000 in dues for the upcoming year for which Trade

Association X recorded cash (dr.) and reduced the receivable (cr.). In its 9/30 financial statements,

what amount of deferred revenue and accounts receivable would you suggest that Trade

Association X report related to these dues on its statement of financial position?

This is an area where some divergence in practice exists today. Trade Association X would most likely

report deferred revenue in the amount of $7,000,000 (i.e., the actual amount that members had paid at

9/30) and not reflect a receivable. However, some NFPs may try to pursue a somewhat more

aggressive position of reporting the entire $10,000,000 in deferred revenue and the remaining

$3,000,000 in accounts receivable if they believe that they will actually receive these amounts shortly

after year end.

G. Suggested solution to Exercise 2-7

When do I have a contract?

In Exercise 2-6 we discussed Trade Association X which believes that all of its annual membership

dues are exchange transaction revenue. We also saw that Trade Association X has a 9/30 year end

and bills its members for the upcoming year (i.e., 10/1 to 9/30) around 7/31 each year. Under the new

revenue recognition standard do you believe Trade Association X would say it has a contract

with the customer on: (1) 7/31 when it bills the customer; or (2) when it actually receives the

renewal payment?

Under the new revenue recognition standard, Trade Association X would most likely say that it has a

contract when it actually receives the renewal payment as until that occurs rights and obligations do not

exist between the parties as the member has not accepted the “contract.” Note. In the solution to

Exercise 2-6 we saw that some NFPs today try to record deferred revenues and accounts receivable for

billed amounts instead of billed and received amounts. Under the new revenue recognition standard,

this position will be much more difficult to take as a contract is not in place just based on the billing.


Conditional and Unconditional Promises to Give

Learning Objectives 1 I. What are we talking about? 1 II. So why is this important? 1 III. Understanding the terminology 2

A. Exercise 3-1 3 IV. Conditional versus unconditional promises to give 4

A. Unconditional promises to give 4 B. Conditional promises to give 4 C. Exercise 3-2 5 D. A difficult determination 6 E. Exercise 3-3 6

V. Valuing unconditional promises to give when received 7 A. Exercise 3-4 9

VI. Key disclosures related to promises to give 9 VII. Common auditing procedures related to contributions 10

A. The importance of controls related to contributions receivable 11 VIII. Suggested solutions to exercises 12

A. Suggested solution to Exercise 3-1 12 Suggested solution to Exercise 3-1 (continued) 13 B. Suggested solution to Exercise 3-2 14 C. Suggested solution to Exercise 3-3 15 D. Suggested solution to Exercise 3-4 16


Conditional and Unconditional Promises to Give

Learning Objectives


Explain the importance of properly distinguishing between donor-imposed

conditions and donor-imposed restrictions;

Identify key FASB ASC terminology related to contributions;

Discern conditional promises to give from unconditional promises to give;

Value unconditional promises to give when received;

Perceive selected disclosure considerations; and

Identify common auditing procedures employed related to contributions.


In this chapter, we are going to discuss the importance of properly discerning conditional promises to give

from unconditional promises to give and key aspects of the current guidance provided for how this is

done. Note. Distinguishing conditional promises to give from unconditional promises to give is really not

an area that the FASB chose to address/change in the Financial Statements of Not-for-Profit Entities

project.

II. So why is this important?

As stated in the last chapter, contributions are a significant source of revenues for many if not most NFPs.

Sometimes donors impose conditions, restrictions, or both in their communications to NFPs. As reflected

below, it is important to distinguish donor-imposed conditions from donor-imposed restrictions.

Distinguishing between donor-imposed conditions and donor-imposed restrictions is important because…

Conditional transfers are not contributions yet; they may become contributions

upon the occurrence of one or more future and uncertain events. Due to the

uncertainty about whether they will be met, conditions imposed by resource

providers may cast doubt on whether the resource provider’s intent was to

make a contribution, to make a conditional contribution, or to make no

contribution. Because of this uncertainty, donor-imposed conditions should

be substantially met by the entity before the receipt of assets (including

contributions receivable) is recognized as a contribution. In contrast to

donor-imposed conditions, donor-imposed restrictions limit the use of the

contribution, but they do not change the fundamental nature of the

contribution transaction or conclusions about when to recognize the

underlying event.

So you kind of, sort of, maybe, might, plan to donate something to us?


III. Understanding the terminology

Before we delve into the topic of distinguishing between conditional and unconditional promises to give, it

is important to understand the following terminology from the FASB ASC upfront.

Conditional Promise to Give - A promise to give that depends on the occurrence of a

specified future and uncertain event to bind the promisor.

Donor-Imposed Condition - A donor stipulation that specifies a future and uncertain

event whose occurrence or failure to occur gives the promisor a right of return of the

assets it has transferred or releases the promisor from its obligation to transfer its assets.

Donor-Imposed Restriction - A donor stipulation that specifies a use for a contributed

asset that is more specific than broad limits resulting from the following: (1) the nature of

the NFP; (2) the environment in which it operates; and (3) the purposes specified in its

articles of incorporation or bylaws or comparable documents for an unincorporated

association.

A donor-imposed restriction on an NFP’s use of the asset contributed may be temporary

or permanent. Some donor-imposed restrictions impose limits that are permanent, for

example, stipulating that resources be invested in perpetuity (not used up). Others are

temporary, for example, stipulating that resources may be used only after a specified

date, for particular programs or services, or to acquire buildings and equipment.

Promise to Give - A written or oral agreement to contribute cash or other assets to

another entity. A promise carries rights and obligations - the recipient of a promise to

give has a right to expect that the promised assets will be transferred in the future, and

the maker has a social and moral obligation, and generally a legal obligation, to make the

promised transfer. A promise to give may be either conditional or unconditional.

Stipulation - A statement by a donor that creates a condition or restriction on the use of

transferred resources.

Unconditional Promise to Give - A promise to give that depends only on passage of

time or demand by the promisee for performance.

In addition to the above, it should also be noted that a restriction on an NFP’s use of contributed assets

may result either from a donor’s explicit stipulation or from circumstances surrounding the receipt of the

contribution that make clear the donor’s implicit restriction on use. Receipts of unconditional promises to

give with payments due in future periods are reported as restricted support unless 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. It is reasonable to assume that by specifying future

payment dates donors indicate that their gift is to support activities in each period in which a payment is

scheduled. As an example, receipts of unconditional promises to give cash in future years generally

increase temporarily restricted net assets.


A. Exercise 3-1

Please review and complete the following exercise related to promises to give.

Is this a promise to give?

You are the auditor of NFP Z and are having lunch with the CFO. The CFO mentions that earlier in the

morning, the CEO of NFP Z stopped by her office and relayed some information regarding a possible

promise to give. A few months ago, the CEO was attending a basketball game with NFP Z’s board of

directors and at one point during the game one of the board members told the CEO that he would give

NFP Z $25,000 at the end of the year if NFP Z really needed it. The CEO did not obtain any written

documentation of the “promise to give” and said that he honestly does not remember which board

member made the promise as it was made when the game was in double overtime. It is now late in the

year and NFP Z does need the $25,000. The CEO would like to have the $25,000 recognized now.

When pressed for more details, the CEO stated that he did not want to call the board members to ask

which one made the offer as it might be embarrassing. The CEO is confident the board member who

made the offer will come forward and donate to NFP Z once they see NFP Z’s financial statements.

The CFO asks for your thoughts as to whether NFP Z has received a promise to give that should

be recognized in the financial statements. How would you answer the CFO?

Pledges

Congratulations, you are the recently hired controller of NFP W. As you examine NFP W’s general

ledger and previous financial statements you notice that NFP W has never recorded any unconditional

promises to give in the past. When you ask the accounting and development staff about this, they state

that the prior controller said that NFP W receives “pledges” instead of “promises to give” and since the

terminology “pledges” is not utilized in FASB ASC 958 there is nothing to record until the cash is

received.

What is the difference between “pledges” and “promises to give” and was the former controller

right?

When might this occur?

We saw earlier that receipts of unconditional promises to give with payments due in future periods are

reported as restricted support unless 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.

Please provide a scenario where a donor might make an unconditional promise to give with

payments due in future periods and specify that they intend it to be used to support activities of

the current period?


IV. Conditional versus unconditional promises to give

Thus far, we have discussed the differences between restrictions and conditions and key terminology, we

will now discuss how those concepts relate to conditional and unconditional promises to give.

A. Unconditional promises to give

As illustrated below, since unconditional promises to give depend only on the passage of time or demand

by the promisee for performance, they are recognized when received.

Recognizing unconditional promises to give

Since unconditional promises to give depend only on the passage of time or

demand by the promisee for performance, they are recognized when received.

To be recognized, there must be sufficient evidence in the form of verifiable

documentation that a promise was made and received.

A communication that does not indicate clearly whether it is a promise is

considered an unconditional promise to give if it indicates an unconditional

intention to give that is legally enforceable. Legal enforceability refers to the

availability of legal remedies, not the intent to use them.

Solicitations for donations that clearly include wording such as information to be used for budget

purposes only or that clearly and explicitly allow resource providers to rescind their indications that they

will give are intentions to give rather than promises to give and are not reported as contributions.

B. Conditional promises to give

As illustrated below, conditional promises to give are recognized when the conditions on which they

depend are substantially met.

Not recognizing conditional promises to give

Conditional promises to give, which depend on the occurrence of a specified

future and uncertain event to bind the promisor, are recognized when the

conditions on which they depend are substantially met, that is, when the

conditional promise becomes unconditional. Imposing a condition creates a

barrier that must be overcome before the recipient of the transferred assets

has an unconditional right to retain those promised assets. For example, a

transfer of cash with a promise to contribute that cash if a like amount of new

gifts are raised from others within 30 days and a provision that the cash be

returned if the gifts are not raised imposes a condition on which a promised

gift depends.

A conditional promise to give is considered unconditional if the possibility that the condition will not be met

is remote. As an example, a stipulation that an annual report must be provided by the donee to receive

subsequent annual payments on a multiyear promise is not a condition if the possibility of not meeting

that administrative requirement is remote.

Hey, I recognize that!

Dude, I just don’t recognize that.


A transfer of assets with a conditional promise

A transfer of assets with a conditional promise to contribute them is accounted

for as a refundable advance (a liability) until the conditions have been

substantially met or explicitly waived by the donor. When the conditions are

substantially met, the refundable advance is recognized as revenue or gain.

Some entities transfer cash or other assets with both donor-imposed restrictions and stipulations that

impose a condition on which a gift depends. If a restriction and a condition exist, the transfer is

accounted for as a refundable advance until the condition on which it depends is substantially met. A

transfer of assets after a conditional promise to give is made and before the conditions are met is the

same as a transfer of assets with a conditional promise to contribute those assets. A change in the

original conditions of the agreement between the promisor and promisee is not implied without an explicit

waiver.

C. Exercise 3-2

Please review and complete the following exercise.

Is this a conditional or unconditional promise to give?

On June 27, Benefactor B promises to contribute $1 for every $2 of contributions received by NFP A

prior to October 1, up to $50,000. From June 27 to June 30, NFP A did not receive any contributions

from other resource providers.

Should any of the amounts promised by Benefactor B be recognized in the financial statements

as of June 30?

During July, NFP A receives contributions of $17,000 from other resource providers. Should

any of the amounts promised by Benefactor B be recognized in the financial statements as of

July 31?

$

I wonder if they are coming back for me?


D. A difficult determination

Determining whether a promise is conditional or unconditional can be difficult if it contains donor

stipulations that do not clearly state whether the right to receive payment or delivery of the promised

assets depends on meeting those stipulations. It may be difficult to determine whether those stipulations

are conditions or restrictions.

When unclear donor stipulations are present…

Professionals will review the facts and circumstances surrounding the

gift and communicate with the donor. If the ambiguity cannot be

resolved as a result of those efforts, a promise containing stipulations

that are not clearly unconditional is presumed to be a conditional

promise. However, if the possibility that the condition will not be met

is remote, a conditional promise to give is considered unconditional.

The absence of a specified time for transfer of cash or other assets, by itself, does not necessarily lead to

a determination that a promise to give is ambiguous. If the parties fail to express the time or place of

performance and performance is unconditional, performance within a reasonable time after making a

promise is an appropriate expectation; likewise, if a promise is conditional, performance within a

reasonable time after fulfilling the condition is an appropriate expectation. Promises to give that are silent

about payment terms but otherwise are clearly unconditional are accounted for as unconditional promises

to give.

E. Exercise 3-3


Two More Cases

Situation

Should the promise to give be recognized in the financial statements?

1

Benefactor Z owns a retail shopping space that

presently is unoccupied. Benefactor Z promises

to give NFP A free use of the space for as long

as it is available. NFP A needs the space and

accepts the offer. Benefactor Z says she expects

to give NFP A 30 days advance notice before

they need to vacate although Benefactor Z may

discontinue providing space at any time.

2

Benefactor K promises to give NFP J his entire

estate when he dies and provides a written copy

of the will. Benefactor K states that his estate will

be worth $4,000,000.

Pick me! Pick me!


V. Valuing unconditional promises to give when received

After an NFP has determined that it has received a communication from a donor that is both unconditional

and a promise to give, its attention turns to recording the transaction. Unconditional promises to give are

recorded at fair value when received. As shown in the following, a critical factor in determining fair value

for unconditional promises to give depends on the expected collection date of the promise.

Determining the fair value of unconditional promises to give cash

Unconditional promises to give cash expected to be collected in less than one year are

recorded at fair value. Unconditional promises to give that are expected to be collected in less

than one year may be measured at net realizable value because that amount results in a

reasonable estimate of fair value. In most cases, the net realizable value is the face value of the

promise net of any estimated uncollectible amount.

Author’s Note: Different NFPs have differing methodologies for estimating the uncollectible

amount of unconditional promises to give. Some NFPs set a certain dollar threshold and for

promises over that threshold the promises are evaluated individually (i.e., an allowance is

determined based on the individual donor and his/her ability to pay) and for the portfolio of

promises below the threshold, a uniform percentage is used based on the history and experience

of the NFP.

Unconditional promises to give cash expected to be collected in more than one year are

recorded at fair value. The present value of the future cash flows is one valuation technique for

measuring the fair value of contributions arising from unconditional promises to give cash; other

valuation techniques are also available (see FASB ASC 820, Fair Value Measurement). FASB

ASC 958-605-55-22 provides the following illustration of the use of present value techniques for

initial recognition and measurement of unconditional promises to give cash that are expected to

be collected one year or more after the financial statement date.

Facts: NFP A receives a promise (or promises from a group of homogeneous donors) to give

$100 in five years, that the anticipated future cash flows from the promise(s) are $70, and that

the present value of the future cash flows is $50.

Solution:

dr. Contributions receivable $70

cr. Contribution revenue – temporarily restricted $50

cr. Discount on contributions receivable $20

(Note: Some NFPs maintain a subsidiary ledger to retain information concerning the $100 face

amount of contributions promised in order to monitor collections of contributions promised.)

Author’s Note: Different NFPs have differing methodologies for selecting the discount rate for

unconditional promises to give in more than one year. The discount rate is supposed to be

based upon the risks involved. Some NFPs begin by estimating the allowance for the

uncollectible amounts and spreading that allowance to the receivables (i.e., to arrive at an

estimated stream of cash flows) and then applying the discount using a risk-free rate with a

minor adjustment to get to a risk-adjusted discount rate.


FASB ASC 820 describes factors to be taken into account in determining an appropriate risk-adjusted

discount rate if present value techniques are used for measuring fair value. The discount rate utilized in

the fair value measurement of a promise to give will be determined at the time the unconditional promise

to give is initially recognized and not subsequently revised unless the NFP has elected the fair value

option (FASB ASC 825-10, Financial Instruments) to measure the promise to give.

Determining the fair value of unconditional promises to give noncash assets

Unconditional promises to give noncash assets expected to be collected in less than one

year are recorded at fair value. Unconditional promises to give that are expected to be collected

in less than one year may be measured at net realizable value as an estimate of their fair value.

Unconditional promises to give noncash assets expected to be collected in more than

one year are recorded at fair value. FASB ASC 820 provides that present value techniques are

one method of measuring fair value and that other methods are possible. When present value

techniques are used, the fair value of an unconditional promise to give noncash assets could be

based on the present value of the projected fair values of the noncash assets at the date and in

the quantities that those assets are to be received. The fair value of the noncash assets today

might not necessarily represent the projected fair values of those assets at the date they are

expected to be received. The fair value of the noncash assets at the date the promise is

received could be used to measure the fair value of the contribution if it is hard to determine the

projected fair value of the underlying assets. A discount would not be recorded in that situation.

Between the time that an unconditional promise to give is initially recorded and the time it is actually

collected, the fair value of the promise can change. Thus, until unconditional promises to give are

collected, they are reevaluated in each subsequent period.

Reevaluations

Recorded unconditional promises to give cash or noncash assets may require periodic

adjustment for: (a) accrual of the interest element for a promise to give measured using

present value techniques; (b) changes in the quantity or nature of assets expected to be

received; (c) changes in the projected fair value of the underlying noncash assets at the

date that those assets are expected to be received; (d) changes in the timing of assets

expected to be received; (e) changes in the time value of money; and (f) changes in fair

value that are required to be recognized if the NFP has elected the fair value option.

NFPs have disclosure requirements related to the valuation of unconditional promises to give (e.g., NFPs

present a schedule of unconditional promises to give showing: the total amount of unconditional promises

separated into amounts receivable in less than one year, in one to five years, and in more than five years;

the amount of the allowance for uncollectible promises receivable; and the unamortized discount).


A. Exercise 3-4

Please review and complete the following exercise. (Note. NFPs may take different approaches to

recording the below entry in their ledger and in this exercise we are trying to simplify things.)

Book it

Last year NFP Z received an unconditional promise to give from Tom Morrow for $500,000. The

promise contained no purpose restrictions and stated that the amount would be paid over a five-year

period at $100,000 per year. NFP Z determined that the present value of the promise was $450,000.

The $50,000 discount was broken down into the following elements: year 1 = $15,000; year 2 =

$12,500; year 3 = $10,000; year 4 = $7,500; and year 5 = $5,000. When NFP Z recorded the

contribution it made the following journal entry:

dr. Contributions receivable $500,000

cr. Contribution revenue – temporarily restricted $450,000

cr. Discount on contributions receivable $50,000

It is now one year after the promise was made and Tom Morrow has just made the first

payment. Nate is the controller for NFP Z and is trying to record the entry for the receipt of the

first payment. Nate is confident of the below amounts but is unsure what the remaining credit

for $15,000 should be called. Please fill in the blank below:

dr. Cash $100,000

dr. Discount on contributions receivable $15,000

cr. Contributions receivable $100,000

cr. __________________________ $15,000

VI. Key disclosures related to promises to give

The following chart discusses several key disclosure requirements related to promises to give.

Key disclosure requirements related to promises to give include:

Recipients of unconditional promises to give are required to disclose all of the following:

• The amounts of promises receivable in less than one year, in one to five years, and

in more than five years.

• The amount of the allowance for uncollectible promises receivable.

• The discount that arises if measuring a promise to give at present value, if that

discount is not separately disclosed by reporting it as a deduction from contributions

receivable on the face of a statement of financial position pursuant to FASB ASC

958-310-45-1.

Note. If unconditional promises to give are subsequently measured at fair value, several

disclosure requirements exist (see discussion at FASB ASC 958-310-50).

Recipients of conditional promises to give are required to disclose both of the following:

• The total of the amounts promised.

• A description and amount for each group of promises having similar characteristics,

such as amounts of promises conditioned on establishing new programs,

completing a new building, and raising matching gifts by a specified date.


We should also note that contributions with donor-imposed restrictions are reported as restricted support;

however, donor-restricted contributions whose restrictions are met in the same reporting period may be

reported as unrestricted support provided that an NFP has a similar policy for reporting investment gains

and income, reports consistently from period to period, and discloses its accounting policy. Also, an

NFP is required to disclose its policy regarding whether or not the entity implies a time restriction that

expires over the useful life of the donated assets if those long-lived assets are received without

stipulations about how long the donated asset must be used or are acquired with gifts of cash or other

assets restricted for those acquisitions.

VII. Common auditing procedures related to contributions

Before ending the chapter, we want to briefly discuss some of the common auditing procedures employed

related to contributions. Chapter 5 of the AICPA Audit and Accounting Guide Not-for-Profit Entities

contains helpful information related to auditing contributions received.

Common auditing procedures employed related to contributions include:

Examining the documentation that supports the recognition of contribution revenue noting

information such as the absence of conditions.

Selecting items from data accumulated and maintained by the fundraising function, determining

whether a contribution should have been recognized and, if so, vouching it to a recognized

contribution, investigating any reconciling items.

Reviewing and testing the methods and assumptions used to measure contribution revenue at

the time of initial recognition.

Examining contributions reported before and after fiscal period end to determine if they are

reported in the proper period.

Reviewing documentation that supports the recognition of contributed services, utilities, facilities,

and use of long-lived assets for completeness and propriety of amounts recognized.

Examining documentation supporting recognition of promises to give, noting information such as

the absence of conditions and the periods over which the promises to give become due.

Comparing the detail of contributions receivable with data accumulated and maintained by the

fundraising function and investigating reconciling items.

Reviewing and testing the methods and assumptions used to measure promises to give at the

time of initial recognition.

Reviewing promises to give for collectibility, and, if appropriate, changes in fair value of the

underlying asset.

Reviewing the documentation that supports contributions and promises to give (including donor

correspondence and governing board minutes) for proper classification.

Determining the appropriateness of disclosures for conditional and unconditional promises to

give.


The auditor may decide to request confirmation of contributions receivable. Confirming recorded

promises to give (contributions receivable) may provide additional evidence about the existence of

promises to give, the existence or absence of restrictions, the existence or absence of conditions, and the

periods over which the promises to give become due. If the auditor confirms promises to give the AICPA

SASs provide requirements and guidance regarding the confirmation process.

A. The importance of controls related to contributions receivable

An NFP receiving contributions needs to have an internal control system that provides effective controls

to ensure that: (1) all contributions received are recorded and that suitable collection efforts are pursued

for unconditional promises to give; and (2) revenues arising from conditional promises to give are

recognized when the conditions have been substantially met and that restrictions on contributions are

recognized in the appropriate net asset class. Although contributions can be a significant revenue source

for many NFPs, their controls are not always as strong as they should be. The following chart contains

an example audit finding for an NFP with an internal control deficiency related to contributions receivable.

A real-world example of an internal control deficiency related to contributions

The below Yellow Book (i.e., financial statement level) finding was recently reported by an auditor as a

significant deficiency in the audit of a college.

Criteria

Under accounting principles generally accepted in the United States of

America, pledges receivable should be recognized as revenue when an

unconditional promise to give is received and recorded at the stated pledge

receivable amount.

Condition

During testing of pledges receivable, it was noted that three pledge amounts

were incorrectly recorded at double the pledged amount. There was also

one pledge that did not have adequate documentation to determine if an

unconditional promise to give was made.

Context

The amount of the pledges improperly recorded as of June 30, 2014 was

approximately $937,000.

Cause

The College did not perform the proper review over the query that is

exported out of the College’s accounting system that is used to accumulate

the pledge listing. Also, there was a lack of communication between the

advancement and accounting departments concerning the pledge with

inadequate documentation.

