Glossary

17.3 Not-for-Profit Financial Reporting

9 min read•july 30, 2024

Not-for-profit organizations have unique financial reporting requirements that differ from for-profit businesses. These organizations follow specific guidelines set by the Financial Accounting Standards Board, focusing on mission-driven activities rather than profit generation.

Financial statements for not-for-profits include the statement of financial position, activities, and cash flows. These reports showcase the organization's assets, liabilities, net assets, revenue, expenses, and cash flow, helping stakeholders understand its financial health and mission progress.

Financial Reporting for Not-for-Profits

Unique Financial Reporting Requirements for NFPs

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  • Not-for-profit organizations (NFPs) have specific financial reporting requirements that differ from for-profit businesses due to their unique characteristics
    • NFPs lack ownership interests and focus on mission-driven activities rather than profit generation
  • NFPs must follow the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 958
    • Topic 958 provides guidance on financial statement presentation, revenue recognition, and disclosure requirements specific to NFPs
  • NFPs must prepare and present financial statements that include:
    • Statement of financial position
    • Statement of cash flows
    • Accompanying notes to the financial statements
  • NFPs must classify and report net assets based on the existence or absence of donor-imposed restrictions
    • This classification affects the presentation of financial information and the availability of resources for various purposes
  • NFPs must disclose information about the nature and amount of donor-imposed restrictions (temporary or permanent)
    • Disclosure provides transparency and facilitates understanding of the organization's financial position and activities

Impact of NFP Characteristics on Financial Reporting

  • The absence of ownership interests in NFPs influences financial reporting
    • NFPs do not have shareholders or owners who expect a financial return on their investment
    • Instead, NFPs focus on achieving their mission and serving their stakeholders (donors, beneficiaries, and the community)
  • The focus on mission-driven activities rather than profit generation affects the presentation of financial information
    • NFPs must demonstrate how they use resources to achieve their mission and provide public benefit
    • Financial statements must show the relationship between revenue, expenses, and program outcomes
  • The reliance on contributions and grants as primary sources of revenue impacts financial reporting
    • NFPs must properly account for and report on the receipt and use of contributed resources
    • Restrictions placed by donors on the use of funds must be carefully tracked and disclosed
  • The tax-exempt status of most NFPs also affects financial reporting
    • NFPs must comply with Internal Revenue Service (IRS) regulations and reporting requirements to maintain their tax-exempt status
    • Financial statements must include disclosures related to tax-exempt status, public support, and unrelated business income

Statements of Financial Position, Activities, and Cash Flows

Statement of Financial Position (Balance Sheet)

  • The statement of financial position presents the NFP's assets, liabilities, and net assets at a specific point in time
    • Assets are classified as current or non-current based on liquidity and expected use within the next year
    • Liabilities are classified as current or non-current based on when they are due to be paid
  • Net assets are classified based on the presence or absence of donor-imposed restrictions
    • Net assets without donor restrictions (unrestricted net assets) are available for use at the discretion of management and the board
    • Net assets with donor restrictions (temporarily or ) are subject to donor-imposed stipulations
  • The statement of financial position helps users assess the NFP's financial health, liquidity, and ability to meet obligations
    • Liquidity is the ability to convert assets into cash quickly to meet short-term obligations
    • Solvency is the ability to pay debts as they come due and to continue operating in the long term

Statement of Activities

  • The statement of activities reports the changes in net assets during a specified period
    • It presents revenue, expenses, gains, and losses, classified based on the nature of the transactions and the existence of donor-imposed restrictions
  • The statement may use a single-column or multi-column format, depending on the complexity of the organization and its activities
    • A single-column format presents all changes in net assets in one column, with net assets classified as with or without donor restrictions
    • A multi-column format presents changes in net assets in separate columns for each class of net assets (unrestricted, temporarily restricted, and permanently restricted)
  • The statement includes sections for:
    • Operating activities (ongoing, mission-driven activities)
    • Non-operating activities (peripheral or incidental transactions)
    • Other changes in net assets (reclassifications, prior period adjustments)
  • The statement of activities helps users understand how the NFP's net assets changed during the period and the reasons for those changes
    • It shows the relationship between revenue, expenses, and program outcomes
    • It demonstrates the NFP's ability to generate revenue and control expenses in pursuit of its mission

Statement of Cash Flows

  • The statement of cash flows presents the NFP's cash inflows and outflows during a specified period
    • Cash flows are classified as operating, investing, or financing activities
    • Operating activities include cash flows from the NFP's ongoing, mission-related activities
    • Investing activities include cash flows from the acquisition and disposal of long-term assets
    • Financing activities include cash flows from borrowing and repaying debt, as well as receipts of restricted contributions for long-term purposes
  • The statement of cash flows helps users assess the NFP's ability to generate positive future net cash flows, meet obligations, and fund mission-related activities
    • It provides information about the NFP's liquidity and cash management
    • It helps users understand how the NFP's operating results translate into cash flows
  • The statement of cash flows can be prepared using either the direct or indirect method
    • The direct method shows cash receipts and payments by major categories (cash received from donors, cash paid to suppliers and employees, etc.)
    • The indirect method starts with the change in net assets and adjusts for non-cash transactions and changes in assets and liabilities to arrive at net cash provided by operating activities

