Chapter 16
Nonprofit
Organizations
Scope of Chapter
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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
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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
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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
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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 AICPA’s 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.
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Accounting Standards
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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
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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
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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
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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.
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.
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Characteristics of
Nonprofit Organizations
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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.
Characteristics of
Nonprofit Organizations
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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.
Characteristics of
Nonprofit Organizations
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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 citizenry’s contribution to nonprofit
organizations are voluntary contributions.
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.
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Characteristics of
Nonprofit Organizations
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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.
Characteristics of
Nonprofit Organizations
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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.
Characteristics of
Nonprofit Organizations
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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.
Fund Accounting By
Nonprofit Organizations
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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.
Fund Accounting By
Nonprofit Organizations
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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:
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Unrestricted fund (unrestricted current fund /
current unrestricted fund / general fund).
Fund Accounting By
Nonprofit Organizations
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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).
Unrestricted Fund
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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.
Unrestricted Fund
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The revenues and gains of an unrestricted fund
are derived from number of sources
Unrestricted Fund
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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.
Unrestricted Fund
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A nonprofit organization’s revenues for
services are accrued as full rates, even
though part or all of the revenues is to be
waived or reduced.
Unrestricted Fund
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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.
Unrestricted Fund
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Significant contributed facilities are
recognized at their current fair value,
offset by a debit to an asset or an
expense account, as appropriate.
Unrestricted Fund
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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.
Unrestricted Fund
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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.
Unrestricted Fund
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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.
Unrestricted Fund
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The pooling technique requires a careful
allocation of investment revenues and realized
and unrealized gains and losses to each
participating fund.
Unrestricted Fund
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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.
Unrestricted Fund
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The expenses of a nonprofit organization can
be classified in two groups:
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Program Services.
Supporting Services.
Program Services are the organization’s
activities that result in the distribution of goods
and services to beneficiaries, customers, or
members that fulfill the purpose or mission of
organization.
Unrestricted Fund
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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:
Unrestricted Fund
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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.
Unrestricted Fund
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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.
Unrestricted Fund
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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.
Unrestricted Fund
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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
organization’s tax-exempt status.
Unrestricted Fund
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Assets and Liabilities: Most assets and
liabilities of a nonprofit organization’s
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.
Unrestricted Fund: Assets &
Liabilities
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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.
Unrestricted Fund: Assets &
Liabilities
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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
organization’s statement of activities and a
note to the financial statements must include
specified disclosures regarding the collections.
Unrestricted Fund
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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 fund’s net assets for a
specific purpose.
Restricted Fund
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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.
Restricted Fund
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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.
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.
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Endowment Fund
Only the revenues from a permanent
endowment fund’s 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.
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Endowment Fund
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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.
Agency Fund
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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.
Annuity Fund
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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.
Annuity Fund
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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.
Life Income Fund
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A life income fund is used to account for
stipulated payments to a named
beneficiary(ies) during the beneficiary’s
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.
Loan Fund
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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.
Loan Fund
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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.
Plant Fund
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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.
Financial Statements
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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 organization’s total
assets, total liabilities, and total net assets.
Financial Statements
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The statement of financial position shall report
the amounts for each of the three classes of the
organization’s 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 organization’s net assets;
permanently restricted, temporarily restricted and
unrestricted.
Financial Statements
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The statement of activities shall report the
amount of the change in the organization’s 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.
Financial Statements
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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.