Prior to the implementation of Accounting Standards Update (ASU) No. 2016-14, Presentation of Financial Statements of Not-for-Profit Entities, there were inconsistencies in the types of information provided about expenses — for example, some, but not all, not-for-profits (NFPs) provided information about expenses by both nature and function. Also, only certain types of NFPs (voluntary health and welfare organizations) were required to include a statement of functional expenses. Now, all NFPs are to report amounts of expenses by both their natural classification and their functional classifications in one location, on the face of the statement of activities, as a separate statement, or in the notes to financial statements.
An important determination in financial reporting for NFPs is whether an item is an expense or a loss. Consider the differences between expenses and losses:
The determination is important because of the following:
Again, activities that are reported as expenses by some entities may be reported as losses by others. For example, a Girl Scouts council could have an annual cookie sale that is its main fund-raising event each year (a major and central activity), whereas a Boy Scouts council could hold a special fund-raising cookie sale for new camping equipment that may be considered a peripheral or incidental activity. Both groups are selling cookies but their reporting of the activity is potentially different.
Many entities have fund-raising or other special events in which the attendee receives some type of direct benefit. For example, an entity may hold a $100 per plate special dinner as a fund-raising event. An entity may also hold special social or educational events where the attendee receives a direct benefit. Often, these activities are considered part of the organization’s ongoing and major activities and therefore revenues and expenses from such events must be reported separately.
Entities have several ways they can report the revenues and expenses from these types of activities. The following is an example of the different ways entities can report a special fund-raising dinner in the statement of activities. Assume the following:
Now, let us review the possible reporting of this in exhibit 3-1.
NFP entities are required to report information about the nature and function of expenses. Functional expense classification is a method of grouping expenses according to the purpose for which costs are incurred, such as major classes of program services and supporting activities. This information can be presented in the statement of activities, as a separate statement, or in the notes to the financial statements.
The proper classification of expenses between program services and supporting services is often important to NFP entities. Resource providers often compare the percentage of expenses that go to providing program services to the percentage of expenses that go to supporting services. Ideally, most of the resources provided to an entity will be used for program services.
An entity must report expense information about program services that it provides. The relationship between functional classification and natural classification for all expenses shall be presented in an analysis that disaggregates functional expense classifications, such as major classes of program services and supporting activities by their natural expense classifications. The financial statements shall provide a description of the nature of the NFP’s activities, including a description of each of its major classes of programs. If not provided in the notes to the financial statements, the description can be presented on the statement of activities (for example, using column headings).
For example, a college may report student instruction, research, public service, and other program areas. An entity should report information for each of its major classes of program services and supporting activities. The number of classes to use requires professional judgment. Entities may consider guidance in FASB Accounting Standards Codification (ASC) 280-10-50 in determining the number of major classes to use.
Supporting services are often classified as management and general, fund-raising, and membership development. However, some NFP industries use other classifications of supporting services. For example, most colleges report institutional support and institutional development activities. Entities may also report more detailed classifications for each type of supporting services.
Management and general activities typically include all items not reported as program services, fund-raising, or membership development. Examples of management and general activities are illustrated as follows:
The cost of oversight and management usually includes the salaries and expenses of the governing board, the chief executive officer, and the supporting staff. If such staff spend a portion of their time directly conducting or supervising program services or categories of other supporting services, however, their salaries and expenses should be allocated among those functions.
Fund-raising activities are connected with inducing potential donors to contribute. The contribution can be money, other assets of value, services, facilities, or time. The activities include
The financial statements should disclose total fund-raising expenses. It should also be noted that fund-raising costs should be expensed as incurred. However, the costs of tangible fund-raising assets, such as brochures and promotional items, may be recorded as assets upon purchase and expensed when used.
In some cases, fund-raising activities are conducted by professional fundraisers or federated fund-raising entities on behalf of an NFP organization. For example, the professional fundraiser may charge a 20% fee for conducting a fund-raising activity, or a federated fund-raising entity may charge a 5% administrative fee for gifts that will be transferred to the NFP organization. In such cases, the NFP should report the gross amount of the contributions raised and a fund-raising expense for any fee.
Membership-development activities include soliciting for prospective members and membership dues, membership relations, and similar activities. To the extent that member benefits are received, membership is an exchange (reciprocal) transaction. If there are no significant benefits or duties connected with membership, however, the substance of membership-development activities may, in fact, be fund-raising, and the related costs should be reported as fund-raising costs.
