Financial Statements Preparation of Not-For-Profit Organizations

Contributions are the primary revenue to a Not-for-Profit Organization (NFPO). Because the NFPO has characteristics which difference with the for-Profit Organization, its accounting method of recording contributions has own standards.

Primarily the nonprofit organization must produce three important annual financial statements: the statement of financial position, the statement of operation, and the statement of cash flow. One of the principle differences in nonprofit financial statements compared to for-profit entities is the objective of a nonprofit is to realize its socially desirable goals and objectives for the community it serves, rather than to realize a net profit. Financial statements are important communication information about NFPO to members, contributors and creditors. Financial statements satisfy their and others interested needs, like the financial condition of organizations and how the management has discharged its stewardship responsibility to those that have provided resources to the organizations, especially important as resources are contributed for specific purposes and management is accountable for the appropriate utilization of such resources.

Although the not-for-profit organization applies a separate set of accounting standards, there should be no differences in accounting between profit-oriented enterprises and non-for-profit organizations when the circumstances and transaction are the same.

Not-for-profit organizations have three types of contributions to report: unrestricted contributions, restricted contributions and endowment contributions. This three types of contributions are accounted under the restricted fund method and the deferral method.

Deferral Method

Under the deferred method, unrestricted contributions are automatically recorded as revenue when they are received. Restricted contributions are recorded as revenue until the related expense as been incurred in the future. Endowment contributions are recognized as direct increases in net assets, which are shown in the statement of changes in net assets. Especially, restricted contributions for the purchase of depreciable capital assets are deferred; the revenue is realized as the asset is being amortized. Non-depreciable capital assets, like land, are recognized as increase in net assets.

Advantages of Deferral Method

For an accounting perspective, using the deferral method means the contribution revenues expected during a specific accounting period are directly matched to the anticipated expenses during this period. This helps the organization to develop an accounting plan extends beyond the current period which more rational use the contributions. Secondly, the deferral method reduces noise from timing mismatch between when expenses are incurred and when revenues are recognized. The matching helps avoid misstating cost for a period. The mention above, the objective of nonprofit financial statements is assessing whether the organization is achieving its objectives at the lowest possible cost. The deferral method can avoid misstating, for instance, avoid result in understated cost. Thus, it better evaluate the actual performance of organization.

Disadvantages of Deferral Method

Along with the benefits of the deferral method, there are several disadvantages need to be aware of. Using the deferral method the results of the unrestricted and restricted contributions are combined, and organization-wide totals are presented in the each of the financial statement. The restricted contributions remain unfulfilled are accumulated as deferred contribution. The organization’s excess of revenue over expenses for the period represents the increase in resources that are not restricted to cover specific expenses of a future period. Thus, it is not clearly presents information regarding how the organization manages the restricted contributions. Another disadvantage is the restrictions are deferred and not reported until used. Deferral of external restricted contributions to a liability may be confusing to the basic users.

Restricted Fund Method

The restricted fund method requires the entity must have a general fund and at least one restricted fund. The Unrestricted contributions and investment income are recorded as revenue in general fund. Restricted contributions are recognized as revenue if a restricted fund has been established for that purpose. If no related fund has been established, restricted contributions are treated the same way under the deferred method in general fund.

Advantages of Restricted Fund Method

Using fund accounting system to record contributions can help to ensure that organizations use their resources in accordance with the stipulations donors; granting agencies and governing boards impose. Fund accounting segregates the account balances related to its purpose and keeps these funds from mingling with the other accounts of the organization. This ensures that the assets assigned to each fund remain available for the purpose of that fund and the restricted fund method keeps the organization accountable to the donors who support the organization. Each donor wants to see the nonprofit serve the individuals who need its assistance. When the nonprofit organization issues its financial statements at the end of the year, the contributors can review the performance of each fund. The financial statements identify the money received for each fund and how the organization distributes those funds. Thus, the restricted fund method is more clearly to present the information of restrictions. Secondly, choosing the restricted funds to report and treating similar contributions in same manner consistently that is increase comparability between current year and previous years in one organization. This is seen as both advantage and disadvantage in the same time.

Disadvantages of Restricted Fund Method

Because of an organization chooses which restricted funds to report, it lack comparability between with two organizations. Because of this choice, two organizations following the restricted fund method may each report similar kinds of restricted contributions differently. For example, one organization may present contributions restricted for purchasing equipment in a separate restricted capital fund. Another organization may not report a separate capital fund. It results in lacking comparability on similar contributions of two organizations.

Comparison on Deferral Method and Restricted Fund Method

The primary difference among two methods is timing treatment restricted contributions. This affects the amount of liabilities and revenues reported.

Under the deferral method, interest is recognized as an increase in the contribution revenue on the statement of operation as scholarship paid out. The operating facility is capitalized and amortization is recorded as expense. The amount of the restricted contribution recognized as revenue for the year is equal to the corresponding expenses incurred. The revenue over expense which is unrestricted contribution received. The amount of the contribution not used at the end of the year is recorded as an increase in the liabilities “deferred contributions” on the statement of position. The deferred contributions decrease when the related revenues are recognized. Land and endowment are recorded as increase in net asset.

Under the restricted fund method, the contributions are classified to general fund, capital fund and endowment fund. Each fund has a self-balancing separately. The Contributions and interest earned are immediately recognized as revenues in the corresponding fund. Any expenditure related to that fund is deducted from the balance. In this case, using the restricted fund method of recording contributions is better than using the deferral method. Because the restricted fund method is more clearly shows the NFPO how to spend the restricted contributions. The restricted fund method makes NFPO easy to report activity to its members, donators, and also to any government entity that is charged with the responsibility of overseeing its operation.

Leave a Reply

Your email address will not be published. Required fields are marked *