Chapter 9Chapter 9

Reporting for Reporting for Not-for-Profit Not-for-Profit OrganizationsOrganizations

© 2013 Advanced Accounting, Canadian Edition by G. Fayerman

Not-for-Profit OrganizationsNot-for-Profit Organizations

There are several different types of not-for-profit organizations, including the following:

• Charities : The Income Tax Act considers an organization to be a charity if its goal is the relief of poverty, the advancement of education, the advancement of religion, or other purposes that benefit the community.

• Foundations : Foundations are formed to support causes or charities.

• Welfare organizations : These organizations are concerned with the welfare of others and may advocate on behalf of a group of individuals (e.g., lobbying).

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Not-for-Profit OrganizationsNot-for-Profit Organizations

• Professional and trade associations : These are normally created to control entry into a profession, maintain standards, educate, and represent the profession in discussions with other bodies.

• Institutions : Educational institutions, such as private schools, along with health institutions such as private clinics or hospitals, are also considered not-for-profit organizations.

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Definition of a Not-for-Profit OrganizationDefinition of a Not-for-Profit Organization

The CICA Handbook defines not-for-profit organizations as follows:

Not-for-profit organizations (NFPO) are entities,

normally without transferable ownership interests,

organized and operated exclusively for social,

educational, professional, religious, health, charitable or

any other not-for-profit purpose. A not-for-profit

organization’s members, contributors and other

resource providers do not, in such capacity, receive any

financial return directly from the organization.

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Definition of a Not-for-Profit OrganizationDefinition of a Not-for-Profit Organization

• We can separate the not-for-profit sector into two categories: those that operate in the public sector and those that are private.

• Public sector not-for-profit organizations include government entities such as municipal or local governments or any agency run by the government.

• All other not-for-profit organizations are considered private.

• A significant difference between the sectors is that:o the public sector not-for-profit entity has the ability to

obtain revenues through taxation,o a private sector not-for-profit must obtain its revenues

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Definition of a Government Definition of a Government Not-for-Profit OrganizationNot-for-Profit Organization

A government not-for-profit organization is defined by the CICA Public Sector Accounting Handbook as:

A government organization that meets the definition of a not-for-profit organization in the CICA Handbook – Accounting and that has counterparts outside the public sector. “Public sector” refers to federal, provincial, territorial and local governments, government organizations, government partnerships, and school boards.

•(These organizations and the related standards will be covered in Chapter 10.)

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Accounting RulesAccounting Rules

• The CICA Handbook, Part III follows the same conceptual framework as ASPE and IFRS. As such, a not-for-profit organization follows the same rules of accounting as those required for all entities.

• The definitions of assets and liabilities are the same and the not-for-profit organization must also follow accrual accounting.

• The revenue recognition criteria are the same as those of profit-oriented enterprises except that contributions to a not-for-profit organization are considered revenue.

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Financial Statements Required ofFinancial Statements Required ofa Not-for-Profit Organizationa Not-for-Profit Organization

• The CICA Handbook requires that a not-for-profit organization present the following statements in its set of financial statements (1001.4):

o Statement of financial position

o Statement of operations

o Statement of changes in net assets

o Statement of cash flows

• The not-for-profit organization is not required to use the titles as presented above. It must, however, prepare the information that is required for each statement.

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Statement of Financial PositionStatement of Financial Position

• The statement of financial position is required to indicate the assets and liabilities at a point in time, as is done for a profit-oriented organization.

• The significant difference is that there is no shareholder equity because a not-for-profit organization has no “shareholders.” The difference between the assets and liabilities is shown as the net assets (or fund balance).

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Statement of Financial PositionStatement of Financial Position

• Not-for-profit organizations also have an option of presenting their statement of financial position using fund accounting. This is a method whereby the assets and liabilities are separated into different funds to reflect a particular objective of the not-for-profit organization.

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Statement of OperationsStatement of Operations

• The statement of operations reflects the net income from operations for the period.

• This net income may also be segregated into distinct funds.

