Essentials of Accounting for
Governmental and
Not-for-Profit Organizations
Chapter 10
Accounting for Private Not-for-Profit
Organizations
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Overview of Chapter 10

This chapter focuses on how the Financial
Accounting Standards Board and AICPA
Audit Guides apply to private not-for-profits,
generally.



Who has standard setting authority?
Accounting and reporting for Voluntary Health
and Welfare and Other Not-for-Profits
Not-for-profits and performance evaluation
10-2
Standard Setting Authority

GASB

Authority over government related not-for-profits



GASB 34 Special Purpose Entity requirements may apply
GASB 35 for Public Colleges and Universities
FASB



Private not-for-profits
AICPA audit guides also applicable
Major SFASs 93, 116, 117, 124, 136, 164
10-3
Private Not-For-Profits

FASBs 116 & 117 were written in order to bring
comparability between the financial reports of Private
Colleges, Hospitals, Voluntary Health and Welfare
Organizations and Other Not-for-Profits.

However, because of unique features of the college and hospital
settings, these entities are covered in greater detail in separate
chapters.
10-4
VHWOs and Other Not-for-Profits


The remainder of this chapter focuses on
Voluntary Health and Welfare
Organizations and Other Not-for-Profits.
What are the characteristics of a VHWO?


Promotes general health and well-being of the
public.
Tends to operate mainly from grants and gifts.
 Examples: United Way, American Cancer Society, Girl
Scouts, YMCA.
10-5
Understanding the Basic Financial Statements
The three required statements are:



Statement of Financial Position
Statement of Activities
Statement of Cash Flows
Voluntary Health and Welfare Organizations must also prepare
a Statement of Functional Expenses

This statement is recommended but not required for other not-forprofits.
10-6
Basis of Accounting and Use of Funds

Accrual Basis: The accrual
basis is required.


This includes calculation and
recording of depreciation
expense.
The financial statements
report expenses, not
expenditures or
encumbrances.

Funds: Many Private Notfor-profit organizations use
fund designations internally
for bookkeeping purposes,
but the financial statements
are on an overall basis and
do not make reference to
funds except in the notes or
supplemental schedules
10-7
Statement of Financial Position



Assets and liabilities are not required to be
classified as current and non-current, but may
be.
Long-term assets and debt are reported.
Net Assets (equities) are classified as:



Unrestricted
Temporarily restricted - time or purpose restrictions
Permanently restricted
10-8
Statement of Activities

The statement must distinguish changes in net assets that
are permanently restricted, temporarily restricted, and
unrestricted. Restrictions must be outside donorimposed


Can use three separate statements, columns or other formats
Revenue vs support:


Support: is a class of revenues limited to gifts such as
contributions
Exchange transaction, such as sales of service, are labeled
“revenues”
10-9
Statement of Activities


Expenses
All expenses are
reported in the
unrestricted column
Classify expenses as
program or supporting
services.

Restrictions
Temporarily restricted
resources must be
‘released’ or moved
from the temporary
column to the
unrestricted column as
restrictions are satisfied.
10-10
Statement of Cash Flows

FASB uses 3 categories




Operating – Interest expense, interest revenue, and gains and
losses are classified as operating
Investing – Purchases or sales of fixed assets as well as
purchases or sales of long-term investments
Financing – Issuance of debt; repayments of principal of debt
Not-for-profits have the option of using either the
indirect approach or the direct approach plus
reconciliation.
10-11
Statement of Functional Expenses

This is a matrix (spreadsheet) of expenses where the columns are
the program or supporting activities and the rows are the type of
expense (salaries, supplies, depreciation, etc.)
 This statement shows more detail than the Activity Statement
on how the expenses were allocated to programs and
supporting services.