Effect

An adjusting entry was made to reduce pledges receivable and contribution

revenues to the proper amount as of June 30, 2014.

Recommendation

The College should implement controls to ensure pledges receivable are

properly recorded in accordance with generally accepted accounting

principles.

Views of responsible

officials

Management agrees with the recommendations and has developed

procedures and controls to enhance the pledge listing review and

communications between the advancement and accounting departments.


VIII. Suggested solutions to exercises



Is this a promise to give?

You are the auditor of NFP Z and are having lunch with the CFO. The CFO mentions that earlier in the

morning, the CEO of NFP Z stopped by her office and relayed some information regarding a possible

promise to give. A few months ago, the CEO was attending a basketball game with NFP Z’s board of

directors and at one point during the game one of the board members told the CEO that he would give

NFP Z $25,000 at the end of the year if NFP Z really needed it. The CEO did not obtain any written

documentation of the “promise to give” and said that he honestly does not remember which board

member made the promise as it was made when the game was in double overtime. It is now late in the

year and NFP Z does need the $25,000. The CEO would like to have the $25,000 recognized now.

When pressed for more details, the CEO stated that he did not want to call the board members to ask

which one made the offer as it might be embarrassing. The CEO is confident the board member who

made the offer will come forward and donate to NFP Z once they see NFP Z’s financial statements.

The CFO asks for your thoughts as to whether NFP Z has received a promise to give that should

be recognized in the financial statements. How would you answer the CFO?

Based on the current facts, it would be very difficult to justify recognizing the promise to give in the

financial statements. While a promise to give can be a written or oral agreement to contribute cash or

other assets to another entity, communications received from potential donors must be carefully

evaluated to determine if they are indeed a promise to give. Pursuant to FASB ASC 958-605-25-8, to

be recognized in financial statements there must be sufficient evidence in the form of verifiable

documentation that a promise to give was made and received. That requirement does not preclude

recognition of verifiable oral promises, such as those documented by tape recordings, written registers,

or other means that permit subsequent verification. To record the “promise to give” in this situation,

NFP Z needs to determine which board member is making the promise and obtain some form of

verifiable documentation that a promise to give was made and received.

Note. The suggested solution to Exercise 3-1 is continued on the following page.


Suggested solution to Exercise 3-1 (continued)

Pledges

Congratulations, you are the recently hired controller of NFP W. As you examine NFP W’s general

ledger and previous financial statements you notice that NFP W has never recorded any unconditional

promises to give in the past. When you ask the accounting and development staff about this, they state

that the prior controller said that NFP W receives “pledges” instead of “promises to give” and since the

terminology “pledges” is not utilized in FASB ASC 958 there is nothing to record until the cash is

received.

What is the difference between “pledges” and “promises to give” and was the former controller

right?

The term “pledges” has long been an area of confusion in the NFP sector. When the FASB initially

issued the exposure draft for FASB No. 116 (which is the source of much of the current contribution

guidance found in FASB ASC 958) it proposed using the term “pledge” to describe a “promise to give”.

However, in the final standard, the FASB did not use the term “pledge” as some use that term to

describe plans or intentions to give that fall short of being an actual promise to give (Note. In the Basis

for Conclusions to FASB No. 116 the FASB did state that it believes that most “pledges” are “promises

to give”). The bottom line here is that you need to avoid getting wrapped up in the word “pledges” and

evaluate the actual written or oral communications from donors and determine whether they represent

promises to give. To the extent they represent unconditional promises to give you generally have a

recordable event.

When might this occur?

We saw earlier that receipts of unconditional promises to give with payments due in future periods are

reported as restricted support unless 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.

Please provide a scenario where a donor might make an unconditional promise to give with

payments due in future periods and specify that they intend it to be used to support activities of

the current period?

In the author’s experience, it is somewhat unusual for a donor to make an unconditional promise to give

with payments due in future periods and specify that they intend it to be used to support activities of the

current period. However, one scenario the author has seen is where a dedicated donor or board

member specifies that they want to help eliminate a current year deficit and promises to pay the

contribution off over a couple of years.



Is this a conditional or unconditional promise to give?

On June 27, Benefactor B promises to contribute $1 for every $2 of contributions received by NFP A

prior to October 1, up to $50,000. From June 27 to June 30, NFP A did not receive any contributions

from other resource providers.

Should any of the amounts promised by Benefactor B be recognized in the financial statements

as of June 30?

No. The offer from Benefactor B is a conditional promise to give and none of the conditions have been

met as of June 30.

During July, NFP A receives contributions of $17,000 from other resource providers. Should

any of the amounts promised by Benefactor B be recognized in the financial statements as of

July 31?

Yes. As contributions are received from other resource providers, the conditions would be met and the

promise would become unconditional. If NFP A received $17,000 in the first month from donors, $8,500

of the conditional promise would become unconditional and recognized as contribution revenue.



Two More Cases

Situation

Should the promise to give be recognized in the financial statements?

1

Benefactor Z owns a retail shopping space

that presently is unoccupied. Benefactor Z

promises to give NFP A free use of the space

for as long as it is available. NFP A needs the

space and accepts the offer. Benefactor Z

says she expects to give NFP A 30 days

advance notice before they need to vacate

although Benefactor Z may discontinue

providing space at any time.

NFP A would recognize the fair value of the

contributed use of facilities as both revenue and

expense in the period it is received and used. If

Benefactor Z explicitly and unconditionally

promises the use of the facility for a specified

period of time the promise would be an

unconditional promise to give.

2

Benefactor K promises to give NFP J his entire

estate when he dies and provides a written

copy of the will. Benefactor K states that his

estate will be worth $4,000,000.

Benefactor K’s promise to give is really an

intention to give. Benefactor K has the ability to

modify the will at any point during his lifetime.

NFP J has not received a promise to give and will

not recognize a contribution received. When the

probate court declares the will valid, NFP J would

recognize contribution revenue and a receivable at

the fair value of its interest in the estate, unless

the promise is conditioned upon a future and

uncertain event, in which case a contribution will

not be recognized until the conditions are

substantially met. A conditional promise in a valid

will should be disclosed in the notes to the

financial statements.



Book it

Last year NFP Z received an unconditional promise to give from Tom Morrow for $500,000. The

promise contained no purpose restrictions and stated that the amount would be paid over a five-year

period at $100,000 per year. NFP Z determined that the present value of the promise was $450,000.

The $50,000 discount was broken down into the following elements: year 1 = $15,000; year 2 =

$12,500; year 3 = $10,000; year 4 = $7,500; and year 5 = $5,000. When NFP Z recorded the

contribution it made the following journal entry:

dr. Contributions receivable $500,000

cr. Contribution revenue – temporarily restricted $450,000

cr. Discount on contributions receivable $50,000

It is now one year after the promise was made and Tom Morrow has just made the first

payment. Nate is the controller for NFP Z and is trying to record the entry for the receipt of the

first payment. Nate is confident of the below amounts but is unsure what the remaining credit

for $15,000 should be called. Please fill in the blank below:

dr. Cash $100,000

dr. Discount on contributions receivable $15,000

cr. Contributions receivable $100,000

cr. Contribution revenue – unrestricted $15,000

Author’s Note. Under FASB ASC 958-310-35-6 if a present value technique is used to measure the

fair value of unconditional promises to give cash, subsequent accruals of the interest element are

accounted for as contribution revenue. NFP Z would also reclassify $85,000 from temporarily

restricted net assets to unrestricted net assets.


Contributed Services, Collection Items and Other Unique Items

Learning Objectives 1 I. What are we talking about? 1 II. Contributed services 1

A. Specialized skills 2 1. Exercise 4-1 2

B. Additional considerations related to contributed services 2 C. ASU No. 2013-06 on contributed services from an affiliate 3 D. Key disclosures related to contributed services 4 E. Exercise 4-2 4 F. An opportunity sometimes missed 5

III. Contributed collection items 6 IV. Contributions of other unique items 6 V. Suggested solutions to exercises 8

A. Suggested solution to Exercise 4-1 8 B. Suggested solution to Exercise 4-2 9


Contributed Services, Collection Items and Other Unique Items

Learning Objectives


Identify key issues related to the recognition of contributed services,

collection items and other unique items that NFPs may receive from donors;

Determine whether and how such contributed items should be reflected in the

financial statements; and

Understand disclosure considerations related to such contributions.


In this chapter, we are going to explore key issues related to the recognition of contributed services,

collection items and other unique items that NFPs may receive from donors. Note. The treatment of

contributed services, collection items and other unique items that NFPs may receive from donors is really

not an area that the FASB chose to address/change in the Financial Statements of Not-for-Profit Entities

project.

II. Contributed services

Contributed services are critical to NFPs. Without the countless hours and skills volunteers provide

where would America be? Americans are a giving people, each day we drive past homeless shelters,

family crisis centers, food banks, animal shelters, boys and girls clubs, churches, synagogues, and

endless other NFPs which need and receive volunteer services to fulfill their mission. So we know

contributed services are critical to NFPs, but how are they reflected in the financial statements and notes?

Should a medical school receiving donated services from a doctor and a soccer association receiving

donated coaching hours both measure and reflect the donated services in their financial statements?

These are the types of issues that NFPs face regarding the accounting and reporting of contributed

services. The following chart discusses the recognition of contributed services.

When do we recognize contributed services in the financial statements?

Contributions of services are recognized if the services received meet any of the

following criteria:

• They create or enhance nonfinancial assets.

• They require specialized skills, are provided by individuals possessing

those skills, and would typically need to be purchased if not provided by

donation. Services requiring specialized skills are provided by

accountants, architects, carpenters, doctors, electricians, lawyers,

nurses, plumbers, teachers, and other professionals and craftsmen.

Contributed services and promises to give services that do not meet the above criteria

are not recognized except for services received from personnel of an affiliate covered

by ASU No. 2013-06 which we will cover in a moment.

0

1

2

3

4

5

6


A. Specialized skills

Since the criteria for recognition of contributed services involves either the creation or enhancement of

nonfinancial assets or services requiring specialized skills, provided by individuals possessing those

skills, and would typically need to be purchased if not provided by donation it is important to understand

the meaning of specialized skills.

What are specialized skills?

The FASB ASC discusses that services requiring specialized skills are provided

by accountants, architects, carpenters, doctors, electricians, lawyers, nurses,

plumbers, teachers, and other professionals and craftsmen. The FASB ASC

Glossary also defines specialized skills as services that require expertise that is

not possessed by most members of the general public or that require an

individual to be licensed to practice the profession or craft.

1. Exercise 4-1


Is this a specialized skill?

As part of its mission, NFP R provides services to help adults learn to read. Many of NFP R’s volunteer

instructors do not have the specialized skills that a reading teacher possesses. For those volunteers,

NFP R provides some training on how to help adults learn to read.

In the financial statements for NFP R, would you recognize the contributed services of the

volunteers without a teaching background that NFP R provides training for on how to help

adults learn to read?

B. Additional considerations related to contributed services

The following chart discusses several additional considerations related to contributed services.

Additional considerations related to contributed services include:

FASB ASC 958-605-55-20 discusses that promises to give services generally involve personal

services that, if not explicitly conditional, are often implicitly conditioned upon the future and

uncertain availability of specific individuals whose services have been promised.

In 2013, the FASB issued ASU No. 2013-06 which has brought changes in the area of services

received from personnel of an affiliate.

FASB ASC 958-605-30-10 discusses that contributions of services that create or enhance

nonfinancial assets may be measured by referring to either the fair value of the services received

or the fair value of the asset or of the asset enhancement resulting from the services. Fair value

should be used for the measure regardless of whether the NFP could afford to purchase the

services at their fair value.

FASB ASC 958-605-55-71 discusses that contributions of services (time, skills, or expertise)

between donors and donees that are facilitated by an intermediary are not contributions received

or contributions made by the intermediary.

I sure thought my skills were special!


C. ASU No. 2013-06 on contributed services from an affiliate

In April 2013, the FASB issued Accounting Standards Update No. 2013-06, Not-for-Profit Entities (Topic

958): Services Received from Personnel of an Affiliate (ASU No. 2013-06). The scope of ASU No. 2013-

06 applies to NFPs (including NFP business-oriented health care entities) that receive services from

personnel of an affiliate that directly benefit the recipient NFP and for which the affiliate does not charge

the recipient NFP. NFPs within an affiliate group often operate under arrangements that provide for the

engagement of personnel and their deployment or use for common purposes and projects among the

affiliate entities. As an example, an entity within an affiliate group may engage personnel who provide

services to affiliate NFPs. Such personnel may provide core program services for the recipient NFP or

may be involved in supporting management or fundraising activities. While the compensation and

benefits of these personnel are paid for by the contributing entity, it does not seek compensation from the

recipient NFP for those personnel costs.

ASU No. 2013-06 made changes to the requirements related to services received from personnel of an

affiliate as shown in the below.

ASU No. 2013-06 made changes to the requirements related to services received from personnel of an affiliate. The changes include…

All services received from personnel of any affiliate that directly benefit the recipient NFP and for

which the affiliate does not charge the recipient NFP will be recognized by the recipient NFP.

Services received from personnel of an affiliate within the scope of ASU No. 2013-06 should be

measured at the cost recognized by the affiliate for the personnel providing those services.

However, in situations in which recording the service received from personnel of an affiliate at the

cost recognized by the affiliate would significantly overstate or understate the value of the service

received, the recipient NFP could elect to recognize that service at either: (1) the cost recognized

by the affiliate for the personnel providing that service; or (2) the fair value of that service.

A recipient NFP within the scope of FASB ASC 954, Health Care Entities, that is required to

provide a performance indicator, should report as an equity transfer the increase in net assets

associated with services received from personnel of an affiliate within the scope of ASU No. 2013-

06. For other recipient NFPs, ASU No. 2013-06 does not prescribe presentation guidance for the

increase in net assets associated with services received from personnel of an affiliate other than

prohibiting reporting as a contra-expense or a contra-asset. All recipient NFPs should report the

corresponding decrease in net assets or the creation or enhancement of an asset resulting from

the use of services received from personnel of an affiliate in a way that is similar to how other such

expenses or assets are reported.

The disclosures in FASB ASC 850, Related Party Disclosures, apply to services received from

personnel of an affiliate within the scope of ASU No. 2013-06, and no additional recurring

disclosures are required by ASU No. 2013-06.

The guidance in ASU No. 2013-06 became effective prospectively for fiscal years beginning after June

15, 2014.


D. Key disclosures related to contributed services

As illustrated in the following chart, NFPs have several disclosure requirements related to contributed

services.

NFPs have several disclosure requirements related to contributed services including:

FASB ASC 958-605-50-1 discusses that an entity receiving contributed services will describe the

programs or activities for which those services were used, including the nature and extent of

contributed services received for the period and the amount recognized as revenues for the

period. Entities are encouraged to disclose the fair value of contributed services received but not

recognized as revenues if that is practicable. The nature and extent of contributed services

received can be described by nonmonetary information, such as the number and trends of

donated hours received or service outputs provided by volunteer efforts, or other monetary

information, such as the dollar amount of contributions raised by volunteers. Disclosure of

contributed services is required regardless of whether the services received are recognized as

revenue in the financial statements.

E. Exercise 4-2


Issues and Answers Related to Contributed Services

Issue: Answer:

1

At University Y uncompensated faculty members who are associated with

religious orders and contribute their services to the university account for

about 15% of the faculty. The remaining faculty members are

compensated. Both compensated and uncompensated faculty members

are regularly and equally evaluated for performance; both must meet the

university’s standards and both provide services in the same way. Would

University Y recognize the contributed services?

2

NFP B constructs a building on its property for after school programming.

During the construction process, NFP B spent $100,000 on architectural

services, materials, permits, and etc. Construction Company C contributed

labor and equipment for the building. Company C was assisted on the

project by a number of volunteers. An independent appraisal of the

structure was obtained and it estimated the fair value to be $250,000

(without the land). Would NFP B recognize the contributed services?

3

One of NFP Z’s board of directors is a CPA. Occasionally, in her role as a

board member, the CPA provides advice on general business matters. The

advice provided is of a routine nature and provided in the role of a board

member. The CPA suggests that NFP Z seeks the advice of its CPA firm

on substantive or complex accounting, audit, or taxation issues. NFP Z’s

board members serve without compensation. Several board members

have specialized expertise in various fields that allows them to provide

helpful advice to NFP Z. Would NFP Z recognize the contributed

services of the CPA board member?


F. An opportunity sometimes missed

Before leaving the topic of contributed services, we wanted to discuss a branding opportunity sometimes

missed by NFPs. While many may feel that the cost of preparing certain of today’s note disclosures

outweighs the benefits achieved, this is really not the case when it comes to disclosing the contributed

services that the NFP received (even if those services are not recognized in the financial statements).

A branding opportunity to donors

Below are note disclosures from three real-world financial statements where the contributed services

received did not meet the criteria for recognition. In looking at the following disclosures, notice the

difference in how: (1) the first NFP essentially just described that no volunteer amounts were being

recognized; (2) the second NFP went beyond the first and gave the estimated volunteer hours worked

which might be appealing to potential donors; and (3) the third NFP gave a feel for the hours, value,

and types of services donated which really lets potential donors know the level and type of involvement

by the community in terms of time.

Okay

A substantial number of volunteers have contributed significant amounts of time in

conjunction with the program services and administration of the NFP for which no

amount has been recorded in the financial statements because the services did not

meet the criteria for recognition under accounting principles generally accepted in

the United States of America.

Better

Many individuals volunteer their time to perform a variety of tasks that assist the

NFP. During the years ended December 31, 2014, and 2013, the NFP received

more than 12,000 and 10,000 volunteer hours for services performed for the NFP,

respectively. The value of these donated services, although clearly substantial,

does not meet the requirements for recognition and is not reflected in the financial

statements.

Best

Contributions of donated services are recognized if the services received (a) create

or enhance long-lived assets; or (b) require specialized skills, are provided by

individuals possessing those skills and would typically need to be purchased if not

provided by donation.

NFP X receives a significant amount of contributed time from volunteers that does

not meet the recognition criteria described above. Accordingly, the value of this

contributed time is not reflected in the accompanying financial statements. NFP X

receives donated services in the form of kitchen assistants, drivers, Board of

Directors and committee members, creative consultants, event volunteers, and office

assistants. The hours contributed is estimated by management to be 37,000 hours

valued at $500,000.

It should also be noted that in addition to the wording used to describe the contributed services received,

the placement of the disclosure can also be used as a branding opportunity. NFPs can have a very well

written disclosure which provides very useful information to donors. However, if that disclosure is buried

at the back of the notes it may be much less likely to be read by potential donors. By placing this

disclosure in a much more prominent position, NFPs can emphasize the importance of contributed

services to the entity.


III. Contributed collection items

Some NFPs maintain collections and receive contributions of works of art, historical treasures, and similar

items for the collection. When discussing contributions of collection items, it is important to understand

the definition of a collection. The following contains the FASB ASC definition of a collection.

What is a collection?

Collections are works of art, historical treasures, or similar assets that meet all of the

following criteria: (1) they are held for public exhibition, education, or research in furtherance

of public service rather than financial gain; (2) they are protected, kept unencumbered, cared

for, and preserved; and (3) they are subject to an organizational policy that requires the

proceeds of items that are sold to be used to acquire other items for collections.

Collections generally are held by museums, botanical gardens, libraries, aquariums,

arboretums, historic sites, planetariums, zoos, art galleries, nature, science, and technology

centers, and similar educational, research, and public service organizations that have those

divisions; however, the definition is not limited to those entities nor does it apply to all items

held by those entities.

NFPs that hold a collection have the following three alternatives for reporting the collection: (1)

capitalization of all collection items; (2) capitalization of all collection items on a prospective basis [i.e., all

items acquired after a stated date]; or (3) no capitalization. Capitalization of selected collections or items

is not allowed. NFPs disclose the capitalization policy chosen for collections (i.e., capitalization,

prospective capitalization, or no capitalization).

The recognition and measurement principles for contributions of collection items depend on the

collections-capitalization policy adopted by the NFP. Contributions of works of art, historical treasures,

and similar items that are not part of a collection are recognized as assets and as revenue or gains. An

NFP need not recognize contributions of works of art, historical treasures, and similar assets if the

donated items are added to collections that meet all three of the criteria in the definition of a collection.

Contributed collection items are recognized as revenues or gains if collections are capitalized and are not

recognized as revenues or gains if collections are not capitalized. An NFP that does not recognize and

capitalize its collections or that capitalizes collections prospectively does have additional disclosure

requirements.

IV. Contributions of other unique items

Contributions can come in a variety of forms and contributions of certain unique items carry distinctive

accounting treatments with them as discussed in the following table.

Be on the watch for contributions of certain unique items that carry distinctive accounting treatments with them including…

NFPs may receive contributions of items such as inventory, equipment, and property which

are commonly referred to as gifts in kind. Gifts in kind that can be used or sold are measured

at fair value. In determining fair value, NFPs consider the quality and quantity of the gifts,

including applicable discounts. Gifts in kind that cannot be sold or used internally have no

value and are not recognized.

continued


Be on the watch for contributions of certain unique items that carry distinctive accounting treatments with them including…

Inputs for measuring fair value of contributed inventory items can be obtained from published

catalogs, vendors, independent appraisals, and other sources. When methods such as

estimates, averages, or computational approximations, such as average value per pound or

subsequent sales, can reduce the cost of measuring fair value, use of those methods is

allowed provided the methods are consistently applied and are not reasonably expected to be

materially different from a detailed fair value measurement.

Sometimes entities other than an NFP use for the NFP’s benefit (or provide at no charge to the

NFP) certain nonfinancial assets that encourage the public to contribute to the NFP or assist

the NFP in communicating its message or mission. Examples of these include fundraising

material, informational material, or advertising, including media time or space for public service

announcements or other purposes. When such nonfinancial assets are used for the NFP’s

benefit (or provided to the NFP at no charge) and they encourage the public to contribute to an

NFP or help the NFP communicate its message or mission, NFPs should consider whether

they have received a contribution. If they have received a contribution, it will be measured at

fair value.

An NFP may receive unconditional contributions of the use of electric, telephone, and other

utilities and of long-lived assets (e.g., a building or the use of facilities) in which the donor

retains legal title to the long-lived asset. An NFP will recognize the fair value of the use of

utilities or property as contribution revenue in the period the contribution is received. If the

transaction is an unconditional promise to give for a specified number of periods, the promise

is reported as contributions receivable and as restricted support that increases temporarily

restricted net assets.

Contributions received by NFPs under irrevocable split-interest agreements are recorded

when received at fair value. The date when an NFP is considered to have received an

irrevocable split-interest agreement often depends on whether the NFP or a third party is the

trustee for the agreement. If an NFP is the trustee or fiscal agent of the assets, the gift is

considered received when the donor executes the agreement. If an unrelated third party (e.g.,

a trust company, bank, foundation, or private individual) is the trustee or fiscal agent of the

assets, the split-interest agreement is recorded when the NFP is notified of the gift’s existence.

The following disclosure is an example from an NFP’s financial statements disclosing the contribution of

the use of a building. Note. This NFP also broke out the donated rent receivable on its financial

statements.