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Statement of Changes in Net AssetsStatement of Changes in Net Assets

• “Total net assets” represents the organization’s residual interest in its assets after deducting its liabilities.

• The statement of changes in net assets replaces the statement of changes in retained earnings and the statement of changes in equity that you would see in a profit-oriented entity.

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Statement of Changes in Net AssetsStatement of Changes in Net Assets

• This statement may be shown separately or may be shown as a continuation of the statement of operations.

• The net assets change provides information about how the net resources the organization has available for carrying out its activities in the future have changed.

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Statement of Cash FlowsStatement of Cash Flows

• The statement of cash flows is the same as that shown for profit-oriented entities.

• Cash from operations would include those funds and expenditures arising from the normal activities of the operation.

• Cash from investing usually involves the acquisition and sale of capital assets, and investments and cash from financing activities would include contributions that are endowments or are restricted for the purchase of capital assets as well as debt financing.

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Reporting for Not-for-Profit Reporting for Not-for-Profit Organizations: SummaryOrganizations: Summary

• Private not-for-profit organizations may follow IFRS (Part I) or Part III of the CICA Handbook. If a not-for-profit organization selects Part III, it must also adopt Part II (ASPE) for all issues not covered in Part III.

• All not-for-profit organizations should apply similar accounting treatments to like transactions when the needs of the users are aligned.

• Revenue recognition criteria mirror those of profit-oriented entities except for contributions.

• A not-for-profit organization may disaggregate its financial statements into funds based on its legal, contractual, or voluntary actions.

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Description of Fund AccountingDescription of Fund Accounting

• A not-for-profit organization may choose to disaggregate, or separate, its assets and liabilities by the activity that they belong to and/or to disaggregate the operating activities by the nature of the activity.

• One way to clearly reflect the results of various different activities is to keep each activity in a separate fund.

• You could liken this to setting up multiple different sets of statements, one set for each activity.

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Description of Fund AccountingDescription of Fund Accounting

• Each fund would then be added together to present the overall financial statements of the organization.

• When all the funds are added together, the inter-fund transfers are in effect eliminated as they are inter-entity. The inter-fund transfers are not considered revenue or expenses of the entity and as such are reflected only in the statement of changes in net assets.

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Types of Funds: Restricted FundTypes of Funds: Restricted Fund

• A restricted fund is a segregation of funds that are externally or internally restricted for a particular purpose.

• This restriction may be imposed externally by the donors, by the legal requirements of the not-for-profit organization, or by the creditors.

• Alternatively, the not-for-profit organization can internally restrict contributions for the purpose that it deems appropriate. This restriction usually requires the approval of the board of directors.

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Types of Funds: Endowment FundTypes of Funds: Endowment Fund

• An endowment fund is a type of restricted fund where, even though funds are collected, the principal is not allowed to be spent.

• The not-for-profit organization is only permitted to use the growth in the funds for selected purposes.

• Many not-for-profit organizations have argued that they may have a great deal of assets but they are “cash poor.” This may be a result of the endowment funds not earning a sufficient return to manage operations.

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Types of Funds: Endowment FundTypes of Funds: Endowment Fund

• Endowment funds can be the best way to ensure the long-term viability of the not-for-profit organization. As the endowment grows, the annual allocation to income will also increase (the organization must determine the best possible way to maximize the return on those investments and limit the risk of loss).

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Types of Funds : Capital Asset FundTypes of Funds : Capital Asset Fund

• A capital asset fund is another type of restricted fund.

• This is a fund that must be used for the acquisition and maintenance of capital assets.

• The above are types of funds that any given not-for-profit organization may select. The not-for-profit organization is not required to disaggregate based on these funds nor is it restricted to only these types of funds. It is up to the not-for-profit organization to determine the best way to convey information to the user.

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Fund Accounting : SummaryFund Accounting : Summary

• Fund accounting is a self-balancing set of accounts created for each fund.

• Net assets and net income are segregated based on the activity or the nature of the activity.

