8
NET ASSETS
PERSPECTIVE AND ISSUES
Net assets are defined as “the residual interest in an entity's assets remaining after liabilities are deducted” (FASB Statement of Financial Accounting Concepts 6, Elements of Financial Statements). In more simple language, net assets represent the difference between an organization's assets and liabilities.
As a residual interest, net assets cannot be measured independently of an organization's assets and liabilities. Changes in net assets result from transactions and other events and circumstances in which total assets and total liabilities change by different amounts. In many not-for-profit organizations, such changes include nonreciprocal transfers of assets received from donors who do not expect to receive either repayment or proportionate economic benefit in return. Display of, and disclosures about, net assets and changes in them are intended to assist donors and other users in assessing an organization's efforts to provide goods and services to its constituencies, its efficiency and effectiveness in providing such services, and its continuing ability to do so.
GAAP requires the reporting of net assets in two different classes, classified based on the presence or absence of donor-imposed restrictions as either net assets without donor restrictions or net assets with donor restrictions. Net assets with donor restrictions includes net assets whose use has been limited (restricted) by restrictions placed either on the time period during which the assets may be used or the purposes for which the assets may be used. Net assets with donor restrictions also includes net assets required by donor restriction or by law to be maintained by the organization in perpetuity. Net assets without donor restrictions are all other net assets.
Total net assets and the total for each of the two classes of net assets must be presented on the statement of financial position. The statement of activities presents the changes in each of the two types of net assets. In addition, the notes to the financial statements should provide information about the nature and amounts of the different types of time and purpose restrictions as well as those net assets restricted in perpetuity. Alternatively, this information can be displayed on the face of the statement of financial position.
CONCEPTS, RULES, AND EXAMPLES
Net assets represent the difference between a not-for-profit organization's assets and liabilities. There are two classes of net assets. They are as follows:
- Net assets without donor restrictions
- Net assets with donor restrictions
Distinctions between classes should be based on the existence or absence of donor-imposed restrictions. Designation of certain assets by a not-for-profit organization for certain programs or purposes does not represent a restriction on net assets that would cause reporting as net assets with donor restrictions. Restrictions must be imposed by donors to result in classification of net assets as other than net assets without donor restrictions. This is true even if the “designation” is formally adopted by the governing board of the not-for-profit organization.
The definitions of these two classes of net assets added to the FASB Master Glossary by ASU 2016-14 are straightforward:
- Net assets with donor restrictions—The part of net assets of a not-for-profit entity subject to donor-imposed restrictions (donors include other types of contributors, including makers of certain grants).
- Net assets without donor restrictions—The part of net assets of a not-for-profit entity not subject to donor-imposed restrictions (donors include other types of contributions, including makers of certain grants).
The definition of “donor-imposed restrictions” is also modified in the FASB as follows:
A donor stipulation (donors include other types of contributors, including makers of certain grants) that specifies a use for a contributed asset that is more specific than broad limits resulting from the following:
- The nature of the not-for-profit entity (NFP);
- The environment in which it operates;
- The purposes specified in its articles of incorporation or bylaws or comparable documents for an unincorporated association.
This definition eliminates the distinction between donor restrictions that are temporary or permanent. However, ASU 2016-14 notes that some donors impose restrictions that are temporary in nature, for example, stipulating that resources be used after a specified date, for particular programs or services, or to acquire buildings or equipment. Other donors impose restrictions that are perpetual in nature, for example, stipulating that resources be maintained in perpetuity. Laws may extend those limits to investment returns from those resources and to other enhancements (diminishments) of those resources. Thus, those laws extend donor-imposed restrictions.
Note that under ASU 2016-14, Board-Designated Net Assets will be displayed similarly to previous standards, but as part of Net Assets Without Donor Restrictions, which is essentially the renamed Unrestricted Net Asset classification. ASU 2016-16 notes, however, that some governing boards may delegate designation decisions to internal management. Such designations are considered to be included in board-designated net assets.