The purpose of this statement is to show the details of the entity’s
spending on direct programs activities versus overhead
(supporting services).
 It helps donors assess entity efficiency.
10-12
Accounting for Contributions

FASB Statement 116 requires contributions,
including unconditional promises of support, to
be recognized as contribution revenue in the
period received at their fair market value.
10-13
SFAS 116: Accounting for
Contributions Received and Made

SFAS 116 does not change the accounting for exchange
transactions (earned revenues). Care should be taken to
identify whether membership dues are contributions or
exchanges.

Not-for-profit organizations must distinguish between
contributions that are permanently restricted,
temporarily restricted, and unrestricted. Such
restrictions are donor-imposed.
10-14
Accounting for Pledges
Under accrual basis, unconditional pledges can be recorded
even before the cash is received.
 Record the receivable at the present value, net of an
allowance for estimated uncollectibles
If there is expected to be an extended time period before the
gift is received record the receivable at its present value:
 The present value will increase as the expected date
of receipt approaches. The change in present value is
recorded as additional contribution revenue rather
than interest.
10-15
Contributed Services

Should contributed services be recorded?

Only if they


Create or enhance a nonfinancial asset OR
Require specialized skills, were provided by someone
possessing those skills, and would have been
purchased if not donated.
10-16
Contributed Services

If recorded, how should they be recorded?

If a nonfinancial asset is enhanced:
Dr. Asset (for the value of the services).
Cr. Contribution revenues

Otherwise:
Dr. Expense (for the value of the services).
Cr. Contribution revenues
10-17
Exchanges vs. Contributions

Contributions are considered as revenues as soon as
received (or pledged) even if the use is restricted.
But depending on the terms of the contribution,
may later be reclassified from temporarily
restricted to unrestricted.

If money is received in advance of providing the service on
an exchange-like transaction, the amount received is
considered Deferred Revenue.
10-18
Intentions to Give

Pledges are recorded if unconditional.


Intentions to give (oral promises, wills) are often
not legally enforceable, as the donors retain legal
right to change their mind.
Intentions to give are not recorded until the actual
gift materializes.
10-19
Fixed Assets

Fixed assets, whether purchased or donated, can be
recorded either as


Unrestricted assets, or
As temporarily restricted.


If initially recorded as temporarily restricted an amount
equal to depreciation must be released each year to
unrestricted assets.
NOTE: Some not-for-profits may prefer the later approach because readers of the
financial statements may think ‘unrestricted net assets’ means expendable funds -listing the long-term assets as temporarily restricted decreases requests to spend
reserves that are not really available in a liquid form.
10-20
Performance Evaluation


FASB 117 presents not-for-profit statements in a
format similar to business statements.
Although revenues and expenses are measured on
the accrual basis, the “bottom line” (Change in net
assets) is not directly comparable to that of a
business.

Since many of the revenues are non-exchange, Change in
Net Assets is not a measure of organizational effectiveness.
10-21
Is it Proper for Not-for-Profits
to Have a Profit?

Legitimate reasons for a not-for-profit to have a profit
are:




To replace and expand equipment and facilities.
To provide working capital.
To retire debt.
To continue programs beyond the time frame when seed money
grants are available.
10-22
Program Expense Ratio

The most commonly used ratio for not-for-profit is
the Program Expense Ratio:
Program Service Expenses/Total Expenses

Program Services include expenses associated with
performing the mission of the organization

Supporting Services include management and general; fund
raising and membership development
10-23
Program Expense Ratio

A high ratio of program
expense will assure
donors that the
organization spends the
bulk of dollars donated
for its mission oriented
activities rather than for
overhead

The organization may
need to keep detailed
time records to properly
report costs (e.g. salary)
associated with both
program and supporting
activities.
10-24
Program vs. Supporting
Expense Allocations

Because of the importance of the program expense
ratio, care must be taken in the allocation of joint
costs between program and supporting services.