An example disclosure of the donated use of a building from an NFP’s financial statements

Donated Rent

NFP Z received a contribution of the use of facilities through January 20X1. The fair value of the

donated rent, adjusted for consumer price index increases, is recorded as donated rent receivable and

temporarily restricted net assets. Donated rent is amortized to in kind rent expense on a monthly basis

and shown as net assets released from restriction.





Is this a specialized skill?

As part of its mission, NFP R provides services to help adults learn to read. Many of NFP R’s volunteer

instructors do not have the specialized skills that a reading teacher possesses. For those volunteers,

NFP R provides some training on how to help adults learn to read.

In the financial statements for NFP R, would you recognize the contributed services of the

volunteers without a teaching background that NFP R provides training for on how to help

adults learn to read?

No. FASB ASC 958-605-55-28 discusses that an individual who receives some training does not

necessarily possess a specialized skill. If a volunteer receives some training from an NFP to learn how

to help other people learn to read, that volunteer does not possess the specialized skills that a reading

teacher possesses.



Issues and Answers Related to Contributed Services

Issue: Answer:

1

At University Y uncompensated faculty

members who are associated with religious

orders and contribute their services to the

university account for about 15% of the faculty.

The remaining faculty members are

compensated. Both compensated and

uncompensated faculty members are regularly

and equally evaluated for performance; both

must meet the university’s standards and both

provide services in the same way. Would

University Y recognize the contributed

services?

University Y would recognize both revenue and

expense for the services contributed by the

uncompensated faculty members. Instructing

requires specialized skills; the religious personnel

are qualified and trained to provide those skills; and

University Y typically would hire paid instructors if

the religious personnel did not donate their

services. University Y could refer to the salaries it

pays similarly qualified compensated faculty

members to determine the fair value of the services

received.

2

NFP B constructs a building on its property for

after school programming. During the

construction process, NFP B spent $100,000

on architectural services, materials, permits,

and etc. Construction Company C contributed

labor and equipment for the building.

Company C was assisted on the project by a

number of volunteers. An independent

appraisal of the structure was obtained and it

estimated the fair value to be $250,000

(without the land). Would NFP B recognize

the contributed services?

NFP B would recognize the contributed services

because the services created or enhanced a

nonfinancial asset. Contributions of services that

create or enhance nonfinancial assets may be

measured by referring to either the fair value of the

services received or the fair value of the asset or of

the asset enhancement resulting from the services.

For example, the fair value of the contributed

services received could be determined by

subtracting the cost of the purchased services,

materials, and permits ($100,000) from the fair

value of the asset created ($250,000), which results

in contributed services received of $150,000.

3

One of NFP Z’s board of directors is a CPA.

Occasionally, in her role as a board member,

the CPA provides advice on general business

matters. The advice provided is of a routine

nature and provided in the role of a board

member. The CPA suggests that NFP Z

seeks the advice of its CPA firm on

substantive or complex accounting, audit, or

taxation issues. NFP Z’s board members

serve without compensation. Several board

members have specialized expertise in various

fields that allows them to provide helpful

advice to NFP Z. Would NFP Z recognize

the contributed services of the CPA board

member?

NFP Z would not recognize the contributed services

it receives from the CPA board member. The

advice provided by board members typically would

not be purchased if not provided by donation. The

advice provided by the CPA is of a routine nature

and NFP Z seeks the advice of its CPA firm on

substantive or complex accounting, audit, or

taxation issues.


Special Events

Learning Objectives 1 I. What are we talking about? 1 II. Gross versus net reporting in the statement of activities 1 III. How are special events presented? 2

A. Three possible methods to display ongoing major or central special events 2 1. Facts common to each illustration 2 2. Illustration 1: Direct benefits to donors displayed on a line below gross revenue from the

special event 3 3. Illustration 2: Special event revenues reported as part exchange and part contribution 3 4. Illustration 3: Direct benefits to donors displayed as a line with other expenses 4

B. Exercise 5-1 4 C. Exercise 5-2 4

IV. Suggested solutions to exercises 5 A. Suggested solution to Exercise 5-1 5 B. Suggested solution to Exercise 5-2 5


Special Events

Learning Objectives


Explain when gross reporting (as opposed to net reporting) is used in the

statement of activities; and

Perceive how special events are presented in the statement of activities.


In this chapter, we are going to explore key issues related to the reporting of special events. Note. The

reporting of special events is really not an area that the FASB chose to address/change in the Financial

Statements of Not-for-Profit Entities project. However, the project certainly has ramifications on the

statement of activities that we will discuss in Chapter 8.

II. Gross versus net reporting in the statement of activities

The following chart discusses key concepts related to gross versus net reporting in the statement of

activities.

Gross versus net reporting in the statement of activities

NFPs use gross reporting for… However, net reporting may be used for…

An NFP’s ongoing major or

central operations and activities.

(1) Gains and losses resulting from peripheral or incidental

transactions or from other events and circumstances that may be

largely beyond the control of the NFP and its management; and

(2) investment revenues and expenses provided that the amount of

investment expense (e.g. custodial fees and internal and external

investment advisory costs) is disclosed either on the face of the

statement of activities or in notes to the financial statements.

Due to the presentation implications discussed above, the determination of whether events are ongoing

major or central or peripheral or incidental is an important one. Similar events may be reported

differently by different NFPs based on the NFP’s overall activities.

The frequency of the events and the significance of the gross revenues and expenses distinguish major or central events from peripheral or incidental events.

Events are ongoing major or central activities if they are normally part

of an NFP’s strategy and it normally carries on such activities or if the

event’s gross revenues or expenses are significant in relation to the

NFP’s annual budget.

Events are peripheral or incidental if they are not an integral part of

an NFP’s usual activities or if their gross revenues or expenses are

not significant in relation to the NFP’s annual budget.


III. How are special events presented?

As one might expect, the treatment of special events in the statement of activities follows the guidance we

have just discussed related to gross versus net reporting.

Under FASB ASC 958-225-45-17 the presentation of special events depends on the nature of the special event as provided below:

Special events are often ongoing major or central activities; if so, an

NFP will report the gross revenues and expenses of those activities.

An NFP may report net amounts for its special events if they result from

peripheral or incidental transactions. Costs netted against receipts from

peripheral or incidental special events are limited to direct costs.

A. Three possible methods to display ongoing major or central special events

As discussed above, special events are often ongoing major or central activities. Thus, an NFP will

frequently report the gross revenues and expenses of those activities. FASB ASC 958-225-55-11

provides three possible methods to display a special event that is an ongoing major or central activity in

the statement of activities. The following illustrations are based off that guidance.

1. Facts common to each illustration

Please review the below facts common to each of the following illustrations:

NFP J has a special event that is an ongoing major activity with ticket revenue of $20,000.

All costs of the activity, other than the direct donor benefits, should be reported as fundraising.

The event includes a dinner that costs NFP J $5,000 and that has a fair value of $7,000.

NFP J also incurs other direct costs for the event of $4,000 in connection with promoting and

conducting the event, including incremental direct costs incurred in transactions with independent third

parties and the payroll and payroll-related costs for the activities of employees who are directly

associated with, and devote time to, the event. The other direct costs are unrelated to the direct

benefits to donors and, accordingly, should not be included as costs of benefits to donors. The other

direct costs include $1,000 that otherwise might be considered management and general costs if they

had been incurred in a different activity, and fundraising costs of $3,000.

NFP J also has the following transactions, which are unrelated to the special event:

Unrestricted contributions of $50,000

Program expenses of $35,000

Management and general expenses of $15,000

Fundraising expenses of $10,000


2. Illustration 1: Direct benefits to donors displayed on a line below gross revenue from the

special event

NFP J may report the gross revenues of special events and other fundraising activities with the cost of

direct benefits to donors (meals and facilities rental) displayed as a line item deducted from the special

event revenues, as follows:

Changes in unrestricted net assets:

Contributions $50,000

Special event revenue 20,000

Less: Costs of direct benefits to donors (5,000)

Net revenues from special events 15,000

Contributions and net revenues from special events 65,000

Other expenses:

Program 35,000

Management and general 15,000

Fundraising 14,000

Total other expenses 64,000

Increase in unrestricted net assets $ 1,000

3. Illustration 2: Special event revenues reported as part exchange and part contribution

NFP J may report the gross revenue from special events and other fundraising activities as part exchange

(for the fair value the participant received) and part contribution (for the excess of the payment over that

fair value), as follows:



Dinner sales 7,000

Less: Costs of direct benefits to donors (5,000)

Gross profit on special events 2,000

Contributions and net revenues from special events 65,000

Other expenses:

Program 35,000


Fundraising 14,000



Note. In the above, the contribution revenue of $63,000 consists of: (1) the unrestricted contributions of

$50,000 that were unrelated to the special event; and (2) the ticket revenue for the special event less the

fair value of the dinner [i.e., $20,000 - $7,000 = $13,000].


4. Illustration 3: Direct benefits to donors displayed as a line with other expenses

NFP J may report the gross revenues of special events and other fundraising activities with the cost of

direct benefits to donors (meals and facilities rental) displayed in the same section of the statement of

activities as are other programs or supporting services and allocated, if necessary, among those various

functions, as follows:


Revenues:


Special event revenue 20,000

Total revenues 70,000

Expenses:

Program 35,000

Costs of direct benefits to donors 5,000


Fundraising 14,000



B. Exercise 5-1


Fundraising Costs

In the three illustrations just presented, the fact pattern stated that NFP J incurred $4,000 in connection

with promoting and conducting the special event. We also saw that these costs were reported as

fundraising expense. Assume that as part of the event, NFP J compiles a listing of attendees it

will use for fundraising activities in future years. Can a portion of the $4,000 be capitalized and

expensed in future years?

C. Exercise 5-2


Where do they go?

Each year NFP E holds an annual pancake breakfast as a fundraising activity. The event is open to the

community and there is no charge to attend. Attendees are encouraged to make contributions only if

they desire to. The annual pancake breakfast is not program related. NFP E spends $5,000 in

marketing and holding the event. In which functional category should the costs of the event be

presented in the statement of activities?


IV. Suggested solutions to exercises



Fundraising Costs

In the three illustrations just presented, the fact pattern stated that NFP J incurred $4,000 in connection

with promoting and conducting the special event. We also saw that these costs were reported as

fundraising expense. Assume that as part of the event, NFP J compiles a listing of attendees it

will use for fundraising activities in future years. Can a portion of the $4,000 be capitalized and

expensed in future years?

No. Costs of fundraising activities, including the cost of special fundraising events, are expensed as

incurred. Costs are incurred when the item or service has been received. Fundraising costs incurred in

one period, such as those made to obtain bequests, compile a mailing list of prospective contributors, or

solicit contributions in a direct-response activity, may result in contributions that will be received in

future periods. Those costs also are expensed as incurred.


Where do they go?

Each year NFP E holds an annual pancake breakfast as a fundraising activity. The event is open to the

community and there is no charge to attend. Attendees are encouraged to make contributions only if

they desire to. The annual pancake breakfast is not program related. NFP E spends $5,000 in

marketing and holding the event. In which functional category should the costs of the event be

presented in the statement of activities?

There is not a great deal of guidance in this area. However, Technical Questions and Answers section

6140.08, “Functional Category of the Costs of Direct Donor Benefits” (AICPA, Technical Practice Aids)

in part provides that:

“The costs of donor benefits that are not program related and that are provided in transactions that

are other than exchange transactions, such as a fundraising dinner for which there is no charge to

attend, should be reported as fundraising.”

Based on the above, the costs of NFP E’s pancake breakfast should be reported as fundraising.

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Classification of Expenses

Learning Objectives 1 I. What are we talking about? 1 II. The classification of expenses 1

A. Program services 2 B. Supporting activities 3

III. Getting from natural expenses to functional expenses 4 IV. Classification of expenses that include fundraising 6

A. Important terminology 6 B. Three important criteria 6 C. What is the purpose criterion? 7

1. The compensation or fees test 8 2. The separate and similar activities test 8 3. The other evidence test 9 4. Exercise 6-1 9 5. Exercise 6-2 10

D. What is the audience criterion? 10 E. What is the content criterion? 11 F. Allocation methods 11 G. Incidental activities 11 H. Key disclosures related to joint costs 12 I. Exercise 6-3 13

V. Suggested solutions to exercises 14 A. Suggested solution to Exercise 6-1 14 B. Suggested solution to Exercise 6-2 15 C. Suggested solution to Exercise 6-3 16


Classification of Expenses

Learning Objectives


Understand key issues related to the classification of expenses in the

statement of activities;

Apply the requirements related to the classification of expenses that include

fundraising; and

Explain the disclosure considerations related to joint costs.


In this chapter, we are going to explore key issues related to the current classification of expenses. Note.

In Chapter 8, we will discuss the impacts of the Financial Statements of Not-for-Profit Entities project on

expense classification in the statement of activities.

II. The classification of expenses

Earlier in the course, we discussed that FASB ASC 958 defines an NFP as an entity that possesses three

characteristics, in varying degrees, that distinguish it from a business entity. The second of those

characteristics is that NFPs have operating purposes other than to provide goods or services at a profit.

The framework for an NFP’s reporting of expenses for program services and supporting activities was

established back in 1993 with FASB No. 117. The FASB kept that second NFP characteristic closely in

mind when developing the current FASB No. 117 based framework.

Trying to measure more than just the bottom line

In the basis for conclusions to FASB No. 117, the FASB stated that “information about

expenses by function, such as major programs or services and major classes of

supporting services, is necessary to an understanding of an NFP’s service efforts and

that a set of financial statements should include that information. Requiring that information

also is a step toward providing information that may be useful in associating an NFP’s

expenses with its accomplishments. The Board concluded that information about an NFP’s

expenses by function may be meaningfully communicated either in a statement of activities

or in notes to financial statements.”

Thus, to assist users in understanding an NFP’s service efforts (i.e., its mission fulfillment), including the

costs of its services and how it allocates its resources, the statement of activities or the notes to the

financial statements provide information about expenses reported by their functional classification such as

major classes of program services and supporting activities.

Se

rvic

e E

ffo

rts

0

1

2

3

4

5

6


The types of activities that make up program services and supporting activities are described below.

Activities that make up program services and supporting activities

FASB ASC 958-720-45 provides more detailed descriptions and guidance related to program services,

management and general activities, fundraising activities, and membership development activities.

A. Program services

As we saw in the prior chart, program services are the activities that result in goods and services being

distributed to beneficiaries, customers, or members that fulfill the purposes or mission for which the NFP

exists. Those services are the major purpose for and the major output of the NFP and often relate to

several major programs. Because there are many different types of NFPs and also the flexibility allowed

within the current standards, there is a great deal of variance in the categories of program services that

appear in NFP financial statements as reflected in the following.

Singing to a different tune - Examples of program services presented in three different musical NFP financial statements

New York Philharmonic Sarasota Orchestra Fort Worth Symphony Orchestra Association

Subscription and other concerts

Student concerts

Free park concerts

Concerts on tour

Recording and broadcasting

Symphony and chamber orchestras/ensembles

Music festival

Music education programs

Program

Program service expenses are the direct and indirect costs of providing the program(s). Providing

information about program services expenses provides important information to donors and others. For

example, in the case of the Sarasota Orchestra, some donors may be interested in the amounts

expended on symphony and chamber orchestras/ensembles as compared to amounts spent on music

education programs.

Activities that result in

goods and services

being distributed to

beneficiaries, members,

or customers that fulfill

the purposes or mission

for which the NFP

exists.

Supporting Activities

Activities that are not

identifiable with a single

program, fundraising

activity, or membership

development activity but

that are indispensable to

the conduct of those

activities and to an

entity’s existence.

Include soliciting for

prospective members

and membership dues,

membership relations,

and similar activities.

Program Services

Management

and General Membership

Development

Activities undertaken

to induce potential

donors to contribute

money, securities,

services, materials,

facilities, other

assets, or time.

Fundraising


As discussed in the following illustration, many NFPs have tremendous pressure to have a high ratio of

expenses in the program services category and a low ratio of expenses in the supporting activities

category.

Pressure to have a high ratio of program services expenses

For many NFPs, there is tremendous pressure to have a high ratio of

expenses in the program services category and a low ratio of expenses in

the supporting activities category. There are several websites available

to donors and others to readily compare the amounts expended on

program services to other expenses and also with other organizations

(e.g., www.charitynavigator.org or www.guidestar.org). Such websites

use the percentage of expenses devoted to program services as a

significant element in how they rate and compare NFPs.

Note. The websites discussed above can also be a tool for auditors in comparing a particular NFP client

to other NFPs with a similar mission.

B. Supporting activities

FASB ASC 958-720-45 provides three common categories of supporting activities and examples of

activities occurring within the categories as reflected in the following.

Examples of supporting activities

Management and General Fundraising Membership Development

All management and administration except for direct conduct of program services or fundraising activities

Preparing and distributing fundraising manuals, instructions, and other materials

Soliciting for prospective members and membership dues

Business management Maintaining donor mailing lists Membership relations

Financing, including interest costs that cannot be allocated

Conducting special fundraising events

Similar activities

Announcements concerning appointments

Publicizing and conducting fundraising campaigns

Note. If there are no significant benefits or duties connected with membership, however, the substance of membership development activities may, in fact, be fundraising, and the related costs reported as fundraising costs.

Soliciting funds other than contributions, including exchange transactions (whether program-related or not), such as government contracts, and related administrative activities

Conducting other activities involved with soliciting contributions from individuals, foundations, government agencies, and others

Disseminating information to inform the public of the NFP’s stewardship of contributed funds

Oversight

The annual report

Related administrative activities

Budgeting

General recordkeeping

Program services

$$

Supporting activities

$

$$ $ $


In some cases, it may be difficult to determine which functional category an expense belongs to.

Some expenses relate to more than one functional category

For example, the costs of oversight and management usually include the salaries and expenses of the

governing board, the chief executive officer of the NFP, and the supporting staff. If such staff spend a

portion of their time directly supervising program services or categories of other supporting services,

however, their salaries and expenses are allocated among those functions.

III. Getting from natural expenses to functional expenses

Earlier, we discussed that the current NFP framework for the reporting of expenses is based on the

premise that providing information about expenses by function is necessary to an understanding of an

NFP’s service efforts. Thus, FASB ASC 958 requires all NFPs to report information about expenses by

their functional classification in either the statement of activities or the notes to the financial statements.

The majority of NFPs choose to present this information in the statement of activities. Providing expense

information by functional classification is different from providing information by the more traditional

natural expense classification. The following provides the FASB ASC definitions of natural expense

classification and functional classification.

The FASB ASC definitions of natural expense classification and functional classification

The FASB ASC defines natural expense classification as a method of grouping expenses

according to the kinds of economic benefits received in incurring those expenses.

Examples of natural expense classifications include salaries and wages, employee

benefits, supplies, rent, and utilities.

The FASB ASC defines functional classification as a method of grouping expenses

according to the purpose for which costs are incurred. The primary functional

classifications are program services and supporting activities.

Typically, expenses originate in their natural expense classification. For example, an NFP pays an

electricity bill and records utilities expense (i.e., a natural expense classification). Some natural expenses

are relatively easy to directly convert to functional expenses (e.g., travel expenses incurred in connection

with a program are easily assigned to that program functionally). Other natural expenses require

allocation in order to arrive at functional expenses (e.g., rent for a building that houses both program and

supporting activities).

I belong over here! Program Activities

Management

and General

$ $ $

I’m not sure where to go!

I’m on this side!

$ $


How do we get from natural expenses to functional expenses?

Getting from natural expenses to functional expenses involves: (1) where

natural expenses can be specifically identified with a program or supporting

service assigning those expenses directly to that function; and (2) where natural

expenses cannot be specifically identified with a program or supporting service

reasonably allocating the natural expenses among the applicable functions.

A reasonable allocation of expenses among functions can be made on a variety of bases. Objective

methods of allocating expenses are preferable to subjective methods. The allocation may be based on

related financial or nonfinancial data. The allocation methods utilized by NFPs affect more than just the

presentation of functional expenses. For example, the allocation methods may also affect the

reclassification of net assets from temporarily restricted to unrestricted if purpose restrictions exist.

The following chart contains some additional comments/guidance related to the allocation of expenses.

Additional comments/guidance related to the allocation of expenses include…

%

Under FASB ASC 958-720-45, interest costs, including interest on a building’s mortgage, should

be allocated to specific programs or supporting services to the extent possible. Interest costs

that cannot be allocated are reported as part of the management and general function.

% Under FASB ASC 958-720-45, occupying and maintaining a building is not a separate

supporting service.

%

The AICPA Audit & Accounting Guide, Not-for-Profit Entities, provides that the expenses

associated with occupying and maintaining a building, such as depreciation, utilities,

maintenance, and insurance, may be allocated among the NFP’s functions based on the square

footage of space occupied by each program and supporting service. If floor plans are not

available and the measurement of the occupied space is impractical, an estimate of the relative

portion of the building occupied by each function may be made.

%

An NFP should periodically (e.g., annually) review the allocation methods utilized and revise

them when necessary to reflect significant changes in the nature or level of the NFP’s current

activities. In reviewing the allocation methods, the NFP may look at items such as time records

or activity reports of key personnel, the utilization of space, and the consumption of supplies and

postage.

NFPs often use account coding in the general ledger to collect and group expenses on both a natural and

functional basis. Allocations may occur through several means such as: (1) through a computerized

program; (2) coding assigned when invoices are submitted/entered into the accounts payable system;

and (3) adjusting journal entries. At different times, expense information on both a natural and functional

basis is needed for internal budgeting, compliance with grant and donor restrictions, and financial

reporting.

Natural Expenses

Functional expenses


IV. Classification of expenses that include fundraising

NFPs frequently solicit support through a variety of fundraising activities, including: (1) direct mail;

(2) telephone solicitation; (3) door-to-door canvassing; (4) telethons; (5) special events; and (6) other

activities. Sometimes fundraising activities are conducted with activities related to other functions.

Special rules (found in FASB ASC 958-720) apply for reporting the costs of activities that are part of the

fundraising function and also have elements of one or more other functions, such as program,

management and general, membership development, or any other functional category used by the entity.

A. Important terminology

In analyzing the FASB ASC 958-720 requirements for accounting for costs of activities that include

fundraising, it is important to understand certain terminology upfront.

Joint Activity - An activity that is part of the fundraising function and has elements of one

or more other functions, such as program, management and general, membership

development, or any other functional category used by the entity.

Costs of Joint Activities - Costs incurred for a joint activity. Costs of joint activities may

include joint costs and costs other than joint costs. Costs other than joint costs are costs

that are identifiable with a particular function, such as fundraising, program, management

and general, and cost of sales. For example, some costs incurred for printing, paper,

professional fees, and salaries to produce donor cards are not joint costs, although they

may be incurred in connection with conducting joint activities.

Joint Costs - The costs of conducting joint activities that are not identifiable with a

particular component of the activity. For example, the cost of postage for a letter that

includes both fundraising and program components is a joint cost. Joint costs may include

the following costs: (1) salaries; (2) contract labor; (3) consultants; (4) professional fees;

(5) paper; (6) printing; (7) postage; (8) event advertising; (9) telephones; (10) airtime; and

(11) facility rentals.

B. Three important criteria

FASB ASC 958-720-45 contains three criteria that are applied to joint activities to determine how these

activities are reported.

