Chapter 16

Nonprofit Organizations

Scope of Chapter

Discusses some of the accounting issues for nonprofit organizations. Illustrates financial statement display issues. A nonprofit ( not-for-profit) organization is a legal and accounting entity that is operated for the benefit of society as a whole, rather than for the benefit of an individual proprietor or a group of partners or stockholders.

Scope of Chapter

The concept of net income is not meaningful for a nonprofit organization. Instead, a nonprofit organization generally strives only to obtain revenues sufficient to cover its expenses. Nonprofit organizations constitute a significant segment of the U.S. economy.

Scope of Chapter

According to FASB, Not-for-profit organizations include cemetery organizations, civic organizations, colleges and universities, cultural institutions, fraternal organizations, hospitals, labor unions, libraries, museums, political parties, private and community foundations etc., but do not include governmental units.

Accounting Standards

For many years, the generally accepted accounting principles were not considered to be entirely applicable to nonprofit organizations. In the period of 1972 to 1974, the unsettled state of accounting for nonprofit organizations was improved by the AICPAs issuance of three Audit and Accounting Guides or Industry Audit Guides:

Accounting Standards
Hospital Audit Guide. Audits of Colleges and Universities. Audits of Voluntary Health and Welfare Organizations. All three guides were amended later.

Accounting Standards

In 1978, AICPA issued Statement of Position 78-10, later incorporated in Audits of Certain Nonprofit Organizations, which applied to at least 18 types of nonprofit organizations, ranging from cemetery societies to zoological and botanical societies.

Accounting Standards

The existence of four separate sources of authoritative support for generally accepted accounting principles for nonprofit organizations led to many inconsistencies among the accounting standards for such organizations. The FASB resolved several of these inconsistencies in four Statements of Financial Accounting Standards:

Accounting Standards

No. 93, Recognition of Depreciation by NotFor-Profit Organizations. No. 116, Accounting for Contributions Received and Contributions Made. No. 117, Financial Statements of Not-For-Profit Organizations. No. 124, Accounting for Certain Investments Held by Not-For-Profit Organizations.

Accounting Standards

Subsequently AICPA issued an Audit and Accounting Guide for Not-For-Profit Organizations that superseded Audits of Colleges and Universities, and Audits of Certain Nonprofit Organizations. Taken together, the actions of the FASB and AICPA brought order out of chaos with respect to accounting standards for nonprofit organizations.

10

Characteristics of Nonprofit Organizations

Hybrid of governmental entities and business enterprises. Service to Society: Nonprofit organizations render services to society as a whole. The services are of benefit to many rather than the few.

11

Characteristics of Nonprofit Organizations

The members of such organization may range from a limited number of citizens to a community to almost entire population of a city, state or nation. No Profit Motivation: Nonprofit organizations do not operate with the objective of earning a profit. Consequently, nonprofit organizations are exempt from federal and state income taxes.

12

Characteristics of Nonprofit Organizations

Stewardship for resources: Because a substantial portion of the resources of a nonprofit organization is donated, the organization must account for the resources on a stewardship basis similar to that of governmental entities. The stewardship requirement makes fund accounting appropriate for many such organizations.

13

Characteristics of Nonprofit Organizations

Financing by the citizenry: As with governmental entities, most nonprofit organizations depend on the general population for a substantial portion of their support, because revenues from charges for their services are not intended to cover all their operating costs. The citizenrys contribution to nonprofit organizations are voluntary contributions.

14

Characteristics of Nonprofit Organizations

Importance of Budget: The preceding characteristics of nonprofit organizations cause their annual budget to be as important as for governmental entities. Use of accrual basis of accounting: Nonprofit organizations employ the same accrual basis of accounting used by business enterprises.

15

Characteristics of Nonprofit Organizations

Governance by board of directors: As with a business corporation, a nonprofit corporation is governed by elected or appointed directors, trustees, or governors. In contrast, the legislative and executive branches of a governmental entity share the responsibilities of governance.

16

Characteristics of Nonprofit Organizations

Measurement of cost expirations: Governance by a board of directors means that a nonprofit organization does not answer to a lawmaking body as does a governmental entity.

17

Characteristics of Nonprofit Organizations

One consequence is that cost expirations, or expenses, rather than expenditures are reported in the statement of activities of most nonprofit organizations. Allocation of expenses and revenues to the appropriate accounting period is a common characteristic of nonprofit organization and business enterprises.

18

Fund Accounting By Nonprofit Organizations

The internal accounting unit for many nonprofit organizations is the fund, which is an accounting entity with a self-balancing set of accounts recording cash and other financial resources, together with all liabilities and residual balances, and changes therein, which are segregated for the purpose of carrying on specific activities in accordance with regulations, restrictions or limitations.

