Wiley not for profit GAAP 2017 interpretation and application of generally accepted accounting principles

About the Authors Not-for-Profi t Accounting Literature Part 1 Overview of Not-for-Profi t Organizations Chapter 1 Overview of Not-for-Profi t Organizations Chapter 2 Cash versus Accru

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Richard F Larkin Marie DiTommaso

Copyright © 2000 by John Wiley & Sons, Inc Reprinted by permission of John Wiley & Sons, Inc

Portions of this book have been reprinted from Wiley GAAP 2002, Interpretation and Application of

Generally Accepted Accounting Principles, by Patrick R Delaney, Barry J Epstein, Ralph Nach, and

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About the Authors

Not-for-Profi t Accounting Literature

Part 1 Overview of Not-for-Profi t Organizations

Chapter 1 Overview of Not-for-Profi t Organizations

Chapter 2 Cash versus Accrual-Basis Accounting

Part 2 Basic Financial Statements

Chapter 3 Statement of Financial Position

Chapter 4 Statement of Activities

Chapter 5 Statement of Cash Flows

Chapter 6 Other Financial Statement Issues

Part 3 Specifi c Not-for-Profi t Accounting Topics

Chapter 7 Fund Accounting

Chapter 8 Net Assets

Exchange Transactions

Chapter 10 Investments

Chapter 11 Affi liated Organizations

Chapter 12 Split-Interest Agreements

Chapter 13 Fundraising and Joint Costs

Chapter 14 Functional Reporting

Chapter 15 Collections

Part 4 Other Accounting-Related Not-for-Profi t Topics

Chapter 16 Accounting for Specific Types of Not-for-Profi ts

Chapter 17 Importance of Budgets to a Not-for-Profi t

Part 5 General Accounting Topics Applied to Not-for-Profi t Organizations

Chapter 19 Current Assets and Current Liabilities

Chapter 20 Inventory

Chapter 21 Long-Lived Assets, Depreciation, and Impairment

Chapter 22 Intangible Assets

Chapter 23 Contingencies

Chapter 24 Mergers and Acquisitions

Chapter 25 Accounting for Pensions and Postretirement Benefi ts Chapter 26 Long-Term Liabilities

Chapter 27 Accounting Changes

Chapter 28 Accounting for Leases

Chapter 29 Financial Instruments

Chapter 30 Capitalization of Interest Costs

Appendix: Disclosure Checklist

Index

Not-for-profit accounting is a specialized field of accounting that is receiving a growing level of attention Over one million not-for-profit organizations currently operating in the United States have unique accounting and financial reporting issues that must be understood by a grow­ing number of not-for-profit organization financial statement preparers and users

The Financial Accounting Standards Board (FASB) has issued a series of statements and accounting standards updates that have significantly affected how not-for-profi t organiza­tions account for and report their activities and financial position In 2016 the FASB issued

an Accounting Standards Update that brings some important changes to certain aspects of the financial reporting model used by not-for-profit organizations The FASB has also been active

in many areas that affect a broad range of business and other organizations, including not-for­profit organizations For example, financial instruments, intangible assets, pension obligations, fair value measurements, revenue recognition, and lease accounting have all been areas that have been impacted by recent FASB pronouncements All of these topics are examined in detail in this book

This book incorporates the codification of accounting standards into the FASB Accounting Standards Codification (the “Codification” or “FASB ASC”) The FASB essentially eliminated the statements on standards and other accounting literature and replaced them with the FASB ASC, which is updated by Accounting Standards Updates as the mechanism of promulgating changes in generally accepted accounting principles

Despite the steady stream of accounting pronouncements that affect not-for-profi t organi­zations, it’s important to understand that accounting standards setting has been infl uenced by

a great deal of recent change The Sarbanes-Oxley Act of 2002 created the Public Company Accounting Oversight Board (PCAOB), which has responsibility for setting auditing and other standards for public companies Even with all of the new requirements and changes, the FASB continues to set generally accepted accounting principles for both public and nonpublic entities, including not-for-profit organizations However, the FASB’s agenda has focused more on issues affecting public companies, which has likely been influenced by the changes in the regulatory environment and issues highlighted by the numerous accounting shortcomings, and by the tur­moil that was experienced in the financial markets This changed a bit as the FASB established a Not-for-Profi t Advisory Committee which has reexamined the reporting model used by not-for­profit organizations and has made suggestions to the FASB to improve the financial reporting of these organizations Some of these changes have been promulgated in an Accounting Standards Update issued in 2016 Additional changes may well result from future FASB deliberations

In addition, the American Institute of CPAs (AICPA), through technical practice aids, industry risk alerts, and accounting and auditing guides, continues to be an important contributor to the body of accounting principles used by not-for-profit organizations It also significantly revised its accounting and audit guide for not-for-profit organizations in the recent past

This book is designed as a complete and easy-to-use reference guide for fi nancial statement preparers and users, as well as for auditors of not-for-profit organizations It focuses on three key areas:

• Distinguishing characteristics of not-for-profit organizations and their fi nancial account­ing and reporting;

• Accounting areas that are unique to not-for-profi t organizations;

• General areas of accounting that are applicable to the accounting and fi nancial reporting

of not-for-profi t organizations

This book would not have been possible without the hard work and efforts of several indi­viduals John DeRemigis and Pam Reh contributed greatly to the production efforts over many years The authors are greatly appreciative of their efforts as well as those of the current editorial and production teams

Richard F Larkin, CPA Marie DiTommaso February 2017

Industry Services Group in the national office of PricewaterhouseCoopers He is a certifi ed pub­lic accountant with over forty years of experience serving not-for-profit organizations as inde­pendent accountant, board member, treasurer, and consultant He teaches, speaks, and writes extensively on not-for-profit industry matters and is active in many professional and industry organizations He has been a member of the Financial Accounting Standards Board Not-for-Profit Advisory Task Force and the AICPA Not-for-Profit Organizations Committee, and chaired the AICPA Not-for-Profi t Audit Guide Task Force He participated in writing both the third and fourth editions of Standards of Accounting and Financial Reporting for Voluntary Health and Welfare Organizations, and the AICPA Practice Aid, Financial Statement Presentation and Dis­closure Practices for Not-for-Profit Organizations He graduated from Harvard College and has

an MBA from Harvard Business School He is a coauthor of the fourth, fi fth, and sixth editions

of Financial and Accounting Guide for Not-for-Profit Organizations, which were published by

John Wiley & Sons, Inc

Marie DiTommaso has thirty years of experience in accounting and fi nancial reporting

in both the not-for-profit and commercial accounting environments She began her career with KPMG after graduating from Queens College of the City University of New York Later in her career, she joined the American Express Company and then Dun & Bradstreet Corporation, both to develop, write, and implement accounting policies and procedures After leaving these corporate organizations, Ms DiTommaso served as the chief fi nancial officer of a not-for-profi t organization

Ms DiTommaso has served as President of the Bergen County chapter of the New Jersey Women Business Owners Association, and as an advisor to its Board of Directors

As more fully described in Chapter 1, the source of all authoritative generally accepted accounting principles for not-for-profit organizations is now contained in the FASB Accounting Standards Codification (ASC) The following tables cross-reference several of the more com­mon ASC sections with the prior FASB pronouncements to assist readers in navigating the ASC References in these charts to the AICPA Audit & Accounting Guide are to the 2012 edition of the Guide Some chapters have been rearranged in the 2013 edition