Classification of the costs of a joint activity based on FASB ASC 958-720-45-29

If…

If the criteria of purpose, audience, and content are met, the costs of a joint activity are

classified as follows: (1) the costs that are identifiable with a particular function are charged

to that function; and (2) joint costs are allocated between fundraising and the appropriate

program or management and general function.

If not…

If any of the criteria (i.e., purpose, audience, or content) are not met, all costs of the joint

activity are reported as fundraising costs, including costs that otherwise might be considered

program or management and general costs if they had been incurred in a different activity,

subject to the exception in the following sentence. Costs of goods or services provided in

exchange transactions that are part of joint activities, such as costs of direct donor benefits

of a special event (e.g., a meal), are not reported as fundraising.


In circumstances in which an NFP that conducts joint activities has a functional structure that includes

functional classifications other than fundraising, program, and management and general, all costs of

those joint activities are charged to fundraising (or the category in which fundraising is reported), unless

the purpose, audience, and content of those joint activities are appropriate for achieving those other

functions.

We will now look at each of the three criteria (i.e., purpose, audience, and content) that are applied to

joint activities to determine how these activities are reported.

C. What is the purpose criterion?

The purpose criterion is used to determine whether the purpose of the joint activity includes

accomplishing program or management and general functions. The purpose criterion is met if the

purpose of the joint activity includes accomplishing program or management and general

functions. The following will be considered in determining whether the purpose criterion is met:

If the joint activity combines program functions with fundraising activities:

To accomplish program functions, the activity will call for specific action by the audience that will

help accomplish the NFP’s mission. Actions that help accomplish the NFP’s mission are actions

that do either of the following: (1) benefit the recipient (e.g., by improving the recipient’s physical,

mental, emotional, or spiritual health and well-being); or (2) benefit society (by addressing societal

problems).

In circumstances in which joint activities are conducted, a presumption exists that expenses are

reported as fundraising rather than as program or management and general. The following

circumstances are insufficient to overcome that presumption: (1) the purpose of the activity

includes educating the public about causes; (2) the audience has a need or reasonable potential

for use of any educational component of the activity pertaining to causes; and (3) the audience

has the ability to assist the NFP in meeting the goals of the program component of the activity by

becoming educated about causes.

To conclude that the criteria of purpose, audience, and content are met, program activities will call

for specific action by the recipient (other than becoming educated about causes) that will help

accomplish the NFP’s mission.

If the activity calls for specific action by the audience that will help accomplish the NFP’s mission,

the guidance in the next section of the chart will also be considered in determining whether the

purpose criterion is met. Note. FASB ASC 958-720-55-4 to 958-720-55-5 provides

implementation guidance for determining whether an activity includes a call for a specific action.

If the joint activity combines program functions, management and general functions, or both with fundraising activities:

The following factors will be considered, in the order in which they are listed, to determine whether

the purpose criterion is met: (1) the compensation or fees test; (2) the separate and similar

activities test; and (3) the other evidence test. Note. FASB ASC 958-720-55-36 to 958-720-55-

159 provides implementation guidance for these three tests.

We will now look at each of the three tests just mentioned (i.e., the compensation or fees test; the

separate and similar activities test; and the other evidence test).


1. The compensation or fees test

The compensation or fees test:

The purpose criterion is not met if a majority of compensation or fees for any party’s performance

of any component of the discrete joint activity varies based on contributions raised for that discrete

joint activity.

Some compensation contracts provide that compensation for performing the activity is based on a

factor other than contributions raised, but not to exceed a specified portion of contributions raised.

For example, a contract may provide that compensation for performing the activity is $15 per

contact hour, but not to exceed 70 percent of contributions raised. In such circumstances,

compensation is not considered based on amounts raised, unless the stated maximum

percentage is met. In situations in which it is not yet known whether the stated maximum

percentage is met, compensation is not considered based on amounts raised, unless it is probable

that the stated maximum percentage will be met.

The compensation or fees test is a negative test in that it either: (1) results in failing the purpose

criterion; or (2) is not determinative of whether the purpose criterion is met.

In considering the three purpose criterion tests (i.e., the compensation or fees test; the separate

and similar activities test; and the other evidence test), the compensation or fees test is the

dominant guidance. Therefore, if the activity fails the compensation or fees test, the activity fails

the purpose criterion and the separate and similar activities test is not considered.

If the purpose criterion is not failed based on the compensation or fees test, this factor is not

determinative of whether the purpose criterion is met, and the factors in the separate and similar

activities test are considered.

2. The separate and similar activities test

The separate and similar activities test:

The purpose criterion is met if a similar program or management and general activity is

conducted separately and on a similar or greater scale. That is, the purpose criterion is met if

either of the following conditions is met:

The first condition (i.e., similar program) is met if both of the following are true: (1) the program

component of the joint activity calls for specific action by the recipient that will help accomplish the

NFP’s mission; and (2) a similar program component is conducted without the fundraising

component using the same medium and on a scale that is similar to or greater than the scale on

which it is conducted with the fundraising. Determining the scale on which an activity is conducted

may be subjective. Factors to consider in determining the scale on which an activity is conducted

may include dollars spent, the size of the audience reached, and the degree to which the

characteristics of the audience are similar to the characteristics of the audience of the activity

being evaluated.

The second condition (i.e., management and general activity) is met if a management and

general activity that is similar to the management and general component of the joint activity being

accounted for is conducted without the fundraising component using the same medium and on a

scale that is similar to or greater than the scale on which it is conducted with the fundraising.

If the purpose criterion is met based on the separate and similar activities test, the other evidence

test is not considered. If the separate and similar activities test is not determinative, the other

evidence test is considered.


3. The other evidence test

The other evidence test:

The compensation or fees test and the separate and similar activities test may not always be

determinative because the attributes that they consider may not be present. If the factors in the

compensation or fees test or the separate and similar activities test do not determine whether the

purpose criterion is met, other evidence may determine whether the criterion is met. All available

evidence, both positive and negative, is considered to determine whether, based on the weight of

that evidence, the purpose criterion is met. FASB ASC 958-720-55-6 to 958-720-55-9 provides

implementation guidance for applying the other evidence test.

4. Exercise 6-1

As we discussed, if program functions are combined with fundraising activities, it is important to determine

whether the activity includes a call for specific action by the audience that will help accomplish the NFP’s

mission. Please review and complete the below related to this.

Fact Pattern:

Does the fact pattern presented include a call for a specific action?

1

NFP C’s mission includes improving individuals’

physical health. As part of a joint activity, NFP C

sends a brochure that urges recipients to stop

smoking and suggests specific methods, instructions,

references, and resources that may be used to stop

smoking.

2

NFP D’s mission includes improving individuals’

physical health. As part of a joint activity, NFP D

sends a brochure educating recipients about NFP

D’s mission and asking for contributions to further the

mission.

3

NFP T’s mission includes improving the environment.

As part of a joint activity, NFP T sends a brochure

educating recipients about environmental problems

caused by not recycling and implicitly calling for the

recipients to increase recycling.


5. Exercise 6-2

As we discussed, the compensation or fees test and the separate and similar activities test may not

always be determinative because the attributes that they consider may not be present. If the factors in

the compensation or fees test or the separate and similar activities test do not determine whether the

purpose criterion is met, other evidence may determine whether the criterion is met. All available

evidence, both positive and negative, is considered to determine whether, based on the weight of that

evidence, the purpose criterion is met. Please review the facts presented in the left column below and

draw a line as to whether the facts indicate that the purpose criterion may or may not have been met.

D. What is the audience criterion?

A rebuttable presumption exists that the audience criterion is not met if the audience includes

prior donors or is otherwise selected based on its ability or likelihood to contribute to the NFP.

That presumption can be overcome if the audience is also selected for any of the reasons in the

following chart. In determining whether that presumption is overcome, an NFP considers the extent to

which the audience is selected based on its ability or likelihood to contribute to the NFP and contrasts that

with the extent to which it is selected for one or more of the reasons in the following chart. As an

example, if the audience’s ability or likelihood to contribute is a significant factor in its selection and it has

a need for the action related to the program component of the joint activity, but having that need is an

insignificant factor in its selection, the presumption would not be overcome.

In circumstances in which the audience includes no prior donors and is not otherwise selected based on its ability or likelihood to contribute to the NFP, the audience criterion is met if the audience is selected for any of the following reasons:

The audience’s need to use or

reasonable potential for use of

the specific action called for by

the program component of the

joint activity.

The audience’s ability to take

specific action to assist the

NFP in meeting the goals of

the program component of

the joint activity.

The NFP is required to direct the

management and general component

of the joint activity to the particular

audience or the audience has

reasonable potential for use of the

management and general component.

NFP K conducts a joint activity with the assistance of a third party

marketing firm. NFP K evaluates the marketing firms’ performance

(for potential future activities) based on contributions raised from the

activity.

The fact provides

evidence that the purpose

criterion may

be met.

The fact provides


criterion may not be met.

NFP O conducts a joint activity. NFP O measures program results

and accomplishments of the activity (other than measuring the

extent to which the public was educated about causes).

NFP Y conducts a joint activity involving a direct mailing. The

program component of the direct mailing calls for specific action by

the recipient that will help accomplish NFP Y’s mission. NFP Y also

conducts the program component without a significant fundraising

component in a series of radio spots.


E. What is the content criterion?

The content criterion:

The content criterion is met if the joint activity supports program or management and

general functions, as follows:

Program. The joint activity calls for specific action by the recipient that will help accomplish the

NFP’s mission. If the need for and benefits of the action are not clearly evident, information

describing the action and explaining the need for and benefits of the action is provided.

Management and general. The joint activity fulfills one or more of the NFP’s management and

general responsibilities through a component of the joint activity.

Information identifying and describing the NFP, its causes, or how the contributions provided will

be used is considered in support of fundraising.

Activities that are undertaken as a result of receiving contributions are management and general

activities (e.g., activities conducted to comply with requirements of regulatory bodies concerning

contributions that have been received are management and general activities).

Activities that are undertaken in order to solicit contributions are fundraising activities. As an

example, activities conducted to comply with requirements of regulatory bodies concerning

soliciting contributions, such as the requirement by some states or other regulatory bodies that

certain disclosures be included when soliciting contributions, are fundraising activities. For

purposes of applying this guidance, communications that include such required disclosures are

considered fundraising activities and are not considered management and general activities.

F. Allocation methods

The cost allocation methodology used shall be rational and systematic, it shall result in an allocation of

joint costs that is reasonable, and it shall be applied consistently given similar facts and circumstances.

FASB ASC 958-720-55-25 to 958-720-55-31 provides explanations and illustrations of some acceptable

allocation methods. The methods shown are the standalone joint cost allocation method, the relative

direct cost method, and the physical units method. The allocation of joint costs is based on the degree to

which costs were incurred for the functions to which the costs are allocated (i.e., program, management

and general, or fundraising). For purposes of determining whether the allocation methodology for a

particular joint activity is consistent with methodologies used for other particular joint activities, facts and

circumstances that may be considered include factors related to the content and relative costs of the

components of the activity. The audience is not considered in determining whether the facts and

circumstances are similar for purposes of determining whether the allocation methodology for a particular

joint activity is consistent with methodologies used for other particular joint activities. A change in cost

allocation methodology is evaluated in accordance with FASB ASC 250 to determine if it is a change in

accounting principle.

G. Incidental activities

Some fundraising activities conducted in conjunction with program or management and general activities

are incidental to such program or management and general activities. For example, NFP D conducts a

fundraising activity by including a generic message, “Contributions to NFP D may be sent to 123 Main

Street, Hometown, Indiana” on a small area of a message that would otherwise be considered a program

activity based on its purpose, audience, and content. That fundraising activity probably would be

considered incidental to the program activity being conducted.


In situations in which a fundraising, program, or management and general activity is conducted in

conjunction with another activity and is incidental to that other activity, and the criteria in FASB ASC 958-

720-45-29 (see discussion at page 6-6) for allocation are met, joint costs are permitted but not required to

be allocated and may therefore be charged to the functional classification related to the activity that is not

the incidental activity. However, in situations in which the program or management and general activities

are incidental to the fundraising activities, it is unlikely that the criteria in FASB ASC 958-720-45-29 to

permit allocation of joint costs would be met.

H. Key disclosures related to joint costs

NFPs that allocate joint costs have several disclosure requirements as discussed in the following chart.

NFPs that allocate joint costs disclose all of the following in the notes to the financial statements:

The types of activities for which joint costs have been incurred.

A statement that such costs have been allocated.

The total amount allocated during the period and the portion allocated to each functional expense

category.

Note. NFPs are encouraged, but not required, to disclose the amount of joint costs for each kind of joint

activity, if practical.

The financial statements will also disclose total fundraising expenses.


I. Exercise 6-3

Please review and answer the following true or false questions related to the classification of expenses

that include fundraising.

True or False

1

If the criteria of purpose, audience, and content are met, the costs

of a joint activity are classified as follows: (1) the costs that are

identifiable with a particular function are charged to that function;

and (2) joint costs are allocated between fundraising and the

appropriate program or management and general function.

2

If the joint activity combines program functions, management and

general functions, or both with fundraising activities the following

factors will be considered, in the order in which they are listed, to

determine whether the purpose criterion is met: (1) the separate and

similar activities test; (2) the compensation or fees test; and (3) the

other evidence test.

3

If the purpose criterion is not failed based on the compensation or

fees test, this factor is not determinative of whether the purpose

criterion is met, and the factors in the separate and similar activities

test are considered.

4

If the purpose criterion is met based on the separate and similar

activities test, this factor is not determinative of whether the purpose

criterion is met, and the factors in the other evidence test are

considered.

5 A rebuttable presumption exists that the audience criterion is not

met if the audience includes prior donors or is otherwise selected

based on its ability or likelihood to contribute to the NFP.

6 The content criterion is met if the joint activity supports program or

management and general functions.

7

The cost allocation methodology used shall be rational and

systematic, it shall result in an allocation of joint costs that is

reasonable, and it shall be applied consistently given similar facts

and circumstances.

8

In situations in which a fundraising, program, or management and

general activity is conducted in conjunction with another activity and

is incidental to that other activity, and the criteria in FASB ASC 958-

720-45-29 for allocation are met, joint costs must be allocated.





Fact Pattern:

Does the fact pattern presented include a call for a specific action?

1

NFP C’s mission includes improving individuals’

physical health. As part of a joint activity, NFP C

sends a brochure that urges recipients to stop

smoking and suggests specific methods, instructions,

references, and resources that may be used to stop

smoking.

Yes. For NFP C, motivating the audience

to take specific action that will improve their

physical health is a call for specific action

by the audience that will help accomplish

NFP C’s mission.

2

NFP D’s mission includes improving individuals’

physical health. As part of a joint activity, NFP D

sends a brochure educating recipients about NFP

D’s mission and asking for contributions to further the

mission.

No. Simply educating the audience about

NFP D’s mission and asking the audience

to make contributions is not a call for

specific action by the audience that will help

accomplish the NFP's mission. Such

activities are considered in support of

fundraising.

3

NFP T’s mission includes improving the environment.

As part of a joint activity, NFP T sends a brochure

educating recipients about environmental problems

caused by not recycling and implicitly calling for the

recipients to increase recycling.

Yes. Some educational activities that might

otherwise be considered as educating the

audience about causes may implicitly call

for specific action by the audience that will

help accomplish the NFP’s mission. If the

need for and benefits of the specific action

are clearly evident from the educational

message, the message is considered to

include an implicit call for specific action by

the audience that will help accomplish the

NFP’s mission.



NFP K conducts a joint activity with the assistance of a third party

marketing firm. NFP K evaluates the marketing firms’ performance

(for potential future activities) based on contributions raised from the

activity.

The fact provides


criterion may

be met.

The fact provides


criterion may not be met.

NFP O conducts a joint activity. NFP O measures program results

and accomplishments of the activity (other than measuring the

extent to which the public was educated about causes).

NFP Y conducts a joint activity involving a direct mailing. The

program component of the direct mailing calls for specific action by

the recipient that will help accomplish NFP Y’s mission. NFP Y also

conducts the program component without a significant fundraising

component in a series of radio spots.



True or False

1

If the criteria of purpose, audience, and content are met, the costs

of a joint activity are classified as follows: (1) the costs that are

identifiable with a particular function are charged to that function;

and (2) joint costs are allocated between fundraising and the

appropriate program or management and general function.

True.

2

If the joint activity combines program functions, management and

general functions, or both with fundraising activities the following

factors will be considered, in the order in which they are listed, to

determine whether the purpose criterion is met: (1) the separate

and similar activities test; (2) the compensation or fees test; and

(3) the other evidence test.

False. The order in which

they are considered is (1) the

compensation or fees test;

(2) the separate and similar

activities test; and (3) the

other evidence test.

3

If the purpose criterion is not failed based on the compensation or

fees test, this factor is not determinative of whether the purpose

criterion is met, and the factors in the separate and similar

activities test are considered.

True.

4

If the purpose criterion is met based on the separate and similar

activities test, this factor is not determinative of whether the

purpose criterion is met, and the factors in the other evidence test

are considered.

False. If the purpose criterion

is met based on the separate

and similar activities test, the

other evidence test is not

considered.

5 A rebuttable presumption exists that the audience criterion is not

met if the audience includes prior donors or is otherwise selected

based on its ability or likelihood to contribute to the NFP.

True.

6 The content criterion is met if the joint activity supports program or

management and general functions. True.

7

The cost allocation methodology used shall be rational and

systematic, it shall result in an allocation of joint costs that is

reasonable, and it shall be applied consistently given similar facts

and circumstances.

True.

8

In situations in which a fundraising, program, or management and

general activity is conducted in conjunction with another activity

and is incidental to that other activity, and the criteria in FASB ASC

958-720-45-29 for allocation are met, joint costs must be allocated.

False. In these situations,

joint costs are permitted but

not required to be allocated.


Financial Reporting Today

Learning Objectives 1 I. NFP financial reporting 1 II. The statement of financial position 2

A. The classification of assets and liabilities 2 B. Providing information about liquidity 3

1. Exercise 7-1 3 2. Exercise 7-2 4

C. Classification of net assets 4 1. Exercise 7-3 6 2. Exercise 7-4 7

D. Key disclosures related to the statement of financial position 7 E. Example statement of financial position 8

III. The statement of activities 9 A. The classification of revenues, expenses, gains, and losses 9

1. Exercise 7-5 10 2. The presentation of contributions in the statement of activities 10 3. Exercise 7-6 10

B. Sequencing the statement of activities 10 C. Including a measure of operations 11

1. Exercise 7-7 11 D. Reporting expenses by function 12

1. Exercise 7-8 12 E. Reclassifications of net assets 12

1. Exercise 7-9 13 F. Gross versus net reporting in the statement of activities 14

1. Exercise 7-10 14 G. Key disclosures related to the statement of activities 15 H. Statement of activities examples 15

1. The single-column format 15 2. The multi-column format 17 3. Exercise 7-11 17

IV. The statement of cash flows 18 A. Cash and cash equivalents 18 B. Cash flows from operating, investing, and financing activities 20

1. Exercise 7-12 21 C. Reconciling the change in net assets to cash flow from operating activities 22 D. Key disclosures related to the statement of cash flows 22

1. Exercise 7-13 22 E. Statement of cash flows examples 22

1. The direct method 23 2. The indirect method 24 3. Exercise 7-14 24

V. The statement of functional expenses 25 A. A financial statement with an unusual history 25 B. What is a voluntary health and welfare entity? 25

1. Exercise 7-15 26 C. The matrix format for the statement of functional expenses 26

1. Exercise 7-16 27 D. Statement of functional expenses example 27

VI. Suggested solutions to exercises 28 A. Suggested solution to Exercise 7-1 28 B. Suggested solution to Exercise 7-2 29 C. Suggested solution to Exercise 7-3 30 D. Suggested solution to Exercise 7-4 30 E. Suggested solution to Exercise 7-5 31 F. Suggested solution to Exercise 7-6 31

cpenow.com / [email protected] Copyright © 2016 Surgent McCoy CPE, LLC -- FMIS/16/01 7-ii

G. Suggested solution to Exercise 7-7 32 H. Suggested solution to Exercise 7-8 32 I. Suggested solution to Exercise 7-9 33 J. Suggested solution to Exercise 7-10 33 K. Suggested solution to Exercise 7-11 33 L. Suggested solution to Exercise 7-12 34 M. Suggested solution to Exercise 7-13 35 N. Suggested solution to Exercise 7-14 35 O. Suggested solution to Exercise 7-15 35 P. Suggested solution to Exercise 7-16 35


Financial Reporting Today

Learning Objectives


Recognize the financial statements that NFPs prepare (i.e., the statement of

financial position, the statement of activities, the statement of cash flows, and

the statement of functional expenses); and

Apply today’s financial reporting requirements for NFPs (i.e., what is required,

what is optional, and what are some best practices for communicating

mission fulfillment).

I. NFP financial reporting

This chapter is all about how NFPs prepare their financial statements under today’s requirements. NFP

financial reporting differs from the financial reporting that business entities utilize due to the mission focus

of NFPs.

Financial statements with a mission!

In Chapter 1, we discussed that the FASB has identified three primary

characteristics that NFPs have which distinguish them from business entities

(i.e., contributions, operating purposes, and the absence of ownership

interests). These characteristics are important as they directly and indirectly get

to the fact that NFPs are focused on mission fulfillment instead of profitability

and the financial statements that NFPs prepare reflect that focus.

NFPs attempt to answer questions about mission fulfillment through their financial statements. The

following illustrates the financial statements prepared by NFPs and the mission focus.

The financial statements prepared by NFPs include:

In addition, voluntary health and welfare entities prepare:

Provides a point in time measurement of the NFP’s resources on hand to achieve its mission going

forward

Primarily provide a period of time measurement of how the NFP’s resources were used in pursuing the mission and how successful the NFP was in attaining resources

The Statement of Financial Position or

Balance Sheet

The Statement

of Activities

The Statement

of Cash Flows

The Statement of Functional

Expenses


II. The statement of financial position

When trying to understand the statement of financial position an important starting point is recognizing

what the statement reports.

The statement of financial position focuses on the NFP as a whole and reports all of the following amounts:

NFPs are not prevented from displaying interfund items in a statement of financial position. However, the

requirement to display total assets and liabilities results in certain practical limits on how interfund items

are displayed. For example, because receivables and payables between fund groups are not entity

assets or liabilities, a statement of financial position clearly labels and arranges those interfund items to

eliminate their amounts when displaying total assets or liabilities.

FASB ASC 958 does not emphasize or prevent specific statement formats. It permits a left-to-right

or top-to-bottom balanced format as well as single-column, multicolumn, single-page, or

multipage formats (i.e., an NFP is allowed to use the approach that is most helpful to its users).

FASB ASC 958-210 describes the unique standards relating to a statement of financial position. An NFP

should follow the industry-specific guidance found in FASB ASC 958 and all effective provisions of the

FASB ASC unless the specific provision explicitly exempts NFPs or its subject matter precludes such

applicability. For example, NFPs should apply the guidance contained in FASB ASC 210, Balance Sheet,

that does not conflict with the industry guidance.

A. The classification of assets and liabilities

It is important to properly classify and aggregate assets and liabilities within the statement of financial

position.