19

Fund Accounting By Nonprofit Organizations

Separate funds may be necessary to distinguish between assets that may be used as authorized by the board of directors and assets whose use is restricted by donors. Funds commonly used by some of the nonprofit organizations include following:

Unrestricted fund (unrestricted current fund / current unrestricted fund / general fund).

20

Fund Accounting By Nonprofit Organizations

Restricted fund. Endowment fund. Agency fund (custodian fund). Annuity fund and life income fund (living trust fund). Loan fund. Plant fund (land, building and equipment fund).

21

Unrestricted Fund

In many aspects, an Unrestricted Fund is similar to General Fund of a government entity. The unrestricted fund includes all the assets of a nonprofit organization that are available for use as authorized by the board of directors and are not restricted for specific purposes. Unrestricted fund is residual in nature.

22

Unrestricted Fund

The revenues and gains of an unrestricted fund are derived from number of sources

23

Unrestricted Fund

For Example: From services, educational programs, research and other grants, unrestricted gifts, unrestricted income from endowment funds, student tuition and fees, governmental grants and contracts, gifts, private grants, revenue from auxiliary activities such as student residences, food services, intercollegiate athletics.

24

Unrestricted Fund

A nonprofit organizations revenues for services are accrued as full rates, even though part or all of the revenues is to be waived or reduced.

25

Unrestricted Fund

Contributed Material, Services, and Facilities: In addition to cash contributions, nonprofit organizations often receive contributions of material, services and facilities. The contributed material is recorded in the Inventories ledger account at its current fair value, with a credit to a revenues account in an unrestricted fund.

26

Unrestricted Fund

Significant contributed facilities are recognized at their current fair value, offset by a debit to an asset or an expense account, as appropriate.

27

Unrestricted Fund

Pledges: A pledge (or promise to give) is a commitment by a prospective donor to contribute a specific amount of cash or property to a nonprofit organization on a future date or in installments. Because a pledge is in writing and signed by the pledgor, it resembles in form the promissory note used in business. However, pledges often are not enforceable contracts.

28

Unrestricted Fund

Under the accrual basis of accounting, unconditional pledges are recognized as receivables and revenues in the unrestricted fund, with appropriate provision for doubtful pledges. Pledges due in future accounting period or having restrictions as to their use generally are accounted for in a restricted fund.

29

Unrestricted Fund

Revenues and Gains from Pooled Investments: Many of the funds of nonprofit organizations have cash available for investments in securities and other money-market instruments. To provide greater efficiency and flexibility I investment programs, the investment resources of all funds of a nonprofit organization may be pooled for investment by a single portfolio manager.

30

Unrestricted Fund

The pooling technique requires a careful allocation of investment revenues and realized and unrealized gains and losses to each participating fund.

31

Unrestricted Fund

Expenses & Losses: A nonprofit organization typically recognizes all expenses in its unrestricted fund. The losses may be recognized in other funds as well as in the unrestricted fund.

32

Unrestricted Fund

The expenses of a nonprofit organization can be classified in two groups:

Program Services. Supporting Services.

Program Services are the organizations activities that result in the distribution of goods and services to beneficiaries, customers, or members that fulfill the purpose or mission of organization.

33

Unrestricted Fund

Supporting Services are all activities of the organization other than program services. Depreciation Expense: In FASB Statement No. 93, the FASB required recognition of depreciation on all long-lived tangible assets of nonprofit organization, except for individual works of art or historical treasures having extraordinarily long economic lives, with disclosure of following in note to the financial statements:

34

Unrestricted Fund

Depreciation expense for the period. Balances of major classes of depreciable assets, by nature or function, at the balance sheet date. Accumulated depreciation, either by major classes of depreciable assets or in total, at the balance sheet date. A general description of the method(s) used in computing depreciation for major classes of depreciable assets.

35

Unrestricted Fund

Fund-Raising Expense: Although fundraising costs may benefit future accounting periods of a nonprofit organization, just as advertising costs of a business enterprise may benefit future periods, fund-raising costs are recognized as an expense when incurred.

36

Unrestricted Fund

Conditional Pledges: Some nonprofit organizations promise to make grants to individuals or to other organizations. Generally, grants are recognized as expense when the governing board unconditionally approves them.

37

Unrestricted Fund

Income Taxes: Some otherwise taxexempt nonprofit organizations may be subject to federal and state income taxes on their unrelated business income, which is derived from activities not substantially related to the educational, charitable or other basis of the organizations tax-exempt status.

38

Unrestricted Fund

Assets and Liabilities: Most assets and liabilities of a nonprofit organizations unrestricted fund are similar to the current assets and liabilities of a business enterprise. Cash, investments, inventories, accounts receivables, receivables from other funds, short term prepayments are typical assets of unrestricted fund.

