Essentials of Accounting for Governmental and Not-for-Profit Organizations Chapter 10 Accounting for Not-For-Profit Organizations McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

10-2 Chapter 10 – Learning Objectives Describe characteristics of private not-for- profit organizations and the accounting for contributions Apply the accrual basis of accounting in the recording of typical transactions of a private not-for-profit organization Prepare the financial statements for a private not-for-profit organization

10-3 Standard Setting Authority GASB Authority over government related not-for-profits Not-for-profits owned or controlled by a governmental entity should follow applicable GASB standards Most commonly, these follow enterprise fund accounting FASB Private not-for-profits AICPA audit guides also applicable Major SFASs 93, 116, 117, 124, 136, 164

10-4 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.

10-5 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.

10-6 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-for- profits.

10-7 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 Not- for-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

10-8 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

10-9 Park County Animal Shelter Statement of Financial Position As of Assets Cash $ 110,700 Pledges receivable 30,000 Interest receivable 500 Supplies Inventory 12,500 Endowment Investments 250,000 Total Assets $ 403,700 Liabilities Accounts payable 3,000 Wages payable 2,700 Total Liabilities 5,700 Net assets Unrestricted 93,000 Temporarily restricted 55,000 Permanently restricted (endowment) 250,000 Total Net Assets 398,000 Total Liabilities and Net Assets $ 403,700 Accounting rules require contributions to be recorded when promised. Do not wait until collected.

10-10 Park County Animal Shelter Statement of Financial Position As of Assets Cash $ 110,700 Pledges receivable 30,000 Interest receivable 500 Supplies Inventory 12,500 Endowment Investments 250,000 Total Assets $ 403,700 Liabilities Accounts payable 3,000 Wages payable 2,700 Total Liabilities 5,700 Net assets Unrestricted 93,000 Temporarily restricted 55,000 Permanently restricted (endowment) 250,000 Total Net Assets 398,000 Total Liabilities and Net Assets $ 403,700 Restrictions are reflected in the Equity Section: called Net Assets

10-11 Statement of Activities The statement must distinguish changes in net assets that are permanently restricted, temporarily restricted, and unrestricted. Restrictions must be outside donor- imposed 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”

10-12 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.

10-13 Park County Animal Shelter, Inc. Statement of Activities For the year ended Revenues Unrestricted Temporarily Restricted Permanently Restricted Total Contributions $ 146,000 $ 50,000 $ 15,000 $ 211,000 Grants – spay & neuter 35,000 Adoption fees 25,000 Interest Income 2,000 Net assets released from restriction: Satisfaction of program restrictions 27,000 (27,000) - Capital improvement restriction 15,000 (15,000) Total Revenues and Other Support 215,000 43,000 15, ,000 Expenses Program Service Expenses Adoption services 123, ,000 Spay and neuter clinic 27,000 30,000 Educational programs 12,000 Total program service expenses 162, Supporting Service Expenses Administration 15,000 Fundraising 10,000 Total Supporting Services Expenses 25, Total Expenses 187, Change in Net Assets 28,000 43,000 15,000 86,000 Net Assets- Beginning of Year 65,000 12, , ,000 Net Assets - End of Year $ 93,000 $ 55,000 $ 50,000 $ 398,000 Revenues are recorded within 3 categories

10-14 Park County Animal Shelter, Inc. Statement of Activities For the year ended Revenues Unrestricted Temporarily Restricted Permanently Restricted Total Contributions $ 146,000 $ 50,000 $ 15,000 $ 211,000 Grants – spay & neuter 35,000 Adoption fees 25,000 Interest Income 2,000 Net assets released from restriction: Satisfaction of program restrictions 27,000 (27,000) - Capital improvement restriction 15,000 (15,000) Total Revenues and Other Support 215,000 43,000 15, ,000 Expenses Program Service Expenses Adoption services 123, ,000 Spay and neuter clinic 27,000 30,000 Educational programs 12,000 Total program service expenses 162, Supporting Service Expenses Administration 15,000 Fundraising 10,000 Total Supporting Services Expenses 25, Total Expenses 187, Change in Net Assets 28,000 43,000 15,000 86,000 Net Assets- Beginning of Year 65,000 12, , ,000 Net Assets - End of Year $ 93,000 $ 55,000 $ 50,000 $ 398,000 Expenses are always reported as unrestricted

