This chapter is divided into separate sections that address issues often considered by not-for-profit organizations in presenting financial statements in accordance with generally accepted accounting principles.
Although they are not required, comparative financial statements increase the usefulness of the financial information presented to the reader. Financial statement presentations are enhanced if they present financial statements for at least two years. Financial statement readers, including donors, boards of directors, audit committees, and creditors, etc., have come to expect to see comparative information in financial statements.
Comparative financial statements help readers understand the trends of current changes affecting an organization. They allow the reader to place the current year statements in a historical context. Just like investors in the commercial world, donors to not-for-profit organizations generally feel comfortable with more, and not less, information. Comparative financial statements increase the amount of information, but do not add to complexity—a double benefit. They also lend a degree of confidence in the future of the organization because there has been a history presented. In addition, current year financial statements are presumed to be more useful if financial statements for one or more prior years are presented.
It is generally preferable to present all financial statements—the statement of financial position, statement of activities, statement of cash flows, and statement of functional expenses (if required) for at least one prior year when the current year financial statements are presented. Note disclosures relating to prior year financial statements should also be included.
Not-for-profit organizations sometimes present comparative information for a prior year or years only in total rather than by net asset class. Such summarized information may not include sufficient detail to constitute a presentation in conformity with GAAP. If the prior year's financial information is summarized and does not include the minimum information required by GAAP (e.g., if the statement of activities does not present revenues, expenses, gains, and losses by net asset class), the nature of the prior year information should be described by the use of appropriate titles on the face of the financial statements and in a note to the financial statements.
The use of appropriate titles includes a phrase such as “with summarized financial information for the year ended June 30, 20PY,” following the title of the statement or column headings that indicate the summarized nature of the information. Labeling the prior year summarized information “for comparative purposes only” without further disclosure in the notes to the financial statements would not constitute the use of an appropriate title.
Reclassifications or other changes may cause items for two or more periods to no longer be comparable. Changes affecting comparability should be disclosed.
Organizations presenting summarized prior year information must describe the summarized nature of the presentation in a note to the financial statements. FASB ASC 958-205-55-31 provides an example of the type of note, as follows:
The financial statements include certain prior-year summarized comparative information in total but not by net asset class. Such information does not include sufficient detail to constitute a presentation in conformity with generally accepted accounting principles. Accordingly, such information should be read in conjunction with the organization's financial statements for the year ended June 30 of the prior year, from which the summarized information was derived.
Not-for-profit organizations are often torn between presenting information in financial statements about funds (described in Chapter 7) and meeting the requirements of generally accepted accounting principles relating to net asset presentation. The following illustrates an example of how these two financial statement objectives may be met.
There are two principal financial statements that most readers want to see. Most important is a statement of functional expenses, which provides information on expenses in their functional and natural classifications and, of lesser importance, the statement of financial position. If all transactions have been skillfully summarized on these two statements, it is then possible to provide a third schedule which shows the appropriate detail of the information on the two primary statements. The key to successful presentation in this third schedule is showing totals that tie back into the statement of functional expenses.
The J. W. M. Diabetes Research Institute financial statements are a good example of how substantial detail can be provided on “name” funds without detracting from the reader's overall understanding of the results of operations. While these statements relate to a medical service and research institute, the form would essentially be the same for almost any type of organization. Exhibits 1, 2, and 3 show these statements.
Overall impression of complexity. The reader's first impression of these statements may be that they “look” complicated and will be hard to understand. This is particularly so with respect to Exhibit 3, which shows changes in the individual “name” funds. Before studying this statement, however, take a few minutes to study the first two statements (Exhibits 1 and 2) to get an overall impression of what has happened during the year. Look first at the “Total” column on the statement of activities and the description of the items of income and expense. The reader should focus on the total picture before looking at some of the detail by individual funds. The same thing should be done with the statement of financial position. Look first at the total, and only then at the detail by funds.