In addition, ASU 2016-14 provides that, in the absence of explicit donor stipulations, a not-for-profit organization is required to use the placed-in-service approach for reporting expirations of restrictions on gifts of cash or other assets to be used to acquire or construct a long-lived asset and reclassify any amounts from net assets with donor restrictions to net assets without donor restrictions for such long-lived assets that have been placed in service as of the beginning of the period of adoption (thus eliminating the current option to release the donor-imposed restriction over the estimated useful life of the acquired asset).
ASU 2016-14 also has important provisions regarding the accounting for endowment funds. Specifically, for underwater endowment funds, ASU 2016-14 provides for disclosure of (1) an NFP's policy, and any actions taken during the period, concerning appropriation from underwater endowment funds, (2) the aggregate fair value of such funds, (3) the aggregate of the original gift amounts (or level required by donor or law) to be maintained, and (4) the aggregate amount by which funds are underwater (deficiencies). Most importantly, underwater endowments are to be classified as part of net assets with donor restrictions. Under the current guidance discussed earlier in this chapter, for financial reporting purposes, the amount by which endowment funds are underwater was reclassified from unrestricted net assets to permanently restricted net assets to make the endowment “whole” for financial reporting purposes. Under ASU 2016-14, the endowment fund will be reported at its actual amount, even if it is underwater.
Net Assets Without Donor Restrictions
Net assets without donor restrictions include all net assets with uses not restricted by donors.
Net assets without donor restrictions generally result from revenues from providing services, producing and delivering goods, receiving unrestricted contributions, and receiving dividends or interest from investing in income-producing assets, less expenses incurred in providing services, producing and delivering goods, raising contributions, and performing administrative functions.
The only limits on the use of net assets without donor restrictions are the broad limits resulting from the nature of the organization, the environment in which it operates, and the purposes specified in its articles of incorporation or bylaws and limits resulting from contractual agreements with suppliers, creditors, and others entered into by the organization in the course of its business. Information about those contractual limits that are significant, including the existence of loan covenants, generally is provided in the notes to the financial statements. Information about self-imposed limits on the use of net assets without donor restrictions may be useful to the financial statement reader. This would include, for example, information about voluntary resolutions by the governing board of an organization to designate a portion of its net assets without donor restrictions to function as an endowment (sometimes called a board-designated endowment). This information may be provided in the notes to or on the face of the financial statements.
NOTE: The current terminology introduced by ASU 2016-18 makes clear that the only restrictions being considered in classifying net assets are donor restrictions. The same held true for prior terminology, yet the current net assets without donor restriction was labeled “unrestricted” net assets in the past. This was really a misnomer in many cases because there were non-donor restrictions on assets (such as restricted assets under bond indentures) that were reported as part of unrestricted net assets because the restriction wasn't donor related.
Another example of a board-designated limitation on the use of net assets without donor restrictions may be for assets being accumulated for a significant capital project that will occur in the near future. In both of these examples, reflecting these designations in the financial statements is beneficial to the reader because the reader understands that the not-for-profit organization already has board-designated plans for a portion of its net assets without donor restrictions. Since not-for-profit organizations exist to provide program services, disclosure of these designations helps to explain why there may be a large amount of net assets without donor restrictions that are not being used for program purposes. This information may be particularly important in making case statements to potential donors, who might otherwise interpret the financial statements as portraying that the not-for-profit organization has more available assets for day-to-day operations than it actually plans to use for day-to-day operations.
In a similar manner, a not-for-profit organization may elect to divide net assets without donor restrictions into additional categories, that, although not required by GAAP, might provide valuable information to the reader. A common example involves property, plant, and equipment and its related debt. Sometimes a not-for-profit organization will show a significant level of net assets without donor restrictions, but a significant part of this is the result of a large amount of property, plant, and equipment, even when the related debt to acquire the property, plant and equipment is offset against it. Displaying a subcategory of net assets without donor restrictions as “invested in property, plant, and equipment, net of related debt” with the balance reported as net assets without donor restrictions available for operating activities can be revealing about the true fiscal health of a not-for-profit organization. In fact, it would not be rare for the “operating” amounts to be negative. Again, this is not required by GAAP, but is a presentation to consider if the results would be meaningful to a financial statement user.