Net Asset Classifications in Not-for-Profit Statements

Net Assets Without Donor Restrictions (Unrestricted Net Assets)

  • Net assets without donor restrictions represent the portion of net assets that are not subject to donor-imposed stipulations
    • These assets are available for use at the discretion of the organization's management and board of directors
  • Unrestricted net assets may be designated by the board for specific purposes, such as:
    • Operating reserves to provide a cushion against unexpected expenses or revenue shortfalls
    • Quasi-endowments to generate investment income to support the NFP's mission
    • Capital projects or equipment purchases
  • Board designations are voluntary and can be changed by the board at any time
    • Designated assets are still considered unrestricted because they are not subject to donor-imposed restrictions
  • Examples of unrestricted net assets include:
    • General operating funds
    • Unrestricted contributions and grants
    • Revenue from program services and membership dues

Net Assets With Donor Restrictions (Temporarily and Permanently Restricted Net Assets)

  • Net assets with donor restrictions represent the portion of net assets that are subject to donor-imposed stipulations
    • These assets are limited in use based on time or purpose restrictions placed by the donor
  • Temporarily restricted net assets are subject to donor-imposed restrictions that can be fulfilled either by the passage of time or by actions of the organization
    • Examples of temporarily restricted net assets include:
      • Contributions restricted for a specific program or project
      • Grants with a time limit for use
      • Pledges receivable due in future periods
  • Permanently restricted net assets are subject to donor-imposed restrictions that require the principal to be maintained in perpetuity
    • The income generated from these assets may be used for either general or specific purposes, depending on the donor's stipulations
    • Examples of permanently restricted net assets include:
      • Endowment funds where the principal must be invested and preserved
      • Beneficial interests in perpetual trusts held by third parties

Accounting for and Reporting Changes in Net Asset Classifications

  • NFPs must account for and report the receipt, expenditure, and release of restricted resources in accordance with the specified donor restrictions
    • When an NFP receives a restricted contribution, it records the transaction as an increase in net assets with donor restrictions
    • As the NFP fulfills the donor-imposed restrictions through the passage of time or by using the funds for the specified purpose, it releases the restricted net assets and reclassifies them as net assets without donor restrictions
  • NFPs must maintain accurate records of restricted contributions and monitor compliance with the terms of the restrictions
    • This includes tracking the receipt, use, and release of
    • NFPs must also report the use of restricted funds to donors and other stakeholders to demonstrate accountability and stewardship
  • The release of restricted net assets is reported in the statement of activities as a reclassification from net assets with donor restrictions to net assets without donor restrictions
    • This reclassification is typically presented as a separate line item or disclosed in the notes to the financial statements

Donor-Imposed Restrictions and Financial Reporting

Types of Donor-Imposed Restrictions

  • Donor-imposed restrictions are stipulations placed by donors on the use of contributed assets
    • These restrictions can limit the NFP's ability to freely utilize the resources for any purpose
  • Purpose restrictions specify the program or activity for which the contributed assets must be used
    • Examples of purpose restrictions include:
      • Contributions designated for a specific educational program
      • Grants limited to the purchase of medical equipment
      • Donations restricted to the construction of a new facility
  • Time restrictions specify the period during which the contributed assets must be used
    • Examples of time restrictions include:
      • Pledges receivable due in future periods
      • Contributions restricted for use in a specific fiscal year
      • Grants with a deadline for expenditure
  • Perpetual restrictions require the principal of the contributed assets to be maintained permanently, while allowing the income to be used for either general or specific purposes
    • Examples of perpetual restrictions include:
      • Endowment funds established to generate investment income to support the NFP's mission
      • Beneficial interests in perpetual trusts held by third parties, where the NFP receives a portion of the trust income each year