Salaries and depreciation must be allocated to the two
functions on an equitable basis.
Fund raising appeals sometimes also include
program elements

and not-for-profits would like to allocate some of these
costs to programs to improve the program expense ratio
10-25
Program vs. Supporting Expense
Allocations cont’d

The criteria to determine whether part of the
cost of a fund raising campaign applies to
program expense are:



Purpose: Does the communication help meet program goals and
functions?
Audience: General audience, not just sent to last year’s donors.
Content: Calls for specific action directed at program goals.
10-26
SFAS 124: Accounting for Certain Investments
Held by Not-for-Profit Organizations
FASB requires investments with readily
determinable market values to be recorded at fair
market values and gains and losses be recognized
10-27
Transfers of Contributions
to Not-for-Profits

Assume a not-for-profit receives assets
from a donor for distribution to a
beneficiary:

ISSUE: If cash or other assets are held by a notfor-profit with instructions to release this money
for specified parties, is this a revenue or is it an
agency relationship (liability)?
10-28
SFAS 136: Transfer of Assets to a
Not-for-Profit

If the not-for-profit agrees to transfer the assets to a
specified beneficiary, the not-for-profit is deemed to
merely be acting as an agent and a liability, rather
than a contribution, is recorded.

If the not-for-profit has the ability to redirect the
assets to another beneficiary, or if the not-for-profit
and beneficiary are related, the assets are recorded as
a contribution.
10-29
Transfers of Contributions
to Not-for-Profits
CENTRAL CONCEPT: It is a revenue if the not-for-profit
can ‘control’ who gets the money, otherwise it is credited to
a liability account because the not-for-profit is only acting
as an agent on behalf of the donor.

EXCEPTION: If the party receiving the money and the
not-for-profit are financially interrelated, then this may
be a revenue to the not-for-profit.
10-30
Consolidation of not-for-profits

The AICPA Audit and Accounting Guide, Not-for-Profit
Organizations, requires consolidation of entities in which
a not-for-profit organization has a controlling financial
interest.


Control may be determined by a majority ownership interest or by
holding a majority voting interest in the governing board of an entity
in which the not-for-profit has an economic interest through
contractual or affiliation agreements.
This is similar to practices followed in the public sector with
component unit reporting.
10-31
Mergers of not-for-profits

FASB Statement No. 164, Not-for Profit Entities:
Mergers and Acquisitions, permits two different
accounting treatments for combinations by notfor-profit organizations. The central issue is
whether the combination is a merger or an
acquisition
10-32
Mergers of not-for-profits

A merger is a transaction in which the governing bodies of two or more notfor-profit entities relinquish control of those entities to create a new not-forprofit entity. To qualify as a new entity, the combined entity must have a
newly formed governing body. Although commonly there will be a new
legal entity, that is not a requirement.

The resulting not-for-profit entity will account for the merger using the
carryover method. Under the carryover method:
10-33
Carryover method – book values
“carryover” to new entity



The new entity recognizes the assets and liabilities of the
separate merging entities in the amounts (and classifications)
reported in the financial statements of the merging entities.
No internally developed intangible assets (such as goodwill)
are recognized.
The entity resulting from the merger is a new reporting entity,
with no activity before the date of the merger.
10-34
Acquisition Method


Combinations not meeting the definition of a merger are
reported as acquisitions.
The accounting treatment is similar to the purchase
method of accounting for business combinations

The essential element of the acquisition method is that the entity
records the acquired assets and liabilities at their fair values, not at
the acquired entity’s book values.
10-35
Acquisition Accounting



The not-for-profit entity recognizes the identifiable assets acquired
and liabilities assumed at their fair values at the date of acquisition.
Noncontrolling interest (if any) is reported at fair value at the
acquisition date and is adjusted in subsequent periods in a manner
similar to business organizations.
Goodwill may be reported.
10-36
Goodwill

Not-for-profit entities that derive their revenues
from business-like activities are required to
measure and report goodwill as an asset in a
similar manner as businesses.

However, entities that derive their revenues
primarily from contributions are to expense the
goodwill at date of acquisition.
10-37