Aggregating assets and liabilities that possess similar characteristics

A statement of financial position, including the accompanying notes to the financial

statements, provides relevant information about liquidity, financial flexibility, and the

interrelationship of an NFP’s assets and liabilities. That information generally is provided by

aggregating assets and liabilities that possess similar characteristics into reasonably

homogeneous groups that include the effects of donor-imposed restrictions as well as other

contractual restrictions.

Permanently Restricted

Net Assets

Temporarily Restricted

Net Assets

Unrestricted

Net Assets

Statement of

Financial

Position

Total

Assets

Total

Liabilities

Total

Net Assets

$$$$

$$$$ $$$$

$$$$

$$$$ $$$$


Classifying and aggregating items with similar characteristics into reasonably homogeneous groups and

separating items with differing characteristics improves the usefulness of information. For example,

entities generally report individual items of assets in homogeneous groups, such as cash and cash

equivalents; accounts and notes receivable from patients, students, members, and other recipients of

services; inventories of materials and supplies; deposits and prepayments for rent, insurance, and other

services; marketable securities and other investment assets held for long-term purposes; and land,

buildings, equipment, and other long-lived assets used to provide goods and services. Similarly, cash

collections of receivables from patients, students, or other service recipients may differ significantly in

continuity, stability, and risk from cash collections of pledges made to a special-purpose fundraising

campaign. Classifying and reporting those receivables and collections of receivables as separate groups

of assets and of cash inflows assists in financial statement analysis.

Assets may be restricted by donors. Normally, however, restrictions apply to net assets, not to specific

assets. Assets need not be disaggregated on the basis of the presence of donor-imposed restrictions on

their use (e.g., cash available for unrestricted current use need not be reported separately from cash

received with donor-imposed restrictions that is also available for current use). However, cash or other

assets received with a donor-imposed restriction that limits their use to long-term purposes should not

be classified with cash or other assets that are unrestricted and available for current use. If its nature is

not clear from the description on the face of the statement of financial position, the kind of asset whose

use is limited should be described in the notes to the financial statements.

If not disclosed in the notes to financial statements, the following information will be displayed on the face

of the statement of financial position: (1) relevant information about the nature and amount of limitations

on the use of cash and cash equivalents; and (2) contractual limitations on the use of particular assets.

B. Providing information about liquidity

FASB ASC 958 requires that NFPs provide information about liquidity.

FASB ASC 958 requires that information about the NFP’s liquidity be provided by any of the following three methods:

1 Sequencing assets according to their nearness of conversion to cash and sequencing liabilities

according to the nearness of their maturity and resulting use of cash.

2 Classifying assets and liabilities as current and noncurrent, as defined by FASB ASC 210-10.

3 Disclosing in notes to financial statements relevant information about the liquidity or maturity of

assets and liabilities, including restrictions on the use of particular assets.

1. Exercise 7-1

Please answer the following question related to providing information about an NFP’s liquidity.

Providing information about an NFP’s liquidity

In the prior chart we saw that NFPs currently have three methods of providing information about their

liquidity. The second method involves classifying assets and liabilities as current and noncurrent (i.e.,

presenting a classified statement of financial position). In the author’s experience, most NFPs do not

elect this method today. Why do many NFPs not use this method today?


2. Exercise 7-2

Please review the issues presented below and answer the questions in the space provided.

Issues and answers related to liquidity

Issue: Answer:

1

NFP A sequences assets and liabilities in the statement of financial

position based on their relative liquidity. At year end, NFP A has

cash and cash equivalents related to permanent endowment funds

which are being held temporarily until suitable long-term investment

opportunities are identified. Where should these cash and cash

equivalents be reported in the statement of financial position?

2

NFP B sequences assets and liabilities in the statement of financial

position based on their relative liquidity. At year end, NFP B has

cash and contribution receivables restricted by donors to

investment in land, buildings, and equipment that are not included

with the line items cash and cash equivalents or contributions

receivable. Where should these cash and contribution receivables

be reported in the statement of financial position?

3

NFP C classifies assets and liabilities as current and noncurrent in

the statement of financial position. At year end NFP C has cash

that is designated for expenditure in the acquisition or construction

of noncurrent assets. Should the cash be classified as a current

asset in the statement of financial position?

C. Classification of net assets

Information about restrictions on net assets is important to the readers of NFP financial statements

whether they be internal or external users. Donor restrictions impose distinct responsibilities on an NFP’s

management to ensure that it uses donated assets as stipulated. Donor restrictions also place limits on

the use of resources which may have a bearing on an NFP’s performance and its ability to provide a

satisfactory level of services. Information about how managers discharge their stewardship

responsibilities for donor-restricted resources is also helpful in assessing an NFP’s performance. The

Basis for Conclusions to FASB No. 117 (i.e., the bellwether standard from which much of the current

FASB ASC 958 reporting guidance came from) outlined why the FASB has required information about

three classifications of net assets since the early 1990s.

The Basis for Conclusions to FASB No. 117 outlined why the FASB has required information about three classifications of net assets

Information about permanent restrictions

is useful in…

Determining the extent to which an organization’s net assets

are not a source of cash for payments to present or prospective

lenders, suppliers, or employees and thus are not expected to

be directly available for providing services or paying creditors.

Information about the extent of unrestricted and temporarily restricted net

assets is useful in…

Assessing an organization’s ability and limitations on its ability

to allocate resources to provide services or particular kinds of

services or to make cash payments to creditors in the future.


Because the FASB believed that aggregated information about the three components of an NFP’s net

assets is especially important to both donors and creditors and that such information is best provided by

display of their amounts in a statement of financial position, it required the amounts of permanently

restricted, temporarily restricted, and unrestricted net assets be displayed on the statement in addition to

total net assets. The three classes of net assets are described in the below.

The three classes of net assets

Permanently Restricted Net Assets – The part of the net assets of an NFP resulting

from the following:

• Contributions and other inflows of assets whose use by the NFP is limited

by donor-imposed stipulations that neither expire by passage of time nor

can be fulfilled or otherwise removed by actions of the NFP.

• Other asset enhancements and diminishments subject to the same kinds

of stipulations.

• Reclassifications from or to other classes of net assets as a consequence

of donor-imposed stipulations.

Temporarily Restricted Net Assets – The part of the net assets of an NFP resulting

from the following:

• Contributions and other inflows of assets whose use by the NFP is limited

by donor-imposed stipulations that either expire by passage of time or

can be fulfilled and removed by actions of the NFP pursuant to those

stipulations.

• Other asset enhancements and diminishments subject to the same kinds

of stipulations.

• Reclassification from or to 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 NFP pursuant to those

stipulations.

Unrestricted Net Assets – The part of the net assets of an NFP that is neither

permanently restricted nor temporarily restricted by donor-imposed stipulations. The

only limits on the use of unrestricted net assets are the broad limits resulting from the

following:

• The nature of the NFP.

• The environment in which the NFP operates.

• The purposes specified in the NFP’s articles of incorporation or bylaws.

• Limits resulting from contractual agreements with suppliers, creditors, and

others entered into by the NFP in the course of its business.

Unrestricted net assets generally result from revenues from providing services,

producing and delivering goods, receiving unrestricted contributions, and receiving

dividends or interest from investing in income-producing assets, less expenses incurred

in providing services, producing and delivering goods, raising contributions, and

performing administrative functions.

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As seen in the prior chart, the amounts for each of the three classes of net assets are based on the

existence or absence of donor-imposed restrictions. Information about the nature and amounts of

different types of permanent and temporary restrictions is required either by reporting their amounts on

the face of the statement or by including relevant details in the notes to the financial statements.

Separate line items may be reported within permanently restricted net assets or in notes to financial

statements to distinguish between permanent restrictions for both of the following holdings: [1] assets,

such as land or works of art, donated with stipulations that they be used for a specified purpose, be

preserved, and not be sold; and [2] assets donated with stipulations that they be invested to provide a

permanent source of income (these result from gifts and bequests that create permanent endowment

funds).

Separate line items may be reported within temporarily restricted net assets or in notes to financial

statements to distinguish between the following temporary restrictions: (1) support of particular operating

activities; (2) investment for a specified term; (3) use in a specified future period; and (4) acquisition of

long-lived assets. Donors’ temporary restrictions may require that resources be used in a later period or

after a specified date (time restrictions), or that resources be used for a specified purpose (purpose

restrictions), or both.

Self-imposed limits

Information about self-imposed limits may be helpful, including information about

voluntary resolutions by the governing board of an entity to designate a portion of

its unrestricted net assets to function as an endowment (sometimes referred to

as a board-designated endowment). This information may be provided on the

face of the financial statements or in the footnotes.

1. Exercise 7-3


True or False

1 In today’s environment, the vast majority of NFPs present some level of

additional disaggregation within the three classifications of net assets in the

statement of financial position.

2

The FASB has historically believed that information about a minimum of three

classes of net assets, based on the presence or absence of donor-imposed

restrictions and their nature, generally is necessary to gain an adequate

understanding of the financial position of an NFP.


2. Exercise 7-4

Please review the below net asset section format. Do you believe that this format is allowable or not

allowable and why?

Donor restricted:

Permanently $XXX

Temporarily XXX

Other:

Designated by the Board for [purpose] $XXX

Undesignated XXX XXX

Net assets $XXX

D. Key disclosures related to the statement of financial position

The following chart discusses several key disclosure requirements related to the statement of financial

position.

NFPs have several statement of financial position related disclosure requirements including:

As discussed earlier, an NFP is required to disclose in the notes to the financial statements

relevant information about the liquidity or maturity of assets and liabilities, including restrictions on

the use of particular items, unless that information is provided on the face of the statement of

financial position.

An NFP is required to disclose all of the following, if present, in the notes to the financial

statements:

• Unusual circumstances, such as special borrowing arrangements, requirements

imposed by resource providers that cash be held in separate accounts, and known

significant liquidity problems.

• The fact that the NFP has not maintained appropriate amounts of cash and cash

equivalents to comply with donor-imposed restrictions.

• Information about significant limits resulting from contractual agreements with

suppliers, creditors, and others, including the existence of loan covenants.

As discussed earlier, the following items are required to be included in the notes to the financial

statements if they are not provided on the face of the statement of financial position:

• A description of the kind of asset whose use is limited.

• Information about the nature and amount of limitations on the use of cash and cash

equivalents.

• Contractual limitations on the use of particular assets.

• Information about the nature and amounts of different types of permanent and

temporary restrictions.


E. Example statement of financial position

The following is an illustrative statement of financial position (excluding footnotes) that sequences assets

and liabilities based on their relative liquidity.

NFP X Statements of Financial Position

September 30, 2016 and 2015

Assets: 2016 2015

Cash and cash equivalents $ 33,500 $ 42,047

Accounts and interest receivable 22,600 37,800

Inventories and prepaid expenses 5,047 7,058

Contributions receivable 52,740 44,321

Short-term investments 78,235 65,035

Land, buildings, and equipment 236,785 205,786

Long-term investments 356,458 378,256

Total assets $785,365 $780,303

Liabilities and net assets:

Accounts payable 29,053 15,089

Refundable advance 1,520

Grants payable 27,250 20,784

Notes payable 12,030 17,235

Long-term debt 82,035 87,568

Total liabilities 150,368 142,196

Net Assets:

Unrestricted 262,785 247,234

Temporarily restricted 70,430 97,695

Permanently restricted 301,782 293,178

Total net assets 634,997 638,107

Total liabilities and net assets $785,365 $780,303

Having discussed the statement of financial position, we are now ready to examine the statement of

activities.


III. The statement of activities

As illustrated below, the statement of activities focuses on the NFP as a whole and reports several key

amounts for the period.

The statement of activities focuses on the NFP as a whole and reports all of the following amounts for the period:

FASB ASC 958 requires the change in net assets to articulate to the net assets or equity reported in the

statement of financial position. It also requires the change in net assets to be referred to with a

descriptive term such as change in net assets or change in equity.

FASB ASC 958-225 describes the unique standards relating to a statement of activities of an NFP. An

NFP should follow that industry-specific guidance and all effective provisions of the FASB ASC unless the

specific provision explicitly exempts NFPs or its subject matter precludes such applicability. For example,

NFPs should apply the guidance contained in FASB ASC 225, Income Statement, that does not conflict

with the industry guidance found in FASB ASC 958.

A. The classification of revenues, expenses, gains, and losses

Information about revenues, expenses, gains, losses, and reclassifications generally is provided by

aggregating items that possess similar characteristics into reasonably homogeneous groups.

Which net asset classification does this belong with?

Revenues The statement of activities reports revenues as increases in unrestricted net assets

unless the use of the assets received is limited by donor-imposed restrictions.

Expenses The statement of activities reports expenses as decreases in unrestricted net assets.

Gains and Losses

The statement of activities reports gains and losses recognized on investments and

other assets (or liabilities) as increases or decreases in unrestricted net assets unless

their use is temporarily or permanently restricted by explicit donor stipulations or by

law.1

1 See FASB ASC 958-320-45 for additional guidance about reporting investment gains and losses, and FASB ASC 958-

205-45-13 through 45-27 for additional guidance about reporting gains and losses on endowment funds. See FASB ASC 958-310-45-3 for additional guidance about bad debt expenses and losses.

The change in permanently

restricted net assets

The change in net assets

The change in

unrestricted net assets

The change in temporarily

restricted net assets

The

Statement of

Activities


1. Exercise 7-5

In this section of the course, we have discussed the classification of revenues, expenses, gains, and

losses. In the below, answer the two questions presented related to this.

Are entitywide totals required for individual line items of revenues, expenses, gains, or losses?

In what level of detail should revenues and expenses be presented?

2. The presentation of contributions in the statement of activities

For many NFPs, contributions represent an essential funding source. The presentation of contributions in

the statement of activities can be involved, as discussed below.

Making the right determinations regarding contribution revenue

In the absence of a donor’s explicit stipulation or circumstances surrounding the receipt

of a contribution that make clear the donor’s implicit restriction on use, contributions are

reported as unrestricted revenues or gains (unrestricted support), which increase

unrestricted net assets. The classification of contributions received as revenues or

gains depends on whether the transactions are part of the NFP’s ongoing major or

central activities (revenues), or are peripheral or incidental to the NFP (gains). Donor-

restricted contributions are reported as restricted revenues or gains (restricted support),

which increase temporarily restricted net assets or permanently restricted net assets

depending on the type of restriction. However, donor-restricted contributions whose

restrictions are met in the same reporting period may be reported as unrestricted

support provided that an NFP has a similar policy for reporting investment gains and

income, reports consistently from period to period, and discloses its accounting policy.

3. Exercise 7-6

Please answer the following question related to providing information about contributions.

Providing information about contributions

In the prior chart, we saw that donor-restricted contributions whose restrictions are met in the same

reporting period may be reported as unrestricted support provided that an NFP has a similar policy for

reporting investment gains and income, reports consistently from period to period, and discloses its

accounting policy. This option is sometimes referred to as the simultaneous release option. What

types of NFPs are most likely to use this option today?

B. Sequencing the statement of activities

FASB ASC 958-205-55-11 suggests three ways that items could be sequenced in the statement of

activities: (1) revenues and gains first, then expenses, then losses, reclassifications, which must be

shown separately, are reported with revenues and gains; (2) revenues, expenses, gains and losses, and

reclassifications shown last; and (3) certain revenues, less directly related expenses, followed by a

subtotal, then other revenues, other expenses, gains and losses, and reclassifications. Those items

could be arranged in other ways, and other subtotals may be included.

Unrestricted

Revenue

Gain

Restricted


C. Including a measure of operations

As discussed below, currently NFPs have a good deal of flexibility when it comes to the presentation of

additional classifications within the statement of activities.

Financial statement flexibility

Classifying revenues, expenses, gains, and losses within classes of net assets

does not prevent incorporating additional classifications within a statement of

activities. For example, within a class or classes of changes in net assets, an

NFP may classify items as: (1) operating and nonoperating; (2) expendable and

nonexpendable; (3) earned and unearned; (4) recurring and nonrecurring; and

(5) in other ways.

Since terms such as operating income, operating profit, operating surplus, operating deficit, and results of

operations are used with different meanings, if an intermediate measure of operations (e.g., excess or

deficit of operating revenues over expenses) is reported, it is required to be in a financial statement that,

at a minimum, reports the change in unrestricted net assets for the period.

Some limitations on an NFP’s use of an intermediate measure of operations are imposed by certain

sections of the FASB ASC. If a subtotal such as income from operations is presented, it is required to

include: [1] an impairment loss recognized for a long-lived asset (asset group) to be held and used,

pursuant to FASB ASC 360; [2] costs associated with an exit or disposal activity that does not involve a

discontinued operation, pursuant to FASB ASC 420; [3] a gain or loss recognized on the sale of a long-

lived asset (disposal group) that is not a component of an entity, pursuant to FASB ASC 360.

If an NFP’s use of the term operations is not apparent from the details provided on the face of the

statement, a note to the financial statements is required to describe the nature of the reported measure of

operations or the items excluded from operations.

1. Exercise 7-7

Please answer the following questions.

Question: Answer:

NFP Z is considering including a measure of operations within

its statement of activities. The controller of NFP Z asks you

for some examples of activities that NFPs commonly include

in nonoperating activities. What are a couple of examples that

you have seen?

Can you name a sector of the NFP community where the

operating/nonoperating format is frequently seen in the

statement of activities?


D. Reporting expenses by function

As we discussed in Chapter 6, to assist users in understanding an NFP’s service efforts (i.e., its mission

fulfillment), including the costs of its services and how it allocates its resources, the statement of activities

or the notes to the financial statements provide information about expenses reported by their functional

classification such as major classes of program services and supporting activities (e.g., management and

general, fundraising, and membership development).

1. Exercise 7-8

Please answer the following question.

Why wouldn’t you?

Currently, either the statement of activities or the notes to the financial statements will provide

information about expenses reported by their functional classification such as major classes of program

services and supporting activities. Most NFPs choose to do this on the face of the statement of

activities. However, some NFPs simply disclose functional expense information in the notes. Why

would an NFP choose to not provide functional expense information on the face of the

statement of activities?

E. Reclassifications of net assets

The term reclassification refers to the simultaneous increase of one class of net assets and decrease of

another, usually as a result of the release or lapsing of restrictions. Reclassifications are required to be

reported as separate items.

Reclassifications of net assets are required if any of the following events occur:

The NFP fulfills the purposes for which the net assets were restricted.

Donor-imposed restrictions expire with the passage of time or with the

death of a split-interest agreement beneficiary (if the net assets are not

otherwise restricted).

A donor withdraws, or court action removes, previously imposed

restrictions.

A donor imposes restrictions on otherwise unrestricted net assets. For

example, a donor may make a restricted contribution that is conditioned

on the NFP restricting a stated amount of its unrestricted net assets.

Such restrictions that are not reversible without donors’ consent result

in a reclassification of unrestricted net assets to restricted net assets.

Unrestricted Restricted





On some occasions, it may be difficult to determine when donor-imposed restrictions have expired. The

following provides additional guidance regarding the expiration of donor-imposed restrictions.

Expirations of donor-imposed restrictions

An NFP will recognize the expiration of a donor-imposed restriction on a contribution in the period

in which the restriction expires. A restriction expires when the stipulated time has elapsed, when

the stipulated purpose for which the resource was restricted has been fulfilled, or both. If two or

more temporary restrictions are imposed on a contribution, the effect of the expiration of those

restrictions will be recognized in the period in which the last remaining restriction has expired.

For example, a gift of a term endowment that is to be invested for four years will be recognized

as restricted support (revenue or gain) in the period it is received. In Year 4, when that term

endowment becomes unrestricted, a reclassification will be reported to reflect the decrease in

temporarily restricted net assets and the increase in unrestricted net assets. Accordingly, the

related effects of that time-restricted gift shall be reported in the period of receipt as well as the

period in which the nature of the restriction changes.

If an expense is incurred for a purpose for which both unrestricted and temporarily restricted net

assets are available, a donor-imposed restriction is fulfilled to the extent of the expense incurred

unless the expense is for a purpose that is directly attributable to another specific external source

of revenue. Temporarily restricted net assets with time restrictions are not available to support

expenses until the time restrictions have expired.

When a donor does not specify a time period over which a donated long-lived asset must be used,

FASB ASC 958-605-45-6 states that an NFP can elect a policy to imply a time restriction that

expires over the useful life of the donated long-lived assets. If an NFP adopts a policy of implying

time restrictions, it will also imply a time restriction on long-lived assets acquired with gifts of cash

or other assets restricted for those acquisitions. If time restrictions are implied on gifts of long-

lived assets, those implied time restrictions expire as the economic benefits of the acquired assets

are used up (i.e., over their estimated useful lives). In the absence of donor stipulations specifying

how long donated assets must be used or an NFP’s policy of implying time restrictions, restrictions

on long-lived assets, if any, or cash to acquire long-lived assets expire when the assets are placed

in service.

1. Exercise 7-9


In the below, try to list three auditing procedures that may be employed to test the presentation and disclosure of net assets in the financial statements:

1

2

3


F. Gross versus net reporting in the statement of activities

As we discussed in Chapter 5, to assist in explaining the relationships of an NFP’s ongoing major or

central operations and activities, a statement of activities reports the gross amounts of revenues and

expenses. However, investment revenues may be reported net of related expenses, such as custodial

fees and internal and external investment advisory costs, provided that the amount of the expenses is

disclosed either on the face of the statement of activities or in notes to the financial statements.

Net reporting

The statement of activities may report gains and losses as net amounts

if they result from peripheral or incidental transactions or from other

events and circumstances that may be largely beyond the control of the

NFP and its management.

The frequency of the events and the significance of the gross

revenues and expenses distinguish major or central events from

peripheral or incidental events.

As discussed above, the frequency of the events and the significance of the gross revenues and

expenses distinguish major or central events from peripheral or incidental events. Events are ongoing

major or central activities if they are normally part of an NFP’s strategy and it normally carries on such

activities or if the event’s gross revenues or expenses are significant in relation to the NFP’s annual

budget. Events are peripheral or incidental if they are not an integral part of an NFP’s usual activities or if

their gross revenues or expenses are not significant in relation to the NFP’s annual budget. Thus, similar

events may be reported differently by different NFPs based on the NFP’s overall activities.

Special events

Remember as we discussed in Chapter 5, an NFP may report net

amounts for its special events if they result from peripheral or incidental

transactions. However, special events often are ongoing major

activities; if so, an NFP will report the gross revenues and expenses of

those activities. Costs netted against receipts from peripheral or

incidental special events will be limited to direct costs.

1. Exercise 7-10

Earlier in this chapter, we discussed that expenses should be reported as decreases in unrestricted net

assets. In this section, we discussed that a statement of activities may report gains and losses as net

amounts if they result from peripheral or incidental transactions or from other events and circumstances

that may be largely beyond the control of the NFP and its management. Based on this information,

answer the question on the following page.

I believe this is largely beyond your control.

Special event

Well, this is kind of special...


Reporting bad debt losses

FASB ASC 958-310-35-7 discusses that if the fair value of a contribution receivable decreases because

of changes in the quantity or nature of assets expected to be received, the decrease is required to be

recognized in the period(s) in which the expectation changes. That decrease is required to be reported

as an expense or loss (bad debt) in accordance with paragraph 958-310-45-3. May bad debt losses

be netted against contribution revenue?