Membership-development activities may be conducted in conjunction with other activities. In circumstances in which membership development is in part soliciting revenues from exchange (reciprocal) transactions and in part soliciting contributions, the activity is a joint activity. If membership development is a joint activity and the purpose, audience, and content of the activity are appropriate for achieving membership development, joint costs should be allocated between fund-raising and the exchange transaction. In circumstances in which membership development is conducted in conjunction with other activities but does not include soliciting contributions, the activity is not a joint activity, and the costs should be allocated to membership development and one or more other functions. For example, membership may entitle the members to group life and other insurance at reduced costs because of the organization’s negotiated rates and to a subscription to the organization’s magazine or newsletter. Under these circumstances, an appropriate part of the costs of soliciting members should be allocated to the membership-development function and a part to program services.
Costs related to sales of goods and services that are related to major or central activity of an entity should be reported separately. Cost of sales and services is permitted to be reported immediately after revenue from the sale of merchandise. If the sale of merchandise is related to the organization’s mission, the cost of sales could be reported as a program expense. For example, if a museum has a store that sells merchandise related to the museum’s program, the cost of the store’s sales could be reported as a program expense. If the sale of merchandise is not related to the organization’s mission, cost of sales would be reported as supporting services.
All NFPs shall report information about all expenses by function and nature in one location — on the face of the statement of activities, as a schedule in the notes to financial statements, or in a separate financial statement.
All expenses shall be presented in an analysis that disaggregates functional expense classifications, such as major classes of program services and supporting activities by their natural expense classifications, such as salaries, rent, electricity, supplies, interest expense, depreciation, awards and grants to others, and professional fees. Expenses reported in cost of goods sold or services provided (or costs related to special events) should be reported by their natural classification in the functional expense analysis. For example, salaries, wages, and fringe benefits that are included as part of the cost of goods sold on the statement of activities shall be included with other salaries, wages, and fringe benefits in the functional expense analysis.
Exhibit 3-2 is a simple example using a statement of functional expenses:
As stated earlier, the proper classification of expenses between program services and supporting activities is often important to NFP entities. Some expenses are easily assigned to a single program or supporting activity. However, some expenses relate to more than one program or supporting activity and must be allocated to the appropriate functions. For example, rent on a building may need to be allocated among program services and supporting activities.
Where possible, direct identification of specific expense is the preferable method of charging expenses to various functions. For example, travel costs incurred in connection with a program activity should be assigned to that program.
Often, it may not be possible or practical to use direct identification to assign costs to various functions. In such cases, an allocation method would be used. Allocating costs is a common practice for both NFP entities and business enterprises. A reasonable allocation of expenses can be made in a variety of ways and should be based on an objective method.
Allocation methods may be based on financial or nonfinancial data. For example, building costs (rent and utilities) may be allocated based on square footage of space occupied by the various programs and support activities. Time records or activity reports may be used to allocate salary of certain personnel. Entities should review their allocation methods periodically to ensure they reflect the most current activity. A description of the methods used to allocate costs among program and support functions would need to be disclosed in the notes to the financial statements.
There is special guidance on allocating costs related to an activity that combines fund-raising activities and also elements of another function. These types of costs are referred to as joint activities and are discussed in the next section.
NFP entities may solicit support through a variety of fund-raising activities, including the following:
Sometimes fund-raising activities are conducted with activities related to other functions, such as program activities or supporting services, such as management and general activities. Sometimes fund-raising activities include components that would otherwise be associated with program or supporting services, but in fact support fund-raising.
If any of the criteria are not met, all costs of the joint activity should be reported as fund-raising costs, including costs that otherwise might be considered program or management and general costs if they had been incurred in a different activity, subject to the following exception. Costs of goods or services provided in exchange transactions that are part of joint activities, such as costs of direct donor benefits of a special event (for example, a meal), should not be reported as fund-raising.
The purpose criterion is met if the purpose of the joint activity includes accomplishing program or management and general functions.
To accomplish program functions, the activity would call for specific action by the audience that will help accomplish the organization’s mission. For example, an entity with a mission to get people to stop smoking may send a brochure that urges the recipient to stop smoking and provides methods to accomplish this task.
One may wonder whether asking an audience to make contributions is a call for specific action. Asking an audience to make contributions is not a call for specific action by the audience that will help accomplish the organization’s mission.
