Not-for-Profit Entities

Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Chapter 19

Not-for-Profit Entities

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Learning Objective 19-1

Understand financial reporting rules and make basic journal entries for

private, not-for-profit entities.

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Types of Not-for-Profit Organizations

Colleges and Universities Health Care Organizations Voluntary Health and Welfare

Organizations Certain (or “all other”) Nonprofit

Organizations

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Excluded Entities

The following entities are not NPOs because they solely serve the economic interests of their owners, members, participants, or trust beneficiaries: Credit unions and mutual banks Employee benefit and pension plans Mutual insurance companies Farms and rural cooperatives Trusts

19-5

Characteristics of NPOs

No outside ownership interest A mission to provide services

To their users, patients, society as a whole, or members

But NOT at a profit A dependence on significant levels of

contributions A significant level of assets that are

restricted as to use because of donor stipulations

Tax-exempt status. IRS Form 990, 990A, or 990PF

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Dependence on Contributions and Federal Funding

Nonprofit religious, charitable, and educational groups receive roughly $40 billion annually in federal government grants.

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Tax-Exempt Status

Advantages to Tax-Exempt Status for U.S. Income Tax Reporting Purposes (in most states): No state income tax No local property taxes No sales taxes on purchases

19-8

Tax-Exempt Status

Private NPOs are exempt from U.S. income taxes if the NPO: Serves some common good. Does not make an accounting profit. Does not primarily benefit its own executives. Does not function for political purposes.

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Tax-Exempt Status

IRS Audits of Tax-Exempt Groups: Annually, the IRS audits approximately 11,000

of the 1.2 million tax-exempt groups. The IRS assesses taxes & penalties

of over $100 million per year. Such taxes are on business-related income

(which is taxable at the highest corporate rate).

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Differences between NPOs and Businesses

Revenues and support are often compared to expenses. However, remember that Expenses are incurred to provide services

(rather than to generate revenues as in commercial accounting).

The purpose of NPOs is not to maximize return on an ownership interest.

ROE = Not Applicable

19-11

The Reporting Model: Private NPOs

The reporting model Focuses on the flow of all economic resources Uses the accrual basis of accounting Recognizes depreciation expense in the

operating statement

The use of this reporting model reveals The improvement or deterioration in the NPO’s

financial condition for the period, and Is similar to the model used in the commercial

sector.

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Who Makes the Rules for Not-for-Profits Entities?

The accounting and financial reporting for

governmental nonprofit entities

GASB

FASBAccounting and

financial reporting for nongovernmental nonprofit entities

19-13

Financial Reporting for Private,Not-for-Profit Entities

Private, not-for-profit entities must report their net assets in accordance with FAC 6.

FAC 6 specifies three mutually exclusive classes of net assets: Unrestricted net assets Temporarily restricted net assets Permanently restricted net assets

19-14

Financial Reporting for Not-for-Profit Entities

ASC 958, “Accounting for Contributions Received and Contributions Made,” provides guidance specific to not-for-profit entities. It covers five important accounting issues:

(1) depreciation,

(2) accounting for contributions,

(3) accounting for investments,

(4) financial display

(5) accounting for transfers of assets to a not-for-profit organization that raises or holds contributions for others.

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Some not-for-profit entities use a fund structure to account for each type of net asset class.

Other not-for-profit entities maintain only an accounting record to show the amounts in each net asset class. The specific identification of any restricted

asset must be made when the asset comes into the entity, generally by donation or bequest.

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Mergers and acquisitions—Exposure drafts The proposed standards

Require the recognition of identifiable assets acquired and liabilities assumed at their fair values at the date of the acquisition

Require that intangible assets other than goodwill and goodwill be assigned to reporting units that are acquired

Approaches to evaluating goodwill impairment Qualitative Evaluation Method

Fair-Value-Based Evaluation

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Contributions: Scope of ASC 958

ASC 958 guidance on contributions applies to ALL 4 types of Private NPOs.

Health Care Organizations

Colleges and Universities

Voluntary Health and Welfare Organizations

Certain Nonprofit Organizations

ASC958

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Contributions: Defined

Contribution An unconditional (no strings attached) transfer

of

1. Cash or

2. Other Assets In a voluntary, nonreciprocal transfer. By a person or entity acting other than as an

owner of the NPO

Examples of Other Assets: Equipment, vehicles, land, and promises of cash.

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Contributions: “Promises, Promises”

“Unconditional transfers” include “unconditional promises” to give cash or other assets in the future.

Promises may be Oral or Written

Unconditional promises result in reporting “Contributions Receivable” in the balance sheet (subject to an allowance for uncollectibles).