G. Key disclosures related to the statement of activities

The following chart discusses several key disclosure requirements related to the statement of activities.

NFPs have several disclosure requirements related to the statement of activities including:

As discussed earlier, if an NFP’s use of the term operations is not apparent from the details

provided on the face of the statement, a note to the financial statements is required to describe the

nature of the reported measure of operations or the items excluded from operations.

As discussed earlier, an NFP is required to disclose the amount of investment-related expenses,

such as custodial fees and investment advisory fees, netted against investment revenues if that

amount is not disclosed on the face of the statement of activities.

H. Statement of activities examples

This section includes a couple of example statements of activities (excluding footnotes).

1. The single-column format

The following is an illustrative statement of activities which reports information in a single column. The

single-column format is also called the pancake approach (as the presentation stacks the levels of net

assets). In the author’s experience, the single-column format is used less frequently than the multi-

column format that we will look at in a moment.


NFP Y Statement of Activities

Year Ended September 30, 2016


Revenues and gains:


Fees 4,546

Income on long-term investments 15,102

Other investment income 7,055

Net unrealized and realized gains on long-term investments 41,024

Other 2,026

Total unrestricted revenues and gains $215,121

Net assets released from restrictions:

Satisfaction of program restrictions 31,058

Expiration of time restrictions 15,012

Total net assets released from restrictions 46,070

Total unrestricted revenues, gains, and other support 261,191

Expenses:

Program Alpha 97,068

Program Beta 83,012


Fundraising 27,884

Total expenses 242,977

Increase in unrestricted net assets 18,214

Changes in temporarily restricted net assets:

Contributions 38,775



Net assets released from restrictions (46,070)

Increase in temporarily restricted net assets 31,300

Changes in permanently restricted net assets:

Contributions 18,001



Increase in permanently restricted net assets 43,076

Increase in net assets 92,590

Net assets at beginning of year 501,190

Net assets at end of year $593,780


2. The multi-column format

The following is an illustrative statement of activities which reports information in a columnar format with a

column for each class of net assets and an optional total column. This format is normally seen more

frequently than the single-column format. Sometimes, NFPs will also add a total only column with prior

year information or perhaps present a full prior year statement on a separate page.

NFP Y Statement of Activities

Year Ended September 30, 2016

Unrestricted

Temporarily Restricted

Permanently Restricted Total

Revenues, gains, and other support:

Contributions $145,368 $38,775 $18,001 $202,144

Fees 4,546 4,546

Income on long-term investments 15,102 17,522 10,012 42,636

Other investment income 7,055 7,055

Net unrealized and realized gains on long-term investments

41,024

21,073

15,063

77,160

Other 2,026 2,026

Net assets released from restrictions:

Satisfaction of program restrictions 31,058 (31,058)

Expiration of time restrictions 15,012 (15,012)

Total revenues, gains, and other support 261,191 31,300 43,076 335,567

Expenses:

Program Alpha 97,068 97,068

Program Beta 83,012 83,012

Management and general 35,013 35,013

Fundraising 27,884 27,884

Total expenses 242,977 242,977

Change in net assets 18,214 31,300 43,076 92,590

Net assets at beginning of year 200,417 100,297 200,476 501,190

Net assets at end of year $218,631 $131,597 $243,552 $593,780

3. Exercise 7-11

In this section of the course, we have seen illustrations of both the single-column and multi-column

formats for the statement of activities. In the below, list some advantages to each format.

Advantages to using the single-column format include:

Advantages to using the multi-column format include:


IV. The statement of cash flows

A statement of cash flows reports the cash effects during a period of an NFP’s operations, its investing

transactions, and its financing transactions. It also provides for a reconciliation of the change in net

assets and net cash flow from operating activities. To achieve this, the statement of cash flows is

required to report certain items as illustrated in the following chart.

The statement of cash flows is required to report all of the following amounts for the period:

The change in net assets

Net increase (decrease) in cash and cash equivalents

Net cash provided (used) by operating activities

Cash and cash equivalents at the beginning of the year

Net cash provided (used) by investing activities

Cash and cash equivalents at the end of the year

Net cash provided (used) by financing activities

In the following sections, we will look at key aspects of an NFP’s statement of cash flows and how items

are portrayed on the statement.

A. Cash and cash equivalents

A statement of cash flows explains the change during the period in cash and cash equivalents. The

statement uses descriptive terms such as cash or cash and cash equivalents rather than ambiguous

terms such as funds. The total amounts of cash and cash equivalents at the beginning and end of the

period shown in the statement of cash flows are required to be the same amounts as similarly titled line

items or subtotals shown in the statements of financial position as of those dates.

What is a cash equivalent?

FASB ASC 230-10-20 provides that cash equivalents are short-term, highly liquid investments that have

both of the following characteristics: (1) readily convertible to known amounts of cash; and (2) so near

their maturity that they present insignificant risk of changes in value because of changes in interest

rates.

Generally, only investments with original maturities of three months or less qualify under the above

definition. Original maturity means original maturity to the entity holding the investment. For example,

both a three-month U.S. Treasury bill and a three-year U.S. Treasury note purchased three months from

maturity qualify as cash equivalents. However, a Treasury note purchased three years ago does not

become a cash equivalent when its remaining maturity is three months. Examples of items commonly

considered to be cash equivalents are Treasury bills, commercial paper, and money market funds.

Not all assets of NFPs that meet the definition of cash equivalents are cash equivalents for purposes of

preparing statements of financial position and cash flows. Restrictions can prevent them from being

included as cash equivalents even if they otherwise qualify. For instance, short-term highly liquid

investments are not cash equivalents if they are purchased with resources that have donor-imposed

restrictions that limit their use to long-term investment.


$

$

$

$

$

$

$

$

$

$

$

$

$

Cash received with a donor-imposed restriction that limits its use to long-term purposes

FASB ASC 958-210-45-6 discusses that cash received with a donor-imposed restriction that limits

its use to long-term purposes should not be classified with cash that is unrestricted and available for

current use on a statement of financial position. Thus, when an NFP reports cash received (or cash

receipts from the sale of donated financial assets that upon receipt were directed without any NFP-

imposed limitations for sale and were converted nearly immediately into cash) with a donor-imposed

restriction that limits its use to long-term purposes an adjustment is necessary for the statement of

cash flows to reconcile beginning and ending cash and cash equivalents. For example, in

accordance with FASB ASC 230, such a cash receipt that is restricted for the purchase of

equipment is required to be reported as a cash flow from financing activities (using a caption such

as contributions restricted for purchasing equipment), and it is required to be simultaneously

reported as a cash outflow from investing activities (using a caption such as purchase of assets

restricted to investment in property and equipment or, if the equipment was purchased in the same

period, purchase of equipment). An adjustment to reconcile the change in net assets to net cash

used or provided by operating activities would also be needed if the contributed asset is not

classified as cash or cash equivalents on the statement of financial position. When the equipment is

purchased in a subsequent period, both the proceeds from the sale of assets restricted to

investment in the equipment and the purchase of the equipment is reported as cash flows from

investing activities.

Note. As seen in the above, when an NFP reports cash received (or cash receipts from the sale of

donated financial assets that upon receipt were directed without any NFP-imposed limitations for

sale and were converted nearly immediately into cash) with a donor-imposed restriction that limits its

use to long-term purposes an adjustment is necessary for the statement of cash flows to reconcile

beginning and ending cash and cash equivalents. The bolded text in the prior sentence represents

somewhat recent guidance that the FASB issued related to NFPs in the form of ASU No. 2012-05. In

October 2012, the FASB issued ASU No. 2012-05, Not-for-Profit Entities: Classification of the Sale

Proceeds of Donated Financial Assets in the Statement of Cash Flows. ASU No. 2012-05 requires an

NFP to classify cash receipts from the sale of donated financial assets consistently with cash donations

received in the statement of cash flows if those cash receipts were from the sale of donated financial

assets that upon receipt were directed without any NFP-imposed limitations for sale2 and were converted

nearly immediately3 into cash. Thus, the cash receipts from the sale of those financial assets should be

classified as cash inflows from operating activities, unless the donor restricted the use of the contributed

resources to long-term purposes, in which case those cash receipts should be classified as cash flows

from financing activities. Otherwise, cash receipts from the sale of donated financial assets should be

classified as cash flows from investing activities by the NFP. ASU No. 2012-05 became effective for

years beginning after June 15, 2013.

2 A limit order is the example of an NFP-imposed limitation provided in the Basis for Conclusions to ASU No. 2012-05. For

example, a limit order on the sale of donated securities would be indicative of an investing decision. Such a limitation should result in an investing cash flows classification for the related proceeds.

3 The Basis for Conclusions to ASU No. 2012-05 discusses that nearly immediately should generally be considered to be within days rather than months, and should be interpreted to be the same regardless of the type of financial asset being sold.


B. Cash flows from operating, investing, and financing activities

A statement of cash flows classifies and reports cash receipts and cash payments as resulting from

operating, investing, or financing activities.

What are operating, investing, and financing activities?

Operating activities

Operating activities include all

transactions and other events

that are not defined as investing

or financing activities. Operating

activities generally involve

producing and delivering goods

and providing services. Cash

flows from operating activities

are generally the cash effects of

transactions and other events

that enter into the determination

of change in net assets.

Investing activities

Investing activities include making and

collecting loans and acquiring and

disposing of debt or equity instruments

and property, plant, and equipment and

other productive assets, that is, assets

held for or used in the production of

goods or services by the entity (other

than materials that are part of the entity’s

inventory). Investing activities exclude

acquiring and disposing of certain loans

or other debt or equity instruments that

are acquired specifically for resale.

Financing activities

Financing activities include

receiving restricted resources

that by donor stipulation must

be used for long-term

purposes; borrowing money

and repaying amounts

borrowed, or otherwise

settling the obligation; and

obtaining and paying for

other resources obtained

from creditors on long-term

credit.

When classifying and reporting cash receipts and cash payments for an NFP, FASB ASC 958-230

provides additional guidance related to agency transactions and collections.

Agency transactions

Cash received and paid in agency transactions should be

reported as cash flows from operating activities in a

statement of cash flows. If the statement of cash flows is

presented using the indirect method, cash received and

paid in such transactions is permitted to be reported either

gross or net.

Collections

Cash flows from purchases, sales, and

insurance recoveries of unrecognized,

noncapitalized collection items should be

reported as investing activities in a

statement of cash flows.

$

$

$ $

$

$ $ $ $ $


1. Exercise 7-12


Cash collected on contributions receivable.

Cash received from service recipients.

Cash paid to lenders and other creditors for interest.

Cash received from contributions and investment income

that by donor stipulation are restricted for the purposes of

acquiring, constructing, or improving property, plant,

equipment, or other long-lived assets or establishing or

increasing a permanent endowment or term endowment.

Cash received from the sale of investments.

Cash paid to acquire investments.

Financing Activities

Operating

Activities

Investing Activities

Cash paid on long-term debt and notes payable.

In the left column below are examples of cash inflows and outflows. Draw a line to connect the

cash inflows and outflows to the statement of cash flows classification they generally belong to

in the right column.

Cash paid for annuity obligations.

Cash received from contributors.

Cash paid to employees and suppliers.

Cash paid to grantees.

Cash paid to purchase equipment.


C. Reconciling the change in net assets to cash flow from operating activities

The statement of cash flows provides a reconciliation of the change in total net assets and net cash flow

from operating activities. NFPs may use either the direct or indirect method of reporting cash flows from

operating activities in a statement of cash flows.

D. Key disclosures related to the statement of cash flows

The following chart discusses several key disclosure requirements related to the statement of cash flows.

NFPs have several disclosure requirements related to the statement of cash flows including:

An NFP should disclose its noncash investing and financing activities.

If the indirect method is used, amounts of interest paid (net of amounts capitalized) and income

taxes paid during the period are required to be disclosed.

An NFP should disclose its policy for determining which items are treated as cash equivalents.

1. Exercise 7-13


Noncash investing and financing activities

An NFP is required to disclose its noncash investing and financing activities. What are three

examples of noncash investing and financing activities that an NFP may have?

E. Statement of cash flows examples

The following pages include two example statements of cash flows (excluding footnotes).


1. The direct method

The following is an illustrative statement of cash flows which utilizes the rarely used direct method.

NFP E Statement of Cash Flows for the Year Ended June 30, 2016

Cash flows from operating activities:

Cash received from contributors $117,298

Cash received from service recipients 41,995

Cash collected on contributions receivable 27,026

Interest and dividends received 9,254

Interest paid (4,123)

Cash paid to employees and suppliers (171,289)

Grants paid (5,999)

Net cash provided by operating activities 14,162

Cash flows from investing activities:

Purchase of equipment (7,025)

Proceeds from sale of investments 22,074

Purchase of investments (27,568)

Net cash used by investing activities (12,519)

Cash flows from financing activities:

Proceeds from contributions restricted for:

Investment in endowment 4,321

Investment in land 8,784

Other financing activities:

Interest and dividends restricted for reinvestment 6,156

Payments on notes payable (4,995)

Net cash provided by financing activities 14,266

Net increase in cash and cash equivalents 15,909

Cash and cash equivalents at beginning of year 7,548

Cash and cash equivalents at end of year $23,457

Reconciliation of change in net assets to net cash provided by operating activities:

Change in net assets $37,033

Adjustments to reconcile change in net assets to net cash provided by operating activities:

Depreciation 7,699

Increase in accounts and interest receivable (1,444)

Increase in inventories and prepaid expenses (2,002)

Increase in contributions receivable (4,777)

Decrease in accounts payable (548)

Decrease in grants payable (887)

Contributions restricted for long-term investment (14,002)

Interest and dividends restricted for long-term investment (6,156)

Net unrealized and realized gains on long-term investments (754)

Net cash provided by operating activities $14,162

Supplemental data for noncash investing and financing activities:

Gift of land $10,000


2. The indirect method

The following is an illustrative statement of cash flows which utilizes the frequently used indirect method.

NFP E Statement of Cash Flows for the Year Ended June 30, 2016


Change in net assets $37,033

Adjustments to reconcile change in net assets to net cash provided by operating activities:

Depreciation 7,699

Increase in accounts and interest receivable (1,444)

Increase in inventories and prepaid expenses (2,002)

Increase in contributions receivable (4,777)

Decrease in accounts payable (548)

Decrease in grants payable (887)

Contributions restricted for long-term investment (14,002)

Interest and dividends restricted for long-term investment (6,156)

Net unrealized and realized gains on long-term investments (754)


















Supplemental data:

Noncash investing and financing activities:


Interest paid 4,123

3. Exercise 7-14


A common error in the statement of cash flows

A common error seen in statements of cash flows is getting the wording and brackets wrong when

saying “increase in” or “decrease in” particularly when using a statement of cash flows template from

the prior year. Do you have any suggestions to prevent this problem?


V. The statement of functional expenses

The statement of functional expenses is an additional financial statement that voluntary health and

welfare entities are required to present. The statement of functional expenses provides information about

the functional and natural classification of expenses. It should be noted that other NFPs are encouraged,

but not required, to provide information about expenses by their natural classification. The rationale for

why all NFPs are not required to prepare a statement of functional expenses is found in the Basis for

Conclusions to FASB No. 117 which stated that “The Board agrees that information about expenses by

natural classification often is useful and encourages NFPs to provide that information. However, it also

believes that information about expenses by natural classification may not be essential in understanding

the service efforts of all NFPs or in assessing the ability of all organizations to continue to provide

services.”

A. A financial statement with an unusual history

The genesis of the statement of functional expenses dates back prior to the issuance of FASB No. 117.

Prior to FASB No. 117, NFPs frequently looked at four different AICPA publications4 to find financial

reporting guidance. NFPs would select the AICPA publication that most appropriately matched their

organization and follow that guidance. The AICPA publication for voluntary health and welfare entities

required those NFPs to provide a statement that reported expenses by their functional and natural

classifications in a matrix format (i.e., the statement of functional expenses). When the FASB developed

FASB No. 117 it retained this requirement for voluntary health and welfare entities but decided against

extending this requirement to other types of NFPs. In the Basis for Conclusions to FASB No. 117, the

FASB stated that they would study whether the requirement should be extended to other NFPs.

However, the issue remained dormant in the intervening years until resurfacing in the FASB’s Financial

Statements of Not-for-Profit Entities project which we will discuss in Chapter 8.

B. What is a voluntary health and welfare entity?

Per FASB ASC 958-205-45-4 voluntary health and welfare entities are required to provide a statement of

functional expenses. So, it is important to understand which types of NFPs are voluntary health and

welfare entities as described in the following chart.

What is a voluntary health and welfare entity?

A voluntary health and welfare entity is defined as an NFP that is formed for the purpose of performing

voluntary services for various segments of society and that is tax exempt (organized for the benefit of

the public), supported by the public, and operated on a not-for-profit basis. Most voluntary health and

welfare entities concentrate their efforts and expend their resources in an attempt to solve health and

welfare problems of our society and, in many cases, those of specific individuals. As a group,

voluntary health and welfare entities include those NFPs that derive their revenue primarily from

voluntary contributions from the general public to be used for general or specific purposes

connected with health, welfare, or community services. For purposes of this definition, the general

public excludes governmental entities when determining whether an NFP is a voluntary health and

welfare entity.

4 The four AICPA publications being: (1) Audits of Colleges and Universities; (2) Audits of Voluntary Health and Welfare

Organizations; (3) SOP 78-10, Accounting Principles and Reporting Practices for Certain Nonprofit Organizations; and (4) Audits of Providers of Health Care Services.


1. Exercise 7-15

Please answer the following question related to voluntary health and welfare entities.

Voluntary health and welfare entities

Can you name a few examples of voluntary health and welfare entities?

C. The matrix format for the statement of functional expenses

The statement of functional expenses uses a matrix format to report information about expenses by their

functional classes (e.g., major classes of program services and supporting activities) as well as

information about expenses by their natural classification (e.g., salaries, rent, electricity, interest expense,

depreciation, awards and grants to others, and professional fees). The following illustrates the key

elements that make up the matrix format.

Key elements of the matrix format

Supporting activities are all activities of an NFP other than program services. Generally, they include: (1) management and general activities; (2) fundraising activities; and (3) membership development activities.

Management and general activities are activities that are not identifiable with a single program, fundraising activity, or membership development activity but that are indispensable to the conduct of those activities and to an entity’s existence.

Program services are the activities that result in goods and services being distributed to beneficiaries, customers, or members that fulfill the purposes or mission for which the NFP exists. Those services are the major purpose for and the major output of the NFP and often relate to several major programs.

Program Services Supporting Services

Program

Alpha Program

Beta

Management and General Fundraising

Membership Development

Total Program and Supporting

Services

Salaries $X $X $X $X $X $X

Rent X X X X X X

Electricity X X X X X X

Interest expense X X X X X X

Depreciation X X X X X X

Awards and grants to others X X X X X X

Professional fees X X X X X X

Total Expenses $X $X $X $X $X $X

Fundraising activities are activities undertaken to induce potential donors to contribute money, securities, services, materials, facilities, other assets, or time.

Membership development activities include soliciting for prospective members and membership dues, membership relations, and similar activities. However, if there are no significant benefits or duties connected with membership, the substance of membership development activities may, in fact, be fundraising.

Expenses by their natural classification

Expenses by their functional classification


The FASB ASC discusses that to the extent that expenses are reported by other than their natural

classification (e.g., salaries included in cost of goods sold or facility rental costs of special events reported

as direct benefits to donors) they are required to be reported by their natural classification if a statement

of functional expenses is presented. As an example, salaries, wages, and fringe benefits that are

included as part of the cost of goods sold on the statement of activities are required to be included with

other salaries, wages, and fringe benefits in the statement of functional expenses. Furthermore,

expenses that are netted against investment revenues are required to be reported by their functional

classification on the statement of functional expenses (if the NFP presents that statement).

1. Exercise 7-16

Please review the below question and provide an answer in the space provided.

Types of functional classifications

In this section we discussed the functional classifications of program services, management and

general activities, fundraising activities, and membership development activities. Are these the only

possible functional classifications in the statement of functional expenses?

D. Statement of functional expenses example

This section includes an example statement of functional expenses (excluding footnotes).

NFP J Statement of Functional Expenses

Year Ended October 31, 2016

Program Services Supporting Services

Elderly

Services Youth

Services Community

Services Management and General Fundraising

Total Program and Supporting

Services

Salaries $40,123 $31,658 $27,858 $12,089 $17,997 $129,725

Employee benefits 4,851 3,658 3,555 2,568 3,425 18,057

Awards and grants 15,012 4,056 7,058 - - 26,126

Professional fees 4,078 2,568 3,698 5,565 2,179 18,088

Supplies 4,514 3,656 2,999 4,121 3,668 18,958

Depreciation 3,500 2,100 2,050 1,021 997 9,668

Utilities 2,568 1,875 1,989 798 678 7,908

Travel 1,798 1,568 958 1,023 2,023 7,370

Interest expense 1,523 758 459 878 754 4,372

Total Expenses $77,967 $51,897 $50,624 $28,063 $31,721 $240,272


VI. Suggested solutions to exercises



Providing information about an NFP’s liquidity

In the prior chart we saw that NFPs currently have three methods of providing information about their

liquidity. The second method involves classifying assets and liabilities as current and noncurrent (i.e.,

presenting a classified statement of financial position). In the author’s experience, most NFPs do not

elect this method today. Why do many NFPs not use this method today?

There really are two drawbacks to presenting a classified statement of financial position. The first is

that to some degree you are doubling the lines on the statement for items like current and noncurrent

contributions receivable which to some degree can clutter the presentation of the statement. The

second drawback is that for some items, the classification of current or noncurrent is either difficult or

not meaningful. For example, certain investments may be classified as noncurrent. However, those

same investments could potentially be liquidated rather quickly to satisfy a current liability. For those

reasons, many NFPs elect to not present a classified statement. Those that do classify tend to be

those NFPs required by either the FASB (i.e., an NFP business-oriented health care entity) or perhaps

a funding source to present classification.



Issues and answers related to liquidity

Issue: Answer:

1

NFP A sequences assets and liabilities in the statement

of financial position based on their relative liquidity. At

year end, NFP A has cash and cash equivalents related

to permanent endowment funds which are being held

temporarily until suitable long-term investment

opportunities are identified. Where should these cash

and cash equivalents be reported in the statement of

financial position?

The cash and cash equivalents of

permanent endowment funds held

temporarily until suitable long-term

investment opportunities are identified

should be included in the classification

long-term investments.

2

NFP B sequences assets and liabilities in the statement

of financial position based on their relative liquidity. At

year end, NFP B has cash and contribution receivables

restricted by donors to investment in land, buildings,

and equipment that are not included with the line items

cash and cash equivalents or contributions receivable.

Where should these cash and contribution receivables

be reported in the statement of financial position?

The cash and contribution receivables

should be reported as assets restricted

to investment in land, buildings, and

equipment. They should be sequenced

closer to land, buildings, and equipment

in the statement of financial position.

3

NFP C classifies assets and liabilities as current and

noncurrent in the statement of financial position. At

year end NFP C has cash that is designated for

expenditure in the acquisition or construction of

noncurrent assets. Should the cash be classified as a

current asset in the statement of financial position?