39

Unrestricted Fund: Assets & Liabilities

Nonprofit organizations that use fund accounting generally account for plant assets in a plant fund, although health care entities may account for such assets in the general fund. The liabilities of an unrestricted fund include payables, accruals, and deferred revenue similar to those of a business enterprise, as well as amount payable to other funds.

40

Unrestricted Fund: Assets & Liabilities

With respect to non-exhaustible collections of museums, art galleries, botanical gardens, libraries, and similar nonprofit organizations, the FASB waived recognition of such assets in the organizations accounting records under specified conditions. However, the organizations statement of activities and a note to the financial statements must include specified disclosures regarding the collections.

41

Unrestricted Fund

Fund Balance: Because most nonprofit organizations do not have owners, the net assets of the organizations unrestricted funds are represented by a fund balance. The board of directors may designate a portion of an unrestricted funds net assets for a specific purpose.

42

Restricted Fund

Nonprofit organizations establish restricted funds to account for assets available for current use but expendable only as authorized by the donor of the assets. The restricted fund resemble the special revenue fund of a governmental entity. Assets are not derived from operations of the nonprofit organization.

43

Restricted Fund

The assets are obtained from restricted gifts or grants from individuals or governmental entities, revenues from restricted fund investments, realized and unrealized gains or investments of the restricted funds, and restricted income from endowment funds. These assets are transferred to the unrestricted fund at the time the designated expenditure is made.

44

Endowment Fund
An endowment fund is similar to nonexpendable trust fund of a governmental entity. A permanent endowment fund is one for which the principal must be maintained indefinitely in revenue producing investments.

45

Endowment Fund
Only the revenues from a permanent endowment funds investments may be expended by the nonprofit organization. In contrast, a term endowment fund may be expended after the passage of a period of time or the occurrence of an event specified by the donor of the endowment principal.

46

Endowment Fund

A quasi endowment fund is established by the board of directors of a nonprofit organization, rather than by an outside donor. At the option of the board, the principal of a quasi endowment fund later may be expended by the entity that established the fund.

47

Agency Fund

An agency fund is used to account for assets held by a nonprofit organization as custodian. The assets are distributed only as instructed by their owner. The undistributed assets is reported as liability of the fund rather than fund balance.

48

Annuity Fund

Assets may be contributed to a nonprofit organization with the stipulation that the organization pay specified fixed amounts periodically to designated recipients, for a specified time period.

49

Annuity Fund

An annuity fund is established by the organization to account for such arrangement. At the end of the specified time period for the periodic payments, the unexpended assets of the annuity fund are transferred to the unrestricted fund or to a restricted fund or endowment fund specified by the donor.

50

Life Income Fund

A life income fund is used to account for stipulated payments to a named beneficiary(ies) during the beneficiarys lifetime. Only the income is paid to the beneficiary. Payments to beneficiary vary from one accounting period to the next, but payments from an annuity fund are fixed in amount.

51

Loan Fund

A loan fund may be established by any nonprofit organization, but loan funds most frequently are included in the accounting records of colleges and universities. Student loan funds generally are revolving: that is old loans are repaid, new loans are made from the receipts.

52

Loan Fund

Loans receivable are carried in the loan fund at estimated realizable value; provisions for doubtful loans are debited directly to the fund balance ledger account, not to an expense account. Interest on loans is credited to the fund balance account, ordinarily on the cash basis of accounting.

53

Plant Fund

The components of plant funds vary among nonprofit organizations. In addition to assets, plant funds may include cash and investments earmarked for additions to plant assets and mortgage notes payable and other liabilities collateralized by the plant assets. Sinking fund assets set aside for retirement of debt incurred to acquire plant assets.

54

Financial Statements

Financial statements of nonprofit organizations shall be a statement of cash flows, statement of financial position, a statement of activities, and notes to financial statements. The statement of financial position shall report the amounts of the organizations total assets, total liabilities, and total net assets.

55

Financial Statements

The statement of financial position shall report the amounts for each of the three classes of the organizations net assets; permanently restricted, temporarily restricted and unrestricted. The statement of activities shall report the amount of the changes in each of the three classes of the organizations net assets; permanently restricted, temporarily restricted and unrestricted.

56

Financial Statements

The statement of activities shall report the amount of the change in the organizations net assets for the period with a caption such as changes in net assets or change in equity. The statement of activities shall report gross amounts of revenues and expenses of the organization, except that investment revenues may be reported net of expenses and gains or losses on disposal of plant assets may be reported net.

57

Financial Statements

The statement of activities or a note thereto shall report expenses by functional classifications such as program services and supporting services. The statement of cash flows shall be similar in format direct method or indirect method to one that is issued for a business enterprise.

58