Not-for-Profit Accounting: CPA FAR Exam Essentials

Overview of Not-for-Profit Accounting

Not-for-profit (NFP) entities follow a distinct set of accounting standards within US GAAP, primarily governed by ASC 958 (Not-for-Profit Entities). NFPs differ from commercial entities in that they receive significant contributions, do not have equity ownership interests, and their primary purpose is not to generate profit. The CPA FAR exam tests NFP accounting concepts regularly, including financial statement presentation, net asset classifications, and contribution accounting.

Net Asset Classifications

Following ASU 2016-14, NFPs classify their net assets into two categories (down from the previous three):

Net Assets Without Donor Restrictions

These are net assets that are not subject to donor-imposed restrictions. This category includes all resources available for the NFP's general operations, as well as board-designated funds (which are internally designated, not donor-imposed). The board can remove board-designated restrictions at any time.

Net Assets With Donor Restrictions

These are net assets subject to donor-imposed restrictions that are either temporary in nature (the restriction will be met by the passage of time or the occurrence of a specified event) or permanent (the donor stipulates that the resources be maintained permanently, such as an endowment). Both types are now combined into a single category, though the nature and amounts of different types of restrictions must be disclosed.

Financial Statements of an NFP

NFPs prepare the following financial statements:

1. Statement of Financial Position: Similar to a balance sheet, it reports assets, liabilities, and net assets (classified as with or without donor restrictions).
2. Statement of Activities: Reports revenues, expenses, gains, and losses, showing the change in each net asset category. Expenses are reported by their natural classification (salaries, rent, supplies, depreciation) in one location and by their functional classification (program services, management and general, fundraising) in another.
3. Statement of Cash Flows: Follows ASC 230 and may use the direct or indirect method.
4. Statement of Functional Expenses: Required for voluntary health and welfare organizations and now encouraged for all NFPs under ASU 2016-14. It presents expenses by both natural and functional classifications in a matrix format.

Contribution Accounting

Contributions are unconditional transfers of cash or other assets to an NFP, or cancellations of the NFP's liabilities. They are recognized as revenue when received, measured at fair value. Contributions may be unrestricted, temporarily restricted, or permanently restricted based on donor stipulations.

Conditional vs. Unconditional Promises to Give

An unconditional promise to give (pledge) is recognized as revenue when the pledge is made. A conditional promise to give (one that depends on the occurrence of a specified future and uncertain event) is not recognized until the conditions are substantially met or explicitly waived. ASU 2018-08 clarifies the distinction between conditional contributions and unconditional contributions, requiring both a barrier to entitlement and a right of return or release.

Donor-Imposed Restrictions

When a contribution is received with a donor-imposed restriction, it is reported as net assets with donor restrictions. When the restriction is satisfied (through the passage of time or the use of funds for the specified purpose), a reclassification is made from net assets with donor restrictions to net assets without donor restrictions. This reclassification is reported as net assets released from restrictions on the statement of activities.

In-Kind Contributions

Contributed services are recognized as revenue and expense only when the services create or enhance nonfinancial assets or require specialized skills, are provided by individuals possessing those skills, and would typically need to be purchased if not donated. Contributed goods (such as food, clothing, or supplies) are recognized at fair value when received.

Investment Income and Endowments

Investment income earned on endowment funds is generally classified as net assets without donor restrictions unless the donor or law restricts its use. The Uniform Prudent Management of Institutional Funds Act (UPMIFA) provides guidance on the spending of endowment funds. NFPs must disclose their interpretation of relevant law and their spending policies for endowment funds.

Exam Preparation Tips

• Know the two net asset categories and be able to classify various receipts and transactions.
• Understand the distinction between conditional and unconditional promises to give, including the barrier and right-of-return criteria.
• Be able to determine when contributed services should be recognized as revenue.
• Remember that functional expense reporting (program, management and general, fundraising) is a key requirement.
• Understand that reclassification of net assets occurs when restrictions are satisfied, not when cash is spent.