An additional table in this section provides the reader with a list of the relatively recently issued (2013 through September 2015) Accounting Standards Updates (“ASUs” which amend the ASC) issued by the FASB Most of the ASUs will not affect the accounting and fi nancial reporting for many, if not all, not-for-profit organizations and are not discussed in this book However, it is important for the reader to be aware of the changes being made to the ASC so that any potential impacts of these changes can be evaluated Note that several ASUs beginning in

2014 are the result of consensus of the FASB’s Private Company Council, which provides a sim­plified method of accounting and reporting for certain transactions of private business entities These ASUs are not applicable to not-for-profi t organizations

Where a specific ASU is addressed in a chapter of this book, that chapter is indicated in the table

ASC–from previous:

958­

20 Financially-interrelated entities FAS 136

30 Split-interest agreements AAG Ch 6 DIG B-35

205 Presentation of fi nancial statements FAS 117, FSP 117-1, FAS 124

225 Income statement FAS 117, others

230 Statement of cash fl ows FAS 117, AAG Ch 3

310 Receivables FAS 116, AAG Ch 5 & others

320 Investments—debt and equity securities FAS 124, AAG Ch 8

325 Investments—other FAS 124, FSP 124-1, AAG Ch 8

360 Property, plant, and equipment FAS 116, FAS 93, AAG Ch 7, 9

605 Revenue recognition FAS 116, FAS 136, AAG Ch 5

715 Compensation—retirement benefi ts FAS 87, 88, 106, 132 (R), 158

720 Other expenses FAS 117, SOP 98-2, AAG Ch 13

805 Combinations FAS 164

810 Consolidation SOP 94-3, FSP 94-3-1, EITF 90-15, 96-21, ARB 51

815 Derivatives and hedging DIG B-35

Accounting Standards Updates Issued During 2014 through 2016

2014-01 Investments—Equity Method and Joint Ventures (Topic 323): Accounting

for Investments in Qualified Affordable Housing Projects

2014-02 Intangibles—Goodwill and Other (Topic 350): Accounting for Goodwill—a

consensus of the Private Company Council

2014-03 Derivatives and Hedging (Topic 815): Accounting for Certain

Receive-Variable, Pay-Fixed Interest Rate Swaps—Simplifi ed Hedge Accounting

Approach—a consensus of the Private Company Council

2014-04 Receivables—Troubled Debt Restructurings by Creditors (Subtopic 310­

40): Reclassification of Residential Real Estate Collateralized Consumer

Loans upon Foreclosures

2014-06 Technical Corrections and Improvements Related to Glossary Terms

2014-07 Consolidation (Topic 810): Applying Variable Interest Entities Guidance

to Common Control Leasing Arrangements—a consensus of the Private

Company Council

2014-08 Presentation of Financial Statements (Topic 205) and Property, Plant,

and Equipment (Topic 360): Reporting Discontinued Operations and

Disclosures of Disposals of Components of an Entity

2014-09 Revenue from Contracts with Customers (Topic 606) 9 2014-10 Development State Entities (Topic 915): Elimination of Certain Financial

Reporting Requirements, Including an Amendment to Variable Interest

Entities Guidance in Topic 810, Consolidation

2014-11 Transfers and Service (Topic 860): Repurchase-to-Maturity Transaction,

Repurchase Financings, and Disclosures

2014-12 Compensation—Stock Compensation (Topic 718): Accounting for

Share-Based Payments When the Terms of an Award Provide That a Performance

Target Could Be Achieved after the Requisite Service Period

2014-13 Consolidation (Topic 810) Measuring the Financial Assets and the Financial

Liabilities of a Consolidated Collateralized Financing Entity

2014-14 Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310­

40) Clarification of Certain Government-Guaranteed Mortgage Loans upon

Foreclosure

2014-15 Presentation of Financial Statements – Going Concern (Subtopic 205-40) 23

Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going

Concern

2014-16 Derivatives and Hedging (Topic 815) Determining Whether the Host

Contract in a Hybrid Financial Instrument Issued in the Form of a Share Is

More Akin to Debt or to Equity

2014-17 Business Combinations (Topic 805) Pushdown Accounting 24 2014-18

Business Combinations (Topic 805) Accounting for Identifi able Intangible

Assets in a Business Combination

2015-01 Income Statement – Extraordinary and Unusual Items (Subtopic 225-20) 6

Simplifying Income Statement Presentation by Eliminating the Concept of

Extraordinary Items

ASU Number Topic Chapter

2015-02 Consolidation (Topic 810) Amendments to the Consolidation Analysis 11 2015-03 Interest – Imputation of Interest (Subtopic 835-30) Simplifying the 26

Presentation of Debt Issuance Costs

2015-04 Compensation – Retirement Benefits (Topic 715) Practical Expedient for 25

the Measurement Date of an Employer’s Defi ned Benefit Obligation and

Plan Assets

2015-05 Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40) 22

Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement

2015-06 Earnings Per Share (Topic 260) Effects on Historical Earnings per Unit of

Master Limited Partnership Dropdown Transactions

2015-07 Fair Value Measurement (Topic 820) Disclosures for Investments in Certain 10

Entities That Calculate Net Asset Value per Share (or Its Equivalent)

2015-08 Business Combinations (Topic 805) Pushdown Accounting – Amendment

to SEC Paragraphs Pursuant to Staff Accounting Bulletin No 115

2015-09 Financial Services – Insurance (Topic 944) Disclosure about Short-Duration

Contracts

2015-10 Technical Corrections and Improvements

2015-11 Inventory (Topic 330) Simplifying the Measurement of Inventory 20 2015-12 Plan Accounting: Defi ned Benefit Pension Plans (Topic 960), Defi ned

Contribution Pension Plans (Topic 962), Health and Welfare Benefi t Plans

(Topic 965) – I Fully Benefit-Responsive Investment Contracts, II Plan

Investment Disclosures, III Measurement Date Practical Expedient

2015-13 Derivatives and Hedging (Topic 815) Application of the Normal Purchases

and Normal Sales Scope Exception to Certain Electricity Contracts within

Nodal Energy Markets

2015-14 Revenue from Contracts with Customers (Topic 606) Deferral of the 9

Effective Date

2015-15 Interest – Imputation of Interest (Subtopic 835-30) Presentation and

Subsequent Measurement of Debt Issuance Costs Associated with

Line-of-Credit Arrangements – Amendments to SEC Paragraphs Pursuant to Staff

Announcement at June 18-2015 EITF Meeting

2015-16 Business Combinations (Topic 805) Simplifying the Accounting for 24

Measurement-Period Adjustments

2015-17 Income Taxes (Topic 740) Balance Sheet Classification of Deferred Taxes

2016-01 Financial Instruments – Overall (Topic 825-10) Recognition and

Measurement of Financial Assets and Liabilities

2016-03 Intangibles—Goodwill and Other (Topic 350), Business Combinations

(Topic 805), Consolidation (Topic 810), Derivatives and Hedging (Topic

815) Effective Date and Transition Guidance (a consensus of the Private

Company Council)

2016-04 Liabilities—Extinguishments of Liabilities (Subtopic 405-20) Recognition

of Breakage for Certain Prepaid Stored-Value Products (a consensus of the

Emerging Issues Task Force)

ASU Number Topic

2016-05 Derivatives and Hedging (Topic 815) Effect of Derivative Contract

Novations on Existing Hedge Accounting Relationships (a consensus of the

Emerging Issues Task Force)