The statement of activity by individual “name” funds (Exhibit 3) is more difficult. The stewardship concept has been introduced in considerable detail on this statement. Apart from the many individual “name” funds, this statement also shows these funds segregated by the type of restriction associated with each fund. Some funds contain restrictions only with respect to the original principal; others restrict both the income and the principal. While this statement is complicated, there is a great deal of information on the statement that the reader should be able to understand if some time is taken to study it. On the other hand, if the reader isn't interested in this detail, the overall statement of activities still clearly summarizes all income and expenses. This is a key point—everything is summarized in total, and readers are required to look at detail only to the extent they wish to do so.
One final observation about the overall impression these statements make. If these same statements had been presented in a separate statement format, including separate statements for each “name” fund, the resulting set of statements would most certainly have discouraged and probably confused all but the most determined readers. There would be just too much detail; few readers would be able to get any meaningful understanding of the overall financial picture of this organization. So, while the supplementary summary on individual “name” funds may seem complex, the alternative would be far less comprehensible.
Statement of activities. On the statement of activities, the number of columns is only what is needed to show the three classes of net assets, with the unrestricted class being subdivided into an investment fund and the operating fund. While there are varying types of restrictions associated with the various restricted amounts, no attempt is made to indicate these on the face of the statement because this represents a detail that can best be left to a supporting statement. It is important that the reader not get lost in detail on the summary statement.
Reclassifications. There are two reclassifications in the bottom part of this statement. The first is a reclassification from the permanently restricted class of an endowment on which the restrictions were released by the donor. This reclassification of $7,119 went directly to the unrestricted class since this amount became unrestricted. The second reclassification is from the unrestricted general fund to the unrestricted investment fund, in the amount of $42,119. In the unrestricted general fund column, only the net amount of $35,000 is shown.
It should be noted that there are no contributions or gains shown directly in the unrestricted investment fund. All unrestricted contributions or gains are shown in the unrestricted general fund. The board can then transfer any portion of such income to the unrestricted investment fund but it should not show such income directly in that fund. Unrestricted income must be reported initially in the unrestricted general fund.
Unrestricted investment income. It will be noted that unrestricted investment income of $92,793 ($81,142 from endowment and $11,651 from unrestricted investment funds) has been shown directly in the unrestricted general fund. It would not have been appropriate for the board to have left this amount in the endowment and unrestricted investment funds since this income contains no restrictions as to its use. To assist the reader in seeing how much income each separate fund earned, this unrestricted income is also shown in the statement of changes in individual funds in the column “Reported directly in general fund.” Inclusion of this column in the statement is optional.
Gains and losses. Endowment gains aggregating $296,480 have been shown partly in each of the three classes. Unrestricted investment fund gains should be reported entirely in the unrestricted general fund. These gains, as with investment income, represent unrestricted income and should be reported as such. There is no reason why the board cannot reclassify all or part of these gains back to the unrestricted investment fund, but this should be handled as a reclassification.
Comparison with last year's figures. An additional column may be added to the statement of financial position and the statement of activities to show last year's actual figures so the reader has a point of reference. This comparison is usually to the total column, although sometimes a comparison is made only to the unrestricted general fund. If the comparison column is to the total column, then this additional column should be next to the current year's total column to make it easier for the reader. If the comparison is only to the unrestricted general fund, it should be set up with headers as shown below. Instead of a comparison to last year's figures, the comparison could have been to this year's budget.
Statement of financial position. Fixed assets have not been set up as a separate category. Instead, they have been included as a part of the unrestricted class. This greatly simplifies the problem of depreciation since depreciation can then be handled in exactly the same manner as it would be handled by a commercial enterprise.
One of the principal reasons why many prefer to see fixed assets in a separate category is that the unrestricted general fund balance then represents the current assets of the organization. In our illustration the net assets of $886,225 are mostly represented by fixed assets. If the fixed assets had been shown separately, the unrestricted general fund balance would have been only $67,675. But this lower figure has limited significance because there are other unrestricted current assets that are available for general purposes if the board chooses to use them. These other unrestricted current assets are the $301,044 of unrestricted investment funds.