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Contributions: Recognizing Unconditional Promises

Recognizing unconditional promises in the financial statements requires having sufficient evidence in the form of verifiable documentation that a promise was made

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Contributions: “Conditional” Promises to Give

Conditional promises The conceptual opposite of unconditional

promises to give Not contributions (as defined by ASC 958) Depend on the occurrence of a specified future

and uncertain event that Must occur to bind the promissor, and

Thus transform the promise from conditional to unconditional status.

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Contributions: “Conditional” Promises That May Be Deemed “Unconditional”

A conditional promise may be deemed unconditional if: “The possibility that the future event will not

be met [occur] is remote.”

Event not likely to occur = Conditional Event likely to occur = Unconditional

19-23

Contributions: “Conditional” Use of Assets Received

If assets have been received and the retention and use of such assets is conditional upon a future event that is not likely to occur, The offsetting credit is to a Refundable

Advance account (a liability) Until the conditional event occurs.

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Contributions: Manner of Reporting By Category

Contributions are reported in the Statement of Activities (the operating statement) by category Unrestricted Temporarily restricted Permanently restricted

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Contributions: Manner of Reporting By Category

Donor-restricted contributions whose conditions are fulfilled in the same period in which the contribution is recognized May be reported in the unrestricted category of

the operating statement (O/S) if the entity: Consistently follows this policy, and

Discloses this policy.

Note: This option negates the need to show transfers between categories in the Operating Statement.

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Contributions: Endowments

Endowments A contribution that cannot be spent. The unspendable amount is called the

principal—it is invested in perpetuity.

Income on Endowments Donor stipulations dictate the reporting

classification (unrestricted, temporarily restricted or permanently restricted).

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Contributions: Temporary Restrictions

Contributed Assetsthat are restricted as to either

or

Temporarily Restricted

Assets

are classified as

Purpose Time Period

19-28

Contributions: Expirations of Restrictions

Manner of Reporting Expirationsof Restrictions: Where: In the statement of activities. How: As a separate line item reclassification as

shown below.

Temporarily UnrestrictedRestricted

Expirations of restrictions $77,000$(77,000)

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Financial Statements: Scope of ASC 958

ASC 958 guidance on financial statements applies to ALL 4 types of Private NPOs.

Health Care Organizations



Certain Nonprofit Organizations

ASC 958

19-30

Financial Statements: ASC 958—The Basic Requirements

ASC 958 specifies: What financial statements are to be presented. What specific information, as a minimum, is to

be shown.

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Financial Statements: Which Financial Statements

ASC 958 requires for the NPO as a whole: A Statement of Financial Position A Statement of Activities A Statement of Cash Flows.

VH&WOs must also report In a separate statement Expenses by Natural Classification in a matrix

format.

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Financial Statements: The Three Classifications of Net Assets

The three mandated classifications of net assets are: Unrestricted. Temporarily restricted. Permanently restricted.

Note that these are the same three classifications used for reporting contributions.

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Contributions: Additional Issues

Contributions of monetary and nonmonetary assets are valued at the fair value of the assets received.

Determining the fair value may require Obtaining quoted market prices. Using independent appraisals. Using other appropriate methods.

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Use of Present Value Procedures: Can use for estimated future cash flows on

unconditional promises to contribute that are expected to be collected over a period of longer than one year.

If used, subsequent recognition of the interest element is reported as contribution income—not as interest income.

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Contributed Services Recognize as revenues only if:

Nonfinancial assets are created or enhanced.

Specialized skills are provided by individuals possessing these skills (e.g., carpenters, electricians, plumbers, lawyers, CPAs).

Required Disclosures for Contributed Services: A description of the nature and extent The amounts recognized as revenues The programs or activities in which the services were

used

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Contributed Services: Recognizable contributed services are usually

recorded as revenues at the fair value of the services contributed.

Allowed alternative valuation method for the creation or enhancement of nonfinancial assets: May value at the fair value of

the asset created or asset enhancement

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“Collection items” (the exception): Consist of contributed works of art, historical

treasures, and similar assets. Need not be recognized in the financial

statements if three conditions are satisfied [how used, how cared for, and use of proceeds upon sale].

Cannot be capitalized on a selective or arbitrary basis.


19-38

Practice Quiz Question #1

How do not-for-profit entities differ from for-profit businesses:

a. Not for profit entities are prohibited from charging more than cost for goods or services provided while for-profit businesses may include a mark up.

b. Both for-profit businesses and not-for-profit organizations are tax exempt.

c. Not-for-profit entities rely heavily on contributions and grants while for-profit businesses rely on profitable operations for survival.

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not-for-profit colleges and universities.