FASB ASC 210-10-45-4 states that the

concept of the nature of current assets

contemplates the exclusion from that

classification of such resources as cash

that is designated for expenditure in the

acquisition or construction of

noncurrent assets.



True or False

1

In today’s environment, the vast

majority of NFPs present some level

of additional disaggregation within the

three classifications of net assets in

the statement of financial position.

False. While a good number of NFPs certainly do present

some level of disaggregation, the author’s experience is

that the majority just present three lines (i.e., permanently

restricted, temporarily restricted, and unrestricted net

assets). If some level of disaggregation is presented, it is

normally presented in the unrestricted class as the board

wants to convey how they intend to use unrestricted

amounts.

2

The FASB has historically believed

that information about a minimum of

three classes of net assets, based on

the presence or absence of donor-

imposed restrictions and their nature,

generally is necessary to gain an

adequate understanding of the

financial position of an NFP.

True. In the Basis for Conclusions to FASB No. 117 the

FASB concluded that “information about a minimum of

three classes of net assets, based on the presence or

absence of donor-imposed restrictions and their nature,

generally is necessary to gain an adequate understanding

of the financial position of an NFP, including its financial

flexibility and ability to continue to render services.”


FASB ASC 958 encourages the use of the terms unrestricted, temporarily restricted, and permanently

restricted net assets; however, other labels exist. For example, equity may be used for net assets, and

other or not donor-restricted may be used with care to distinguish unrestricted net assets from the

temporarily and permanently restricted classes of net assets. The net asset section format shown in

Exercise 7-4 is actually an example from the Implementation Guidance and Illustrations section of FASB

ASC 958 (see FASB ASC 958-210-55-3).

At a minimum, FASB ASC 958-210-45-1 requires that the amounts for each of the three classes of net

assets (i.e., unrestricted net assets, temporarily restricted net assets, and permanently restricted net

assets) and the total of net assets be reported in a statement of financial position. The captions used to

describe those amounts must correspond with their meanings.



Are entitywide totals required for individual line items of revenues, expenses, gains, or losses?

No, entitywide totals are not necessary for

individual line items of revenues, expenses, gains,

or losses. Information about reasonably

homogeneous components of revenues (e.g.,

unrestricted contributions available to support

current expenses and restricted contributions to be

used to acquire land and buildings) is typically more

useful than the aggregated total of those

components.

In what level of detail should revenues and expenses be presented?

Disaggregated information that permits users of

financial information to relate components of

revenues to components of expenses is often

preferable to information provided by their

aggregated amounts. Financial statement

preparers are generally the best able to make

judgments about the extent to which financial

statements or notes to financial statements

should provide disaggregated information about

various items of revenues or expenses.


Providing information about contributions

In the prior chart, we saw that donor-restricted contributions whose restrictions are met in the same

reporting period may be reported as unrestricted support provided that an NFP has a similar policy for

reporting investment gains and income, reports consistently from period to period, and discloses its

accounting policy. This option is sometimes referred to as the simultaneous release option. What

types of NFPs are most likely to use this option today?

In today’s environment, the use of the simultaneous release option is most commonly seen in the

college and university sector and in larger NFPs. In the author’s experience, most NFPs do not elect

the simultaneous release option. Some donors do not prefer this option as they cannot see all of the

temporarily restricted amounts that were met during the period. It really comes down to the NFP

selecting the approach that works best for its user base.



Question: Answer:

NFP Z is considering including a

measure of operations within its

statement of activities. The controller

of NFP Z asks you for some

examples of activities that NFPs

commonly include in nonoperating

activities. What are a couple of

examples that you have seen?

Because of the flexibility permitted in the standards, there can

be many answers to this question. However, two of the more

frequently seen nonoperating activities are: (1) investment

gains or income in excess of the NFP’s spending policy [i.e.,

either you have a spending rate or some budgeted amount of

investment return and the difference between that number

and the actual return is presented as nonoperating]; and

(2) certain items related to capital assets [e.g., contributions

restricted for the acquisition of long-lived assets].

Can you name a sector of the

NFP community where the

operating/nonoperating format is

frequently seen in the statement

of activities?

One example of a sector within the NFP community where the

operating/nonoperating format is frequently seen is the

college and university sector.

H. Suggested solution to Exercise 7-8

Why wouldn’t you?

Currently, either the statement of activities or the notes to the financial statements will provide

information about expenses reported by their functional classification such as major classes of program

services and supporting activities. Most NFPs choose to do this on the face of the statement of

activities. However, some NFPs simply disclose functional expense information in the notes. Why

would an NFP choose to not provide functional expense information on the face of the statement

of activities?

Some NFPs, which operate more on fees for services they provide than contributions (e.g., an NFP

business-oriented health care entity), may feel that the statement of activities should emphasize

expenses by nature rather than function and thus present functional expense information in the notes.

For example, Baylor Health Care System (a large health care system in the southwestern United States)

operates primarily off of fees for medical services even to the extent that contributions are reported as

gains instead of revenues. Thus, the statement of activities for Baylor Health Care System (i.e., the

statement of operations and changes in net assets) emphasizes expenses by nature and functional

expense information is provided deep in the notes to the financial statements. Contrast this treatment to

St. Jude Children’s Research Hospital, Inc. which relies heavily on contribution revenue and thus

presents functional expense information on the face of the statement of activities.


I. Suggested solution to Exercise 7-9

In the below, try to list three auditing procedures that may be employed to test the presentation and disclosure of net assets in the financial statements:

1 Reviewing the minutes of the governing board and governing board committee meetings for

evidence of donor restrictions.

2 Determining compliance with donor restrictions and testing expenditures to determine that

restricted net assets are used for their restricted purposes.

3 Determining that appropriate reclassifications are reported in the statement of activities when

donor-imposed restrictions have been fulfilled.

J. Suggested solution to Exercise 7-10

Reporting bad debt losses

FASB ASC 958-310-35-7 discusses that if the fair value of a contribution receivable decreases

because of changes in the quantity or nature of assets expected to be received, the decrease is

required to be recognized in the period(s) in which the expectation changes. That decrease is

required to be reported as an expense or loss (bad debt) in accordance with paragraph 958-310-45-3.

May bad debt losses be netted against contribution revenue?

No. Since losses are permitted to be netted only against gains, and not against revenues, bad debt

losses cannot be netted against contribution revenue. Per FASB ASC 958-310-45-3 decreases

recognized under paragraph 958-310-35-7 are required to be reported as expenses or losses (bad

debt) in the net asset class in which the net assets are represented. Because all expenses are

reported in the unrestricted net asset class, those decreases are reported as losses if they are

decreases in temporarily restricted net assets or permanently restricted net assets.

K. Suggested solution to Exercise 7-11

Advantages to using the single-column format include:

The single-column format provides for a more

straightforward presentation of multi-year

comparative information than the multi-column

format does.

Advantages to using the multi-column format include:

The multi-column format makes it clear that the

effects of expirations on donor restrictions result in

reclassifications between classes of net assets

and do not change total net assets. The multi-

column format also assists in the presentation of

aggregated information about contributions and

investment income for the entity as a whole.


L. Suggested solution to Exercise 7-12

Cash collected on contributions receivable.

Cash received from service recipients.

Cash paid to lenders and other creditors for interest.

Cash received from contributions and investment income

that by donor stipulation are restricted for the purposes of

acquiring, constructing, or improving property, plant,

equipment, or other long-lived assets or establishing or

increasing a permanent endowment or term endowment.

Cash received from the sale of investments.

Cash paid to acquire investments.

Financing Activities

Operating

Activities

Investing Activities

Cash paid on long-term debt and notes payable.

Cash paid for annuity obligations.

Cash received from contributors.

Cash paid to employees and suppliers.

Cash paid to grantees.

Cash paid to purchase equipment.


M. Suggested solution to Exercise 7-13

Noncash investing and financing activities

An NFP is required to disclose its noncash investing and financing activities. What are three

examples of noncash investing and financing activities that an NFP may have?

Three examples of noncash investing and financing activities are: (1) receiving contributions of

buildings and equipment; (2) receiving contributions of securities; and (3) receiving contributions of

recognized collection items.

N. Suggested solution to Exercise 7-14

A common error in the statement of cash flows

A common error seen in statements of cash flows is getting the wording and brackets wrong when

saying “increase in” or “decrease in” particularly when using a statement of cash flows template from

the prior year. Do you have any suggestions to prevent this problem?

One suggestion to prevent this type of error is using the wording “changes in” instead of “increase in” or

“decrease in.”

O. Suggested solution to Exercise 7-15


Can you name a few examples of voluntary health and welfare entities?

Examples of NFPs that may qualify as being voluntary health and welfare entities could include entites

such as: (1) The Salvation Army; (2) soup kitchens; (3) crisis centers; (4) United Way; (5) Boy Scouts &

Girl Scouts; (6) Boys & Girls Clubs; (7) The American Cancer Society; (8) The ALS Association; and

(9) The Leukemia & Lymphoma Society.

Note. NFPs that are not voluntary health and welfare entities are NFPs where: (1) the primary revenue

source comes from non-contribution revenues; or (2) the NFP’s activities are not focused on health,

welfare, or community services. In some cases, the determination of whether an NFP is or is not a

voluntary health and welfare entity may be difficult and in that scenario most would recommend

deciding that the NFP is a voluntary health and welfare entity.

P. Suggested solution to Exercise 7-16

Types of functional classifications

In this section we discussed the functional classifications of program services, management and

general activities, fundraising activities, and membership development activities. Are these the only

possible functional classifications in the statement of functional expenses?

Chapter 13 of the AICPA Not-for-Profit Entities Audit and Accounting Guide discusses that different

NFPs may have various kinds of functions. While the classifications of program, management and

general, and fundraising are the functions most commonly seen in practice other functional

classifications are possible. Consequently, the classifications used in the matrix may include program,

management and general, and fundraising or other classifications, such as cost of sales or investing.

cpenow.com / [email protected] Copyright © 2016 Surgent McCoy CPE, LLC – FMIS/16/01 8-i

Financial Reporting Tomorrow

Learning objectives 1 I. Changes coming to NFP financial reporting 1

A. The who, what, and when of the changes coming to NFP financial reporting 2 B. Targeted changes in five key areas 2 C. Changes in the reporting of net assets 2

1. Reducing and renaming the classifications of net assets 3 2. Exercise 8-1 4 3. Emphasizing the amounts and purposes of board-designated net assets 4 4. Exercise 8-2 4 5. Reporting expirations of restrictions on gifts related to long-lived assets 5 6. Exercise 8-3 5 7. Exercise 8-4 6 8. Reporting amounts related to underwater endowment funds 6

D. Changes in the liquidity information provided 6 1. Exercise 8-5 8

E. A change related to the statement of cash flows 8 1. Look for more changes to be coming related to the statement of cash flows 9

F. A change related to presenting an operating measure 10 1. Exercise 8-6 11 2. Look for more changes to be coming related to presenting an operating measure(s) 11

G. Changes in the reporting of expenses 12 1. Changing how investment expenses are reported 12 2. Exercise 8-7 12 3. Providing additional information related to allocated costs 13 4. Refining/updating the definition of management and general activities 13 5. Adjusting how NFPs report functional and natural expense information 14 6. Exercise 8-8 16

H. Transitional provisions related to the new requirements 16 II. Suggested solutions to exercises 17

A. Suggested solution to Exercise 8-1 17 B. Suggested solution to Exercise 8-2 17 C. Suggested solution to Exercise 8-3 17 D. Suggested solution to Exercise 8-4 18 E. Suggested solution to Exercise 8-5 18 F. Suggested solution to Exercise 8-6 18 G. Suggested solution to Exercise 8-7 19 H. Suggested solution to Exercise 8-8 19

cpenow.com / [email protected] Copyright © 2016 Surgent McCoy CPE, LLC – FMIS/16/01 8-1

Financial Reporting Tomorrow

Learning objectives


Understand the background and status of the FASB’s Financial Statements

of Not-for-Profit Entities project; and

See how NFP financial reporting will be different in the future under the new

reporting requirements.

I. Changes coming to NFP financial reporting

When you look at a set of NFP financial statements today, they generally look the same as they did 20+

years ago (except for the note disclosures which are longer). This is true because for the most part, the

current NFP reporting requirements found in FASB ASC 958 come primarily from FASB No. 117,

Financial Statements of Not-for-Profit Organizations which was issued in 1993. However, back in 2011,

the FASB’s Not-for-Profit Advisory Committee (NAC) began a project to reexamine the existing standards

for financial statement presentation and determine whether they could be improved. In 2012, the NAC

provided several recommendations to the FASB for their consideration. The FASB subsequently began

deliberating on the Financial Statements of Not-for-Profit Entities project and issued an exposure draft in

April 2015. The comment period for the exposure draft ended in August 2015. As the FASB began

reviewing the comment letters on the exposure draft, they ran into difficulties with regard to two proposed

areas as discussed in the following.

Running into a few delays

When the FASB began reviewing the comment letters on the exposure draft related to

the Financial Statements of Not-for-Profit Entities project, it became apparent that a

couple of proposed changes were perhaps more controversial/complex than the FASB

originally thought. These two issues related to proposals that would have: (1) required

all NFPs to present two defined operating measures in their statement of activities; and

(2) changed the way certain items are classified within the statement of cash flows.

We will discuss both of these issues later in the chapter. However, the key point

is that the FASB plans to address these two issues in a separate (i.e., Phase 2)

project/standard which they may begin working on as early as the 2nd half of 2016.

The following chart discusses the status of the Financial Statements of Not-for-Profit Entities project.

The present status of the Financial Statements of Not-for-Profit Entities project

After the FASB decided to temporarily defer addressing the proposals related to requiring operating

measures and reclassifying items on the statement of cash flows, the FASB began its final deliberations

on the remaining issues in late 2015. During its deliberation process, the FASB periodically announced

its decisions on the remaining issues in the exposure draft. In this chapter, we will discuss those

decisions. As this course was written in April 2016, a final standard had not been issued. However, the

issuance of a final ASU was imminent. Please review the wording in the final ASU at the FASB website

(www.fasb.org) as sometimes minor changes can occur in the final wording of a standard.


A. The who, what, and when of the changes coming to NFP financial reporting

The following chart discusses the who, what, and when of the changes coming from the Financial

Statements of Not-for-Profit Entities project.

The who, what, and when of the changes coming to NFP financial reporting

Who will be affected by the

changes?

The changes will affect substantially all NFPs (e.g., charities, foundations,

private colleges and universities, nongovernmental health care providers,

cultural institutions, religious organizations, trade associations, and others).

What standards will be affected

by the changes?

The changes will affect FASB ASC 958, Not-for-Profit Entities and FASB ASC

954, Health Care Entities.

When will the changes become

effective?

The new reporting requirements will be effective for annual financial

statements for years beginning after December 15, 2017. Early adoption is

allowed if the NFP adopts all the new requirements at the same time. Later in

this chapter, we will discuss certain transitional provisions related to the new

requirements.

B. Targeted changes in five key areas

As discussed below, NFP financial reporting in the future will change in five key areas.

The Financial Statements of Not-for-Profit Entities project targeted changes in five key areas

The reporting of net assets by NFPs;

The liquidity information provided by NFPs;

The statement of cash flows that some NFPs prepare (i.e., those that use the direct method);

The operating measure information provided by some NFPs; and

The reporting of expenses by NFPs.

C. Changes in the reporting of net assets

Net assets are essentially the equity portion of an NFP’s statement of financial position. In this section of

the course, we are going to review how the reporting of net assets in the future will be different from what

NFPs are doing today. There are four key areas of change coming in the reporting of net assets.

The four key areas of change coming in the reporting of net assets relate to…

1 Reducing and renaming the classifications of net assets;

2 Emphasizing the amounts and purposes of board-designated net assets;

3 Reporting expirations of restrictions on gifts related to long-lived assets; and

4 Reporting amounts related to underwater endowment funds.


1. Reducing and renaming the classifications of net assets

The following chart discusses how the current classifications of net assets will be reduced and renamed

in the future.

Reducing and renaming the classifications of net assets

What the FASB requires NFPs to do today:

What the FASB will require NFPs to do tomorrow:

Currently, NFPs are required to present three classes

of net assets on the face of a statement of financial

position (i.e., unrestricted net assets, temporarily

restricted net assets, and permanently restricted net

assets).

In the future, NFPs will be required to

present two classes of net assets on the

face of a statement of financial position

(i.e., net assets without donor restrictions

and net assets with donor restrictions).

In looking at the above, it should be noted that NFPs will continue to report total net assets on the

statement of financial position. The FASB believes that users of NFP financial statements will find the

use of two net asset classes less confusing than three. The FASB also believes that the term net assets

without donor restrictions will be clearer to users than unrestricted net assets has been. The following

chart further illustrates the reducing and renaming of the classifications of net assets that will occur.

A further illustration of the reducing and renaming of the classifications of net assets

Today NFPs have three classifications of net assets:

Unrestricted net assets

Temporarily restricted net assets

Permanently restricted net assets

Tomorrow NFPs will have two classifications of net assets:

Net assets without donor restrictions (i.e., we are just renaming

unrestricted net assets)

Net assets with donor restrictions (i.e., we are just combining temporarily restricted net assets and permanently

restricted net assets)

While NFPs will only have two classifications of net assets in the future, they will still be providing relevant

information about the nature and amounts of donor restrictions on net assets as discussed in the below.

NFPs will continue to have disclosures related to restrictions on net assets

In the future, NFPs will continue to provide information about the nature and amounts of different types

of donor-imposed restrictions either by: (1) reporting their amounts on the face of the statement of

financial position; or (2) including relevant details in the notes to the financial statements. Separate line

items may be reported within net assets with donor restrictions or in notes to the financial statements to

distinguish between various types of donor-imposed restrictions, which include, for example, restrictions

related to: (1) support of particular operating activities; (2) use in a specified future period; (3) the

acquisition of long-lived assets; (4) investment for a specified term; (5) the creation of a donor-

restricted endowment that is perpetual in nature; and (6) assets, like land or works of art, that are

donated with stipulations that they be used for a specified purpose, be preserved, and not be sold.


2. Exercise 8-1


True or False

1 In the future, the statement of activities will report: (1) the change in net

assets with donor restrictions; (2) the change in net assets without donor

restrictions; and (3) the change in total net assets.

3. Emphasizing the amounts and purposes of board-designated net assets

Board-designated net assets are net assets without donor restrictions that are subject to self-imposed

limits by action of the governing board. Board-designated net assets may be earmarked for future

programs, investment, contingencies, purchase or construction of fixed assets, or other uses. In the

Financial Statements of Not-for-Profit Entities project the FASB determined that the amounts and

purposes of board-designated net assets should to be emphasized in either the financial statements or in

the notes as described in the following chart.

Emphasizing the amounts and purposes of board-designated net assets



Currently, NFPs are allowed but not required to

present information about board-designated net

assets on the face of the statement of financial

position or in the notes.

In the future, NFPs will be required to disclose

the amounts and purposes of board-designated

net assets either on the face of the statement of

financial position or in the notes.

The above change represents a fairly significant reversal in the FASB’s thought process regarding board-

designated net assets. For example, in the Basis for Conclusions to FASB No. 117, the FASB concluded

that information about board-designated net assets was not essential and that NFPs should be permitted

but not required to provide information about such designations. Note. NFPs have had and will continue

to have disclosures related to board-designated endowments.

4. Exercise 8-2

Please answer the following question related to board-designated net assets.

But I don’t want to change

NFP Z has always felt that the fewer lines on the financial statements and the fewer disclosures

the better. Historically, the board of directors of NFP Z has internally designated some amounts of

unrestricted net assets for certain programs and purchases of assets. However, NFP Z has not

disclosed those amounts on its financial statements or in the notes as it did not believe that the

information was useful to its financial statement users. In the future, NFP Z would prefer to just

show the net assets without donor restrictions classification and not break out board-designated

amounts on the face of the statement of financial position or in the notes. Do you have any ideas

for how NFP Z could do this?


5. Reporting expirations of restrictions on gifts related to long-lived assets

Historically, NFPs have chosen either of two approaches (i.e., either the implied over time approach or

the placed in service approach) for the expiration of restrictions on capital assets where the donor has not

specified a time period over which the asset must be used. As discussed below, in the future the FASB is

eliminating the implied over time approach.

Reporting expirations of restrictions on gifts related to long-lived assets



Currently, when a donor does not specify a time period

over which a donated long-lived asset must be used,

FASB ASC 958-605-45-6 states that an NFP can elect a

policy to imply a time restriction that expires over the

useful life of the donated long-lived assets. If an NFP

adopts a policy of implying time restrictions, it will also

imply a time restriction on long-lived assets acquired with

gifts of cash or other assets restricted for those

acquisitions. If time restrictions are implied on gifts of

long-lived assets, those implied time restrictions expire as

the economic benefits of the acquired assets are used up

(i.e., over their estimated useful lives). In the absence of

donor stipulations specifying how long donated assets

must be used or an NFP’s policy of implying time

restrictions, restrictions on long-lived assets, if any, or

cash to acquire long-lived assets expire when the assets

are placed in service.

In the future, gifts of long-lived assets

received without stipulations about how

long or for what purpose the donated

asset must be used will be reported as

revenue without donor restrictions.

Long-lived assets acquired with gifts of

cash or other assets restricted for those

acquisitions will initially be reported as

donor-restricted support and released

from restrictions by reclassifying net

assets with donor restrictions to net

assets without donor restrictions when

the asset is placed in service unless the

donor also has placed a time or purpose

restriction on the use of the long-lived

asset.

6. Exercise 8-3

Please answer the following question related to reporting expirations of restrictions on gifts to be used for

long-lived assets.

But I don’t want to change (Part 2)

Historically, University A has elected to imply a time restriction on buildings acquired with gifts of cash

restricted to acquire those buildings when the donor did not specify a time period over which the

building must be used. University A has preferred this approach as it aligns the reclassification of net

assets with the depreciation expense on the buildings. Do you have an idea for how University A

could continue to align the reclassification of net assets with depreciation expense on future

gifts to construct buildings under the new requirements?


7. Exercise 8-4


True or False

1

Currently, NFP business-oriented health care entities are already required

to use the placed in service approach related to long-lived assets. Thus,

in doing away with the option of implying time restrictions, the FASB is

putting all NFPs on the same page.

8. Reporting amounts related to underwater endowment funds

Underwater endowment funds are donor-restricted endowment funds for which the fair value of the fund

is less than either the original gift amount or the amount required to be maintained by the donor or law.

The FASB is making some changes related to underwater endowment funds as illustrated in the below.

Reporting amounts related to underwater endowment funds



Currently, NFPs present

the aggregate amount by

which endowments are

underwater in unrestricted

net assets. NFPs are also

required to disclose the

aggregate amount for

donor endowments that

are underwater.

In the future, the aggregate amount by which endowment funds are

underwater will be classified within net assets with donor restrictions

rather than net assets without donor restrictions. For endowment

funds that are underwater, NFPs will disclose: (1) the NFP’s policy to

either reduce expenditure or not spend from underwater endowment

funds; (2) the aggregate fair value; (3) the aggregate original

endowment gift amount or level required by donor stipulations or by

law to be maintained; and (4) the aggregate of the amount of the

deficiencies.

The following chart provides a simple illustration of how the new underwater endowment fund guidance

might play out for an entity.

