The Financial Accounting Standards Board has issued two statements that will change the way many not-for-profit organizations account for their contributions and report information in financial statements. These standards are effective for fiscal years beginning after December 15, 1994. Small not-for-profit organizations, those with less than $1 million in expenses and $5 million in total assets, are allowed a one- year delay of the effective date.

The standards are part of a broader project to resolve certain inconsistent accounting and reporting practices of not-for-profit organizations. Industry groups within the nonprofit sector currently account for similar contributions differently and provide financial statements that differ widely in their form and content. The major benefit expected from compliance with the standards is increased relevance, understandability, and comparability that will result from eliminating some of the inconsistencies in the current practices. The following overview will describe the major provisions of each statement and identify certain provisions that were the subject of some controversy.

Financial Statements of

Not-for-Profit Organizations

Statement No. 117, Financial Statements of Not-for-Profit Organizations, establishes minimum requirements for a complete set of general-purpose external financial statements while allowing an organization's management the flexibility to report information in ways they believe are most useful to users of financial statements. The Statement requires certain basic information be classified in comparable ways and certain basic totals be reported by all not-for-profit organizations.

The standard focuses on the entity rather than fund groups. Although disaggregated information can be useful, the differing terminology and definitions used when reporting by fund groups make current financial reporting difficult to understand. Reporting certain basic information about the organization as a whole will improve the overall understandability of financial reporting as well as help in comparing an organization with other not-for-profit organizations.

Statement No. 117 requires three basic financial statements: a statement of financial position, a statement of activities, and a statement of cash flows. Each statement must show certain basic totals. A statement of financial position reports amounts for the organization's total assets, liabilities, and net assets. A statement of activities reports the change in the organization's net assets. A statement of cash flows reports the change in the organization's cash and cash equivalents.

An organization's net assets, revenues, expenses, gains, and losses are classified based on the existence or absence of donor-imposed restrictions. The amounts for each of the three classes of net assets - permanently restricted, temporarily restricted, and unrestricted - are displayed in a statement of financial position. The amount of the change in each of those three classes is displayed in a statement of activities.

Controversial Matters

Many constituents agree there is a need to establish consistent standards for reporting information in financial statements of not-for- profit organizations. Many also agree the requirements should focus on basic information that is essential for all organizations and should allow organizations sufficient latitude to arrange information in ways they consider meaningful and practical.

Although constituents generally agree with those broad objectives and the resulting broad general standards, some conclusions in the Statement were questioned during the exposure period. Four areas of debate emerged: 1) Should a statement of functional expenses be required? 2) Should a measure of operations be required? 3) Is the distinction between classes of net assets appropriate? 4) is the classification of gains and losses on endowment investments proper?

Statement of Functional Expenses.

A statement of functional expenses, which details the nature of expenses incurred in each functional category of program and supporting services, is required by the specialized accounting and reporting practices of voluntary health and welfare organizations. When considering whether the standards should require all organizations to provide a statement of functional expenses, the Board found no compelling reason to extend this requirement. Some users of financial statements were concerned they may lose meaningful information if a statement of functional expenses was not required of all organizations currently presenting that statement. Others said the information in a statement of functional expenses is so important that the requirement should be extended to all not-for-profit organizations receiving a significant part of their revenues from the general public.

The Statement requires all not-for-profit organizations to report expenses by their functional classifications and encourages organizations to also report expenses by their natural classification. It explicitly requires voluntary health and welfare organizations to continue to provide information about functional and natural categories of expense in a matrix format. Further, the Board explained the specialized accounting and reporting practices that are not inconsistent with the Statement continue in effect.

Measure of Operations. Some said that a separate operating statement or a "bottom line" other than the change in net assets (equity) is necessary and suggested a definition of the term "operations." Opinions differed on which revenues and expenses should be included or excluded from operations. The Board concluded that a not-for-profit organization should have the same latitude as a business enterprise to make distinctions that provide meaningful information.

Thus, operating or non-operating distinctions can be made in a statement of activities as long as the required basic totals are reported and the events summarized in those totals are consistently recognized by all not-for-profit organizations. if an organization wants to present a measure of operations in a separate statement, that statement must, at a minimum, also report the change in unrestricted net assets. Whenever a measure of operations is presented and the nature of items excluded from operations is not apparent, a note to the financial statements should describe the nature of the measure or the rationale used to exclude items from operations.

The Board believes that this provision allows flexibility for organizations to define "operations." At the same time, users of financial statements can more easily understand the organization's definition because the types of transactions included in the operating measure and those excluded will appear in the same statement. This approach minimizes the dangers that users may focus too heavily on a single undefined highly aggregated amount and that comparability between organizations may be impaired because each organization defines operations in its own manner.

Classes of Net Assets. Some commentators on the Exposure Draft disagreed with a classification of net assets based on the existence or absence of donor restrictions. Rather than segregating net assets into three classes based on whether they are temporarily or permanently restricted by donors or whether no donor restrictions exist, they preferred classifications based on management stewardship, such as operating/capital distinctions or fund groups.