The AICPA Audit & Accounting Guide Not-for-Profit Entities (March 2018) (the AICPA Guide) includes guidance on the classification of net assets in consolidation. Specifically, paragraph 3.104 of the AICPA Guide addresses whether the net assets without donor restrictions (terminology has been updated from the AICPA Guide) of subsidiary not-for-profit organizations should always be combined with the net assets without donor restrictions of the parent organization and thus continue to be reported as net assets without donor restrictions in the consolidated financial statements.
The issue is that the separately issued financial statements of a subsidiary not-for-profit organization may report certain net assets as not being restricted by a donor because the use of the contributed assets is no more specific than the broad limits resulting from the nature of the organization, the environment in which it operates, and the purposes specified in the organization's articles of incorporation or comparable document. However, when this subsidiary not-for-profit organization is consolidated with a parent organization, their use may, in fact, be more specifically limited than the broad limits resulting from the nature of the parent organization, the environment in which it operates, and purposes specified in the parent's articles of incorporation. If this is the case, the AICPA Guide specifies that the net assets without donor restrictions of the subsidiary should be reported as net assets with donor restrictions in the consolidated financial statements.
The example provided in the AICPA Guide makes this point very clearly. A parent membership organization has a subsidiary whose mission is to provide scholarships. Donors make unrestricted contributions to the educational subsidiary with the intent that the subsidiary use the contributions to support its mission of granting scholarships and incurring supporting services expenses. If the educational subsidiary were to issue its own financial statements, these contributions would be reported as increases in net assets without donor restrictions. However, if the educational subsidiary is consolidated with the parent membership organization's financial statements, these same contributions will result in a donor purpose restriction that is part of net assets with donor restrictions. The donors did not intend that their contributions support the activities of the membership organization as a whole. Rather, these contributions are restricted for use in the scholarship program, and accordingly, should be reported in the consolidated financial statements as giving rise to net assets with donor restrictions.
Net Assets with Donor Restrictions
Time and purpose restrictions. One component of net assets with donor restrictions is net assets whose use is limited by either donor-imposed time restrictions or purpose restrictions. Time restrictions require resources to be used in a certain period or after a specified date. Purpose restrictions require resources to be used for a specified purpose. Even after implementation of ASU 2016-14, which combined the former temporarily restricted net assets and permanently restricted net assets into one category, not-for-profit organizations will continue to need to track net assets subject to donor time and purpose restrictions separately. The nature of donor restrictions continues to be a disclosure requirement of ASU 2016-14, so the concept of time and purpose restrictions remains. In addition, for purposes of releasing net assets with donor restrictions to net assets without donor restrictions, a not-for-profit organization will continue to need to know the nature of the restrictions to report those net assets released from restrictions.
An example of a time restriction would be as follows: A donor contributes $20,000 to a not-for-profit in 2020, but requires that the organization not use the funds for the intended purpose until 2021. The donor places a time restriction on when the organization uses the funds.
An example of a purpose restriction would be as follows: A donor contributes $20,000 to a not-for-profit organization to use for its program to feed the homeless. In this case the donor places a purpose restriction on how the organization uses the funds. That is, the organization cannot use the contribution in any of its other programs.
Net assets with donor restrictions representing time and purpose restrictions generally result from the following:
- Contributions and other inflows of assets whose use by the organization is limited by donor-imposed stipulations that either expire by passage of time or can be fulfilled and removed by actions of the organizations pursuant to those stipulations.
- Other asset enhancements and diminishments subject to the same kinds of stipulations.
- Reclassifications to another class of net assets as a consequence of donor-imposed stipulations, their expiration by passage of time, or their fulfillment and removal by actions of the organization pursuant to those stipulations (Concepts Statement 6, para 93).
