Wiley not for profit GAAP 2018 interpretation and application of generally accepted accounting principles

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.. Accou

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Preface vii

Chapter 9 Contributions, Pledges, Noncash Contributions, and

Chapter 18 Principal Federal and State Tax Reporting and Regulatory Requirements 255

Part 5 General Accounting Topics Applied to Not-for-Profit Organizations 317

Chapter 24 Mergers and Acquisitions 371

Index 531

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 grow-ing 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-profit 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 profit 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

not-for-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-profit zations, it’s important to understand that accounting standards setting has been influenced by

organi-a greorgani-at deorgani-al of recent chorgani-ange The Sorgani-arborgani-anes-Oxley Act of 2002 creorgani-ated the Public Comporgani-any 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 tur-moil that was experienced in the financial markets This changed a bit as the FASB established a Not-for-Profit Advisory Committee, which has reexamined the reporting model used by not-for-profit 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 financial 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 financial ing and reporting;

account-• Accounting areas that are unique to not-for-profit organizations;

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

of not-for-profit organizations

This book would not have been possible without the hard work and efforts of many 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, CPAMarie DiTommasoFebruary 2018

Richard F Larkin is technical director of not-for-profi t accounting and auditing for BDO

USA, LLP, in McLean, Virginia Previously he was the technical director of the Not-for-Profi t Industry Services Group in the national offi ce of PricewaterhouseCoopers He is a certifi ed pub-lic accountant with over forty years of experience serving not-for-profi t organizations as inde-pendent accountant, board member, treasurer, and consultant He teaches, speaks, and writes extensively on not-for-profi t industry matters and is active in many professional and industry organizations He has been a member of the Financial Accounting Standards Board Not-for-Profi t Advisory Task Force and the AICPA Not-for-Profi t 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 Dis-closure Practices for Not-for-Profi t 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-Profi t 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-profi t 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 offi cer 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

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 financial 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-profit organizations

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

ASC-from previous:

958-10 Overall AAG (AICPA Audit Guide) Ch 1 Para 15.04

20 Financially-interrelated entities FAS 136

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

205 Presentation of financial statements FAS 117, FSP 117-1, FAS 124

210 Balance sheet FAS 117

225 Income statement FAS 117, others

230 Statement of cash flows 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

405 Liabilities AAG Ch 10, 11, 13, EITF D-089

450 Contingencies FAS 116, AAG Ch 10, 3

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

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

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

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

815 Derivatives and hedging DIG B-35

840 Leases SOP 94-3, EITF 90-15, 96-21, 97-01

FAS 136 Pass-through gifts 958-605, 20

FIN 48 Uncertain tax positions 740-10

DIG B-35 Derivative in a split-interest 958-30, 815

Accounting Standards Updates Issued During 2016 - February 2018

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)

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

10 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

9

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-Profit Entities

3,5,8,9,14 2016-15 Statement of Cash Flows (Topic 230) Classification of Certain Cash Receipts

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

5

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)

5 2016-19 Technical Corrections and Improvements

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

Contracts with Customers

9

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

11

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

Goodwill Impairment

22 2017-06 Plan Accounting: Defined Benefit Pension Plans (Topic 960), Defined

Contribution Plans (Topic 962), Health and Welfare Benefit Plans (Topic

965): Employee Benefit Plan Master Trust Reporting (a consensus of the

Emerging Issues Task For

2017-07 Compensation—Retirement Benefits (Topic 715) Improving the

Presentation of Periodic Pension Cost and Net Periodic Postretirement

Benefit Cost

25

2017-08 Receivables—Nonrefundable Fees and Other Costs (Subtopic 310-20):

Premium Amortization of Purchased Callable Debt Securities

10 2017-09 Compensation—Stock Compensation (Topic 718): Scope of Modification

Accounting

2017-10 Service Concession Arrangements (Topic 853): Determining the Customer

of the Operation Services (a consensus of the FASB Emerging Issues Task Force)