2016-06 Derivatives and Hedging (Topic 815) Contingent Put and Call Options in

Debt Instruments (a consensus of the Emerging Issues Task Force)

2016-07 Investments—Equity Method and Joint Ventures (Topic 323) Simplifying

the Transition to the Equity Method of Accounting 

2016-08 Revenue from Contracts with Customers (Topic 606) Principal versus

Agent Considerations (Reporting Revenue Gross versus Net)

2016-09 Compensation—Stock Compensation (Topic 718) Improvements to

Employee Share-Based Payment Accounting

2016-10 Revenue from Contracts with Customers (Topic 606) Identifying

Performance Obligations and Licensing

2016-11 Revenue Recognition (Topic 605) and Derivatives and Hedging (Topic 815)

Rescission of SEC Guidance Because of Accounting Standards Updates

2014-09 and 2014-16 Pursuant to Staff Announcements at the March 3,

2016 EITF Meeting (SEC Update)

2016-12 Revenue from Contracts with Customers (Topic 606) Narrow-Scope

Improvements and Practical Expedients

2016-13 Financial Instruments—Credit Losses (Topic 326) Measurement of Credit

Losses on Financial Instruments

2016-14 Not-for-Profit Entities (Topic 958) Presentation of Financial Statements of

Not-for-Profi t Entities

2016-15 Statement of Cash Flows (Topic 230) Classification of Certain Cash Receipts

and Cash Payments (a consensus of the Emerging Issues Task Force

2016-16 Income Taxes (Topic 740) Intra-Entity Transfers of Assets Other Than

Inventory

2016-17 Consolidation (Topic 810) Interests Held through Related Parties That Are

under Common Control

2016-18 Statement of Cash Flows (Topic 230) Restricted Cash (a consensus of the

FASB Emerging Issues Task Force)

2016-19 Technical Corrections and Improvements

2016-20 Technical Corrections and Improvements to Topic 606, Revenue from

Contracts with Customers

2017-01 Business Combinations (Topic 805): Clarifying the Definition of a Business

2017-02 Not-for-Profit Entities—Consolidation (Subtopic 958-810) Clarifying

When a Not-for-Profit Entity That Is a General Partner or a Limited Partner

Should Consolidate a For-Profit Limited Partnership or Similar Entity

2017-03 Accounting Changes and Error Corrections (Topic 250) and Investments—

Equity Method and Joint Ventures (Topic 323): Amendments to SEC

Paragraphs Pursuant to Staff Announcements at the September 22, 2016

and November 17, 2016 EITF Meetings  (SEC Update)

2017-04 Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for

© 2017 John Wiley and Sons Ltd Published 2017 by John Wiley and Sons Ltd.

1 OVERVIEW OF NOT-FOR-PROFIT

Perspective and Issues

Key Differences between Not-for-Profi t

and Profi t Organizations

3

5

Resource Use Consideration Generally Accepted Accounting Principles

7

7

PERSPECTIVE AND ISSUES

Not-for-profit organizations represent a significant portion of the economy of the United States Over one million of these organizations provide almost every conceivable type of ser­vice from education to politics, from social services to country clubs, and from religious to research organizations The number and importance of these organizations to the overall US economy continues to grow The Financial Accounting Standards Board (FASB) defi nes not-for­profit organizations by distinguishing them from profit organizations It defi nes not-for-profi t organizations as entities that possess the following characteristics not usually found in other organizations:

1 They receive contributions from significant resource providers who do not expect a com­mensurate or proportionate monetary return

2 They operate for purposes other than to make a profi t

3 There is an absence of ownership interests like those of business enterprises

Item 1 above describes transactions that are sometimes called “nonexchange” transactions In a typical contribution to a not-for-profit organization, the giver (donor) and the receiver (the not-for-profit organization) do not exchange items of equivalent value—the not-for-profit organization receives the majority of the value in the actual transaction The donor compensates for this difference by obtaining value separate from the transaction, such as through a tax deduction that it is likely to receive recognition, goodwill, or simply a good feeling about supporting a cause that the donor believes is worthwhile

While not-for-profit organizations share many of the same accounting principles as com­mercial enterprises, their accounting and financial reporting are quite unique because the focus

of financial reporting for not-for-profit organizations is not on the measurement of net income Reflecting this, and other differences, the FASB has issued some pronouncements specifi cally affecting the accounting and financial reporting of not-for-profits In addition, the application

of the FASB’s other accounting standards to not-for-profit organizations typically requires some modification for applying those standards to not-for-profit organizations because the primary focus of financial reporting for not-for-profit organizations is not on the measurement of net income or comprehensive income

© 2017 John Wiley and Sons Ltd Published 2017 by John Wiley and Sons Ltd.

Typically, not-for-profit organizations are controlled by boards of directors composed of individuals who generally volunteer their time The size of not-for-profit organizations varies greatly A small not-for-profit organization may have no paid staff; all functions may be per­formed by a governing board and volunteers On the other hand, some not-for-profi t organi­zations are quite large with hundreds or even thousands of employees, such as a university, a health-related research association, or a large cultural organization such as a museum When

a small, newly formed organization becomes large enough or complex enough in operation to require it, the board may delegate either limited or broad operating responsibility to a part-time

or full-time paid executive This executive may be given any one of many alternative titles— president, executive director, administrator, manager, etc Regardless of the size of the not-for­profi t organization, the board will usually appoint one of its own part-time volunteer members as treasurer In most cases, the treasurer is second in importance only to the chairperson of the board because the ability of the organization to carry out its programs is based upon strong oversight and administration of its fi nances

Every board member has a fi duciary responsibility for all of the affairs of the organization, including finances While the treasurer may be charged with paying special attention to this area, this does not excuse any board member from exercising diligent oversight in the fi nance,

as well as all other areas of operation The governing board’s involvement with setting appropri­ate levels of executive compensation is an area that has come under closer public and regulatory scrutiny in recent years, and is an important area for consideration in fulfilling these fi duciary responsibilities

In many instances, the board member designated as treasurer is a businessperson who is active in both professional and community affairs and has only a limited amount of time to devote to the organization Therefore, financial awareness from the rest of the board is necessary as is the appropriate development of a financial function within the organization that has the appropriate skill set given the size of the organization

The treasurer has significant responsibilities, including the following:

1 Keeping fi nancial records;

2 Preparing accurate and meaningful fi nancial statements;

3 Budgeting and anticipating fi nancial problems;

4 Safeguarding and managing the organization’s fi nancial assets;

5 Complying with federal and state reporting requirements

While this list certainly is not all-inclusive, most of the financial problems the treasurer will face are associated with these five major areas

In the public company commercial accounting environment, the role of the board of direc­tors (including board members who are part of an organization’s audit committee) has been under close scrutiny This scrutiny has a number of different causes, but certainly the inappropri­ate (or perceived inappropriate) application of accounting principles by a number of these public companies can be described as one of the more important factors leading to this scrutiny While the circumstances receiving public attention relate primarily to public companies, not-for-profit organizations are not immune to the misapplication of accounting principles Boards of directors, management, and independent auditors of not-for-profit organizations must be vigilant

to ensure that accounting principles used are appropriate and are appropriately applied In addi­tion to meeting the “letter of the law” as found in various accounting standards, not-for-profi t organizations must ensure that the application of generally accepted accounting principles to

their financial statements results in statements that truly do present fairly the activities and fi nan­cial position of the organization Further, some states have enacted legislation which defi nes certain responsibilities for boards of directors, including audit committees, covering areas such

as the relationship with independent auditors, conflicts of interest policies, and other governance matters