The following factors should be considered to determine if the purpose criterion is met:
A rebuttable presumption exists that the audience criterion is not met if the audience includes prior donors or is otherwise selected based on its ability or likelihood to contribute to the organization. That presumption can be overcome if the audience is also selected for one or more of the reasons listed subsequently. In determining whether that presumption is overcome, entities should consider the extent to which the audience is selected based on its ability or likelihood to contribute to the entity and contrast that with the extent to which it is selected for one or more of the reasons listed subsequently. For example, if the audience’s ability or likelihood to contribute is a significant factor in its selection and it has a need for the action related to the program component of the joint activity, but having that need is an insignificant factor in its selection, the presumption would not be overcome.
In circumstances in which the audience includes no prior donors and is not otherwise selected based on its ability or likelihood to contribute to the organization, the audience criterion is met if the audience is selected for one or more of the following reasons:
The content criterion is met if the joint activity supports program or management and general functions, as follows:
Information identifying and describing the organization, causes, or how the contributions provided will be used is considered in support of fund-raising.
As we have just described, the process for accounting for joint activities is complex. Exhibit 3-3 illustrates how to apply the criteria of purpose, audience, and content.
In the preceding discussion we have attempted to summarize and simplify a rather complicated subject. For important details on this topic see FASB ASC 958-605, which is available at www.fasb.org.
The cost allocation method used should be rational and systematic, it should result in an allocation of joint costs that is reasonable, and it should be applied consistently given similar facts and circumstances.
As illustrated in the following, NFPs that allocate joint costs have several disclosure requirements.
Entities are encouraged, but not required, to disclose the amount of joint costs for each kind of joint activity, if practical.
We have had a lengthy discussion of joint activities and one may wonder at this point if we have covered everything. In a word, no, but we have covered the core requirements and issues. For more information on this topic, consult chapter 13 of AICPA Audit and Accounting Guide Not-for-Profit Entities.
Some contributions are limited by donor-imposed stipulations that either expire by passage of time (time restriction) or can be fulfilled and removed by actions of the entity pursuant to these stipulations (purpose restriction).
The expiration of a donor-imposed restriction simultaneously increases net assets without donor restrictions and decreases net assets with donor restrictions and is referred to as a reclassification. Reclassifications are reported as separate items in the statement of activities. For example, a donor contributes $1,000 to cover the cost of a training program for staff of an NFP organization. The entity can meet this restriction by spending the $1,000 on the training program. The cost of the program would be reported as an expense that decreases net assets without donor restrictions and a reclassification would be reported that simultaneously increases net assets without donor restrictions and decreases net assets with donor restrictions.
Reclassifications of net assets should be made if
Expenses may be incurred for purposes for which both non-donor restricted and donor restricted net assets are available. If an expense is incurred for a purpose for which both net assets with and without donor restrictions are available, a donor-imposed restriction is fulfilled to the extent of the expense incurred unless the expense is for a purpose that is directly attributable to another specific external source of revenue. For example, an employee’s salary may meet donor-imposed restrictions to support the program on which the employee is working. In that situation, the restriction is met to the extent of the salary expense incurred unless incurring the salary will lead to inflows of revenues from a specific external source, such as revenues from a cost reimbursement contract or a conditional promise to give that becomes unconditional when the entity incurs the salary expense.
An entity may meet donor-imposed restrictions on all or a portion of the amount contributed in the same reporting period in which the contribution is received. NFP entities can adopt an accounting policy were the contribution (to the extent that the restrictions have been met) would be reported as an increase in net assets without donor restrictions. The entity must have a similar policy for reporting investment gains and income, reports consistently from period to period, and discloses its accounting policy in the notes to the financial statements. This is illustrated in exhibit 3-4.
NFP entities are required to report expenses gross, where gains and losses may be reported net. In addition, expenses are always reported as decreases in net assets without donor restrictions. Gains and losses may change the other class of net assets if the use of such gains and losses is restricted by a donor or law.
NFP entities are required to report information about the nature and functional classification of expenses, such as major classes of program services and supporting activities. This information can be presented on the face of the statement of activities, as a separate statement, or in the notes to the financial statements.
The proper classification of expenses between program services and supporting activities is often important to NFP entities. There are special rules for allocation costs of an activity that combines fund-raising activities with activities that have elements of another function (joint activities).
The expiration of the donor-imposed restriction simultaneously increases net assets without donor restrictions and decreases net assets with donor restrictions (reclassifications) which are reported as separate items in the statement of activities.
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