Impact of Donor-Imposed Restrictions on Financial Reporting

  • The presence of donor-imposed restrictions affects the classification and reporting of net assets in the financial statements
    • NFPs must distinguish between net assets with and without donor restrictions
    • Restricted contributions must be recorded as increases in net assets with donor restrictions
  • Donor-imposed restrictions also affect the timing and nature of revenue recognition
    • Restricted contributions are recognized as revenue when received or pledged, rather than when the restrictions are met
    • The release of restrictions is reported as a reclassification between net asset classes, not as revenue
  • Expense allocation and disclosure requirements are also impacted by donor-imposed restrictions
    • NFPs must track and report expenses related to restricted activities separately from unrestricted expenses
    • Disclosures about the nature and amount of restrictions, as well as the NFP's compliance with those restrictions, are required in the notes to the financial statements
  • The impact of donor-imposed restrictions extends to the NFP's liquidity and availability of resources
    • Restricted net assets are not available for general use, which can limit the NFP's ability to respond to unexpected expenses or opportunities
    • NFPs must carefully manage their restricted and unrestricted resources to ensure they have sufficient liquid assets to meet their obligations and fund their mission-related activities
  • NFPs must disclose information about the nature and amount of donor-imposed restrictions in the notes to the financial statements
    • This includes a description of the purpose and time restrictions, as well as the amount of net assets subject to each type of restriction
    • NFPs must also disclose the amount of restricted net assets released from restrictions during the reporting period and the nature of those releases
  • NFPs are required to provide a reconciliation of the beginning and ending balances of net assets with donor restrictions, showing the changes during the period
    • This reconciliation should include the amount of restricted contributions received, the amount of restricted net assets released from restrictions, and any other changes in restricted net assets (such as investment income or losses)
  • NFPs must also disclose information about the availability of their financial assets to meet cash needs for general expenditures within one year of the balance sheet date
    • This disclosure helps users understand the NFP's liquidity and the extent to which restricted net assets may limit the availability of resources
  • In addition to the financial statement disclosures, NFPs must also report the use of restricted funds to donors and other stakeholders
    • This may include periodic reports on the progress of restricted projects, the achievement of milestones, and the impact of the restricted funds on the NFP's mission
    • These reports demonstrate the NFP's accountability and stewardship of the restricted resources and help maintain positive relationships with donors

Key Terms to Review (11)

Charitable organizations: Charitable organizations are not-for-profit entities established to provide various forms of assistance, support, or services to the public for social welfare, education, or relief from poverty. They play a vital role in addressing community needs and enhancing the quality of life by mobilizing resources through donations and grants to achieve their missions. The financial reporting for these organizations is essential for transparency and accountability, helping stakeholders understand how funds are raised and spent.
FASB Standards: FASB Standards are a set of accounting principles established by the Financial Accounting Standards Board (FASB) that govern how financial statements should be prepared and reported in the United States. These standards are crucial for ensuring consistency, transparency, and comparability in financial reporting, especially for not-for-profit organizations, as they provide specific guidelines on how these entities should report their financial activities, revenue, and expenses.
Form 990: Form 990 is an annual information return that certain tax-exempt organizations in the United States must file with the IRS. It provides detailed financial information about the organization, including revenue, expenses, and executive compensation, serving as a transparency tool for the public and the IRS. This form is essential for ensuring compliance with federal tax regulations and helps maintain public trust in not-for-profit entities.
Fund accounting: Fund accounting is a specialized accounting system used primarily by not-for-profit organizations and governmental entities to track and manage financial resources by segregating them into various funds based on their intended purpose. This method helps ensure that funds are utilized according to donor restrictions, legal requirements, or organizational policies, providing transparency and accountability in financial reporting.
IRS Guidelines: IRS guidelines refer to the regulations and instructions set forth by the Internal Revenue Service (IRS) to govern federal tax obligations for individuals and organizations. These guidelines play a crucial role in determining how financial transactions are reported for tax purposes, impacting both taxable income and the recognition of deferred tax assets and liabilities, as well as the financial reporting requirements for not-for-profit organizations.
Liquidity ratio: A liquidity ratio is a financial metric used to evaluate an organization's ability to pay off its short-term obligations with its most liquid assets. This ratio provides insight into the financial health of an organization by measuring how easily it can convert assets into cash to meet current liabilities, which is particularly important for not-for-profit organizations that rely on donations and grants.
Operating Margin: Operating margin is a financial metric that indicates the percentage of revenue that remains after covering operating expenses, excluding taxes and interest. This ratio provides insights into a company's operational efficiency and profitability, illustrating how well it generates profit from its core business activities. A higher operating margin reflects better management of operating costs relative to revenue, which is crucial for assessing overall financial health.
Permanently restricted net assets: Permanently restricted net assets refer to a category of net assets in not-for-profit organizations that are subject to specific donor-imposed restrictions, requiring that the principal amount remain intact and only the income generated can be utilized for specified purposes. This is crucial for organizations to manage their long-term funding and ensures that certain contributions are preserved, maintaining the integrity of donor intentions over time.
Restricted funds: Restricted funds are resources set aside by a not-for-profit organization for a specific purpose, which limits their use to that designated goal. These funds ensure that donations or grants are utilized according to the donor's intentions and help maintain transparency and accountability within the organization. By categorizing these funds separately, not-for-profits can clearly track the allocation of resources and demonstrate compliance with donor restrictions.
Single Audit: A single audit is a comprehensive audit designed to evaluate the financial statements and compliance of a non-federal entity that receives federal funds. This type of audit ensures that the entity is using federal funds in accordance with applicable laws and regulations, which is especially important for not-for-profit organizations that rely heavily on these funds to achieve their missions.
Statement of activities: A statement of activities is a financial report used primarily by not-for-profit organizations to summarize their revenues, expenses, and changes in net assets over a specific period. This statement provides insight into the organization's financial performance and is crucial for assessing how resources are allocated and whether the organization is fulfilling its mission. It helps stakeholders understand the operational results and financial position in terms of funding sources and program expenses.
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