Reclassifications are generally made from net assets with donor restrictions to net assets without donor restrictions. Not-for-profit organizations will report expenses related to net assets that are time or purpose restricted by donors as decreases in net assets with donor restrictions on the statement of activities. As the time and purpose restrictions are satisfied, the statement of activities will reflect a transfer of net assets from net assets with donor restrictions to net assets without donor restrictions. In other words, assume a donor places a purpose restriction on a contribution. Then, when funds are spent by the not-for-profit organization in fulfilment of the purpose restriction, the decrease in net assets related to spending the funds is recorded as a decrease in net assets without donor restrictions. Since the purpose restriction has been fulfilled, a transfer is reflected on the statement of activities moving net assets with donor restrictions to net assets without donor restrictions, since there is no longer a time or purpose restriction on those net assets—it has been fulfilled.
Assets restricted in perpetuity. Net assets with donor restrictions restricted by the donor in perpetuity are those that the donor stipulates must be maintained by the organization in perpetuity. Net assets restricted in perpetuity (as a component of net assets with donor restrictions) increase when organizations receive contributions for which donor-imposed restrictions limiting the organization's use of an asset or its economic benefits neither expire with the passage of time nor can be removed by the organization's meeting certain requirements.
For example, contributions of cash or securities restricted by the donor with the stipulation that they be invested in perpetuity (that is, the not-for-profit organization cannot “spend” the principal). In addition, contributions of collection items (if they are capitalized) required by the donor to be maintained in perpetuity in the organization's collections should be recognized as increases in net assets with donor restrictions.
Net assets restricted in perpetuity may also change as a result of increases and decreases in existing assets that are subject to these restrictions. For example, increases in the carrying amounts of assets that are invested in perpetuity because of donor-imposed restrictions should be recognized as increases in net assets with donor restrictions to the extent that donor stipulations or applicable law require those increases to be retained permanently.
In summary, net assets restricted in perpetuity generally result from the following:
- Contributions with donor-imposed permanent restrictions;
- Increases or decreases in existing assets that are subject to permanent restrictions by donor or by law (such as unrealized gains on permanently restricted assets that are also restricted in perpetuity);
- Reclassifications from another net asset class as a result of donor stipulations or by law.
Changing Net Asset Classification Reported in a Prior Year
Not-for-profit organizations (and/or their auditors) may sometimes determine that the classification of net assets reported in the prior year was not correct. For example, although the total of net assets that was reported was correct, an amount that was reported in the prior year as net assets without donor restrictions actually should have been reported as net assets with donor restrictions. The question arises as to whether this would be considered a correction of an error in previously issued financial statements, or whether this is simply a “reclassification” and the often-seen disclosure “Prior year amounts have been reclassified to conform to the current year presentation” would suffice. The AICPA issued a response to a technical inquiry (TIS 6140.23, which guidance is now also included in the AICPA Guide, paragraph 11.59) that addresses this question. The response is that individual net asset classes, rather than net assets in the aggregate, are relevant in determining whether a not-for-profit organization's correction of net asset classifications previously reported in prior year financial statements is an error in previously issued financial statements. Simply stated, assuming material, this is a correction of an error.
The AICPA bases its conclusion on FASB commentary and concepts that highlight the importance of individual classification of net assets, as well as this situation not being included in the list of circumstances in current GAAP that give rise to net asset classification on the statement of activities.
Endowment Fund Reporting
FASB ASC 958-205 provides guidance on the net asset classification of donor-restricted endowment funds for a not-for-profit organization that is subject to an enacted version of the Uniform Prudent Management of Institutional Funds Act of 2006 (UPMIFA).
UPMIFA has been adopted in some form in all states, except Pennsylvania, so the applicability to specific not-for-profit organizations needs to be made on a case-by-case basis. UPMIFA updates its predecessor, the Uniform Management of Institutional Funds Act of 1972 (UMIFA), which focused on the prudent spending of the net appreciation of the fund. UMIFA set a historical dollar value threshold for an endowment, an amount below which an organization could not spend from the fund. UPMIFA eliminates the historical dollar value threshold and has more expanded guidelines as to what constitutes prudent spending, explicitly requiring consideration of the duration and preservation of the fund. UPMIFA states that “unless stated otherwise in the gift instrument, the assets in an endowment fund are donor-restricted until appropriated for expenditure by the institution.” The question arises then as to whether the appreciation of an endowment would be unrestricted or whether this amount would have a temporary time restriction.