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Special conventions of revenue and expenditure recognition Tuition and fee remissions/waivers and

uncollectible accounts The full amount of the standard rate for tuition and

fees is recognized as revenue

Accounting for university-sponsored scholarships, fellowships, tuition and fee remissions or waivers depends on whether the recipient provides any services to the university

19-41


Special conventions of revenue and expenditure recognition Tuition and fee reimbursements for

withdrawals from coursework Accounted for as a reduction of revenue

Academic terms that span two fiscal periods Accounted for as revenue in the fiscal year in which

the term is predominantly conducted, along with all expenses incurred

NACUBO recommended the use of the accrual basis of accounting

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Board-designated funds The board may designate unrestricted current

fund resources for specific purposes. ASC 958 specifies that these funds may not be

reported as restricted net assets because only external, donor-imposed restrictions can result in restricted net assets.

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Public colleges and universities Accounting and reporting is specified by the

GASB. GASB 35 requires that they follow the standards

for governmental entities as specified in GASB 34. Most public institutions will be special-purpose

government entities engaged in only business-type activities.

These entities present only the financial statements required for enterprise funds and then are included as component units of the state government.

19-44


Private colleges and universities The FASB specifies the accounting and financial

reporting standards. The three financial statements required are:

The Statement of Financial Position

The Statement of Activities

The Statement of Cash Flows

They are free to select any account structure that best serves their management and financial reporting needs.

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Overview of the Accounting and Reporting of Colleges and Universities

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Colleges and UniversitiesOverview of the Accounting and Reporting of Colleges and Universities

19-47


Which of the following statements accurately describes differences between the accounting public and private universities?

a. Both public and private universities follow FASB rules.

b. Both public and private universities follow GASB rules.

c. Public universities follow GASB rules while private universities follow FASB rules.

d. Public universities follow FASB rules while private universities follow GASB rules.

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not-for-profit health care providers.

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Health Care Providers

Hospital accounting Investor-owned hospitals provide the same

types of financial reports as commercial entities. Not-for-profit hospitals present their financial

results using a specific format required by the FASB.

Governmental hospitals follow the GASB’s accounting and reporting requirements and are considered special-purpose entities engaged in business-type activities.

19-50


Hospital fund structure Although not required to do so, many hospitals

have used a fund accounting structure for accounting purposes.

Operating activities are carried on in the general fund, and a series of restricted funds can be used to account for assets whose use has been restricted by the donor.

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Overview of the Hospital Accounting and Reporting

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Financial statements for a not-for-profit hospital Separate, not-for-profit hospitals issue four basic

financial statements The Balance Sheet

The Statement of Operations

The Statement of Changes in Net Assets

The Statement of Cash Flows

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Not-for-profit hospital: The Balance Sheet Presents the total assets, liabilities, and net

assets of the organization as a whole Major accounts

Receivables Investments

Initially recorded at cost if purchased or at fair value at the date of receipt if received as a gift

Plant assets Property, plant, and equipment reported with any

accumulated depreciation

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Not-for-profit hospital: The Balance Sheet Assets whose use is limited

Separate disclosure should be made for assets that have restrictions placed on their use

Long-term debt The hospital must also account for its long-term debt

and pay the principal and interest as it becomes due Net Assets

1. Unrestricted net assets available

2. Temporarily restricted net assets available for use

3. Permanently restricted net assets

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Not-for-profit hospital: The Statement of Operations Also often termed “the statement of activities” Includes the revenues, expenses, gains and

losses, and other transactions affecting the unrestricted net assets during the period

Only general fund transactions are reported Should report an operating performance

indicator

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Not-for-profit hospital: Major accounts in The Statement of Operations Net patient service revenue Contractual adjustments Income from ancillary programs Interfund transfers General fund expenses Donations

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Not-for-profit hospital: The Statement of Changes in Net Assets It presents the changes in all three categories of

net assets Unrestricted Temporarily restricted Permanently restricted

Statement of Cash Flows Its format is similar to that for commercial

entities

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Summary of hospital accounting and financial reporting Major operating activities take place in the

general fund. The restricted funds are holding funds that

transfer resources to the general fund for expenditures upon satisfaction of their respective restrictions.

General fund uses the accrual basis of accounting.

Patient services revenue is reported at gross amounts measured at standard billing rates.

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Summary of hospital accounting and financial reporting A deduction for contractual adjustments is then

made to arrive at net patient services revenue. Other revenue is recognized for ongoing

nonpatient services. Charity care services are presented only in the

footnotes; no revenue is recognized for them.

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Summary of hospital accounting and financial reporting Operating expenses in the general fund include

depreciation, bad debts, and the value of recognized donated services that are in support of the basic services of the hospital.

Not all donated services are recognized. Donated property and equipment are typically recorded

in a restricted fund until placed into service, at which time they are transferred to the general fund.

Donated assets are recorded at fair values at the date of gift.

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Which of the following is false with respect to not-for-profit hospital accounting?

a. Not-for-profit hospitals follow FASB rules.b. Not-for-profit hospitals usually use fund

accounting.c. Not-for-profit hospitals do not prepare a

statement of cash flows.d. The general fund of not-for-profit

hospitals uses the accrual basis of accounting.

