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Feb 1994

What are assets doing on the not-for-profit's income statement? (Accounting)

by Seville, Mary Alice

    Abstract- Not-for-profit organizations will encounter new terms in their financial statements as a result of the implementation of Statement of Financial Accounting Standard (SFAS) Nos 116 and 117. One of the newly introduced terms that may cause confusion is 'net loss' which replaced the term 'fund balance.' This refers to the assets the nonprofit owns minus its debts. The FASB is promoting the use of 'net assets,' but it is also allowing the use of other terms. However, whatever caption is used, it is required that the 'unrestricted,' 'temporarily restricted' and 'permanently restricted' classifications be applied. Under SFAS 116 and 117, 'restricted' refers exclusively to donor imposed restrictions. Another possible source of confusion is the adoption of the term 'promise to give' in place of 'pledge.' SFAS 116 and 117 will take effect for years starting after Dec 15, 1994 for large organizations and a year after for small nonprofits.

Net assets is not a new term to accountants. It is used in the financial statements of employee benefit plans. It was introduced to not-for- profit accounting in Statement of Financial Accounting Concepts (Concept) No. 6, Elements of Financial Statements. However, it is not a familiar term to most people involved with not-for-profit organizations. Simply put, net assets replaces the term "fund balance" and is the excess of what the organization owns over what it has borrowed and still owes. The organization may be cash poor, but if it has office furniture and no debts, it has net assets. Or the organization may be cash rich, but if it just borrowed a large sum, it may have no net assets. Net assets are also seen as the cumulative results of running the not-for- profit organization. If the organization has received (including contributions, fees for services, sale of assets, etc.) more resources that it has used in providing goods or services, it will have positive net assets. If the goods and services cost more than was received (including contribution, etc.), the organization will have negative net assets. Depending on the sophistication of your client, you could use accrual accounting terminology. Exhibit 1 can be used to help your client visualize what events cause net assets to change and not to change.

Fund Balance Didn't Do It

The FASB encourages use of the term net assets, but other terms are permitted. When deciding what caption to use, consider that the Board did not switch to net assets from fund balance just to make life interesting. The term fund balance was not intuitively clear either. Many who have use for reading not-for-profit financial statements think "money" when hearing "fund" and so thought fund balance was the balance in the bank. On a more theoretical plane, the FASB believes the emphasis should be on the organization as a whole, not on funds which are artificial pieces of it. The Board has discouraged, but not prohibited, reporting by funds. When you do not report funds, fund balance makes even less sense.

The term "equity" may be used instead of net assets, but equity has a business connotation. To many people, equity implies ownership interest, and there is no ownership interest in a not-for-profit organization. Other terms could have been used, but they would not have been any more intuitively clear.

No matter what caption is used, three classes--unrestricted, temporarily restricted and permanently restricted--are to be reported when appropriate. Here is another chance for confusion. Not because temporary and permanent are confusing; those terms are used as most people understand them. Restricted is the term with possible confusion. In not- for-profit accounting, restricted has meant that external parties, e.g., contributors, government agencies, or lawmakers, have placed limitations on how the organization could use the resources. In SFAS 116 and 117 parlance, restricted is used only for donor imposed restrictions. The key concept here is there must be a donation that is a non-reciprocal transaction: no donor, no restriction. Since grants, (government or corporate) are often reciprocal in nature, many grants will no longer be reported as restricted net assets. Organizations will have to maintain accounting records to satisfy the grantor resources were used properly even if the general purpose financial statements do not report grants as restricted. Business enterprises have a similar requirement for their government contracts. Promises, Promises

"Promise to give" is another potentially troublesome term. In the first exposure draft leading up to No. 116, the term pledge was used. The Board found pledge was an ambiguous term and switched to "promise to give." The comment letters to the exposure drafts indicate organizations may not be happy about recording promises to give/pledges as revenue.

Assuming the promise/pledge is unconditional, there are two key provisions in determining when to record revenue. Unconditional means the fulfillment of the promise depends only upon passage of time or demand by the organization. The first is whether there has been a promise. If the organization is unsure if the donor promised to give, an indication the donor intended to give is considered a promise if it is legally enforceable. Legal enforceability does not depend on the organization's intent to use its legal remedies. It depends on state law. The other key provision is that there is documentation of the promise. The promise does not have to be made in writing. An oral communication can also result in a promise if there is documentation of the communication--tape recordings, contemporaneous logs, etc. Exhibit 2 provides a flow chart illustrating when a communication is to be recorded as a "promise to give." In the past, when not-for-profit organizations recorded "promises to give" as assets, the credit was to deferred revenue because the contribution was restricted to a specific purpose or to use in a future period. After SFAS No. 116 is effective, the credit will generally be to revenue in the temporarily restricted class of net assets. This is true for all contributions that are restricted to use in a specific time period or for a specific purpose. This treatment follows the guidance of Concept No. 6 that says a restricted contribution creates a fiduciary responsibility, not an obligation to a creditor. Additionally, the Board believed the usual assumption is that the contribution will be used as the contributor requested. Restricted contributions will no longer be recorded as deferred revenue until the purpose has been accomplished. Deferred revenue will be used only when a not-for-profit organization is paid fees for services in advance of delivery.

This discussion does not pretend to offer solutions for all the problems you will experience implementing SFAS 116 and 117. The intention is to alert you to some terminology problems. Client understanding of the terminology is a necessary step in implementation. How to implement the statements will be discussed from now until at least December 15, 1994, or 1995.


A task force of AcSEC on ADC arrangements prepared a proposed SOP on identifying and accounting for real estate loans that qualify as real estate investments. The SOP would replace guidance in the form of a notice to practitioners (1986) dealing with accounting for acquisition, development, and construction loans. The notice to practitioners was issued during the time that many financial institutions encountered ADC loans of troubled borrowers. The proposed guidance is extensive, starting with a definition of the characteristics of a real estate loan. Loan arrangements not meeting the criteria, are to be classified and accounted for as a real estate investment. "Sweat equity" will become an accounting term under the proposed accounting.

The comment period on the exposure draft ends on January 31, 1994.


Changes in assets and liabilities that don't cause changes in net assets

1. Exchanges of assets for assets, e.g., pay cash for a building

2. Exchanges of liabilities for liabilities, e.g., borrow from bank to pay unpaid suppliers

3. Acquisitions of assets by incurring liabilities, e.g., borrow to buy a building

4. Settlements of liabilities by transferring assets, e.g., pay off unpaid suppliers

Changes in asset or liabilities that cause changes in the amount of net assets

1. Revenues, e.g., contribution of dollars or time or fees for services

2. Gains, e.g., sale of used vehicle for more than its value on the books. Not part of what the organization does

3. Expenses, e.g., salaries, rent--costs of doing what organization does to achieve its mission

4. Losses, e.g., sale of used vehicle for less than its value on the books. Not part of what the organization does

Changes in net assets that do not affect assets or liabilities

1. Reclassifications between classes of net assets from changes in donor-imposed restrictions, e.g., a contribution given in 19X1 to be used in 19X2. Would be temporarily restricted when given. On 1/1/X2 it is considered (reclassified) as unrestricted.

2. Changes within a class of net assets, e.g., decision by Board to establish a contingency fund. Decision to not spend everything available, but save some for a rainy day

Adapted from FASB Statement of Financial Accounting Concepts No. 6

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