• Common funds are restricted funds, endowment funds, and capital asset funds.

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Definition of ContributionsDefinition of Contributions• Contributions are considered revenue to the not-for-

profit organization. Contributions may be made by governments (in the form of grants and loans), individuals, or corporations, or may be interest or gains on investments. Contributions may be given in cash, assets, or settlement of debt.

• A pledge is a promise to contribute cash or other assets. A contribution receivable should be recognized as an asset if it meets both of the following two criteria (CICA Handbook 4420.03):o The amount to be received can be reasonably estimated.

o Ultimate collection is reasonably assured.

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Definition of ContributionsDefinition of Contributions

• There are two methods to account for contributions: the deferral method or the restricted fund method.

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Deferral Method of Fund AccountingDeferral Method of Fund Accounting

• Using the deferral method of accounting, expenses are recorded in the period in which they occur and restricted contributions are then brought into income to match against those expenses.

• If the expenses will only be incurred in a future period, the contribution is shown as a deferred liability until such point as the expenses are incurred.

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Deferral Method of Fund AccountingDeferral Method of Fund Accounting

• Externally restricted resources would be presented as deferred contributions.

• Internally restricted resources are determined by the entity, for instance an amount invested in capital assets, and the contribution is deferred to offset against the related asset. This is sometimes referred to as an “appropriation.”

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Restricted Fund Method of Restricted Fund Method of Fund AccountingFund Accounting

• Under the restricted fund method, the organization classifies its restricted operations by fund and recognizes the contributions immediately as revenue of that particular fund.

• When using the restricted fund method, the organization will have at least a general fund, which is composed of non-restricted contributions, and an endowment fund. Any other funds that it uses must be restricted by an external source.

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Restricted Fund Method of Restricted Fund Method of Fund AccountingFund Accounting

• It is up to the not-for-profit organization to decide how many restricted funds it wants to report.

• Any restricted funds that do not have a separate fund are reported using the deferral method through the general fund.

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CICA HandbookCICA Handbook, Part III, Section 4410, Part III, Section 4410

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Recording Contributions: SummaryRecording Contributions: Summary• Not-for-profit organizations have the option of selecting

the deferral method or the restricted fund method to record contributions.

• Under the deferral method, restricted contributions are recorded as revenue in the same period as the related expense is recorded.

• Under the restricted fund method, the not-for-profit organization creates, at least, a general fund and an endowment fund.

• Under the restricted fund method, contributions to the restricted funds are considered revenues to those funds. Unrestricted contributions are revenues to the general fund.

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Inventories Held by Inventories Held by Not-for-Profit OrganizationsNot-for-Profit Organizations

Recognition of Contributed Inventory

• A not-for-profit organization is not required to record materials or services that are donated to it.

• An NFPO can only recognize materials or services ifo the fair value can be reasonably estimated, and

o when the materials and services are used in the normal course of the organization’s operations and would otherwise have been purchased (4410.16).

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Inventories Held by Inventories Held by Not-for-Profit OrganizationsNot-for-Profit Organizations

Recognition of Contributed Inventory (cont.)

•If the not-for-profit organization records the inventory, it measures it at fair value at the date of the contribution.

•A not-for-profit organization typically will not recognize the value of volunteers when it is heavily reliant on volunteer services.

o In keeping with the cost-benefit principle, generally, the cost necessary to determine the fair value is considered to be greater than the benefit to be derived from reporting the fair value.

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Inventories Held by Not-for-Profit Inventories Held by Not-for-Profit OrganizationsOrganizations

Inventories to Be Distributed at No Charge or at a Nominal Charge•The NFPO measures the inventory (if it has decided to recognize the inventory) at the lower of cost and current replacement cost.•The logic is that since the not-for-profit is giving away the inventory, there is no relation to the organization’s ability to generate cash flows.•As such, the benefit of the inventory is the amount that the organization saved if it would have to replace this inventory so as to complete its objective.

