ACCOUNTING FOR CERTAIN
INVESTMENTS HELD BY
NOT-FOR-PROFIT ORGANIZATIONS

By James H. Thompson

FASB Statement No. 124 (SFAS No. 124), Accounting for Certain Investments by Not-for-Profit-Organizations, was issued in November 1995. It establishes standards of accounting and reporting for certain investments in securities, including disclosure requirements for most investments held by not-for-profit organizations. It does not apply to investments in equity securities accounted for under the equity method or to investments in consolidated subsidiaries.

Generally accepted accounting principles other than those provided by SFAS No. 124 also apply to investments held by not-for-profit organizations. For example, not-for-profit organizations must disclose information required by FASB Statements No. 105, Disclosure of Information About Financial Instruments with Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit Risk, No. 107, Disclosures About Fair Value of Financial Instruments, and No. 119, Disclosure About Derivative Financial Instruments and Fair Value of Financial Instruments.

In May 1993, the board issued SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. SFAS No. 115 specifically excluded not-for-profit organizations from its scope. The board decided to consider issues about investments held by not-for-profit organizations after it resolved its agenda projects on accounting for contributions and financial statement display by those organizations. FASB Statements No. 116, Accounting for Contributions Received and Contributions Made, and No. 117, Financial Statements of Not-for-Profit Organizations, were issued in June 1993. The board began to consider standards for reporting investments by not-for-profit organizations in February 1994.

Background

Prior to the issuance of SFAS No. 124, guidance for accounting and reporting of investments held by not-for-profit
organizations was provided by four AICPA guides:

* Audits of Colleges and Universities

* Audits of Voluntary Health and Welfare Organizations

* Audits of Providers of Health Care
Services

* Audits of Certain Nonprofit
Organizations

Organizations

The requirements in those guides are similar in some respects, but in others they are quite different from each other and from generally accepted accounting principles applicable to other entities. The inconsistencies lead to differences in accounting practices and, hence, to comparability and understandability problems. Further, three of the guides permit accounting alternatives that lead to further inconsistencies within the subsector they cover. Guides that are inconsistent with SFAS No. 124 are no longer acceptable specialized accounting and reporting principles and practices.

In addition to inconsistencies in the guides, the loard identified other problems the SFAS No. 124 project attempted to resolve:

* Greater relevance of fair value information. Some believed fair value information about investments is a more relevant measure of the ability of the organization's assets to support operations than cost-based information.

* LOCOM is not evenhanded. The lower-of-cost-or-market (LOCOM) method, which is required by one guide and permitted by another, is not evenhanded because it recognizes the net diminution but not the net appreciation in value of investments.

* Managing change in net assets. Cost-based measures create situations in which decisions to sell certain securities may be based on the sale's effect on the change in net assets. Organizations may choose to sell appreciated securities to recognize unrealized gains while choosing to retain other securities with unrealized losses. Similarly, organizations may choose to sell securities with unrealized losses while choosing to retain appreciated securities to reduce the change in net assets.

* Accounting based on intent. Accounting standards based on the intent of management make the accounting treatment depend on the plans of management rather than the economic characteristics of an asset. Intent-based accounting impairs comparability.

Measurement

Investments in equity securities that have readily determinable fair values and all debt securities should be reported at fair value in the statement of financial position. The fair value of an equity security is readily determinable if one of the following three criteria is met:

* Sales prices or bid-and-asked quotations for the security are currently available on a securities exchange registered with the SEC or in the over-the-counter market, provided those prices or quotations for the over-the-counter market are publicly reported by the National Association of Securities Dealers Automated Quotations systems or by the National Quotation Bureau. Restricted stock does not meet this definition.

* For an equity security traded only on a foreign market, that foreign market is of a breadth and scope comparable to one of the above U.S. markets.

* For an investment in a mutual fund, the fair value per share (unit) is determined and published and is the basis for current transactions.

SFAS No. 124 vs. SFAS No. 115

SFAS No. 124 does not establish the three categories of investments of SFAS No. 115, since such distinction is less relevant for not-for profit organizations. First, change in net assets is not a performance measure equivalent to earnings of a business enterprise. Not-for-profit organizations generally have no single indicator of performance comparable to a business enterprise's profit. Although the magnitude of profits is generally indicative of how successfully a business enterprise performed, the same relationship is not true of a not-for-profit organization. The magnitude of change in net assets does not indicate how successfully a not-for-profit organization performed in providing goods and services. Further, because donor-imposed restrictions affect the types and levels of service a not-for-profit organization can provide, the change in each class of net assets may be more significant than the change in net assets for the organization as a whole.