Not-for-profit organizations that are large enough to be required by the laws and regula­tions of the state in which they are located to have their financial statements audited each year (or in some cases compiled or reviewed) are increasingly establishing audit committees to oversee this obligation Generally the audit committee members represent a subgroup of the members of the board of directors, although sometimes nonboard members are invited to join audit committees States are becoming increasingly active in requiring not-for-profi t organi­zations to comply with prescribed governance requirements These requirements can impact board and audit committee functions and composition Some states have established specifi c requirements for establishing audit committees, including specific requirements on their mem­bership and duties

Audit committees generally concern themselves with ensuring the integrity of the fi nancial reporting process of the not-for-profit organization by understanding and overseeing the organi­zation’s internal control, internal audit function (if any), financial reporting process, engaging the independent certified public accountant that will audit the financial statements, as well as review­ing the annual Form 990 filed with the Internal Revenue Service Audit committees should have a direct relationship with the independent certified public accountant in terms of planning the audit, reviewing the results of the audit and addressing how the not-for-profit organization responds to any recommendations that the independent auditor makes as a by-product of the audit

Key Differences between Not-for-Profit and Profi t Organizations

One of the principal differences between not-for-profit and profit organizations is that they have different reasons for their existence In oversimplified terms, it might be said that the ulti­mate objective of a commercial organization is to realize net profits for its owners through the provision of some product or performance of some service wanted by other people, whereas the ultimate objective of a not-for-profi t organization is to meet some socially desirable need

of the community or its members

Like any organization, a not-for-profit organization should have sufficient resources to carry out its objectives However, there is no real need or justification for “making a profi t” (having an excess of revenue over expenses for a year) or having an excess of assets over liabilities at the end of a year beyond that which is needed to provide a reasonable cushion or reserve against a rainy day or to be able to take advantage of an unexpected opportunity While

a prudent board of a not-for-profi t organization should plan to provide for the future, the prin­cipal objective of the board is to ensure fulfillment of the programmatic functions for which the organization was founded A surplus or profit, per se, is only incidental That said, larger not-for-profit organizations sometimes borrow funds, and often the lender imposes certain fi nancial criteria as a condition for the loan (usually called debt covenants) which can make attention to reported results important

Instead of profit, many not-for-profit organizations are concerned with the size of their cash and investment balances They can continue to exist only so long as they have suffi cient cash resources to provide for their programs Thus the financial statements of not-for-profi t organizations often emphasize the liquid financial resources of the organization Commercial

organizations are also very much concerned with cash, but if they are profitable they will prob­ably be able to finance their cash needs through loans or from investors Their principal concern

is profitability and this means that commercial accounting emphasizes the matching of revenues and costs

The nature of most not-for-profit organizations’ operations is that they receive most of their revenues from contributions (rather than receiving fees for services) This means of receiving revenues gives a not-for-profit organization an important fiduciary responsibility for the funds that it receives This responsibility is why donors to a not-for-profit organization are signifi cant users of the financial statements of not-for-profi t organizations

For example, if a customer goes into a hardware store and buys a gallon of paint for $20, the customer really isn’t concerned with what the hardware store does with the $20 or how it controls and accounts for the money On the other hand, when a donor puts a $5 bill in a cash collection canister for the local children’s soccer league, the donor is very interested in knowing that the $5 actually gets to the soccer league, that most of the $5 is spent on soccer programs instead of administrative costs, and that the $5 is spent conservatively and appropriately (i.e., not on extravagant meals for the league’s board meetings or travel to World Cup games) Many of the financial reporting principles and practices that are described throughout this book are aimed at meeting some of these very basic, but very important, needs of donors to not-for-profi t organizations

Somewhat conceptually in between a simple donation and selling a can of paint in the above example, are fees for service activities that not-for-profit organizations sometimes perform for governmental entities, often in the social services area These services may include providing care for the developmentally disabled, educational services, or perhaps temporary housing While the not-for-profit organization may be receiving a payment based on the number of clients served (a fee for service activity) it is almost always the case that the governmental grant or con­tract provider will have specifi c requirements that must be adhered to with respect to the use of funds, how those funds are “earned” and to the potential disallowances of costs upon audit by the government grantor or contractor

Not-for-profit organizations also usually have a responsibility to account for specifi c funds that they have received This responsibility includes accounting for certain specific funds that have been given for use in a particular project, for a particular constituency, or for a speci­fied period of time In some cases, donors provide not-for-profit organizations with resources in the form of an endowment, in which the not-for-profi t organization must maintain the principal

or corpus of the gift in perpetuity and only use the investment earnings in support of its pro­grams Emphasis must also be placed on accountability and stewardship of these specifi c types

of resources in addition to the general fiduciary aspects discussed above

Many times, not-for-profit organizations receive from donors gifts that are restricted for a specific purpose This would sometimes require segregation of these funds in separate accounts and special financial reporting procedures

In commercial or business enterprises, there is no such thing as a “pledge” or a contribution for something other than obtaining an ownership interest If the business is legally owed money, that amount is recorded as an account receivable A pledge to a not-for-profit organization may

or may not be legally enforceable, or even if technically enforceable, the organization may (for public relations reasons) have a policy of not taking legal action to attempt to enforce unpaid pledges because they know from experience that they will not collect them This represents another accounting and financial reporting challenge for not-for-profi t organizations

Resource Use Consideration

The fundamental purposes for the existence of not-for-profit organizations have a signifi cant impact on how these organizations use their available resources and compete for new resources

in the marketplace Not-for-profit organizations often struggle to find resources to support their administrative functions because there is always a preference to spend their resources on pro­gram activities For example, in a competitive labor market, not-for-profit organizations may fi nd

it difficult to allocate resources to attract and retain the necessary talent needed to effectively manage their operations There are no stock option plans or performance share programs that are available to commercial enterprises to compensate a not-for-profit organization’s staff In addition, application of new technology is costly to implement and yet, in many cases, essential for existence These factors may create a resource gap between not-for-profit organizations and commercial enterprises, particularly with smaller not-for-profi t organizations

Generally Accepted Accounting Principles

The purpose of this book is to provide the reader with information about how generally accepted accounting principles apply to not-for-profi t organizations In addition, other informa­tion related to fi nancial activities of not-for-profi t organizations is included for the reader’s use, including discussions of budgeting, fund accounting, and federal tax compliance

In June 2009 the FASB made the FASB Accounting Standards Codification (the Codifi cation)

the source of authoritative United States generally accepted accounting principles recognized

by the FASB to be applied to nongovernmental entities, including not-for-profi t organizations All existing accounting and financial reporting standards (other than those promulgated by the United States Securities and Exchange Commission for public entities) were superseded Any nongrandfathered (discussed below) non-SEC accounting literature not included in the FASB

ASC is not considered authoritative The Codifi cation does contain in its SEC Sections authori­

tative content of the SEC related to the basic financial statements Not-for-profi t organizations which are nonpublic will continue to have to follow this guidance for public companies Note that

the issuance of the Codifi cation has not changed any of the requirements of previously existing

GAAP It does rearrange and organize the standards to make them more available and to give the indicated standards the same level of authority in the GAAP hierarchy Since its issuance, the Codification has been updated by Accounting Standards Updates (ASUs) which are issued periodically each year