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Tangible Capital Assets and Tangible Capital Assets and Intangible Assets Held by NFPOsIntangible Assets Held by NFPOs

• NFPOs basically follow the same criteria as profit-oriented companies with respect to the recognition and measurement of tangible capital assets and intangibles;o they are capitalized at cost and then amortized over their

useful life, or

o in the case of land or an intangible that has a non-determinable life, at cost.

• If the capital asset is contributed, or if the organization purchases the asset at an amount significantly below fair value, cost is considered to be the fair value at the date of the contribution.

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Tangible Capital Assets and Tangible Capital Assets and Intangible Assets Held by NFPOsIntangible Assets Held by NFPOs

• If in the rare circumstance that the fair value cannot be determined, the capital asset is recorded at a nominal value.

• When an asset is to be constructed, the contribution of labour is measured at the fair value of that labour.

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Tangible Capital Assets and Intangibles: Tangible Capital Assets and Intangibles: Exemption from CapitalizationExemption from Capitalization

• If the organization’s average annual revenues recognized in the statement of operations for the current and preceding period are less than $500,000, it does not have to capitalize and depreciate its capital assets (Section 4431).o This exception is premised on the cost-benefit

principle.

• These “small NFPOs” may be more interested in cash flows, and as such, they are allowed to immediately expense these costs, or to capitalize these assets and not depreciate them.

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Tangible Capital Assets and Intangibles: Tangible Capital Assets and Intangibles: Exemption from CapitalizationExemption from Capitalization

• If the NFPO subsequently has revenues more than $500,000, it must begin to capitalize and depreciate assets going forward. If the revenues then fall below $500,000 again, the organization still continues to capitalize and depreciate assets. The exemption is lost forever and is no longer available to it.

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Tangible Capital Assets and Intangibles: Tangible Capital Assets and Intangibles: ImpairmentImpairment

• Under Part III of the CICA Handbook, the organization writes down the capital asset or intangible asset when the asset no longer has any long-term service potential to the organization.

• At that point, the carrying amount is written down to its residual value.

• Once the asset is written down, it cannot be reversed.

• It is possible that the organization has deferred revenue that corresponds to that asset that is impaired. The organization recognizes the revenue for the amount of the impairment.

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Tangible Capital Assets and Intangibles: Tangible Capital Assets and Intangibles: CollectionsCollections

• Collections are defined as works of art and historical treasures that have cultural, aesthetic, or historical value that is worth preserving perpetually (4431.21).

• The difficult aspect in presenting these collections is valuation. These items are usually received as a contribution and as such the organization does not have the benefit of an arm’s length transaction to determine fair value.

• Part III allows a not-for-profit organization to not record any cost for these collections. The organization decides whether the benefit to be derived from the fair value outweighs the cost to determine the fair value.

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Strategic Investments Held by NFPOsStrategic Investments Held by NFPOs

• If the NFPO elects to follow the CICA Handbook, Part III, it is not to follow Part II of the CICA Handbook with respect to strategic investments.

• Rather, the organization adopts section 4450 of Part III.

• NFPOs may invest in profit-oriented entities, other not-for-profit entities, or other economic interests. The CICA Handbook, Part III defines an economic interest as an organization:o that holds resources that must be used to produce revenue

or provide services for the reporting organization, or

o whose liabilities the reporting organization is responsible for (4450.02f).

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Strategic Investments Held by Strategic Investments Held by NFPOs: ControlNFPOs: Control

• There is a presumption that control exists if the organization has the right to appoint the majority of the other entity’s board of directors.

• When two organizations have the same board of directors, the presumption is that one organization controls the other.o For instance, it is very common for a not-for-profit

organization to create a separate entity to hold its investments and major capital assets, where this entity is often referred to as a foundation.

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Strategic Investments Held by Strategic Investments Held by NFPOs: Significant InfluenceNFPOs: Significant Influence

• In the case that control does not exist, the not-for-profit organization may be able to exercise significant influence over the strategic operating, financing, and investing activities of the other entity. The criteria are similar to that under ASPE.