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Understand financial reporting rules and make basic journal

entries for not-for-profit voluntary health and welfare

organizations.

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Voluntary health and welfare organizations (VH&WOs) provide a variety of social services They solicit funds from the community at large

and typically provide their services for no fee. VH&WOs are typically audited. The federal government normally provides them

tax-exempt status.

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Accounting for a VH&WO Similar to other not-for-profit organizations

except for special financial statements that report on the important aspects of VH&WOs.

The accrual basis of accounting is required. VH&WOs have been free to use fund accounting

in their accounting and reporting processes.

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Financial statements for a VH&WO Statement of Financial Position Statement of Activities Statement of Cash Flows Statement of Functional Expenses

The statements are designed primarily for those who are interested in the organization as “outsiders.”

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The Statement of financial position for a VH&WO Major balance sheet accounts:

Pledges from donors

Investments

Land, buildings, and equipment

Liabilities

Net assets

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Statement of activities The overall structure of the statement of

activities for voluntary health and welfare organizations and other not-for-profit entities should be very similar as a result of ASC 958.

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Statement of activities Public support

The primary source of funds is likely to be contributions from individuals or organizations that do not derive any direct benefit from the VH&WO for their gifts.

Revenues Funds received in exchange for services provided or

other activities

Gains Gain or loss on sale of investments and other assets

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Statement of activities Donated materials and services

Should be recorded at fair value when received

Expenses Information about the major costs of providing

services to the public, fund-raising, and general and administrative costs

Costs of informational materials that include a fund-raising appeal Many VH&WOs prefer to classify such costs as

program rather than fund-raising

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Statement of Cash Flows The format of this statement is similar to that for

hospitals.

Statement of Functional Expenses Details the items reported in the expenses

section of the statement of activities

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Summary of Accounting and Financial Reporting for VH&WOs Reporting requirements are specified in ASC 958

and the AICPA Audit and Accounting Guide for Not-for-Profit Organizations.

The accrual basis of accounting is used. Primary activities are reported in the

unrestricted asset class.

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Summary of Accounting and Financial Reporting for VH&WOs Resources restricted by the donor for specific

operating purposes or future periods are reported as temporarily restricted assets.

Assets contributed by the donor with permanent restrictions are reported as permanently restricted assets.

19-73


Which of the following is false with respect to the accounting for voluntary health and welfare organizations?

a. VH&WOs solicit funds from the community and typically provide their services for no fee.

b. VH&WOs use the modified accrual basis of accounting.

c. VH&WOs must provide a statement of cash flows.

d. VH&WOs primary activities are reported in the unrestricted asset class.

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Understand financial reporting rules and make basic journal

entries for othernot-for-profit organizations.

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Other Not-for-Profit Entities

Examples of other not-for-profit organizations (ONPOs):

Private elementary and secondary schools

Professional associations Public broadcasting stations Religious organizations Research and scientific

organizations Social and country clubs Trade associations Zoological and botanical

societies

Cemetery organizations Civic organizations Fraternal organizations Labor unions Libraries Museums Other cultural institutions Performing arts

organizations Political parties Private and community

foundations

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Accounting for ONPOs In addition to ASC 958, the AICPA Audit Guide for

Not-for-Profit Organizations provides guidance for accounting and financial reporting standards.

While accrual accounting is required for all ONPOs, some small organizations operate on a cash basis during the year and convert to an accrual basis at year-end.

19-77


Accounting for ONPOs With the adoption of ASC 958, the procedures

used by ONPOs and VH&WOs may move away from the traditional funds used.

They may account for all transactions in a single entity or by establishing separate accounts for unrestricted, temporarily restricted, and permanently restricted net assets.

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Financial Statements of ONPOs Explains how the available resources have been used to

carry out activities. They should disclose the nature and source of the

resources acquired, any restrictions on the resources, and the principal programs and their costs.

They should also provide information on the ability to continue to carry out objectives.

ASC 958 requires

1. A Statement of Financial Position2. A Statement of Activities, and

3. A Statement of Cash Flows

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Summary of Accounting and Financial Reporting Accounting is similar to that for VH&WOs. The accrual basis of accounting is used when a large

number of programs or a number of very different types of programs are part of the operations.

It may be desirable to prepare a statement of expenses by functional area or major program as well.

As a result of ASC 958, the reporting requirements of ONPOs are substantially the same as VH&WOs.

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Which of the following is false with respect to the accounting other not-for-profit organizations?

a. While accrual accounting is required for all ONPOs, some small organizations operate on a cash basis during the year and convert to an accrual basis at year-end.

b. Accounting is similar to that for VH&WOs.c. ONPOs may account for all transactions in a

single entity or by establishing separate accounts for unrestricted, temporarily, and permanently restricted net assets

d. ONPOs follow GASB rules.

Conclusion

The End

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Not-for-Profit Entities

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