The Codification provides that if the guidance for a transaction or event is not specifi ed within a source of authoritative GAAP for an entity, that entity should fi rst consider accounting principles for similar transactions or events within a source of authoritative GAAP for that entity and then consider nonauthoritative guidance from other sources Examples of the sources of nonauthoritative accounting guidance are provided as follows:

• Practices that are widely recognized and prevalent either generally or in the industry;

• FASB Concepts Statements;

• AICPA Issues Papers;

• International Financial Reporting Standards of the International Accounting Standards Board;

• Pronouncements of professional associations or regulatory agencies;

• Technical Information Service Inquiries and Replies included in AICPA Technical Prac­tice Aids;

• Accounting textbooks, handbooks, and articles

Of course, the appropriateness of the other sources of accounting guidance depends on its relevance to particular circumstances, the specifi city of the guidance, the general recognition of the issuer or author as an authority, and the extent of its use in practice

In December 2013, the FASB issued ASU 2013-12, Definition of a Public Business Entity —

an Addition to the Master Glossary The FASB’s primary purpose in issuing ASU 2013-12 was

to determine which entities would be within the scope of its Private Company Decision-Making

Framework: A Guide for Evaluating Financial Accounting and Reporting for Private Compa­ nies (the Guide) The Guide provides a context in which the FASB began issuing certain ASUs

in 2014 meant to simplify certain accounting and financial reporting requirements for private companies In addition, the FASB has increasingly been distinguishing between public and non-public entities when establishing accounting and financial reporting standards, as well as when those standards become effective However, no single definition of a public business entity was contained in the Codification’s Master Glossary

ASU 2013-12 d specifi es that:

1 An entity that is required by the SEC to file or furnish financial statements with the SEC,

or does file or furnish financial statements with the SEC, is considered a public business entity

2 A consolidated subsidiary of a public company is not considered a public business entity for purposes of its standalone financial statements other than those included in an SEC filing by its parent or by other registrants or those that are issuers and are required to fi le

or furnish financial statements with the SEC

3 A business entity that has securities that are not subject to contractual restrictions on transfer and that is by law, contract, or regulation required to prepare US GAAP fi nancial statements (including footnotes) and make them publicly available on a periodic basis is considered a public business entity

ASU 2013-12 notes that generally, most not-for-profit organizations have received the same financial accounting and reporting alternatives within US GAAP that have been available to nonpublic business entities Distinctions about which not-for-profit organizations would receive financial accounting and reporting alternatives within US GAAP typically have been made on the basis of whether the not-for-profit organization has public debt securities, including conduit debt ASU 2013-12 specifically excludes all not-for-profit organizations from the defi nition

of public business entity so that a public versus nonpublic distinction will no longer be made between not-for-profit organizations in future standard setting Instead, the FASB will consider factors such as user needs and not-for-profit organizations, resources, on a standard-by-standard basis, when determining whether all, none, or only some not-for-profit organizations will be eligible to apply financial accounting and reporting alternatives within GAAP for private compa­nies All employee benefit plans are also excluded from the definition of public business entity in

a manner similar to not-for-profit organizations as described above

This can be summarized as follows: Not-for-profit organizations are not included in the new definition of public business entities, however, they cannot use the private company framework accounting standards unless the FASB specifically says they can in each ASU that is issued Also of note is that prior definitions of public entities in existing standards are still appli­cable to those standards Hence, not-for-profit organizations previously subject to a requirement because they were considered public entities (usually because they were conduit debt obligors) are still subject to those requirements The new definition is not retroactive

OBSERVATION: In August 2016 the FASB issued Accounting Standards Update 2016-14

entitled Not-for-Profi t Entities (Topic 958) Presentation of Financial Statements of Not-for-Profit

Entities ASU 2016-14 is the result of a complete re-examination of the financial reporting model

currently used by not-for-profi t organizations While certain aspects of the re-examination were deferred into the future and may or may not be addressed by the FASB at some point, ASU 2016-14 provides new accounting guidance for certain areas where the FASB was able to reach a conclusion within a reasonable period of time The main provisions are as follows:

1 The statement of financial position would report amounts for two classes of net assets

at the end of the period—net assets with donor restrictions and net assets without donor

restrictions, rather than for the currently required three classes The statement of activi­

ties would report the amount of the change in each of the two classes of net assets rather than that of the currently required three classes

2 The statement of cash flows would continue to be permitted to be prepared on either the direct or indirect methods To encourage use of the direct method, the reconciliation of the indirect method would no longer be required when the direct method is used

3 Provide enhanced disclosures about the following:

a Governing board designations, appropriations, and similar transfers that result in the addition or removal of self-imposed limits on the use of resources without donor-imposed restrictions

b Composition of net assets with donor restrictions at the end of the period and how the restrictions affect the use of resources

c Qualitavie information about how the organization manages its liquidity In addition, quantitative information about fi nancial assets available to meet cash needs for gen­eral expenditures within one year of the balance sheet date ASU 2016-14 notes that the availability of a financial asset may be affected by (1) its nature, (2) external limits imposed by donors, grantors, laws, and contracts with others and (3) internal limits imposed by governing board decisions

d Expenses, including amounts for operating expenses by both their nature and func­tion That information could be provided on the face of the statement of activities, as

a separate statement, or in notes to fi nancial statements

e Method(s) used to allocate costs among program and support functions

f Underwater endowment funds, which are donor-restricted endowment funds for which the fair value of the fund is less than either the original gift amount or the amount required to be maintained by the donor or law In addition to disclosing the currently required aggregate amount by which funds are underwater, a not-for-profi t organization would be required to disclose the aggregate of the original gift amounts (or level required by donor or law) for such funds and any governing board policies or decisions to spend or not spend from such funds In addition, a not-for-profi t organi­zation would classify the amount by which the endowment is underwater in net assets with donor restrictions rather than in the current unrestricted net asset category

4 In the absence of explicit donor stipulations, use the placed-in-service approach for reporting expirations of restrictions on gifts of cash or other assets to be used to acquire

or construct a long-lived asset, thus eliminating the option to release the donor-imposed restriction over the estimated useful life of the acquired asset

5 Report investment income net of external and direct internal investment expenses, and no longer require disclosure of those netted expenses

ASU 2016-14 is effective for annual financial statements issued for fiscal years beginning after December 15, 2017, with early application permitted

2 CASH VERSUS ACCRUAL-BASIS

Perspective and Issues

Concepts, Rules, and Examples

Advantages of Cash Basis

Advantages of Accrual Basis

Combination Cash Accounting and

Accrual Statements

PERSPECTIVE AND ISSUES

11 When Accrual-Basis Reporting Should

Conclusion 19

16

Although most of the medium-sized and larger not-for-profit organizations keep their records

on an accrual basis of accounting, many smaller organizations still keep their records on the cash

basis of accounting The purpose of this chapter is to illustrate both bases of accounting and to

discuss the advantages and disadvantages of each For financial reporting in accordance with

generally accepted accounting principles, the accrual basis of accounting must be used However,

the cash basis of accounting is a recognized “special purpose framework” of fi nancial reporting

and an independent auditor may opine on cash-basis statements as long as the statements (and the

auditor’s opinion letter) clearly indicate that the cash-basis financial statements are not presented

in accordance with generally accepted accounting principles The cash-basis fi nancial statements

should also provide a description of the cash basis of accounting, including a summary of signifi ­

cant accounting policies, and how those policies differ from GAAP, as well as include disclosures

similar to those required by GAAP and any additional disclosures that may be necessary to achieve

a fair presentation Recently revised auditing standards refer to “other comprehensive bases of

accounting,” such as the cash basis, as special purpose financial reporting frameworks

CONCEPTS, RULES, AND EXAMPLES

Perhaps the easiest way to fully appreciate the differences between cash and accrual state­

ments is to look at the financial statements of a not-for-profit organization prepared both ways

The Johanna M Stanneck Foundation is a “private” foundation with assets of about $200,000

The income from these assets plus any current contributions to the foundation are used for medical

scholarships to needy students Exhibit 1 shows the two basic financial statements that, in one form

or another, are used by nearly every profit and not-for-profit organization; namely, a balance sheet as

of the end of a given period and a statement of income and expenses for the period Exhibit 1 shows

these statements on both the cash basis and the accrual basis, side-by-side for ease of comparison In

actual practice, an organization would report on one or the other basis, and not both bases, as here

© 2017 John Wiley and Sons Ltd Published 2017 by John Wiley and Sons Ltd.