• The fact that a not-for-profit organization relies on another entity for resources does not in itself imply that the entity has control or significant influence over the organization. For example, many organizations rely on government funding to exist; however, the government is not considered to control or significantly influence the organization.

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Strategic Investments Held by Strategic Investments Held by NFPOs: PresentationNFPOs: Presentation

Control

• The organization has options for presenting controlled investments, which are different options than those available under ASPE:

o controlled profit-oriented organizations (4450.30): either (a) consolidate, or (b) use equity method providing required disclosures in 4450.32.

o controlled not-for-profit organizations (4450.14): (a) consolidate, or (b) provide disclosure in 4450.22, or (c) if the NFPO is one of many individually immaterial organizations, provide disclosures required in 4450.26.

o for controlled organizations that are not consolidated(4450.22), disclose: (a) total assets, liabilities and net assets; (b) revenues, expenses and cash flows for the period; (c) details of any restrictions; and (d) significant difference in accounting policies.

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Strategic Investments Held by Strategic Investments Held by NFPOs: PresentationNFPOs: Presentation

Joint Ventures

• Part III provides an organization with the option of reporting a joint venture either using proportionate consolidation or the equity method. Regardless of which method is chosen, the organization is required to provide additional note disclosure.

Related-Party Transactions

• The disclosure requirements for related-party transactions are basically the same as those for a profit-oriented company. The definition is adjusted to include entities where one has an economic interest in the other.

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Allocated Expenses by NFPOsAllocated Expenses by NFPOs

• Section 4470 of the CICA Handbook is only relevant for organizations that have chosen to separate their financial statements by function.

• Some expenses contribute to or produce the output of more than one function.

• The NFPO may consider it important information to the reader to allocate the common costs (e.g., administrative costs) to the specific functions in order to prevent a lack of transparency.

• CICA Handbook Section 4470.A3 provides guidance as to how an organization may perform this allocation. For example, expense allocation may be based on: time, usage, per capita, or space.

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Specific Not-for-Profit Specific Not-for-Profit Transactions: SummaryTransactions: Summary

• The CICA Handbook, Part III includes sections that deal with issues of particular interest to a not-for-profit organization (NFPO).

• Valuation of contributed assets such as inventory, capital assets, or intangible assets is generally difficult since a contribution lacks the arm’s-length valuation of fair value.

• NFPOs generally have the option of determining a fair value at the day of receipt or recording it at a nominal value if it is materials or services.

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Specific Not-for-Profit Specific Not-for-Profit Transactions: SummaryTransactions: Summary

• Not-for-profit organizations reflect capital assets and intangibles at the fair value at the transaction date.

• Not-for-profit organizations determine control based on the ability to control the board of directors of the other entity. This ability is achieved in various ways other than through voting shares.

• Not-for-profit organizations require additional disclosure with respect to strategic investments, related party transactions, and allocated expenses.

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Appendix 9A: Budgeting in a NFPOAppendix 9A: Budgeting in a NFPO

• Budgeting in a NFPO is particularly important as the entity’s liquidity is usually a constant issue.

• It is very difficult for a not-for-profit organization to take funds from one activity to compensate for losses in another. As such, planning is vital in these types of organizations.

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Appendix 9A: Budgeting in a NFPOAppendix 9A: Budgeting in a NFPO

• There are several ways that an organization may choose to incorporate its budget into its recording system:o Budget to actual analysis : Reports the

budgeted figures along with the actual figures to date and a projected actual figure to year end. Problem areas can be identified on a timely basis and remedied.

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Appendix 9A: Budgeting in a NFPOAppendix 9A: Budgeting in a NFPO

o Internal budget restrictions: It is possible to create a budget system where the budgeted amounts are set up as opposite entries to the account. For example, the budgeted salaries expense above of $37,500 is set up as a credit to the expense account. As the salaries are paid, the account is debited. The account is not permitted to become negative.

o Encumbrance accounting: An encumbrance is any pre-expenditure, such as a purchase order, that will lead to a charge against an account.

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