USCPA (FAR) – (29) Not-for-Profit Financial Reporting

I would like to record about the key points of the US CPA exam content.

<Create and note the points based on mainly Becker’s workbook>

Key Components of Financial Statements under ASC 958

• Statement of Financial Position: This is similar to a balance sheet in for-profit organizations and shows the organization’s assets, liabilities, and net assets at the end of the reporting period.
• Statement of Activities: This shows how the organization’s net assets have changed over the reporting period due to revenue, expenses, gains, and losses.
• Statement of Cash Flows: This provides information about the cash inflows and outflows during the reporting period, helping users understand the organization’s liquidity and cash management.
• Statement of Functional Expenses: While not required for all not-for-profits, this statement is essential for those that provide certain types of services, detailing expenses by both nature and function.

Expenses for nonprofit organization

• Expenses for nonprofit organizations are classified into fundraising expenses and support services and management and general expenses. Fundraising expenses are direct costs incurred to promote donations, while support services and management and general expenses are costs incurred to support the overall operations of the organization. This classification is crucial for maintaining accurate financial reporting and transparency in accordance with FASB ASC 958.
• Not-for-profit reporting guidance included in FASB ASC 958 primarily focuses on basic information for the organization as a whole. The standards establish guidance for general-purpose external financial statements provided by a not-for-profit organization.

How expenses are recognized

• Recognition of Expenses: All expenses are recognized as changes to “net assets without donor restrictions.” This means that the costs incurred by the organization for its operations are considered to be paid out of funds that are not subject to donor-imposed restrictions. The purpose of the statement of financial position for a nongovernmental not-for-profit entity would be the same as the purpose fulfilled by the balance sheet produced by a commercial entity: it provides relevant information about assets, liabilities and equity (net assets) and their relationship to one another at a moment in time.
• Reclassification of Earnings with Donor Restrictions: When earnings with donor restrictions are used in a manner that satisfies the donor’s stipulations, these earnings are reclassified from “net assets with donor restrictions” to “net assets without donor restrictions.” This indicates that the income has been used for the specific purpose designated by the donor, thus lifting the restriction.
• Funding the Expense: The reclassified earnings are then used to fund the expenses. This process ensures that the earnings originally subject to donor restrictions are properly utilized, and the necessary expenses for the organization’s operations are paid.

Functional & Natual Classification

• A not-for-profit organization needs to report its expenses in the statement of activities by their functional classification (program classification, supporting activities, fund-raising, etc.) and disclose the expenses in a natural classification by function in the notes to the financial statements.
• Non-profit organizations need to classify their expenses based on different functions such as program activities, support activities, and fundraising activities. This classification clarifies how much resources are allocated to each activity.
• Program services (expenses) are the activities for which an organization is chartered. Support services are everything not classified on the statement of activities as a program service.
• Program services are all expenses (direct and indirect) that relate to activities for which an organization is chartered, not just direct costs.
• In the notes to the financial statements, the organization reports expenses in more detail according to natural classification. This shows how much is spent on each type of expense, including items such as Salaries, Rent, and Supplies.
• Functional classifications of expenses categorize costs as program and support services. Program services relate to the purpose and mission of the not-for-profit organization. Support services relate to such activities as management and general, fundraising, and membership development.
• While details of functional classifications and their relationship to natural expense classifications must be presented either in the notes or on the face of the financial statements.

Classification of Net Assets

• In the statement of financial position for a non-profit organization, net assets are reported in two categories:
• Net Assets with Donor Restrictions: These are funds that a donor has restricted for a specific purpose, time frame, or other conditions. This category includes permanent funds (endowments) that are expected to be maintained permanently for a specified purpose.
• Net Assets without Donor Restrictions: These are funds that are not subject to specific restrictions and can be used more freely by the organization. This includes operating funds and general activity funds. Designations made by the board of directors are internal and are not considered donor restrictions because donor restrictions can only arise from outside the organization.
• Endowment funds, due to their nature, fall under the latter category but are not considered as a separate major classification. Instead, they are managed as part of the net assets with donor restrictions. By classifying net assets in this manner, non-profit organizations can appropriately track the purpose and conditions of fund usage, maintaining transparency for donors and other stakeholders.
•  When donor restrictions are either satisfied or withdrawn, the funds will be reclassified from out of net assets with donor restrictions into net assets without donor restrictions.
• When a nonprofit organization receives a donation with donor-imposed restrictions, it is typically recorded as “net assets with donor restrictions.” However, if those restrictions are satisfied within the same accounting period in which the donation was received, the organization can record the donation as “net assets without donor restrictions.” To do this, the organization must consistently apply this accounting policy and disclose it.
•  Donor-imposed restrictions that are met in the same period they are received may be recorded as support (contribution revenue) without donor restrictions, provided that the organization discloses and consistently applies this accounting policy.

the funds used for the acquisition of the building

• Recognition of Release from Restriction: Funds used for the acquisition of a building are recognized as “total revenues, gains, and other support without restrictions” due to the release from donor restrictions.
• Reclassification of Net Assets: As a result, “net assets with donor restrictions” decrease and “net assets without donor restrictions” increase.
• Recognition of Capital Addition: The acquisition of the building is recorded as a capital addition and recognized as an asset under “net assets without donor restrictions.”