Exhibit 1: Cash-basis and accrual-basis statements side-by-side to highlight the

differences in these two bases of accounting

The Johanna M Stanneck Foundation Statement of Financial Position*

-­

$200,135

$ 13,616 186,519 3,550 2,000

$205,685

Total liabilities and net assets

* On a cash basis, the title should be “Statement of Assets and Liabilities Resulting from Cash Transactions.”

Gain on sale of investments

12,759 12,759 Total

27,212 29,909 Administrative expenses:

Investment advisory service fees

(17,600) (21,800) Excess of income over expenses and scholarship grants

$ 3,258 $ 506

* On a cash basis, the title should be “Statement of Receipts, Expenditures, and Scholarships Paid” to emphasize the

“cash” aspect of the statement There would also have to be a note to the fi nancial statement disclosing the amount

of scholarships granted but not paid at the end of the year

As can be seen most easily from the balance sheet, a number of transactions not involving cash are reflected only on the accrual-basis statements These transactions are as follows:

1 Uncollected dividends and accrued interest income at December 31, 20X1, of $3,550 are recorded as an asset on the statement of financial position Since there were also uncollected dividends and accrued interest income at December 31, 20X0, the effect

on the accrual-basis income as compared to the cash-basis income is only the increase (or decrease) in the accrual at the end of the year In this example, since the cash-basis income from this source is shown as $8,953 and the accrual basis as $9,650, the increase during the year must have been the difference, or $697, and the amounts not accrued at December 31, 20X0, must have been $2,853

2 An uncollected contribution receivable at December 31, 20X1, of $2,000 is recorded as

an asset on the statement of financial position; and because there were no uncollected contributions at the end of the previous year, this whole amount shows up as increased income on an accrual basis

3 Unpaid expenses of $1,354 at the end of the year are recorded as a liability on the basis statement of financial position, but on the accrual-basis expense statements are par­tially offset by similar items unpaid at the end of the previous year

accrual-4 The federal excise tax not yet paid on 20X1 net investment income is recorded as a liability and as an expense on the accrual basis The $350 tax shown on the cash-basis expenditure statement is the tax actually paid in 20X1 on 20X0 net investment income

5 Unpaid scholarships granted during the year are recorded as an obligation Most of these scholarships will be paid within the following year but one scholarship has been granted that extends into 20X2 As in the case of the other items just discussed, it is necessary to know the amount of this obligation at the prior year-end and to take the difference into account in order to relate accrual-basis scholarship expenses to cash-basis expenditures

6 Investments reflected on the statement of financial position on both the cash basis and accrual basis are $186,519, assuming that the investments are extremely short-term so that there is no difference between cost and fair value In most cases, cash-basis state­ments would reflect investments at cost, while accrual-basis statements, to conform with current generally accepted accounting principles, would present most of the investments

at fair value This would create still another difference between the cash and accrual bases of accounting

As a result of these noncash transactions, there are significant differences in the amounts between the cash and accrual basis On the cash basis, expenditures of $17,600 for scholarships are shown, compared to $21,800 on the accrual basis; excess of income of $3,258 compared to

$506; and net assets of $200,135 compared to $189,787 Which set of figures is more appropri­ate? In theory, the accrual-basis figures are What then are the advantages of the cash basis, and why might someone use the cash basis?

Advantages of Cash Basis

The principal advantage of cash basis accounting is its simplicity, and the ease with which nonaccountants can understand and keep records on this basis The only time a transaction is recorded under this basis of accounting is when cash has been received or expended A simple checkbook may be all that is needed to keep the financial records of the organization When financial reports are required, the treasurer just summarizes the transactions from the checkbook

stubs This sounds almost too easy, but a checkbook can be an adequate substitute for formal bookkeeping records, provided a complete description is recorded on the checkbook stubs The chances are that someone with no bookkeeping training could keep the records of the Johanna

M Stanneck Foundation on a cash basis, using only a checkbook, files of paid bills, files on each scholarship, etc This would probably not be true with an accrual-basis set of books In lieu of a

“checkbook,” a simple accounting software package might also be used

Some larger organizations, including those with bookkeeping staff, also use the cash basis

of accounting primarily because of its simpler nature Often the difference between fi nancial results on a cash and on an accrual basis is not material, and the accrual basis provides a degree

of sophistication not needed For example, in Exhibit 1, what real significance is there between the two sets of fi gures? Will the users of the fi nancial statements do anything differently if they have accrual-basis figures? If not, the extra costs to obtain accrual-basis statements may not be worthwhile

Another reason organizations often keep their records on a cash basis is that they feel uneasy about considering a pledge receivable (often called a contribution receivable) as income until the cash is in the bank These organizations frequently pay their bills promptly, and at the end of the period have very little in the way of unpaid obligations With respect to unrecorded income, they also point out that because they consistently follow this method of accounting from year to year, the net effect on income in any one year is not material Last year’s unrecorded income is col­lected this year and tends to offset this year’s unrecorded income The advocates of a cash basis say, therefore, that they are being conservative by using this approach Recent fi nancial statement restatements by some very well-known public companies have contributed to the view held by some that an organization’s cash flows may be a more meaningful measure of fi nancial perfor­mance than an accrual-based “earnings” amount

For organizations that choose to present their financial statements on the cash basis, a ques­tion often arises as to what, if any, notes and other disclosures should be made in the fi nan­cial statements Generally accepted accounting principles require many different disclosures in accrual-basis statements, but are mostly silent about the requirement to make such disclosures in cash-basis statements Some guidance, however, has been issued that will assist fi nancial state­ment preparers (and auditors) in determining the adequacy of disclosures for cash-basis fi nancial statements, as well as financial statements prepared on the modified cash basis (discussed later in this chapter) and the income tax basis During 1998, the Auditing Issues Task Force of the AICPA

issued an Auditing Interpretation (Evaluating the Adequacy of Disclosure in Financial State­

ments Prepared on the Cash, Modified Cash, or Income Tax Basis of Accounting) of Statement of

Auditing Standards 62, Special Reports The Interpretation concludes that the discussion of the

basis of accounting needs to only include the significant differences of the accounting basis from generally accepted accounting principles and that these differences do not have to be quantifi ed This information has now been incorporated into the AICPA’s Clarified Auditing Standards in

Section 800—Special Considerations—Audits of Financial Statements Prepared in Accordance

with Special Purpose Frameworks

FASB ASC 855, Subsequent Events, requires disclosure of the date through which an entity

has evaluated subsequent events and the basis for that date (i.e., whether that is the date that the financial statements were issued or were available to be issued) The AICPA’s Technical Questions and Answers, Section 1500.07, addresses whether this recent GAAP requirement would apply

to financial statements prepared on another comprehensive basis of accounting (which would include the cash basis or modified cash basis) The conclusion is that it would The date through which an entity has evaluated subsequent events and the basis for that date should be disclosed

(Generally, this will be the date of the auditor’s report.) If there are nonrecognized subsequent events that are of such a nature that they must be disclosed to keep the financial statements from being misleading, these events should be disclosed using the guidance of FASB ASC 855

In addition, if the financial statements prepared on these accounting bases contain elements, accounts, or items for which generally accepted accounting principles would require disclosure, the financial statements should either:

• Provide the relevant disclosure that would be provided under generally accepted account­ing principles; or

• Provide information that communicates the substance of that disclosure

Qualitative information may be substituted for some of the quantitative information required

in a presentation in accordance with generally accepted accounting principles In addition, dis­closure requirements under generally accepted accounting principles that are not relevant to the measurement of the element, account, or item need not be considered The disclosures described

in the following section would be consistent with this Auditing Interpretation, although clearly cash-basis financial statement preparers should consider all disclosures that would be made under generally accepted accounting principles and then apply the above guidance to determine if they are relevant to the cash-basis statements

The authors believe that, even in cash-basis statements, certain disclosures should be made

to fully inform readers of matters affecting the financial situation of the organization These include information about, at least, the following (to the extent applicable to the organization):

• Accounting policies and any changes in the policies used (FASB ASC 235-10-50);

• Related parties (FASB ASC 850-10, 958-810);

• Commitments, contingencies, and possible impairments of recorded assets (FASB ASC 450-20-50, 360-10);

• Extraordinary items, prior period adjustments, and similar unusual matters (FASB ASC 250-10);

• Major categories of fixed assets (if capitalized) (FASB ASC 360-10);

• Major categories, and fair market value, of investments (FASB ASC 958-320, 325, 205);

• Mergers with other organizations (FASB ASC 958-805);

• Employee benefits (FASB ASC 715-20-50);

• Credit risk and information about financial derivatives (FASB ASC 815-10);

• Restrictions on contributions and net assets (FASB ASC 958-605);

• The format requirements for not-for-profit organization financial statements (FASB ASC 958-205, 210, 225, 230, 270);

• Joint costs of multipurpose activities (FASB ASC 958-720);

• Risks and uncertainties, including concentrations (FASB ASC 275-10);

• Disclosures about fair values of financial instruments (FASB ASC 825-10-50)

Advantages of Accrual Basis

What are the advantages of the accrual basis? In many instances, the cash basis just does not present the financial picture of the organization fully enough The accrual basis of accounting becomes the more appropriate basis when the organization has substantial unpaid bills or uncol­lected income at the end of each period and these amounts vary from period to period If the cash basis were used, the organization would have great difficulty in knowing where it actually stood These unpaid bills or uncollected income would materially distort the fi nancial statements

In Exhibit 1, there probably is not a great deal of difference between the two bases But assume for the moment that toward the end of 20X0 the foundation had made a grant of $100,000

to a medical school, to be paid in 20X1 Not recording this large transaction would distort the financial statements of both years

Not-for-profit organizations are becoming more conscious of the need to prepare and use budgets as control techniques It is very difficult for an organization to effectively use a budget without being on an accrual basis A cash-basis organization has difficulty because payment may lag for a long time after incurring the obligation For this reason, organizations that must care­fully budget their activities will find accrual basis accounting essential (Chapter 17 describes not-for-profit organization budgetary considerations.)

Combination Cash Accounting and Accrual Statements

One practical way to avoid the complexities of accrual basis accounting, and still have mean­ingful financial statements on an annual or semiannual basis, is to keep the books on a cash basis but make the necessary adjustments on worksheets to record the accruals for statement purposes These “adjustments” could be put together on worksheets without the need to formally record the adjustments in the bookkeeping records

It is even possible that monthly or quarterly financial statements could be prepared on the cash basis, with the accrual-basis adjustments being made only at the end of the year In this way,

it is possible to have the simplicity of cash basis accounting throughout the year, while at the end

of the year converting the records through worksheets to accrual basis accounting

Exhibit 2 gives an example of the type of worksheet that can be used It shows how the Johnstown Orphanage converted a cash-basis statement to an accrual-basis statement at the end

of the year Cash-basis figures are shown in column 1, adjustments in column 2, and the resulting accrual-basis amounts in column 3 The financial statement given to the board would show only column 3 Adjustments were made to the cash statement in column 2 as follows:

• Investment income—$20,000 of dividends and interest that were received during the cur­

rent year applicable to last year were deducted At the same time at the end of the year, there were dividends and interest receivable of $25,000 that were added Therefore, on an accrual basis, a net adjustment of $5,000 was added

• Fees from the city—This year the city changed its method of paying fees for children

sent to the orphanage by the courts In prior years the city paid $15 a day for each child assigned at the beginning of the month This year, because of a tight budget, the city got behind and now pays in the following month At the end of the year the city owed

$25,000, which was added to income

• Expenses—All the unpaid bills at the end of the year were added up and compared to the

amount of unpaid bills as of last year (which were subsequently paid in the current year) Here is a summary of these expenses

Less paid in current Add unpaid at year applicable Net add end of this year to last year (deduct)

As can be seen, it is not difficult to adjust a cash-basis statement to the accrual basis in a small organization The bookkeeper just has to go about it in a systematic manner, being very careful not to forget to remove similar items received, or paid, in the current year that are appli­cable to the prior year

Exhibit 2: An example of a worksheet that converts a cash-basis statement to an accrual-basis statement

Adjustments Accrual Cash basis Add (deduct) basis (col 1) (col 2) (col 3)

Excess of expenses over income $ 45,000 $ 29,000 $ 14,000

Actually, in this illustration there is relatively little difference between the cash and accrual basis except for the $25,000 owed by the city due to its change in the timing of payments Possi­bly the only adjustment that need be made in this instance is the recording of this $25,000 How­ever, until this worksheet has been prepared, there is no way to be sure that the other adjustments are not significant It is recommended that a worksheet similar to this one always be prepared to insure that all significant adjustments are made

Many times the organization’s independent auditors assist in converting the cash-basis financial information maintained during the year into accrual-basis statements that can be presented in accordance with generally accepted accounting principles Because of auditors’ independence requirements, management must be in

a position to oversee this conversion and take responsibility for the adjustments that are made and for the resulting fi nancial statements

Modified Cash Basis

Some not-for-profit organizations use a “modified cash basis” system of accounting On this basis of accounting, certain transactions will be recorded on an accrual basis and other transactions on a cash basis Usually, on a modified cash basis all unpaid bills will be recorded

on an accrual basis but uncollected income on a cash basis However, there are many different variations

Sometimes only certain types of unpaid bills are recorded Payroll taxes that have been withheld from employee salaries but which have not yet been paid to the government are a good example of the type of transaction, not involving cash, which might be recorded These taxes are just as much an obligation as the salaries