2017-11 Earnings per Share (Topic 260); Distinguishing Liabilities from Equity

(Topic 840); Derivatives and Hedging (Topic 815): (Part I) Accounting

for Certain Financial Instruments with Down Round Features, (Part II)

Replacement of the Indefinite Deferral for Mandatorily Redeemable

Financial Instruments of Certain Nonpublic Entities and Certain

Mandatorily Redeemable Noncontrolling Interests with a Scope Exception

2017-12 Derivatives and Hedging (Topic 815): Targeted Improvements to

Accounting for Hedging Activities

29

2017-13 Revenue Recognition (Topic 605), Revenue from Contracts with

Customers (Topic 606), Leases (Topic 840), and Leases (Topic 842):

Amendments to SEC Paragraphs Pursuant to the Staff Announcement

at the July 20, 2017 EITF Meeting and Rescission of Prior SEC Staff

Announcements and Observer Comments (SEC Update)

2017-14 Income Statement—Reporting Comprehensive Income (Topic 220),

Revenue Recognition (Topic 605), and Revenue Contracts with Customers (Topic 606) (SEC Update)

2017-15 Codification Improvements to Topic 995, U.S Steamship Entities:

Elimination of Topic 995

2018-01 Leases (Topic 842): Land Easement Practical Expedient for Transition to

Topic 842

28

2018-02 Income Statement—Reporting Comprehensive Income (Topic 220):

Reclassification of Certain Tax Effects from Accumulated Other

Comprehensive Income

Overview Of NOt-fOr-PrOfit OrgaNizatiONs

OrgaNizatiONs

Key Differences between Not-for-Profit

Generally Accepted Accounting Principles 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) defines not-for-profit organizations by distinguishing them from profit organizations It defines not-for-profit 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 mensurate or proportionate monetary return

com-2 They operate for purposes other than to make a profit

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 mercial enterprises, their accounting and financial reporting are quite unique because the focus

com-of financial reporting for not-for-prcom-ofit organizations is not on the measurement com-of net income Reflecting this, and other differences, the FASB has issued some pronouncements specifically 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

Copyright © 2018 by John Wiley & Sons, Inc

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-profit 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-for-profit 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 finances

Every board member has a fiduciary 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 finance,

as well as all other areas of operation The governing board’s involvement with setting ate 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 fiduciary responsibilities

appropri-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 financial records;

2 Preparing accurate and meaningful financial statements;

3 Budgeting and anticipating financial problems;

4 Safeguarding and managing the organization’s financial 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 tion to meeting the “letter of the law” as found in various accounting standards, not-for-profit organizations must ensure that the application of generally accepted accounting principles to

addi-their financial statements results in statements that truly do present fairly the activities and cial position of the organization Further, some states have enacted legislation that defines certain responsibilities for boards of directors, including audit committees, covering areas such

finan-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-profit organizations to comply with prescribed governance requirements These requirements can impact board and audit committee functions and composition Some states have established specific requirements for establishing audit committees, including specific requirements on their membership and duties

Audit committees generally concern themselves with ensuring the integrity of the financial reporting process of the not-for-profit organization by understanding and overseeing the organi-zation’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 review-ing 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 Profit 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-profit 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 profit” (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-profit organization should plan to provide for the future, the cipal 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 financial criteria as a condition for the loan (usually called debt covenants), which can make attention to reported results important

prin-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 sufficient cash resources to provide for their programs Thus the financial statements of not-for-profit organi-zations often emphasize the liquid financial resources of the organization Commercial orga-nizations 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 significant users of the financial statements of not-for-profit 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-profit 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 specific 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 specific 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-profit 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 specific 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-profit organizations

Resource Use Consideration

The fundamental purposes for the existence of not-for-profit organizations have a significant 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 find 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-profit 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-profit organizations In addition, other information related to financial activities of not-for-profit organizations is included for the reader’s use, including discussions of budgeting, fund accounting, and federal tax compliance

The FASB Accounting Standards Codification (the Codification) is the source of authoritative

United States generally accepted accounting principles recognized by the FASB to be applied

to nongovernmental entities, including not-for-profit organizations All previously 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 Codification does contain in its SEC Sections authoritative content of the SEC

related to the basic financial statements Not-for-profit organizations that are nonpublic will continue to have to follow this guidance for public companies Note that the issuance of the

Codification did not change 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 specified within a source of authoritative GAAP for an entity, that entity should first 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 tice Aids;

Prac-• Accounting textbooks, handbooks, and articles

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

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 specify which entities would be within the scope of its Private Company Decision-Making Framework: A Guide for Evaluating Financial Accounting and Reporting for Private Companies (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 nonpublic 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 specifies 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 file

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 financial 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 definition 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-Profit Entities (Topic 958) Presentation of Financial Statements of Not-for-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-profit 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 of ASU 2016-14 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 Qualitative information about how the organization manages its liquidity In tion, quantitative information about financial 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

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

func-a sepfunc-arfunc-ate stfunc-atement, or in notes to finfunc-ancifunc-al stfunc-atements

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-profit 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 poli-cies or decisions to spend or not spend from such funds In addition, a not-for-profit 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

aCCounting

Concepts, Rules, and Examples 11

Combination Cash Accounting and

When Accrual-Basis Reporting Should

Be Used 18

Conclusion 19

PERSPECTIVE AND ISSUES

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 financial 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 financial 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 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

state-or another, are used by nearly every profit and not-fstate-or-profit state-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

Copyright © 2018 by John Wiley & Sons, Inc

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*

Accrued expenses payable

Federal excise tax payable

$200,135

$200,135

$200,135

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

$205,685

$ 1,354 394 12,150 2,000 15,898 189,787

$205,685

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

The Johanna M Stanneck Foundation

For the Year Ended December 31, 20X1

Cash basis Accrual basis

Income:

Contributions

Dividends and interest income

Gain on sale of investments

Total

Administrative expenses:

Investment advisory service fees

Bookkeeping and accounting expenses

Federal excise tax

Other expenses

Total

Income available for scholarships

Less: Scholarship grants

Excess of income over expenses and scholarship grants

$ 5,500 8,953 12,759 27,212 2,000 2,350 350 1,654 6,354 20,858 (17,600)

$ 3,258

$ 7,500 9,650 12,759 29,909 2,200 2,500 394 2,509 7,603 22,306 (21,800)

$ 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 financial 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 par-tially 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 state-ments 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 ate? In theory, the accrual-basis figures are What then are the advantages of the cash basis, and why might someone use the cash basis?

appropri-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 financial 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 figures? Will the users of the financial 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 col-lected 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 financial 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 financial perfor-mance than an accrual-based “earnings” amount

For organizations that choose to present their financial statements on the cash basis, a tion often arises as to what, if any, notes and other disclosures should be made in the finan-cial 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 financial state-ment preparers (and auditors) in determining the adequacy of disclosures for cash-basis financial 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

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

State-basis of accounting needs to only include the significant differences of the accounting State-basis from generally accepted accounting principles and that these differences do not have to be quantified 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 ing principles; or

account-• 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, closure 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

dis-in the followdis-ing section would be consistent with this Auditdis-ing 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 uncol-lected 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 financial 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 care-fully 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 ingful 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

mean-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

Add unpaid at end of this year

Less paid in current year applicable

to last year

Net add (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 appli-cable to the prior year.

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

Johnstown Orphanage Worksheet Showing Conversion of Cash to Accrual Basis For the Year Ended December 31, 20X1

Cash basis (col 1)

Adjustments Add (deduct) (col 2)

Accrual basis (col 3)

Salaries and wages 430,000 (5,000) 425,000

Food and provisions 50,000 2,000 52,000

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 Possi-bly the only adjustment that need be made in this instance is the recording of this $25,000 How-ever, 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 financial 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-profit organi-zations, 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 ser-vices 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-profit organi-zations 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-profit

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 sim-plicity 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 unre-corded amounts

basic financial statements

Concepts, Rules, and Examples 23

Liquidity 24

PERSPECTIVE AND ISSUES

The statement of financial position is one of the basic financial statements of a profit 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

not-for-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 financial statements)

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

In August 2016 the FASB issued Accounting Standards Update 2016-14 entitled Profit Entities (Topic 958) Presentation of Financial Statements of Not-for-Profit Entities Upon

Not-for-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 fiscal 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.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

Copyright © 2018 by John Wiley & Sons, Inc

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-profit organi-zations 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, financial flexibility, 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-profit organization, including those providing financing, such as banks, and those providing “trade credit” such as contractors and vendors from which the not-for-profit organization procures goods and services In short, these financial statement readers are interested in the not-for-profit 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-profit organization’s basic ability to meet its finan-cial obligations that is portrayed by the statement of financial position.

The statement of financial position provides information about an organization’s assets, bilities, and net assets at a specific moment in time The focus of this statement is on the organi-zation as a whole The statement reports total assets, liabilities, net assets, and separate totals for the three classifications 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 informa-tion is fully disclosed in the notes to financial statements

lia-The basis on which assets and liabilities are carried on the statement of financial position ies depending on the particular assets or liabilities Generally, specific 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 financial position at fair value Other assets, such as property, plant, and equipment, are reported on the statement of financial posi-tion at their historical cost, reduced by accumulated depreciation or amortization, where applicable

var-GAAP provides reporting entities, including not-for-profit organizations, with the option to report many financial assets and liabilities at their fair value This option is described in Chapter 29.

The statement of financial position should reflect assets and liabilities in reasonably geneous 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)

homo-Liquidity

Liquidity should be presented in one of the following formats:

1 Sequencing assets according to their nearness of conversion to cash, and liabilities according to the nearness of their maturity and resulting use of cash on the statement of financial position;

2 Classifying assets and liabilities on the statement of financial position as current and noncurrent

The concept of classifying assets and liabilities as current or noncurrent is slightly different

for not-for-profit organizations than for commercial organizations FASB ASC 210-10 ing Research Bulletin 43, Chapter 3A) covers the classification of current assets and liabilities

(Account-Commercial organizations are used to applying these criteria in evaluating current assets as those that will be turned into cash to satisfy liabilities within one year, or the organization’s operating cycle, whichever is longer Current liabilities are those liabilities that are expected to be satisfied with current assets

While some not-for-profit organizations have an operating cycle (a college or university with

a finite academic calendar is a good example), others (such as a homeless shelter) really do not.Classification of current assets and liabilities for not-for-profit organizations should focus

on liquidity For the vast majority of not-for-profit organizations, even ones with clearly defined operating cycles, the one-year time period used in the above definition appears reasonable.One caution in classifying current assets is a specific requirement (FASB ASB 210-10-45-4) that current assets should exclude “cash and claims to cash which are restricted as to withdrawal

or use for other than current operations, are designated for expenditure in the acquisition or construction of noncurrent assets, or are segregated for the liquidation of long-term debts.” This exclusion is likely to impact a number of not-for-profit organizations because in many cases:

1 Donors restrict the use of cash and investments These assets are often not available for use in the current operations of the organization

2 Donors or the not-for-profit organization itself may designate funds that are to be used for acquisition and/or construction of land, buildings, or other long-term assets These funds, many times obtained in “capital campaigns,” are not available for use in the operations of the organization

3 Not-for-profit organizations that issue debt may be required to maintain cash and ments in reserve funds that are designed to provide additional credit protection to the debt holders These reserve funds are not available for use in the operations of the organization.The organization could disclose information about liquidity, including information about restrictions on the use of particular assets, in the notes to financial statements Exhibit 1 presents

invest-a sinvest-ample sequenced stinvest-atement of fininvest-anciinvest-al position, invest-and Exhibit 2 illustrinvest-ates invest-a sinvest-ample clinvest-assified statement of financial position

OBSERVATION: ASU 2016-14 has specific requirements as to providing both qualitative and quantitative information about a not-for-profit organization’s liquidity or maturity of assets and liabilities, including restrictions and self-imposed limits on the use of particular items

ASU 2016-14 provides that the following information should be displayed either on the face

of the statement of financial position or in the notes to financial statements, unless otherwise required on the face of the statement of financial position:

a Relevant information about the nature and amount of limitations on the use of cash and cash equivalents (such as cash held on deposit as a compensating balance)

b Contractual limitations on the use of particular assets These include, for example, restricted cash or other assets set aside under debt agreements, assets set aside under self-insurance funding arrangements, assets set aside under collateral arrangements, or assets set aside to satisfy reserve requirements that states may impose under charitable gift annuity agreements

c Quantitative information, and additional qualitative information in the notes as sary, about the availability of an NFP’s financial assets at the balance sheet date to meet

neces-cash needs for general expenditures within one year of the balance sheet date ity of a financial asset may be affected by:

Availabil-a Its nature

b External limits imposed by donors, laws, and contracts with others

c Internal limits imposed by the governing board of directors

Certain of the current methods for providing information about liquidity discussed earlier in this section remain relevant ASU 2016-14 provides that additional information about liquidity should be provided by any of the following:

1 Sequencing assets according to their nearness of conversion to cash and sequencing bilities according to the nearness of their maturity and resulting use of cash;

lia-2 Classifying assets and liabilities as current and noncurrent;

3 Disclosing in notes to financial statements any additional relevant information about the liquidity or maturity of assets and liabilities, including restrictions on the use of particu-lar assets ASU 2016-14 requires a not-for-profit organization to disclose the follow-ing, where applicable, in the notes to the financial statements (these disclosures may be included in the quantitative disclosures about liquidity):

a Unusual circumstances, such as special borrowing arrangements, requirements imposed by resource providers that cash be held in separate accountants, and known liquidity problems

b The fact that the not-for-profit organization has not maintained appropriate amounts

of cash and cash equivalents to comply with donor-imposed restrictions

c Information about significant limits resulting from contractual agreements with suppliers, creditors, and others, including the existence of loan covenants

4 ASU 2016-14 also discusses the following items that should be disclosed in the notes to the financial statements if not provided on the face of the statement of financial position:

a A description of the kind of asset whose use is limited

b Information about the nature and amount of limitations on the use of cash and cash equivalents

c Contractual limitations on the use of particular assets

d Information about the nature and amounts of different types of restrictions that affect how and when, if ever, the resources can be used

e Information about additional limitations placed on net assets, such as information about the amounts and purposes of board designations of net assets without donor restrictions.ASU 2016-14 provides illustrative note disclosures designed to meet the above requirements

To implement these requirements, a not-for-profit organization should begin by identifying its financial assets that are available within one year from the balance sheet date, keeping in mind that donor and other restricted financial assets are not available for general expenditure These amounts would be disclosed in the notes, with a discussion of how they would or wouldn’t be sufficient to meet general expenditures This discussion would include management’s plans to use short-term borrowings or lines of credit to cover any temporary shortfall in available financial assets

Offsetting Assets and Liabilities

A question addressed by GAAP is the accounting for situations where an entity has both a able from and a liability to the same third party Should these receivables and payables be reported on

receiv-a gross breceiv-asis (i.e., both the receiv-asset receiv-and the lireceiv-ability reported)? Or, should these receiv-amounts be netted receiv-agreceiv-ainst each other and only the net receivable or payable be reported on the statement of financial position?FASB ASC 210-20-05 provides that it is a general principle of accounting that the offsetting of assets and liabilities in the balance sheet is improper except if a “right of setoff” exists A “right of set-off” is defined as a debtor’s legal right, by contract or otherwise, to discharge all or a portion of the debt owed to another party by applying against the debt an amount that the other party owes to the debtor Such a right of setoff exists when all of the following conditions are met (FASB ASC 210-20-45-1):

