Unrestricted Net Assets (Net Assets Without Donor Restrictions)

Unrestricted net assets are defined in the FASB ASC Master Glossary as net assets that are neither temporarily restricted nor permanently restricted. Therefore, they include all net assets with uses not restricted by donors.

Unrestricted net assets 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 unrestricted net assets 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 unrestricted net assets 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 unrestricted net assets 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.

Another example of a board-designated limitation on the use of unrestricted net assets 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 unrestricted net assets. 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 unrestricted net assets 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 unrestricted net assets 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 unrestricted net assets, 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 unrestricted net assets as “invested in property, plant, and equipment, net of related debt” with the balance reported as unrestricted net assets 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 2015) (the AICPA Guide) includes guidance on the classification of net assets in consolidation. Specifically, paragraph 3.104 of the AICPA Guide addresses whether the unrestricted net assets of subsidiary not-for-profit organizations should always be combined with the unrestricted net assets of the parent organization and thus continue to be reported as unrestricted net assets 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 unrestricted 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 unrestricted net assets of the subsidiary should be reported as temporarily restricted net assets 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 unrestricted net assets. However, if the educational subsidiary is consolidated with the parent membership organization's financial statements, these same contributions will result in donor-restricted net assets that are temporarily restricted. 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 temporarily restricted net assets.

Temporarily Restricted Net Assets (A Component of Net Assets with Donor Restrictions)

Temporarily restricted net assets are 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. Upon implementation of ASU 2016-14, 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 concepts 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.

Temporarily restricted net assets generally result from the following:

1. 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.
2. Other asset enhancements and diminishments subject to the same kinds of stipulations.
3. Reclassifications to other classes 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 temporarily restricted to unrestricted net assets, rather than from unrestricted net assets to temporarily restricted. Not-for-profit organizations will report expenses related to net assets that are temporarily restricted by donors as decreases in unrestricted net assets on the statement of activities. As the temporary restrictions are satisfied, the statement of activities will reflect a transfer of net assets from temporarily restricted net assets to unrestricted net assets. 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 unrestricted net assets. Since the purpose restriction has been fulfilled, a transfer is reflected on the statement of activities moving temporarily restricted net assets to unrestricted net assets, since there is no longer a temporary restriction on those assets—it has been fulfilled.

Permanently Restricted Net Assets (A Component of Net Assets with Donor Restrictions)

Permanently restricted net assets are those that the donor stipulates must be maintained by the organization in perpetuity. Permanently restricted net assets 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 permanently in the organization's collections should be recognized as increases in permanently restricted net assets.

Permanently restricted net assets may also change as a result of increases and decreases in existing assets that are subject to permanent 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 permanently restricted net assets to the extent that donor stipulations or applicable law requires those increases to be retained permanently.

In summary, permanently restricted net assets generally result from the following:

1. Contributions with donor-imposed permanent restrictions;
2. 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 permanently restricted);
3. Reclassifications from another net asset class as a result of donor stipulations or by law (usually from temporarily restricted net assets).

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 unrestricted actually should have been reported as permanently restricted. 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 permanently restricted 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. Under existing GAAP, permanently restricted net assets are not reduced by losses on the investments of the fund (except to the extent required by the donor, including losses that the donor requires the organization to hold in perpetuity), nor are they reduced by an organization's appropriations from the fund. Losses on permanently restricted endowment funds reduce temporarily restricted net assets to the extent that donor-imposed temporary restrictions on net appreciation of the fund have not been met before the loss occurs. Any remaining loss shall reduce the unrestricted net assets. Upon implementation of ASU 2016-14, net assets without donor restrictions will not be reduced for losses on endowment funds. Rather, the endowment funds (which are part of net assets with donor restrictions) will be reported at their reduced amount and reflect any losses in excess of previous gains or unappropriated earnings.

GAAP now provides that for donor-restricted endowment funds, a not-for-profit organization should classify the portion of the fund that is not classified as permanently restricted as temporarily restricted (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 unrestricted net assets.

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 three 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 permanent restrictions, 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 temporary 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.

ASU 2016-14 Changes to Net Asset Classifications and Endowments

As mentioned earlier in this chapter the FASB issued Accounting Standards Update 2016-14 entitled Not-for-Profit Entities (Topic 958) Presentation of Financial Statements of Not-for-Profit Entities. Upon implementation of ASU 2016-14 net assets will be reported in two classes—net assets with donor restrictions and net assets without donor restrictions, rather than for the currently required three classes. ASU 2016-14 is effective for annual financial statements issued for fiscal years beginning after December 15, 2017, with early application permitted.

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 contributions, 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:

1. The nature of the not-for-profit entity (NFP);
2. The environment in which it operates;
3. 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 current 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 include 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.