The Board considered other classifications but concluded that a focus on donor restrictions is essential for all not-for-profit organizations. Contributions are a primary source of support for many not-for-profit organizations. Donor-imposed restrictions place limits on the use of contributed assets which affect the types and levels of service an organization can provide. Because the limitations generally are pervasive, recurring, and sometimes permanent, the Statement requires that financial reporting reflect the extent and nature of donor-imposed limits and changes in them. Users of financial statements need to know whether and to what extent the resources of a not-for-profit organization are restricted in a manner that places them beyond the discretionary control of the organization's governing body.

The flexibility provided by the Statement allows the other distinctions, such as between operating and "capital" transactions, to be made within the required net asset classifications. Requiring financial statements to display classes of net assets in no way suggests that other information cannot also be incorporated in those statements.

Classification of Gains and Losses

The classification of gains and losses on endowment assets required in the Statement is a significant change from current practice. Traditionally, net appreciation on endowment assets has been reported as an increase in the managed fund group "endowment funds" until appropriated for expenditure by the governing board. The Board rejected that tradition by specifying that the net appreciation of a permanently restricted endowment fund is to be reported as unrestricted unless it is restricted by explicit donor stipulations or by law.

Those who disagreed said this classification is inconsistent with the traditional view of endowment, their interpretation of the Uniform Management of Institutional Funds Act (the relevant law in many states), or both. Many of those constituents said the classification would commingle operating and capital funds in a confusing way, especially if an operating deficit is masked by an offsetting unrealized gain on investments. Others believed different organizations in the same state will interpret the relevant law differently, resulting in reporting similar transactions differently from organization to organization. Still others believed the classification will encourage organizations to unwisely spend their endowments, jeopardizing their futures for their current operating needs.

In explaining its decision, the Board said the issue of classification of gains and losses is one of fact - if a donor or the law of the relevant jurisdiction, as interpreted by the governing board, places permanent restrictions on some part of the net appreciation of the endowment, that amount should be reported as permanently restricted net assets in the organization's financial statements. In the absence of such a law or a donor's explicit permanent restriction, net appreciation should be reported as unrestricted if the endowment's income is unrestricted or temporarily restricted if the endowment's income is temporarily restricted by the donor.

The Board explained that if net appreciation is available for use by the organization, those gains are not permanently restricted and classifying those gains as permanently restricted is misleading. Decisions about when to spend the net gains do not bear on the issue of whether the resources are available for spending.

Accounting for Contributions

Received and Contributions Made

Statement No. 116, Accounting for Contributions Received and Contributions Made, was first proposed by the FASB in October 1990. Considerable debate ensued, again the Board deliberated, and re-exposed a draft in November 1992. Several changes and clarifications were incorporated in the revised Exposure Draft and the final Statement.

The Statement applies to all entities that receive or make contributions. Three characteristics help distinguish contributions from other transactions - contributions are a) nonreciprocal transfers, b) transfers to or from entities acting other than as owners, and c) made or received voluntarily.

The final Statement retains many of the provisions of the original Exposure Draft. The Statement requires that contributions received by an organization be recognized as revenue in the period received, measured at fair value. Contributions made are recognized as an expense in the period made, also at fair value. An unconditional promise to give cash or other assets is a contribution received and made. Exceptions to these general guidelines are provided for receipts of most services and for contributions of works of art, historical treasures, and similar items that are added to collections.

The distinction in the original Exposure Draft between donor-imposed conditions and restrictions also was retained. A condition specifies a future and uncertain event whose occurrence, or failure to occur, binds the donor. Transfers of assets and promises to give that contain conditions would be recognized in the period when the conditions are substantially met. In contrast, an unconditional gift with a donor- imposed restriction, which limits the use of the contributed assets, is recognized when the gift is made.

The Statement retains the requirement for not-for-profit organizations to distinguish between contributions received that increase permanently restricted net assets, temporarily restricted net assets, and unrestricted net assets. It also retains the requirement for recognition of the expiration of donor-imposed restrictions in the period in which the restrictions expire.

The final Statement clarifies the classification of certain contributions. Receipts of unconditional promises to give generally are recognized as restricted support because of an implied restriction to support activities in each period in which a payment is scheduled. It is reasonable to assume a similar restriction to use in future periods on gifts of long-lived assets or cash to acquire long-lived assets. Some respondents to the original proposal said misunderstandings would occur if those gifts were recognized as unrestricted revenue and perceived as currently available funds. Recognition as restricted support should avoid those misunderstandings.

Contributions of services are recognized only if they 1) create or enhance non-financial assets or 2) they require specialized skills, are provided by individuals possessing those skills, and would typically need to be purchased if not provided by donation. These criteria are more restrictive than those in the original proposal. Additionally, recognition is precluded for contributed services that do not meet the revised criteria. The original Exposure Draft encouraged that recognition.

Works of art, historical treasures, and similar items need not be capitalized if they are added to collections. Collections are 1) held for public exhibition, education, or research in furtherance of public service rather than financial gain, 2) protected, kept unencumbered, cared for and preserved, and 3) subject to an organizational policy that requires the proceeds from sales of collection items to be used to acquire other items for collections. Disclosures are required about collections that are not capitalized. This is a significant change from the original Exposure Draft which required organizations to recognize contributed collection items as assets and capitalize them retroactively.