On a modified cash basis, it is not necessary for the organization to have a complex set of books to record all obligations and receivables In small and medium-sized not-for-profi t organi­zations, it is sufficient to keep the records on the cash basis and then at the end of the month tally

up the unpaid bills and the uncollected receivables and either record these formally in the books through journal entries or record them through a worksheet in the manner described above Under the cash basis, one of the practical ways some smaller organizations use to record all accrued expenses is to hold the disbursement record “open” for the first four or five days of each month This allows the bookkeeper to pay last month’s bills as they arrive on about the first of the month and record them in the prior month’s records While the organization actually pays such amounts

in the first few days of the new period, it considers the payment as having been made on the last day of the prior period This means that the organization does not show accounts payable but instead shows a reduced cash balance This is frequently a useful practice for reporting internally

to the board because it gives reasonable assurance that all expenditures incurred are recorded in the proper period In financial statements prepared for external use, such payments subsequent

to the end of the period should be shown as accounts payable instead of a decrease in cash

When Accrual-Basis Reporting Should Be Used

There are many advantages of cash basis accounting and reporting, but the accrual basis is ordinarily necessary for fair presentation of the financial statements Unless the organization does not have any significant amounts of unpaid bills or uncollected income at the beginning or end

of the period, accrual-basis reporting is required to present an accurate picture of the results of operations and of the financial position of the organization

Accrual-basis reporting is also required if an organization is trying to measure the cost of

a product or service It is impossible to know what a particular activity cost during the year if unpaid bills have not been included as an expense in the statement The same is true where ser­vices are provided for a fee but some fees have not been billed and collected during the period

If a board or its membership is trying to draw conclusions from the statements as to the cost or profitability of a particular service, accrual-basis statements are essential The same is true when

an organization is on a tight budget and budget comparisons are made with actual income and expenses to see how effectively management has kept to the budget Without including unpaid bills or uncollected income, such a comparison to budget can be very misleading and useless Generally accepted accounting principles (GAAP) for both commercial and not-for-profi t organi­zations include the use of accrual basis accounting Organizations that have their books audited

by certified public accountants, and who wish the CPA to report that the financial statements are prepared in accordance with generally accepted accounting principles, have to either keep their records on the accrual basis, or make the appropriate adjustments at the end of the year to convert

to this basis

LEGAL REQUIREMENTS

For some organizations soliciting funds from the public, there are legal requirements with respect to using the accrual basis of accounting In New York State, for example, not-for-profi t

organizations that are required to report to the state must use the accrual basis However, even

in New York the requirement is not that the records be kept on an accrual basis, but only that the organization files reports prepared on an accrual basis This means the organization could still keep cash-basis records throughout the year, provided it adjusts them to accrual basis for report purposes If an organization is required to file reports with one or more state agencies, it should examine the instructions accompanying the report very carefully to see what the reporting requirements are

CONCLUSION

There are two bases for keeping records—the cash basis and the accrual basis Many small not-for-profit organizations use the cash basis of accounting, and this is probably an acceptable and appropriate basis for such organizations The chief reason for using the cash basis is its sim­plicity Where there are no significant differences between the cash and accrual basis, the cash basis should be used Where there are material differences, however, the records should either be kept on an accrual basis, or cash-basis statements should be modified to reflect the major unre­corded amounts

© 2017 John Wiley and Sons Ltd Published 2017 by John Wiley and Sons Ltd.

3 STATEMENT OF FINANCIAL POSITION

PERSPECTIVE AND ISSUES

The statement of financial position is one of the basic financial statements of a not-for­profit organization It is the organization’s balance sheet and reports the organization’s assets, liabilities, and net assets The statement must be presented in order to present an organization’s financial position as part of a complete set of financial statements prepared in accordance with generally accepted accounting principles

The statement of financial position should present information about an organization’s liquidity by either sequencing assets and liabilities or classifying assets and liabilities as current and noncurrent The statement should view the organization as a whole and report total assets, total liabilities, and total net assets It should also report totals for unrestricted net assets, as well

as information about the nature and amounts of temporarily restricted and permanently restricted net assets (unless disclosed in the notes to the fi nancial statements)

FASB ASC 958-210 provides the basic GAAP requirements for preparing the statement of

fi nancial position

In August 2016 the FASB issued Accounting Standards Update 2016-14 entitled

Not-for-Profi t Entities (Topic 958) Presentation of Financial Statements of Not-for-Not-for-Profit Entities Upon

implementation of ASU 2016-14, the statement of financial position would report amounts for

two classes of net assets at the end of the period—net assets with donor restrictions and net assets

without donor restrictions, rather than for the currently required three classes Additional details

on reporting net assets under ASU 2016-14 are provided in Chapter 8 ASU 2016-14 also has requirements regarding providing information about liquidity These requirements are discussed later in this chapter ASU 2016-14 is effective for annual financial statements issued for fi scal years beginning after December 15, 2017, with early application permitted

CONCEPTS, RULES, AND EXAMPLES

The statement of financial position, along with required note disclosures and other infor­mation in the financial statements, has a two-fold purpose, which is described in FASB ASC 958-210-45

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© 2017 John Wiley and Sons Ltd Published 2017 by John Wiley and Sons Ltd.

First, the statement is meant to help readers (such as donors, creditors, members, and oth­ers) to assess the organization’s ability to continue to provide services This objective may be

a primary concern for potential donors who want to make sure that they are contributing to an organization that will be in existence for a reasonable period of time For example, a large donor may be reluctant to contribute $10 million to build a new wing of a not-for-profit museum if the museum’s financial position is so precarious that it may not be in existence for more than another year or two Conversely, a poor financial position in some other types of not-for-profi t organizations may become part of the “case” statement made to potential donors For exam­ple, the not-for-profit homeless shelter that battles month to month to pay its bills may use its precarious financial position as part of its impassioned plea to donors to help it not have to close its doors and cease providing services Either way, the statement of financial position is the statement that provides primary information about an organization’s ability to continue to provide services

Second, the statement is meant to provide information about liquidity, fi nancial fl ex­ibility, ability to meet obligations, and whether the organization has a need for external financing This information may be a primary concern for creditors of the not-for-profi t organization, including those providing financing, such as banks, and those providing “trade credit” such as contractors and vendors from which the not-for-profi t organization procures goods and services In short, these financial statement readers are interested in the not-for­profit organization’s ability to pay its bills Donors, such as the $10 million potential con­tributor in the preceding paragraph, will also have an interest in the picture of a not-for-profi t organization’s basic ability to meet its financial obligations that is portrayed by the statement

of fi nancial position

The statement of financial position provides information about an organization’s assets, lia­bilities, and net assets at a specific moment in time The focus of this statement is on the organi­zation as a whole The statement reports total assets, liabilities, net assets, and separate totals for the three classifi cations of net assets—that is, totals for unrestricted, temporarily restricted, and permanently restricted net assets The statement should also present information about the nature and amounts of temporarily restricted and permanently restricted net assets unless that informa­tion is fully disclosed in the notes to fi nancial statements

The basis on which assets and liabilities are carried on the statement of fi nancial position varies depending on the particular assets or liabilities Generally, specifi c accounting rules gov­erning the various types of assets and liabilities will determine how those items are reported and the bases for presentation are covered throughout the chapters in this book For example, most investments held by not-for-profit organizations are reported on the statement of fi nancial position at fair value Other assets, such as property, plant, and equipment, are reported on the statement of financial position at their historical cost, reduced by accumulated depreciation or amortization, where applicable

GAAP provides reporting entities, including not-for-profit organizations, with the option to report many

fi nancial assets and liabilities at their fair value This option is described in Chapter 29

The statement of fi nancial position should refl ect assets and liabilities in reasonably homo­geneous groups However, if cash or other assets have donor-imposed restrictions limiting their use to long-term purposes, they should not be grouped with similar assets available for current use (FASB ASC 958-210-45-6)