Reporting of Investment Income

Pursuant to SFAS No. 117, gains and losses on investments should be reported in the statement of activities as increases or decreases in unrestricted net assets unless their use is temporarily or permanently restricted by explicit donor stipulations or by law. Similarly, dividend, interest, and other investment income should be reported in the period earned as increases in unrestricted net assets unless the use of the assets received is limited by donor-imposed restrictions. Donor-restricted investment income is reported as an increase in temporarily restricted net assets or permanently restricted net assets. SFAS No. 124 does not specify methods to be used for measuring the amount of dividend or interest income.

Gains and investment income limited to specific uses by donor-imposed restrictions may be reported as increases in unrestricted net assets if the restrictions are met in the same reporting period as the gains and income are recognized, provided an organization has a similar policy for reporting contributions received, reports consistently from period to period, and discloses its accounting policy.

A donor's stipulation that requires a gift to be invested in perpetuity or for a specified term creates a donor-restricted endowment fund. Unless gains and losses are temporarily or permanently restricted by a donor's explicit stipulation or by a law that extends a donor's restriction to them, gains and losses on investments of a donor-restricted endowment fund are changes in unrestricted net assets.

In the absence of donor stipulations or law to the contrary, losses on investments of a donor-restricted endowment fund should reduce temporarily restricted net assets to the extent that donor-imposed temporary restrictions on net appreciation of the fund have not been met before the loss occurs. Any remaining loss should reduce unrestricted net assets. If losses reduce the assets of a donor-restricted endowment fund below the level required by the donor stipulations or law, gains that restore the fair value of the assets of the endowment fund to the required level should be classified as increases in unrestricted net assets.

Disclosures

The statement also establishes reporting standards for all investments held by not-for-profit organizations. For each period for which a statement of activities is presented, a not-for-profit organization should disclose the following:

* The composition of investment return, including, at a minimum, investment income, net realized gains and losses reported at other than fair value, and net gains or losses on investments reported at fair value.

* A reconciliation of investment return to amounts reported in the statement of activities if investment return is separated into operating and nonoperating amounts, together with a description of the policy used to determine the amount included in the measure of operations and a discussion of circumstances leading to a change, if any, in that policy.

For each period for which a statement of financial position is presented, a not-for-profit organization should disclose the
following:

* The aggregate carrying amount of investments by major types, for example, equity securities, U.S. Treasury securities, corporate debt securities, mortgage-backed securities, oil and gas properties, and real estate.

* The basis for determining the carrying amount for investments other than equity securities with readily determinable fair values and all debt securities.

* The method(s) and significant assumptions used to estimate the fair values of investments other than financial instruments if those investments are reported at fair value.

* The aggregate amount of the deficiencies for all donor-restricted endowment funds for which the fair value of the assets at the reporting date is less than the level required by donor stipulations or law.

For the most recent period for which a statement of financial position is presented, a not-for-profit organization should disclose the nature and carrying amount for each individual investment or group of investments that represents a significant concentration of market risk.

Effective Date

SFAS No. 124 is effective for fiscal years beginning after December 15, 1995, and interim periods within those fiscal years. Earlier application is encouraged. SFAS No. 124 may be applied retroactively by restating the beginning net assets for the earliest year presented or, if no prior years are presented, for the year the statement is first applied. The expiration of restrictions on previously unrecognized gains and losses may
be recognized prospectively. In the
period SFAS No. 124 is first applied,
a not-for-profit organization should disclose the nature of any restatement
and its effect on the change in net
assets and on each class of net assets for each period presented.

Unless SFAS No. 124 is retroactively applied, the effect of initially applying the statement should be reported as the effect of a change in accounting principle in a manner similar to the cumulative effect of a change in accounting principle in APB Opinion No. 20, Accounting Changes. The amount of the cumulative effect should be based on a retroactive computation, except that the expiration of restrictions on previously unrecognized gains and losses may be recognized prospectively. A not-for-profit organization should report the cumulative effect of a change in accounting on each class of net assets in the statement of activities between the captions' "extraordinary items," if any, and "change in unrestricted net assets," "change in temporarily restricted net assets," and "change in permanently restricted net assets." *

James H. Thompson, PhD, CPA, is professor of accounting at Meinders School of Business, Oklahoma City University.

Editor:
Douglas R. Carmichael, PhD, CPA
Baruch College