The Statement also adds requirements for disclosures about receipts of promises to give and provides for recognizing expirations of donor- imposed restrictions prospectively.

Controversial Matters

Debates raised three questions: 1) Are unconditional promises to give revenue when received? 2) Are requirements for recognizing expiration of restrictions appropriate? 3) Are implicit time restrictions on gifts of long-lived assets and cash to acquire long-lived assets proper?

Unconditional Promises to Give. Several reasons for concern about recognition of pledges were expressed. Some believed promises to give the assets, but revenue should not be recognized until the gift is spent in accordance with the donor's restrictions. Others argued promises to give are not assets because there is no intent to legally enforce them, or because it is difficult to estimate reliably the amount to be collected. Still others said recording promises to give makes the organization appear wealthier than it is and thus may hinder fund- raising efforts. Similarly, some are concerned that requiring donors to expense multi-year unconditional promises to give at the time the promises are made will discourage that type of contribution.

These objections did not differ significantly from the objections to the original Exposure Draft. The Board considered the objections when re-examining accounting for promises to give; but after additional research, including consultations with lawyers, it again affirmed its earlier decisions that promises to give are assets and revenues (or expenses and liabilities) at the time the promise is made. In response to those who said that promises to give, especially oral promises, could not be distinguished from other communications indicating an intention to give, the Statement provides additional guidance. To be recognized, there must be sufficient evidence for the promises to give in the form of verifiable documentation. Further, a communication that does not indicate clearly whether it is a promise would be considered an unconditional promise to give if it indicates an unconditional intention to give that is legally enforceable.

Expiration of Restrictions. The Statement says that if an expense is incurred for which both unrestricted and temporarily restricted net assets are available, a donor-imposed restriction expires to the extent of the expense incurred. Some said, instead that restrictions expire when management identifies an expense with a restricted gift. They said that method is necessary because it reflects management stewardship or because determining when the restrictions expire is complicated if the expense is funded with unrestricted funds. In explaining its position, the Board said the expiration of a door-imposed restriction should be recognized when the event - the expense - occurs. The method suggested by constituents would result in different accounting for similar events because of differences in management objectives.

The Board clarified that an expense does not fulfill a donor restriction net assets if that expense is incurred to bring additional resources to the organization. For example to an reimbursed by a sponsored research contract or a conditional award from a government agency would not fulfill a restriction on similarly restricted net assets.

Implicit Time Restrictions. The revised Exposure Draft required that a time restriction be implied on a donor's gift of long-lived assets unless the donor explicitly stated the gift was to be sold to provide services in future periods. Some constituents disagreed. They said a gift of a long-lived asset may be used in any manner that is prudent, cost-effective, and consistent with the organization's mission, including sale of the asset. They also said a restriction on a gift of cash to acquire a long-lived asset expires when the long-lived asset is placed in service.

Other constituents agreed with the Exposure Draft. When a gift of a long-lived asset is recognized as time restricted and the expiration of the restriction is recognized over the life of the asset, depreciation expense is offset with an inflow from the expiration. They liked that result.

But others were not concerned about offsetting the inflow and the expense. They said the cost of the additional record-keeping exceeds the benefit of reporting an offset. Instead, they would have preferred showing both gifts long-lived assets and depreciation expense as "capital" transactions reported below a subtotal for "operations."

The Board modified the provision of the revised Exposure Draft. The Statement provides that in the absence of explicit donor restrictions specifying how long the donated assets must be used, an organization may adopt an accounting policy that reports those gifts as donor restricted over the useful life of the long-lived asset. Organizations should disclose the accounting policy adopted.

The FASB Statements provide illustrations of financial statements that have been prepared following their guidance. Presented in Table 1 and 2 are two of those examples. It should be noted however, that the examples in the Statements are but a few of the permissible formats that can result. Other formats or levels of detail may be appropriate for certain circumstances.

TABULAR DATA OMITTED

Transition Period

The Board has allowed an extended transition period for these Statements to allow not-for-profit organizations, their volunteers, and their auditors to become familiar with the requirements and make any necessary system changes. The extended transition period will also allow the AICPA and not-for-profit representative organizations to update existing guidance and provide their members with educational materials and seminars. By allowing a delay in the effective date for small not- for-profit organizations, the education and experience gained by larger organizations and their auditors during the initial year of implementation can be shared to facilitate subsequent implementation at the smaller organizations. Earlier application is encouraged. The goal is to make financial statements of not-for-profit organizations more useful, comparable, and understandable.

Susan E Weiss, CPA Assistant Project Manager, joined the staff of the FASB in November 1991 and has worked exclusively, the not-for-profit projects. Prior to FASB she was Assistant Controller of Northwestern University, and prior to that a senior acconnt with Deloitte & Touche, She is a member of the AICPA and the Illinois Society, of CPAs. She is a frequent contributor to trade and professional journals.

Expressions of individual views by members of the FASB and its staff are encouraged. The views expressed in this article are those of Susan Weiss. Official positions of the FASB on accounting matters are determined only after extensive due process and deliberation.