1 Each of the parties owes the other determinable amounts

2 The reporting party has the right to set off the amount owed with the amount owed by the other party

3 The reporting party intends to set off

4 The right of setoff is enforceable by law

As part of the FASB’s process to converge its standards with International Financial ing Standards (IFRS) it addressed the issue of offsetting conditional amounts recognized for contracts under which the amounts to be received or paid or items to be exchanged in the future depend on future interest rates, future exchange rates, future commodity prices, or other fac-tors Essentially, US GAAP permits offsetting of these conditional amounts, which basically applies to reporting derivatives, while IFRS does not Essentially, the FASB concluded that it will continue to permit netting of these conditional amounts; however, it has issued new disclosure requirements to assist in the comparability of US GAAP and IFRS financial statements These

Report-new disclosure requirements are contained in ASU 2011-11 Balance Sheet (Topic 210) sures about Offsetting Assets and Liabilities.

Disclo-The disclosure requirements of ASU 2011-11 (which were amended by ASU 2013-01, as discussed below) do not apply to all instances where offsetting of assets and liabilities occurs The disclosure requirements are designed only to apply to financial instruments such as:

• Derivatives;

• Sale and repurchase agreements;

• Reverse sale and repurchase agreements;

• Securities borrowing arrangements;

• Securities lending arrangements

The disclosure requirements include:

1 The gross amounts of those recognized assets and those recognized liabilities

2 The amounts offset in accordance with the guidance in FASB ASC 210-20-45 and 10-45 to determine the net amounts presented in the statement of financial position

815-3 The net amounts presented in the statement of financial position

4 The amounts subject to an enforceable master netting arrangement or similar agreement not otherwise included in 2:

a The amounts related to recognized financial instruments and other derivative ments that either:

instru-1 Management makes an accounting policy election not to offset, or

2 Do not meet some or all of the guidance in either FASB ASC 210-20-45 or 815-10-45

b The amounts related to financial collateral (including cash collateral)

5 The net amount after deducting the amounts in 4 from the amounts in 3

This information is encouraged to be reported in tabular format In addition, a description of the rights of setoff associated with an enforceable master netting arrangement, or similar agree-ment, should be provided, including the nature of those rights.

The FASB issued ASU 2013-01 Balance Sheet (Topic 210) Clarifying the Scope of sures about Offsetting Assets and Liabilities in response to concerns that ASU 2011-11’s dis-

Disclo-closure requirements would apply to the standard commercial provisions of many contracts that equate to master netting arrangements This would result in a large number of instances that would be subject to the disclosure requirements

ASU 2013-01 clarifies that the scope of ASU 2011-11 applies to derivatives accounted for in

accordance with the FASB Codification Topic 815 Derivatives and Hedging, including bifurcated

embedded derivatives, repurchase agreements, reverse repurchase agreements, and securities rowing and lending activities that are either offset or subject to an enforceable master arrangement.Accordingly, entities with types of financial assets and financial liabilities subject to a master netting arrangement or similar agreement other than those described in the preceding paragraph are no longer subject to the disclosure requirements of ASU 2011-11

bor-Acceptable Formats

There are two general views or formats of the statement of financial position that are mon, and GAAP is flexible and allows either format to be used Some organizations prefer to use a “balanced” format in which assets are presented in the left-hand column with a total, and liabilities and net assets are presented in the right-hand column with a total The total of assets equals the total of liabilities and net assets, proving that the books are balanced Other organiza-tions prefer a more top-to-bottom presentation in which assets are presented first with a total, liabilities are presented second with a total, and net assets are presented last with a total This approach emphasizes that net assets represent the difference between a not-for-profit organiza-tion’s assets and liabilities, which is a useful concept to communicate In addition, from a purely practical viewpoint, this format is usually easier to present on a single page

com-Exhibit 1: Sequenced statement of financial position

The Museum of Accounting Statements of Financial Position September 30, 20X1 and 20X0

Assets restricted for permanent endowment $xxx $xxx