10-15 Park County Animal Shelter, Inc. Statement of Activities For the year ended Revenues Unrestricted Temporarily Restricted Permanently Restricted Total Contributions $ 146,000 $ 50,000 $ 15,000 $ 211,000 Grants 35,000 Adoption fees 25,000 Interest Income 2,000 Net assets released from restriction: Satisfaction of program restrictions 27,000 (27,000) - Capital improvement restriction 15,000 (15,000) Total Revenues and Other Support 215,000 43,000 15, ,000 Expenses Program Service Expenses Adoption services 123, ,000 Spay and neuter clinic 27,000 30,000 Educational programs 12,000 Total program service expenses 162, Supporting Service Expenses Administration 15,000 Fundraising 10,000 Total Supporting Services Expenses 25, Total Expenses 187, Change in Net Assets 28,000 43,000 15,000 86,000 Net Assets- Beginning of Year 65,000 12, , ,000 Net Assets - End of Year $ 93,000 $ 55,000 $ 50,000 $ 398,000 There are 2 required categories of expenses

10-16 Park County Animal Shelter, Inc. Statement of Activities For the year ended Revenues Unrestricted Temporarily Restricted Permanently Restricted Total Contributions $ 146,000 $ 50,000 $ 15,000 $ 211,000 Grants – spay & neuter 35,000 Adoption fees 25,000 Interest Income 2,000 Net assets released from restriction: Satisfaction of program restrictions 27,000 (27,000) - Capital improvement restriction 15,000 (15,000) Total Revenues and Other Support 215,000 43,000 15, ,000 Expenses Program Service Expenses Adoption services 123, ,000 Spay and neuter clinic 27,000 30,000 Educational programs 12,000 Total program service expenses 162, Supporting Service Expenses Administration 15,000 Fundraising 10,000 Total Supporting Services Expenses 25, Total Expenses 187, Change in Net Assets 28,000 43,000 15,000 86,000 Net Assets- Beginning of Year 65,000 12, , ,000 Net Assets - End of Year $ 93,000 $ 55,000 $ 50,000 $ 398,000 When we spend cash according to the donor’s wishes, we reclassify $ from Temp. Restricted to Unrestricted

10-17 Park County Animal Shelter, Inc. Statement of Activities For the year ended Revenues Unrestricted Temporarily Restricted Permanently Restricted Total Contributions $ 146,000 $ 50,000 $ 15,000 $ 211,000 Grants 35,000 Adoption fees 25,000 Interest Income 2,000 Net assets released from restriction: Satisfaction of program restrictions 27,000 (27,000) - Capital improvement restriction 15,000 (15,000) Total Revenues and Other Support 215,000 43,000 15, ,000 Expenses Program Service Expenses Adoption services 123, ,000 Spay and neuter clinic 27,000 30,000 Educational programs 12,000 Total program service expenses 162, Supporting Service Expenses Administration 15,000 Fundraising 10,000 Total Supporting Services Expenses 25, Total Expenses 187, Change in Net Assets 28,000 43,000 15,000 86,000 Net Assets- Beginning of Year 65,000 12, , ,000 Net Assets - End of Year $ 93,000 $ 55,000 $ 50,000 $ 398,000 (Rev – Exp) is called change in net assets

10-18 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.

10-19 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.

10-20 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.

10-21 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.

10-22 Accounting for Pledges Under accrual basis, unconditional pledges are 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.

10-23 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.

10-24 Contributed Services If recorded, how should they be recorded? If a nonfinancial asset is enhanced: Dr. Capital Asset (for the value of the services). Cr. Contribution revenues Otherwise: Dr. Expense (for the value of the services). Cr. Contribution revenues

10-25 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.

10-26 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.

10-27 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.

10-28 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.

10-29 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.

10-30 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

10-31 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.

10-32 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

10-33 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.

10-34 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

10-35 Transfers of Contributions to Not-for-Profits Assume a not-for-profit receives assets from a donor for distribution to a beneficiary: ACCOUNTING ISSUE: If cash or other assets are held by a not-for-profit with instructions to release this money for specified parties, is this a revenue or is it an agency relationship (liability)?

10-36 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.

10-37 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.

10-38 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.

10-39 Mergers of not-for-profits FASB Statement No. 164, Not-for Profit Entities: Mergers and Acquisitions, permits two different accounting treatments for combinations by not- for-profit organizations. The central issue is whether the combination is a merger or an acquisition

10-40 Mergers of not-for-profits A merger is a transaction in which the governing bodies of two or more not-for-profit entities relinquish control of those entities to create a new not- for-profit 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:

10-41 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.

10-42 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.

10-43 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.

10-44 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.