Some will argue that the fixed asset amounts should not be included in the “unrestricted” figure since the organization could not exist without its buildings. This may be so, but there is no reason why the institute has to use its present buildings. They could be sold and new ones built on less expensive land or in a better location. Alternatively, property could be rented. These are all decisions that the board is free to make and, being free to make them, the assets are unrestricted.
An alternative presentation that avoids the problem of mixing currently available net assets with the fixed assets is to show the fixed assets on a separate line. The authors recommend this approach whenever fixed assets are a significant part of total assets, and especially if the financial condition of the organization is not very liquid. If an organization has a large total unrestricted net assets balance, but most of it is represented by fixed assets, there might not be enough cash available to pay current bills as they come due.
Sometimes an organization will even have a fixed assets balance in excess of its total unrestricted net assets. In this case, there is effectively a deficit in available resources, and serious financial trouble may not be far away.
Many not-for-profit organizations present their statement of financial position to show total assets less liabilities equaling net assets.
Total assets | $442,000 |
Less—Liabilities | (20,000) |
Net assets | $422,000 |
In the J. W. M. Diabetes Research Institute statements (Exhibit 1), the more conventional statement of financial position approach was followed, showing total assets equaling the sum of the liabilities and net assets.
Total assets | $3,798,900 |
Liabilities | ($ 96,230) |
Net assets | 3,702,670 |
Total liabilities and net assets | $3,798,900 |
Either approach is acceptable. The first is more appropriate for organizations with relatively few categories of liabilities, and therefore for smaller organizations.
Statement of changes in individual funds. Notice the line at the top of Exhibit 3, “All income and expenses have been shown in total on the Statement of Activities.” This or a similar statement helps readers to recognize that they do not have to add the income and expenses shown on this statement to the amounts shown on the statement of activities (Exhibit 2) in order to get total income and expenses. While technically there is no requirement that this type of caption be shown, it helps in understanding the nature of this statement. Most of the totals shown on this statement can be tied in directly to the statement of activities.
Restricted income from endowments. Income on permanent or term endowment that is restricted to a specified purpose should be recorded directly in the fund for that purpose. Note that in the Malmar endowment fund no investment income has been shown. Actually $4,970 of income was received but it was reported directly in the fund for specified purposes in a separate fund maintained for this income (Malmar repair fund). This $4,970 plus $108 of income earned on this restricted fund balance is the $5,078 reported as investment income.
There are two other endowment funds with restrictions on the income. In both instances, the income has been left in the endowment fund. Presumably the donor specified that the income was to be accumulated for a period of time before it could be spent. There is no disclosure of the terms of the fund on the statement, but if they were significant a footnote could be added to tell the reader. However, unless the terms of the restriction are significant, footnote details should be avoided.
There is no reason why unrestricted investments couldn't also have “names” associated with them. Here, all of the unrestricted investments are shown as the Elmer C. Bratt fund. The board could also have had other “name” funds, all part of the total unrestricted investment fund.
While it is not obvious from this statement, most of the investments are “pooled” together and individual funds have a percentage or share interest in the total investment portfolio. Since all of the individual funds are “pooled” together, each gets its proportionate share of income and gains or losses on the sale of investments.
Other supporting statements. There are other statements that could be included with the three statements we have just discussed. For example, many readers might want to see a great deal more of the details of the expense categories than are shown in total on the statement of income and expenses, and perhaps also a comparison with the budget or last year's actual figures. Exhibit 4 shows an example of this type of supporting schedule. Again, as with all supporting or supplementary statements, the format must be so designed that the reader clearly sees how the figures tie into the main statement.