Non-current assets

• Include the restricted cash

Endowment Funds

• Endowment Funds Endowment funds are established when a donor permanently donates funds to an organization, specifying that the principal amount must be preserved and only the earnings may be used for a specific purpose. Endowments typically support the long-term financial stability and growth of non-profit organizations, and the original amount of the funds must be maintained in principle.
• Temporary vs. Permanent Restrictions: Net assets with donor restrictions can either have temporary restrictions (such as until a specific project is completed) or permanent restrictions (restricted to a specific purpose permanently), but endowment funds specifically imply the preservation of funds permanently and the designated use of earnings.
• Preservation of Principal: Endowment funds are characterized by the permanent retention of the principal, although there are instances within “net assets with donor restrictions” where the principal may be spent (depending on the conditions).
• Accounting Treatment: Endowment funds are subject to specific accounting standards, typically managed as investments, and only their earnings are used. Conversely, general donor-restricted funds allow for a broader range of uses and are often limited to specific projects or time periods.

Cash Contributions to a Perpetual Endowment

• No Change in the Nature of the Fund: When cash is donated to a perpetual endowment, the nature of the fund remains unchanged. Specifically, the classification of the donated funds does not change from “net assets with donor restrictions” to “net assets without donor restrictions” or any other category. The donated funds are permanently incorporated into the principal of the endowment fund.
• Maintenance of Principal: The donated funds are incorporated as the principal of the endowment and this principal remains intact. Only the earnings generated from the principal are used for the purposes intended by the donor. In this way, the principal itself remains untouched, and its purpose and structure remain unchanged.
• Importance of the Principle: This principle is extremely important for nonprofit organizations. It ensures the perpetuity of the fund and strict adherence to the donor’s intentions. Donors and stakeholders can trust that the fund will remain stable and continuous, and that its purpose will be preserved
• Funds designated as a quasi-endowment are classified as “donations without donor restrictions,” meaning they are excluded from specific financial calculations and treated as funds the organization can use freely. This allows the nonprofit organization to manage its funds flexibly while maintaining transparency in financial reporting. Since this donation is provided to the organization in an unrestricted form, it may not be included in calculations based on specific conditions or requirements.

Conditional Donation

• As the conditions have not yet been met, these funds are considered to have “no value to classify”. This means the funds do not qualify as net assets and are treated only as a liability affecting the financial state.
• The donor provides funding for the construction of a new facility, but this is contingent upon for example, securing operational funding for the program it is intended to support. This means if the conditions are not met, the funds could be returned to the donor.

Unconditional promises to pay in the future

• Unconditional promises to pay in the future are recorded as net assets with donor restrictions and are recognized as revenue over time.

Unconditional Donor-Restricted Contributions

• Unconditional Donor-Restricted Contributions: This type of contribution comes with explicit restrictions imposed by the donor, although the contribution itself is made unconditionally. This means that while there are no conditions attached to the receipt of the donation, there are specific restrictions on how it can be used.
• Satisfying the Restrictions: The restrictions attached to the donation can be satisfied through the actions of the non-profit organization. This implies that the organization can fulfill the purposes or conditions set by the donor by carrying out specific activities or projects.
• Net Assets with Donor Restrictions: Such contributions are recorded as “net assets with donor restrictions” in accounting. This designation means that the funds can only be used for specific purposes until the donor’s restrictions are met.

Nonprofit organizations may record the fair value of donated services

• if the following conditions are met: 1) The service creates or enhances non-financial assets 2) The service requires (S) specialized skills provided by individuals possessing those skills and would (O) otherwise be purchased if not provided by donation and be (ME) measured easily. Donated services are recorded SOME of the time.
• Accounting firm services meet the requirements for recording as revenues, gains, and other support without donor restrictions.

 Investments with donor-imposed restrictions and the income generated from such investments

• Investment with Donor Restrictions: An investment is classified as “with donor restrictions” because the donor has imposed specific conditions on how the income generated from the investment should be used. These conditions place specific restrictions on the purpose or manner in which the investment income can be utilized.
• Classification of Investment Income: The income generated from the investment (e.g., interest or dividends) is also classified as an increase to net assets with donor restrictions until it is expended as specified by the donor. This means that the income cannot be freely used and must be utilized according to the donor’s specified purpose.
• Utilization of Income and Net Asset Movement: When the income is actually used for the donor-specified purpose, the amount is transferred from “net assets with donor restrictions” to “net assets without donor restrictions.” This reflects that the income has been expended for the designated purpose, thus fulfilling the donor’s restriction.

the statement of cash flows

• The cash contributions without donor restrictions are reported as increases in operating activities in the statement of cash flows.
• The cash contributions with donor restrictions are reported as increases in financing activities because the restriction is the acquisition of property, not general operations.
• As with commercial accounting, a cash flow statement prepared using the indirect method will not present cash payments for interest as a separate line item in the cash flow from operations section of the cash flow statement. Interest paid will be specifically included as a supplemental disclosure.
• Cash flows from operating activities in a nongovernmental not-for-profit organization include applicable agency transactions, cash contributions without donor restrictions, program income, and interest income or dividend income from investments.
• In the statement of cash flows, proceeds from the sale of long-lived assets and insurance proceeds related to the loss of long-lived assets are recorded as investing activities.
• The deferred cash items are classified in the organization’s cash flow statement as cash flows from operations. This accounting process records cash inflows and outflows arising from day-to-day business activities.
•  The cash contributions with donor restrictions are reported as increases in financing activities because the restriction is the acquisition of property, not general operations.
• Cash contributions restricted by the donor for long-term purposes must be reported as a cash inflow in the financing activities section of the statement of cash flows, segregated from other financing activities.

Collection

• Investing activities in the statement of cash flows should include proceeds from the sale of long lived assets or insurance proceeds associated with the loss of long lived assets. Entities that do not capitalize their permanent collections display insurance proceeds from lost, stolen or damaged items on the statement of activities in an appropriate change in net asset classification separate from revenues, expenses, gains, and losses.
• Contributed collection items should not be recognized as revenues or gains if collections are not capitalized. 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.
• A not-for-profit organization that does not recognize and capitalize its collections should report the following on the face of its statement of activities separately from revenues, expenses, gains, and losses: