Interpreting Nonprofit Financial Statements

1. Interpreting Nonprofit Financial Statements By James L. White Bernard & Franks, A Corporation of Certified Public Accountants

2. Contact Information jimwhite@bernardfranks-cpa.com James L. White 4141 Veterans Boulevard Suite 313 Metairie, LA 70002 (504)885-0170

3. Introduction to Nonprofits • Over one million nonprofits in the US • For GAAP purposes (ASC 958-10-20) • Receive contributions (gifts) • Mission driven • Absence of ownership interests • Tax Classifications • 501(c)(3)-Charitable organizations • 501(c)(4)-Civic and Social Welfare • 501(c)(6)-Business Leagues • 501(c)(7)-Social and Recreational

4. Voluntary Health and Welfare Organizations • Only VHW are required to present a statement of functional expenses. • GAAP definition of VHW • Contributions from the public (not Government) • Purpose must be to provide health, welfare, or community services. • Examples of VHW are Salvation Army, Red Cross, Goodwill Industries, United Way, Boy Scouts, etc.

5. Understanding Differences Between Commercial and Nonprofit Reporting

6. Objectives of Nonprofit Reporting • Groups that external statements should address: • Funders • Regulatory agencies • Governing boards • Beneficiaries of services • Employees • Creditors • National organization

7. Objectives of Nonprofit Reporting • Communicate the use of resources • Identify the principal programs and costs • Communicate ability to carry out fiscal objectives • Other objectives include: • Amount and nature of assets, liabilities and net assets • Inflows and outflows of resources • Factors that affect liquidity • Service efforts of the organization

8. Other General Financial Reporting Issues • Comparative financial statements • Prior years • Budget • Fund accounting • Not required by GAAP

9. Interpretation Model

10. Significant Differences Between For Profit and Nonprofit Financials Unrestricted Unrestricted Temporarily Restricted Permanently Restricted Three “bucket” reporting

11. Significant Differences-Three Buckets • Permanently Restricted-Donor imposed permanent restrictions on contributed assets. • Endowment • Land committed to be used for programs • Temporarily Restricted-Donor imposed temporary restrictions on contributed assets. • Time • Use • Unrestricted-No donor imposed restrictions.

12. Significant Differences-Revenue Recognition • Contributions-generally are voluntary, unconditional transfers of assets (or cancellations of liabilities). • Results in an asset “unconditional promises to give”. • Can be placed in any of the buckets based on donor imposed restrictions. • Immediate recognition of revenue when conditions are met. For example, an unconditional pledge is recorded as revenue when delivered to nonprofit. • Must determine if a contribution (gift) or exchange transaction.

13. Significant Differences-Terminology • Statement of Financial Position as opposed to Balance Sheet. • Net assets as opposed to retained earnings • Must be separated by unrestricted, temporarily restricted and permanently restricted. • Statement of Activities as opposed to Income Statement • Increase (decrease) in Net Assets as opposed to Net Income.

14. Interpreting Nonprofit Statement of Financial Position

15. To Classifyor Not to Classify? Nonprofit statements are not required to include the caption of “Current Assets” and “Current Liabilities.” Classified-Statement can include the Classification which allows for current ratio and quick ratio analysis. Sequenced Statement-Assets and liability are sequenced according to their nearness to cash and maturity. Other-Liquidity information is in no particular order. Liquidity is disclosed in the notes.

16. Cash • Focus on restrictions to cash • Cash available for current unrestricted use does not need to be segregated. • Cash limited to long-term purposes (even if it meets the cash equivalency definition) should be excluded from cash. • Examples: • Cash restricted for acquisition of property • Cash in permanent endowment

17. Investments Marketable equity securities (equity and debt securities) with readily determinable market values must be reported at fair value. Contributions of investments are recorded at fair market value.

18. Endowment Investments • Consider restrictions-Donor requirements may produce long-term assets, (e.g. Investments Held for Endowment). • Restrictions can be placed on investment income • Restrictions can be placed on investment gain • In the absence of donor restrictions or law, donor restrictions on income applies to the fund's net appreciation. • In the absence of restrictions or law, restrictions on income applies to the fund’s net losses on investments and reduce appreciation in which use restrictions have not been met. Remaining losses reduce unrestricted net assets. Subsequent gains can restore previous decreases. • Board designated endowments- gains and income are always considered unrestricted net assets.

19. Endowment Funds-UPMIFA • Abandons historic cost as a floor for expenditures • Allows expenditures from endowments during an economic downturn. • The Board must act prudently in good faith considering a number of factors in deciding a distribution from an endowment.

20. Endowments-UMIFA Requires the historical dollar amount of an endowment must be preserved. Absent donor restriction net appreciation (realized and unrealized) is spendable.

21. Example

22. Year 2 Endowments

23. Promises to Give • Promises to Give-(also called pledges) are oral of written agreements by donors to contribute cash or other assets. Must be recorded immediately. • Pledges must be verifiable • Pledge card • Tape recordings • Contemporaneous registers • Written follow-up correspondence • Promises to give must be unconditional. • Promises to give are recorded at fair value if to be collected in more than one year. Amortization is charged to contributions not interest. • Collectability must be considered and allowance for doubtful accounts established.

24. Inventory Issues • Purchased inventory is recorded at lower of cost (FIFO, LIFO, average) or market. • Donated inventories are recorded as contributions and inventory at the fair market value at date. • Donated items that have no value should not be recognized (e.g. outdated clothing). No value if: • Cannot be used internally in programs and activities. • Cannot be sold.

25. Collections of Items • Collections are defined as works of art, historical treasures, that are- • held for public display, education, or for research. • protected, cared for and preserved, and • subject to a policy that requires sales of collectibles to be reinvested into other collectibles. • Acceptable accounting includes: • Capitalization (no depreciation) • No capitalization • Capitalize only collection items after adoption of SFAS 116

26. Interpreting Nonprofit Liabilities

27. Deferred Revenues • Collection of cash received in advance of the delivery of goods or performance of services are liabilities. Examples include: • Membership dues and fees received in advance. • Advance ticket sales. • Advance rental payments. • Deferred Revenues should be reduced and revenues recognized ratably over the period earned (e.g. membership dues). • On classified statements, deferred revenues should be segregated between current and long-term.

28. Refundable Advances • Refundable advances result from: • Receipt of an advance from third party in which the services have not yet been performed (exchange transaction). • Receipt of a contribution subject to donor imposed restrictions and the conditions have not yet been fulfilled.

29. Grants Payable The awarding of a unconditional contribution s to other organizations should be recorded as a grant payable liability. This is the reciprocal of the unconditional promise to give.

30. When Is Receipt of a Contribution a Liability? • Agency transactions-Voluntary transfers of assets to a nonprofit – • Nonprofit has little or no discretion over the use of the assets. • Really acting as an agent for the transfer of funds to another nonprofit agency. • Agency transactions are recorded as liabilities, funds are for other Organizations.

31. Interpreting Net Assets

32. Net Assets • Net Assets-represent the difference between assets and liabilities. • Must be classified according to: • Unrestricted-not restricted by donors or by law. • Can be designated by Board action. • Board can never restrict. • Temporarily Restricted-Use has been restricted by donor-imposed time or use restrictions. • Permanently Restricted-Restricted by donor or law to be maintained for perpetuity.

33. Interpreting Statement of Activities

34. Revenue Recognition Issues • Contribution-voluntary , unconditional transfers of assets (or payment of liabilities) • Nonreciprocal-gives something with nothing received in exchange. • Gift out of kindness of heart. • Recorded as asset and income when conditions are fulfilled or amount determinable. • Exchange Transactions-purchase of goods and services from another party. • Recognized as revenue as services performed or goods delivered. • Agency Transactions-Nonprofit is really an agent. • No revenue recognized. • Funds are recorded as a liability until delivered to other agency.

35. Exchange vs. Contribution

36. Donations of Materials Donated materials are recorded at fair market value and are considered contributions. Donated items used in retail operations should be recorded as inventory and contributions. Sales and cost of sales are recorded upon sale. Free advertising is recorded at fair market value.

37. Donation of Facilities • Contribution income (fair value) is recorded for the free or below market use of facilities. • Value cannot exceed the fair market value of the asset being used. • If the contribution is for several years, than the contribution is the net present value of the fair rental values. • Contribution is recorded as temporarily restricted net asset and released over time.

39. Donation of Services • The fair value of donated services is recorded as contribution revenue and expense if: • Create or enhance a nonfinancial asset (e.g. non-skilled labor to build a new facility). • Require specialized skills and would be needed to be purchased if they were not donated.

40. Membership Fees • Membership dues might be a combination contribution revenues and a portion might be exchange transaction. • Exchange portion of dues would provide benefits to members; contribution would provide benefits to others • Exchange portion is classified as deferred revenues and is earned ratably over the membership period.

41. Reclassifications • Reclassifications take place between temporarily restricted net assets and unrestricted net assets • Reclassifications take place when restrictions (use or times) are satisfied. • Reclassifications have no effect on total net assets.

42. Expenses • Program Expenses-Direct and indirect costs related to providing programs and social services. • “Hands on” client and program expenses • Describe the programs-opportunity to market services and benefits to the community and funders. • Program services includes allocation indirect cost such as facility use (rent , utilities, insurance, etc.), telephone, supplies, supervision, etc.

43. Expenses • Support expenses-Activities not directly related to the mission of the nonprofit. • Management and General-Includes accounting, board expenses, business management, finance, budgeting expenses. • Includes Executive Director and their staff, except for the time spent supervising program, fundraising. • Fundraising-Includes all expenses related to the appeal for funds. • Payments to Affiliated Organizations-Allocated between program and administrative services when possible. If the allocation cannot be determined, then the costs is G&A.

44. Expenses All expenses must be reported in the Unrestricted Net Asset bucket. Netting of expenses against revenues is not allowed (except for investments). Depreciation is required.

45. Allocations Importantfor nonprofit to have an allocation plan. A general plan would be as follows: Allocation Method Time sheets Based on salaries and wages Square footage Square footage Square footage Number of phones Account • Salaries and wages • Employee benefits • Office rent • Utilities • Building supplies • Telephone

46. Fundraising-Joint Costs • Nonprofit organizations often have joint purpose printed materials or events. Organizations wish to classify expense as program, G & A and fundraising • The default classification for joint expenses is fundraising expense. To overcome this presumption: • Purpose must have a program component and request an action other than fundraising. • Audience must be selected to meet a program need. • Content must support program goals.

47. Three Bucket Reporting • The three buckets of Net Assets (Unrestricted, Temporarily Restricted and Permanently Restricted) must be presented in Statement of Activities. • Can be presented in columns • Can be presented in sections

48. Interpreting the Statement of Functional Expenses Required for Voluntary Health and Welfare organizations. Large donors require the information. Natural expense categories Required to allocate expenses between program and support (G & A and fundraising).

49. Interpreting the Statement of Cash Flow • Cash and cash equivalents that have been • designated for long-term purposes , or • received with donor restrictions for long-term use should be excluded from cash or equivalent. • Receipt of contributions restricted to long-term purposes is classified as a Financing activity. The amount would also need to be a reduction from operating activities to balance the statement when using the indirect method.

50. Interpreting Nonprofit Disclosures • Unconditional Promise to Give • Amounts receivable in one to five years. • Amount of the Allowance for Uncollectible • Unamortized discount ( also face amount and discount rate) • Conditional Promises to Give must be disclosed • Property policy for the handling of donations of long-lived assets. • Nature of relationship with owner of donated property • Nature of restrictions on assets. • Details of permanent and temporarily restricted net assets.