The reader interested in detail gets a great deal of information from looking at this type of analysis. There is comparison both with budget for the year and with last year's actual expenses, by type of expense and function. It must be remembered that the more detail provided, the greater the risk that the reader will get lost in the detail. Financial statements are not necessarily improved by providing details or additional supporting schedules. In fact, often they detract from the overall effectiveness.
Interim reporting is financial reporting for periods of less than a year, generally for a period of three months (quarterly reporting). Many of the interim reporting concepts discussed in this chapter have developed from the need of public entities to provide quarterly financial information to the United States Securities and Exchange Commission and investors. The discussions in this chapter use those practices as a basis for providing guidance to not-for-profit organizations that prepare and publish interim financial information. The purpose of quarterly reports is to provide financial statement users with more timely information for investment and credit decisions. Not-for-profits may provide interim financial reports to meet one of two needs:
Organizations may be required under certain contracts or grant agreements to provide interim financial reports.
The basic objective of interim reporting is to provide frequent and timely assessments of enterprise performance. However, interim reporting has inherent limitations. As the reporting period is shortened, the effects of errors in estimation and allocation are magnified. The proper allocation of annual operating expenses is a significant concern. Other annual operating expenses are often concentrated in one interim period, yet benefit the entire year's operations. Examples include advertising expenses and major repairs or maintenance of equipment. The effects of seasonal fluctuations and temporary market conditions further limit the reliability, comparability, and predictive value of interim reports. For example, many not-for-profit organizations experience an increase in contributions in December as donors rush to seek tax deductions prior to the close of the calendar year. Because of this reporting environment, the issue of independent auditor association with interim financial reports is subject to continuing controversy.
Two distinct views of interim reporting have developed. Under the first view, the interim period is considered to be an integral part of the annual accounting period. Annual operating expenses are estimated and then allocated to the interim periods based on forecasted annual activity levels such as sales volume. The results of subsequent interim periods must be adjusted to reflect estimation errors. Under the second view, the interim period is considered to be a discrete accounting period. Thus, there are no estimations or allocations different from those used for annual reporting. The same expense recognition rules apply as under annual reporting, and no special interim accruals or deferrals are applied. Annual operating expenses are recognized in the interim period incurred, irrespective of the number of interim periods benefited.
Proponents of the integral view argue that the unique expense recognition procedures are necessary to avoid misleading fluctuations in period-to-period results. Using the integral view results in interim earnings which are indicative of annual earnings and, thus, useful for predictive purposes. Proponents of the discrete view argue that the smoothing of interim results for purposes of forecasting annual earnings has undesirable effects. For example, a turning point during the year in an earnings trend may be obscured.
The American Institute of Certified Public Accountants auditing standards (AU-C 930) provide guidance to independent auditors performing reviews of interim financial information, primarily addressing required reviews performed of interim financial information of public companies. While not common, not-for-profit organizations should be aware of their option to have interim financial information reviewed by their independent auditors and, if they so choose, the procedures performed by the independent auditor will be guided by these standards.
Not-for-profit organizations usually do not apply the provisions of GAAP related to interim financial reporting, as contained in FASB ASC 270-10, as they are not publicly traded companies. However, they are not prohibited from following this part of GAAP if they wish to do so. The guidelines described below certainly provide a useful framework to not-for-profit organizations, which would be well served by following the general guidelines of GAAP. Basically, each interim period should be viewed as a part of the entire fiscal year. The results should be based on the application of the same accounting principles that the not-for-profit organization uses in preparing its fiscal year financial statements. Of course, this would be modified if a change in accounting practice or policy has been adopted during the current year.
GAAP provides guidelines for recognizing revenues and expenses during interim periods.