An illustration of how the reporting for underwater endowment funds may change

NFP Z has a $1,000,000 endowment fund with a value of $980,000. Under current GAAP,

NFP Z would show $20,000 as a negative amount in unrestricted net assets and $1,000,000

in permanently restricted net assets related to the endowment fund. In the future, NFP Z

would show $980,000 in net assets with donor restrictions related to the endowment fund.

NFP Z would then have more extensive disclosures regarding the underwater amount.

D. Changes in the liquidity information provided

In this section we are going to review how in the future NFPs will provide more information regarding

liquidity than they do today. In the area of liquidity, the FASB wanted to have NFP financial reporting

provide additional information that would be useful in assessing: (1) how an NFP manages its liquid

resources available to meet cash needs for general expenditures; and (2) the availability of an NFP’s

financial assets at the balance sheet date to meet cash needs for general expenditures.

$


In deliberating the Financial Statements of Not-for-Profit Entities project, it appeared early on that the

FASB was leaning towards requiring all NFPs to prepare a classified balance sheet as NFP business-

oriented health care entities do. Then, in the exposure document the FASB proposed a disclosure

requirement that was very specific and somewhat boilerplate which received mixed reviews. Ultimately,

the FASB decided to add a disclosure requirement that is a little more flexible than the disclosure

originally proposed as discussed below.

Providing additional liquidity information



Currently, NFPs are required to provide

information about liquidity by any of the

following: [1] sequencing assets according

to their nearness of conversion to cash

and sequencing liabilities according to the

nearness of their maturity and resulting

use of cash; [2] classifying assets and

liabilities as current and noncurrent (Note.

NFP business-oriented health care entities

are required to use this option); or

[3] disclosing in the notes to the financial

statements relevant information about the

liquidity or maturity of assets and liabilities,

including restrictions on the use of

particular assets.

In the future, NFPs will continue to provide the

information on the left. NFPs will also be required to

provide: [1] qualitative information in the notes that

communicates how an NFP manages its liquid

resources available to meet cash needs for general

expenditures within one year of the balance sheet date;

and [2] quantitative information either on the face of the

balance sheet or in the notes, and additional qualitative

information in the notes as necessary, that

communicates the availability of an NFP’s financial

assets at the balance sheet date to meet cash needs

for general expenditures within one year of the balance

sheet date. (Note. The availability of a financial asset

may be affected by its nature; external limits imposed

by donors, laws, and contracts with others; and internal

limits imposed by governing board decisions.)

The FASB believes that the new information that NFPs will provide is particularly desired by the lending

community which has found difficulties in assessing an NFP’s liquidity as assets may appear to be liquid

on the basis of their nature, however limitations imposed by contracts, laws, and donor stipulations may

make an otherwise liquid asset unavailable for purposes of meeting near-term cash demands. For

example, donor-imposed restrictions may influence the liquidity or cash flow patterns of certain assets

(e.g., a donor stipulation that donated cash be used to acquire land and buildings limits an entity’s ability

to take effective actions to respond to unexpected opportunities or needs, such as emergency disaster

relief). However, some donor-imposed restrictions have little or no influence on cash flow patterns or an

entity’s financial flexibility (e.g., a gift of cash with a donor stipulation that it be used for emergency-relief

efforts has a negligible impact on an entity if emergency relief is one of its major ongoing programs). The

following chart discusses how the new liquidity information may assist financial statement users.

How the new liquidity information may assist financial statement users

In looking at the new liquidity information, the qualitative information on how an NFP manages its liquid

resources is trying to provide an ongoing look at how the NFP manages its liquid resources. The

quantitative and qualitative information regarding the availability of an NFP’s financial assets will more

or less provide a snapshot at the balance sheet date of where the NFP stands liquidity wise and

whether there are any restrictions on financial assets that affect the NFP’s liquidity.


1. Exercise 8-5


True or False

1

The requirement to provide quantitative information regarding financial assets

to be available within one year of the balance sheet date may encourage

more NFPs to adopt a classified statement as the information provided on the

statement in addition to the disclosure of other information regarding other

items that may limit availability (e.g. potentially donor restrictions, board

designations) will likely cover the availability disclosure requirement.

E. A change related to the statement of cash flows

A statement of cash flows reports the cash effects during a period of an NFP’s operations, its investing

transactions, and its financing transactions. It also currently provides for a reconciliation of the change in

net assets and net cash flow from operating activities.

Changing the statement of cash flows

Since FASB No. 95, Statement of Cash Flows, was issued in 1987, NFPs have

been encouraged to prepare the statement of cash flows using the direct method

but allowed to use the indirect method. Today, the vast majority of NFPs utilize the

indirect method to prepare the statement of cash flows. The FASB believes that

the statement of cash flows has been underutilized and that a different direction

is needed for the statement of cash flows. In the exposure draft related to the

Financial Statements of Not-for-Profit Entities project the FASB proposed requiring

all NFPs to prepare the statement of cash flows using the direct method. However,

in a close 4-3 vote the FASB ultimately decided to make a less significant change.

The following chart discusses the change that the FASB decided to make to the statement of cash flows.

A change related to the statement of cash flows



Currently, NFPs are allowed to use either

the direct method or the indirect method to

prepare the statement of cash flows. If the

direct method is used, NFPs are required

to disclose the indirect reconciliation of the

change in total net assets to net cash flow

from operating activities.

In the future, NFPs will continue to be allowed to use

either the direct method or the indirect method to

prepare the statement of cash flows. However, if the

direct method is used, NFPs will not be required to

disclose the indirect reconciliation of the change in total

net assets to net cash flow from operating activities.

(Note. By making the direct method a little easier the

FASB is hoping that more NFPs will voluntarily migrate

to this approach.)

The Statement of Cash Flows

New & possibly

improved!


The following is an illustration of a statement of cash flows using the direct method which excludes the

indirect reconciliation of the change in total net assets to net cash flow from operating activities.

How a statement of cash flows under the direct method might appear tomorrow…


Cash received from contributors $117,298

Cash received from service recipients 41,995

Cash collected on contributions receivable 27,026

Interest and dividends received 9,254

Interest paid (4,123)

Cash paid to employees and suppliers (171,289)

Grants paid (5,999)


















Supplemental data for noncash investing and financing activities:


1. Look for more changes to be coming related to the statement of cash flows

In the exposure draft related to the Financial Statements of Not-for-Profit Entities project the FASB also

proposed changes in how certain items are classified within the statement of cash flows. A couple of

examples of the proposed changes included: (1) reporting cash payments of interest expense as

financing cash flows instead of operating cash flows; and (2) reporting cash proceeds from the sale of

long-lived assets used for operating purposes as operating cash flows instead of investing cash flows.

The FASB proposed these changes to make the statement of cash flows more compatible with the

mission dimension of the proposed intermediate measures of operations in the statement of activities that

was in the exposure draft. Since the FASB deferred the proposed required operating measures in the

statement of activities into Phase 2 of the Financial Statements of Not-for-Profit Entities project, the FASB

also deferred action on the realignment of items within the statement of cash flows into Phase 2 as well.


F. A change related to presenting an operating measure

In this section we are going to review a change related to presenting an operating measure in the

statement of activities.

A change related to presenting an operating measure



Currently, NFPs are allowed but not required to

have a self-defined operating measure on the

statement of activities. For example, an NFP may

break its statement of activities down into operating

and nonoperating components. If an NFP chooses

to do this, it is required to: (1) report the change in

unrestricted net assets for the period on the

statement of activities; and (2) if the use of the term

operations is not apparent from the details provided

on the face of the statement of activities, include a

note to the financial statements describing the

nature of the reported measure of operations or the

items excluded from operations.

In the future, NFPs will continue to follow the

guidance on the left. However, NFPs that

choose to present an operating measure that

also present internal board designations,

appropriations, and similar actions on the

face of the financial statements affecting

that measure will have additional reporting

requirements. Specifically, such NFPs will

be required to report those types of internal

transfers appropriately disaggregated and

described by type, either on the face of the

financial statements or in the notes.

The following chart discusses the reason that the FASB is adding the above requirement regarding

transfers for NFPs that elect to present an operating measure.

Why is the FASB doing this?

The term operating activities is currently not defined in NFP GAAP. An

NFP is typically not required to provide any disclosure about its reported

intermediate measure of operations other than describing the reported

measure if that information is not apparent from the face of the statement of

activities. The FASB has noted that some NFPs report an operating measure

on the statement of activities which is impacted by governing board

designations, appropriations, and similar transfers. Some NFPs currently

present these transfers as a single line item on the statement of activities

and it is difficult to determine if one or multiple transfers are occurring (and

possibly being netted) as such transfers are often not described in the notes.

The FASB believes that such transfers can involve significant amounts that

warrant separate line items or disclosure for the user to be able to understand

the impact on the operating measure.

It should be noted that NFP business-oriented health care entities are currently required by FASB ASC

954, Health Care Entities, to present a performance indicator. However, that measure is not considered

to be a measure of operations. So, if an NFP business-oriented health care entity elected to also include

a self-defined operating measure it would need to provide the additional information regarding transfers

described above.


Nonoperating activities

Net assets


1. Exercise 8-6


True or False

1 NFP Z does not elect to provide an operating measure in its statement of

activities. Thus, the change we just discussed regarding providing

information on transfers will not impact NFP Z.

2 Today, very few NFPs provide an operating measure in their statement of

activities.

2. Look for more changes to be coming related to presenting an operating measure(s)

Historically, NFPs have had a good deal of latitude in terms of the classifications used in the statement of

activities. However, the FASB would like to see more uniformity in financial reporting across the NFP

sector. One area where the FASB feels more uniformity is needed is in the area of presenting an

operating measure(s). In the exposure draft for the Financial Statements of Not-for-Profit Entities project,

the FASB proposed that all NFPs: (1) present two operating measures within the statement of activities;

and (2) present those two operating measures consistently across the NFP sector as opposed to being

self-defined. The following summarizes the FASB’s proposal that was contained in the exposure draft.

The proposed intermediate measures of operations format that was contained in the Financial Statements of Not-for-Profit Entities project exposure draft

Under the FASB proposal a typical NFP would report the following sections in the net assets without donor restrictions column of a statement of activities:


The operating excess (deficit) before transfers

Board designations, appropriations, and similar transfers to operations and from operations

The operating excess (deficit) after transfers

Nonoperating activities

Board designations, appropriations, and similar transfers to nonoperations and from nonoperations

Increase (decrease) in net assets

Net assets at beginning of year

Net assets at end of year

Note. The bold italicized subtotals above represent the two additional subtotals the FASB proposed to

provide uniform intermediate measures of operations.

The above proposal was somewhat controversial as it would have required all NFPs to present operating

measures and as some did not like the format. Ultimately, the FASB deferred the proposed required

operating measures into Phase 2 of the Financial Statements of Not-for-Profit Entities project. So,

practitioners should watch for future FASB deliberations on this topic.


G. Changes in the reporting of expenses

In this section we are going to review how the reporting of expenses in the future will be different from

what NFPs are doing today. There are four key areas of change coming in the reporting of expenses.

The four key areas of change coming in the reporting of expenses relate to…

1 Changing how investment expenses are reported;

2 Providing additional information related to allocated costs;

3 Refining/updating the definition of management and general activities; and

4 Adjusting how NFPs report functional and natural expense information.

So, let us begin by looking at how investment expenses will be reported differently in the future.

1. Changing how investment expenses are reported

An area where the FASB believed that financial reporting complexity could be reduced and the

comparability of information across the NFP sector could be increased was in the reporting of investment

expenses. The following chart discusses how the reporting of investment expenses will be different in the

future from what NFPs do currently.

Changing how investment expenses are reported



Currently, NFPs have the option to either

report investment return net of related

expenses or on a gross basis. However,

if it is reported net, there is a requirement

to disclose the details that comprise the

net result.

In the future, NFPs will be required to report investment

return net of external and direct internal investment

expenses. NFPs will not be required to disclose any

investment expenses that are netted against investment

return (including internal salaries and benefits that are

netted against investment return).

Related to the above, it should also be noted that in the future NFPs will no longer be required to display

the investment return components in the endowment net assets roll forward. NFPs would also not be

required to include external and direct internal investment expenses that have been netted against

investment return in the functional expense analysis.

2. Exercise 8-7


True or False

1

In the exposure draft for the Financial Statements of Not-for-Profit Entities

project, the FASB had proposed that NFPs would be required to continue

to disclose the amount of internal salaries and benefits, if any, that have

been netted against investment return.


3. Providing additional information related to allocated costs

As discussed in the following chart, in the future NFPs will provide additional information related to

allocated costs.

Providing additional information related to allocated costs



Currently, an NFP is required to disclose certain

information related to joint costs (i.e., costs which are

part fundraising and part other functional category)

that were allocated. However, current GAAP generally

does not require a description of the method(s) used to

allocate other types of costs among program and

support functions (although many NFPs provide this

information).

In the future, NFPs will also be required to

provide a description of the methods used

to allocate costs among program and

support functions.

The following chart illustrates what the new disclosure describing the methods used to allocate costs

among program and support functions might look like.

The new disclosure describing the methods used to allocate costs among program and support functions might look like…

The financial statements of NFP Z report certain categories of expenses that are attributable to more

than one program or supporting function. Therefore, these expenses require allocation on a reasonable

basis that is consistently applied. The expenses that are allocated include depreciation of office and

occupancy, which are both allocated on a square footage basis, as well as salaries and benefits, which

are allocated on the basis of time and effort studies.

4. Refining/updating the definition of management and general activities

The FASB wanted to refine/update the definition of management and general activities as discussed in

the following chart.

Refining/updating the definition of management and general activities



Currently, management and general activities of NFPs

are defined as activities that are not identifiable with a

single program, fundraising activity, or membership

development activity but that are indispensable to the

conduct of those activities and to an entity’s existence.

In the future, management and general

activities of NFPs will be defined as

supporting activities that are not identifiable

with one or more program, fundraising, or

membership development activities.


5. Adjusting how NFPs report functional and natural expense information

One of the final areas deliberated by the FASB in the Financial Statements of Not-for-Profit Entities

project was the area of reporting functional and natural expense information. In FASB No. 117, the FASB

generally took the position that reporting functional expense information [i.e., breaking expenses down

into program services and supporting activities (e.g., management and general activities, fundraising

activities, and membership development activities)] was critical to understanding an NFP. In FASB No.

117, the FASB also took the position that natural expense information (i.e., breaking expenses down into

natural categories like salaries, travel, and depreciation) could be important to understanding some NFPs

but was not as critical as functional expense information. Thus, FASB No. 117 said that voluntary health

and welfare entities should provide a statement of functional expenses (which provides functional and

natural expense information) and other NFPs were encouraged but not required to provide this

information.

Over the years, various interest groups have expressed various opinions on the importance of functional

and natural expense information as discussed in the following chart.

Over the years various opinions have been expressed on the importance of functional and natural expense information

Creditors

Creditors have generally said that natural expense information is more

important than functional expense information as it provides information

regarding which costs are possibly variable (e.g., travel) as opposed to fixed

(e.g., depreciation).

Donors, NFP rating agencies, and regulators

Donors, NFP rating agencies, and regulators tend to prefer functional expense

information as it provides information about the allocation of resources for

missional fulfillment.

NFP business-oriented health

care entities

NFP business-oriented health care entities (and some other NFPs that are

more fee based than contribution based) have expressed the opinion that

natural expense information is useful but that functional expense information

has very little value. For example, some NFP business-oriented health care

entities just have a small disclosure breaking expenses down into two

functions (e.g., patient or health care services and general and administrative

expenses).

NFPs in general

From just a recording standpoint, expenses generally originate in natural form

(e.g., utilities expense on an invoice) and then require coding and allocation to

get to functional form (which has been the form required to be presented on

the statement of activities or disclosed in the notes by GAAP for many years).

Many NFPs prefer to not present both natural and functional expense

information in the financial statements (as voluntary health and welfare entities

are required to do) as it tends to focus the reader’s attention on things like

salaries and travel expenses by the management and general function and the

fundraising function.

Ultimately, the FASB decided to make both functional and natural expense proponents happy and those

who do not like having both functional and natural information being presented together unhappy.


The following chart discusses how the reporting of functional and natural expense information will be

different in the future from what NFPs do currently.

Changing how NFPs report functional and natural expense information



Currently, all NFPs are required to

provide information about expenses

by their functional classification either

on the statement of activities or in the

notes to the financial statements.


are required to provide a statement

of functional expenses which means

that they are also required to provide

information about expenses by

nature.

In the future, all NFPs will continue to have the requirement

to the left regarding providing functional information. All

NFPs will also be required to provide information about

expenses by their nature. NFPs will have the flexibility to

present expenses by function, by nature, or by both on the


NFPs will also be required to provide an analysis of all

expenses (other than netted investment expenses) by

function and nature in one location either: [1] on the

statement of activities; [2] in a separate statement (e.g., think

statement of functional expenses); or [3] in a schedule in the

notes. Note. This also applies to voluntary health and

welfare entities so they will have the option of presenting this

information on the statement of activities or in the notes if

they do not want to prepare a separate statement of

functional expenses.

As discussed in the above, in the future all NFPs will be required to provide an analysis of all expenses

(other than netted investment expenses) by function and nature in one location either: [1] on the

statement of activities; [2] in a separate statement; or [3] in a schedule in the notes. For NFPs choosing

the schedule in the notes option, the disclosure will likely look very similar to how a statement of

functional expenses appears today for voluntary health and welfare entities. The following chart

illustrates what a disclosure providing an analysis of all expenses by function and nature might look like.

A disclosure providing an analysis of all expenses by function and nature might look like...

The table below presents NFP Z’s expenses by both their function and nature for fiscal year 20X1.

Program Activities Supporting Activities

Alpha Beta Gamma Programs Management and General Fundraising Supporting

Total Expenses

Salaries and benefits $7,400 $3,900 $1,725 $13,025 $1,130 $960 $2,090 $15,115

Grants to other organizations 2,075 750 1,925 4,750 4,750

Supplies and travel 865 1,000 490 2,355 240 560 800 3,155

Services and professional fees 160 1,490 600 2,250 200 390 590 2,840

Office and occupancy 1,160 600 450 2,210 218 100 318 2,528

Depreciation 1,440 800 570 2,810 250 140 390 3,200

Interest 133 66 40 239 78 65 143 382

Total expenses $13,233 $8,606 $5,800 $27,639 $2,116 $2,215 $4,331 $31,970


6. Exercise 8-8

Please answer the following question related to reporting functional and natural expense information in

the future.

What will they do?

As we have discussed, in the future all NFPs will be providing an analysis of all expenses by function

and nature. This analysis will be provided either: (1) on the statement of activities; (2) in a separate

statement; or (3) in a schedule in the notes. Which option do you believe that NFPs will migrate

to?

H. Transitional provisions related to the new requirements

When an NFP implements the new requirements (i.e., years beginning after December 15, 2017) the

requirements will be applied on a retrospective basis for all periods presented except for the changes

related to the new liquidity information and the analysis of expenses by function and nature which only

need to be presented for the year of adoption and not for any prior years presented. If an NFP early

adopts the new financial reporting requirements they will apply all of the new requirements.


II. Suggested solutions to exercises



True or False

1 In the future, the statement of activities will report: (1) the change in net

assets with donor restrictions; (2) the change in net assets without donor

restrictions; and (3) the change in total net assets.

True.


But I don’t want to change

NFP Z has always felt that the fewer lines on the financial statements and the fewer disclosures

the better. Historically, the board of directors of NFP Z has internally designated some amounts of

unrestricted net assets for certain programs and purchases of assets. However, NFP Z has not

disclosed those amounts on its financial statements or in the notes as it did not believe that the

information was useful to its financial statement users. In the future, NFP Z would prefer to just show

the net assets without donor restrictions classification and not break out board-designated amounts on

the face of the statement of financial position or in the notes. Do you have any ideas for how NFP Z

could do this?

It really comes down to how the board of directors of NFP Z chooses to operate. NFP Z could

determine that it really does not need to designate amounts of net assets. For example, if the board

of directors feels that it could more or less have its say in the operations of NFP Z through budgetary

oversight instead of board designations that could be an option to avoid this disclosure in the future.


But I don’t want to change (Part 2)

Historically, University A has elected to imply a time restriction on buildings acquired with gifts of cash

restricted to acquire those buildings when the donor did not specify a time period over which the

building must be used. University A has preferred this approach as it aligns the reclassification of net

assets with the depreciation expense on the buildings. Do you have an idea for how University A

could continue to align the reclassification of net assets with depreciation expense on future

gifts to construct buildings under the new requirements?

University A could simply ask donors to place a time restriction on the use of the long-lived asset

which aligns to the depreciation period. The elimination of the implied over time approach and the

requirement to use the placed in service approach only comes into play when the donor has not placed

a time or purpose restriction on the use of the long-lived asset.



True or False

1

Currently, NFP business-oriented health care entities are already required

to use the placed in service approach related to long-lived assets. Thus, in

doing away with the option of implying time restrictions, the FASB is putting

all NFPs on the same page.

True. This is an

area where the

FASB wanted more

standardization.


True or False

1

The requirement to provide quantitative information regarding financial

assets to be available within one year of the balance sheet date may

encourage more NFPs to adopt a classified statement as the information

provided on the statement in addition to the disclosure of other information

regarding other items that may limit availability (e.g. potentially donor

restrictions, board designations) will likely cover the availability disclosure

requirement.

True.


True or False

1

NFP Z does not elect to

provide an operating measure

in its statement of activities.

Thus, the change we just

discussed regarding providing

information on transfers will

not impact NFP Z.

True.

2 Today, very few NFPs provide

an operating measure in their


False. Currently, the majority of colleges and universities

classify items as operating or nonoperating within the statement

of activities (i.e., they include an intermediate measure of

operations). Perhaps half of other types of NFPs also include

an intermediate measure of operations. NFPs that present an

intermediate measure of operations often believe that including

such a measure allows them to communicate how they view their

results internally to others (i.e., which activities relate to the core

operations or mission of the NFP).



True or False

1

In the exposure draft for the Financial Statements of

Not-for-Profit Entities project, the FASB had proposed

that NFPs would be required to continue to disclose the

amount of internal salaries and benefits, if any, that

have been netted against investment return.

True. In a close 4-3 vote the FASB

ultimately decided against this position

that was in the exposure draft. Thus,

NFPs will not be required to disclose

this information in the future.

H. Suggested solution to Exercise 8-8

What will they do?

As we have discussed, in the future all NFPs will be providing an analysis of all expenses by function

and nature. This analysis will be provided either: (1) on the statement of activities; (2) in a separate

statement; or (3) in a schedule in the notes. Which option do you believe that NFPs will migrate

to?

This is obviously a question that we do not know the answer to today. However, in making their

decision, NFPs will likely consider how useful the information may or may not be to their key financial

statement user groups. For example, NFP business-oriented health care entities will likely migrate to

the schedule in the notes option as they may feel that the functional information provided in the

analysis is not particularly helpful to their users. Voluntary health and welfare entities may well decide

to continue preparing a separate financial statement as that is what their users are accustomed to

seeing.


Latest Developments

This chapter is reserved for additional materials to be added throughout the year as appropriate. As this

course went to press there were no latest developments to include.

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