One of the more difficult reporting issues facing not-for-profit organizations is the classification of net assets between unrestricted, temporarily restricted, and permanently restricted categories. These categories are based on the existence or absence of donor-imposed restrictions, and are defined in the accounting standards under FASB ASC 958-210-20. Readers rely on these classifications to determine what assets have external purpose or time restrictions or to put it simply, what assets are spoken for and what assets are available for use. While this net asset reporting model has been around for quite some time, challenging classification issues and reporting pitfalls still exist.
- Determining whether a grant should be treated as a contribution or an exchange transaction. This distinction is not always clear and often requires judgment, which can significantly affect the financial statements. FASB ASC 958-605-55 includes a table with indicators that are helpful in determining whether a grant or asset transfer is a contribution, exchange transaction or combination of both. Misclassifying contributions and exchange transactions can result in improper revenue recognition, as well as improper reporting of the resulting net assets as unrestricted or temporarily restricted. Grants treated as contributions should be recognized upon receipt or notification. Depending on the nature or absence of any donor restrictions, any unspent funds will drop to the bottom line as income and increase unrestricted or temporarily restricted net assets. In contrast, grants treated as exchange transactions look and feel more like reciprocal contracts and are classified and recognized as unrestricted revenue when the obligation to the resource provider is fulfilled. Often this means revenue is recognized only to the extent the allowable expenditures are incurred (i.e. a net zero income result). Any expenditures over and above the funds received, or any funds received over and above expenditures incurred, flow through the statement of financial position respectively as a receivable or deferred revenue/refundable advance.
- Reporting revenue from gifts of long-lived assets (i.e. property, buildings, equipment, etc.). An often overlooked and misclassified transaction is the reporting of revenue from these types of gifts-in-kind as unrestricted, without regard to donor intent or the choice that accounting rules offer. If a donor places a time restriction or purpose restriction on the long-lived asset, the revenue should be temporarily restricted. Absent a donor stipulation, the nonprofit can choose to adopt a policy to imply a time restriction, in which case they would also treat the gift as temporarily restricted. Then, an amount equal to the depreciation taken on the asset is released from the temporarily restricted net assets each year. Since land is not depreciated, donated land that is temporarily restricted remains in temporarily restricted net assets until sold or otherwise retired.
- Determining the amount to report as permanently restricted net assets with regard to endowment fund reporting. Historic dollar value of the original gift corpus has been a typical measure used to determine the minimum amount of an endowment fund to report as permanently restricted. Since state law typically allowed for the net appreciation of the endowment's investments to be spent (in the absence of any permanent or temporary restriction to the contrary by the donor), the historic dollar value amount gave present and future governing bodies the flexibility to spend those appreciated investment funds. Interest, dividends and gains on the permanently restricted endowment funds were then classified as temporarily restricted net assets until they were appropriated by the organization for expenditure. The adoption by many states of the Uniform Prudent Management of Institutional Funds Act (UPMIFA) made the determination of the amount to report as permanently restricted net assets a bit more difficult. The Act requires organizations to interpret the law as to how they would act to preserve principal (i.e. maintain the purchasing power of the amounts contributed to the fund) while spending the income. This means an organization needs to monitor principal in relation to inflation or deflation, and determine the adjustment to value needed to maintain the purchasing power of the fund, and correspondingly report as permanently restricted net assets. This involves judgment and complicated calculations using various economic indexes.
Adding to the challenges stated above, the Financial Accounting Standards Board (FASB) has proposed significant changes to not-for-profit reporting, including replacing the three existing net asset classes with two net asset classes -- net assets with donor restrictions and net assets without donor restrictions. This proposal is currently in the comment period and the effective date will be determined after the comment period ends in August 2015.
The issues highlighted here are just a few of the more challenging reporting issues that not-for-profit organizations face. Reporting net assets in the appropriate classification is not always an easy determination. It requires sound and informed judgment, an understanding of legal and accounting standards and the ability to look ahead to the consequences and implications these classifications may have.
For more information, contact Audrey Sherrick, CPA and Partner by sending an email to ASherrick@friedmanllp.com or calling +1-609-927-2151.