While most not-for-profit organizations do not have significant manufacturing or retailing operations that result in complex inventory accounting issues, for those organizations that do, the guidance of FASB ASC 270 is provided below. The principles used to determine ending inventory and cost of goods sold in annual reports are used in interim reports, although GAAP provides that the following modifications to inventory accounting principles may be appropriate in interim periods:
Most other costs and expenses are recognized in interim periods as incurred. However, an expenditure that clearly benefits more than one interim period (e.g., annual repairs or property taxes) may be allocated among the periods benefited. The allocation is to be based on estimates of time expired, benefit received, or activity related to the periods. Such allocation procedures should be consistent with those used by the firm at year-end reporting dates. However, if cost or expense cannot be readily associated with other interim periods, such costs should not be arbitrarily assigned to those periods. Application of these interim reporting expense principles is illustrated in the examples below.
Costs and expenses subject to year-end adjustment, such as uncollectible pledges receivable, should be estimated and assigned to interim periods in a reasonable manner.
At each interim date, the organization should make its best estimate of the effective tax rate expected for the full fiscal year that relates to any unrelated business income that it earns during the year. This estimate should reflect expected federal and state tax rates, tax credits, and other tax-planning techniques. However, changes in tax legislation are reflected only in interim periods after the effective date of the legislation.
The tax effect of losses in early quarters of the year should be recognized only when such losses can be carried back, or when the realization of the carryforward is reasonably assured. In the absence of contrary evidence, an established seasonal pattern of early-year losses offset by income later in the year constitutes reasonable assurance.
Extraordinary items and the effects of disposal of a segment should be reported separately in the interim period in which they occur. The same treatment is given to other unusual or infrequently occurring events. No attempt should be made to allocate such items over the entire fiscal year. Materiality is determined by relating the item to the annual results of operations.
OBSERVATION: In January 2015, the FASB issued ASU 2015-01 Income Statement— Extraordinary and Unusual Items (Subtopic 225-20) Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items (ASU 2015-01). As its name suggests, ASU 2015-01, effective for fiscal years and interim periods beginning after December 15, 2015, eliminates the concept of reporting extraordinary items. ASU 2015-01 may be applied prospectively or retrospectively to all prior periods presented in the financial statements.
Retroactive changes in accounting principle are handled on the same basis as in annual reports. Previously issued interim financial statements are retroactively restated.
In general, contingencies at an interim date should be accrued or disclosed in the same manner required for annual reports. The materiality of the contingency should be evaluated in relation to the expected annual results.
Certain items that are adjustments related to prior interim periods, such as a settlement of litigation, are accorded special treatment in interim reports. If such items are material, directly related to prior interim periods of the current fiscal year, and become reasonably estimable in the current interim period, they should be reported as follows:
The operations of many not-for-profit organizations are subject to significant seasonal variations. Such organizations should disclose the seasonality of their activities to avoid the possibility of misleading interim reports. GAAP also suggests that such organizations supplement their disclosures with information for twelve-month periods ending at the interim date of the current and preceding year. Many not-for-profit organizations receive significant amounts of contributions in December of each calendar year. This seasonal variance may be an appropriate disclosure in the interim financial reports that include this month.
When the fourth quarter results are not separately reported, material year-end adjustments as well as disposals of segments, extraordinary items, and unusual or infrequently occurring items for the quarter should be disclosed in a footnote to the annual report.
Generally, disclosure requirements for interim financial statements are the same as those for annual financial statements; however, the use of the interim financial statements needs to be considered. If the interim financial statements are being represented as being presented in accordance with GAAP, financial statement disclosure requirements would apply. However, if the interim financial statements are presented only as a means to update the board of directors (or even significant donors, contractors, or lenders) on the status of activities and financial positions, the management of the not-for-profit organization may elect not to present financial statement disclosures and footnotes. Although this would result in a modification of any auditor's report that accompanies the interim statements, the statements may still meet their objectives, but probably will be more timely and less costly to prepare. Often, the independent auditors are not asked to provide any assurance on the interim financial information that is prepared by a not-for-profit organization's management.