The amount of an endowment that is classified as restricted in perpetuity is the amount of the fund (1) that must be retained permanently in accordance with explicit donor stipulations, or (2) that, in the absence of such stipulations, the organization's governing board determines must be retained (preserved) permanently consistent with the relevant law. In accordance with ASU 2016-14, net assets without donor restrictions are not to be reduced for losses on endowment funds. Rather, the endowment funds (which are part of net assets with donor restrictions) are reported at their reduced amount and reflect any losses in excess of previous gains or unappropriated earnings.
For donor-restricted endowment funds, a not-for-profit organization should classify the portion of the fund that is not classified as restricted in perpetuity as a time restriction until appropriated for expenditure by the organization. The amount appropriated for spending is a result of the not-for-profit organization's endowment spending policy. Upon appropriation for expenditure, the time restriction expires for the amount appropriated and, absent any other purpose restriction, the amount appropriated is reclassified to net assets without donor restrictions.
GAAP now has additional disclosures that are applicable to all endowments.
Financial Statement Presentation
GAAP requires the statement of financial position to report total net assets and the amounts of each of the two classes of net assets. The statement of activities should report the changes in each net asset class and the total change in net assets.
Information about the following should be shown on the face of the financial statements or in the notes:
- Different kinds of restrictions in perpetuity, such as those related to collection items and other specific assets to be held in perpetuity and to assets that have been contributed by donors with stipulations that they be invested in perpetuity.
- Different kinds of time or purpose restrictions, such as those concerning the support of specific operating activities, use in specific future periods, or the acquisition of long-term assets.
Separate disclosure of significant limitations other than those imposed by donors, such as those imposed by governing boards, are permitted to be made on the face of the financial statements or in the notes to the financial statements.
| A presentation of the net assets section of a statement of financial position that includes board designations and restricted net assets with donor restrictions is presented below. Other than the net asset totals, the information could also be presented in the notes to the financial statements. | |
| Net assets without donor restrictions | |
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xxx |
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xxx |
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xxx |
| Total net assets without donor restrictions | $ x,xxx |
| Net assets with donor restrictions | |
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xxx |
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xxx |
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xxx |
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xxx |
| Total net assets with donor restrictions | x,xxx |
| Total net assets | $xx,xxx |
DISCLOSURE REQUIREMENTS
Not-for-profit organizations should disclose the following as required by GAAP:
- The nature and amounts of the different types of restrictions (presented either on the face of the statement of financial position or in notes to the financial statements).
- Significant limits on net assets without donor restrictions, such as:
- Limits in contracts with suppliers, creditors, or others;
- Limits resulting from loan covenants;
- Self-imposed limits, such as voluntary resolutions of the board of directors.
- Disclosure requirements related to endowment funds are as follows:
- A description of the governing board's interpretation of the law(s) that underlies the not-for-profit organization's net asset classification of donor-restricted endowment funds.
- A description of the organization's policy or policies for the appropriation of endowment assets for expenditure. In other words, its endowment spending policy.
- A description of the organization's endowment investment policies, including return objectives, risk parameters, how the objectives relate to the spending policy, and the strategies employed to meet the objectives.
- The composition of the not-for-profit organization's endowment by net asset class at the end of the period, in total and by type of endowment fund, showing donor-restricted endowment funds separately from board-designated endowment funds.
- A reconciliation of the beginning and ending balance of the organization's endowment, in total and by net asset class, including, at a minimum, the following line items where applicable:
- Investment return, separated into:
- Investment income (interest, dividends, rents, etc.).
- Net appreciation (depreciation) of investments.
- Investment return, separated into:
- Contributions.
- Amounts appropriated for expenditure.
- Reclassifications.
- Other changes.
An organization is also required to provide information about the net assets of endowment funds, including:
- The nature and types of donor restrictions.
- The aggregate amount of the deficiencies for all donor-restricted endowment funds for which the fair value of the assets at the reporting date is less than the level required by donor stipulation or law.