The ASC Master Glossary defines subsequent events as:
Events or transactions that occur after the balance sheet date but before financial statements are issued or are available to be issued. There are two types of subsequent events:
There are two often-used examples (modified for the not-for-profit environment) that demonstrate these concepts.
For nonrecognized subsequent events, GAAP (ASC 855-10-50-2) provides that some such subsequent events may be of such a nature that they must be disclosed to keep the financial statements from being misleading. For such events, the not-for-profit organization shall disclose the following:
This basic concept has existed in financial reporting for a long period of time, although its requirements were moved fairly recently from the auditing literature to an FASB Statement, which is now included in the ASC. As part of including these requirements in the accounting literature (FASB ASC 855), two additional requirements were included:
The ASC Master Glossary defines issued and available to be issued as follows:
Issued—Financial statements are considered issued when they are widely distributed to shareholders and other financial statement users for general use and reliance in a form and format that complies with GAAP.
Available to be issued—Financial statements are considered available to be issued when they are complete in a form and format that complies with GAAP and all approvals necessary for issuance have been obtained, for example, from management, the board of directors, and/or significant shareholders. The process involved in creating and distributing the financial statements will vary depending on an entity's management and corporate governance structure as well as statutory and regulatory requirements.
The FASB issued ASU 2010-9 (Subsequent Events [Topic 855] Amendments to Certain Recognition and Disclosure Requirements) which provides that an entity that is either:
is required to evaluate subsequent events through the date that the financial statements are issued.
If an entity meets neither of these two criteria, then it should evaluate subsequent events through the date the financial statements are available to be issued.
As a result of ASU 2010-9, most not-for-profit organizations will be required to use the date that the financial statements are available to be issued as the date through which management discloses it has evaluated subsequent events. However, not-for-profit organizations, particularly larger organizations, are often conduit debt obligors, and as described below, would be considered public entities and be required to use the issued date for evaluating subsequent events.
Certain FASB pronouncements have specific requirements or implementation deadlines that apply specifically to “public entities.” Some not-for-profit organizations may fail to realize that this term, as defined by the FASB, is not synonymous with publicly traded SEC reporting entities. In fact, more than a few not-for-profit organizations are considered public entities under the FASB definition because they are obligated for “conduit debt,” which is discussed next.
The FASB definition of a “public entity” is contained in the ASC Master Glossary and is defined as an entity that meets any of the following conditions:
Not-for-profit organizations are sometimes “conduit debt obligors” as discussed below, which would mean that they would meet the definition of public entity as to the application of FASB standards. Also be aware that an entity that is controlled by a not-for-profit organization that is a public entity would also be considered a public entity under item e. above.
Many not-for-profit organizations (particularly colleges and universities) frequently avail themselves of financing through conduit debt securities. As explained in the ASC Master Glossary, conduit debt securities refer to certain limited-obligation revenue bonds, certificates of participation, or similar debt instruments issued by a state or local governmental entity for the express purpose of providing financing for a specific third party (the conduit bond obligor) that is not a part of the state or local government's financial reporting entity. Although conduit debt securities bear the name of the governmental entity that issues them, the governmental entity often has no obligation for such debt beyond the resources provided by a lease or loan agreement with the third party on whose behalf the securities are issued. Further, the conduit bond obligor is responsible for any future financial reporting requirements. Additional discussion of conduit debt has been added to Chapter 10 of the 2013 edition of the AICPA not-for-profit audit guide.
For not-for-profit organizations that are conduit debt obligors and use the date through which financial statements are issued to evaluate subsequent events, the definition of when financial statements are considered issued is important. Unlike an SEC filer where the issuance/filing date is clear, not-for-profit organizations typically don't have a specific requirement to distribute their financial statements on the date that they are issued. Accordingly, these not-for-profit organizations should take steps to ensure that there is at least some distribution of the financial statements (e.g., posting on a website) on the issuance date to effectively “stop the clock” on the time period for which they are responsible for evaluating subsequent events.