FAR

6
NFP Accounting and
Governmental Accounting

Module

1 Not-for-Profit Financial Reporting: Part 1 3

2 Not-for-Profit Financial Reporting: Part 2 15

3 Not-for-Profit Revenue Recognition 21

4 Not-for-Profit Transfers of Assets

and Other Accounting Issues 31

5 Governmental Accounting Overview 37

6 Governmental Fund Structure and Fund Accounting 45

 NOTES

F6–2 © Becker Professional Education Corporation. All rights reserved.

1
MODULE

Not-for-Profit Financial
Reporting: Part 1 FAR 6

1 Introduction to Not-for-Profit Accounting

1.1 Characteristics of Not-for-Profit Organizations

Not-for-profit entities are defined by the FASB as entities that have the following characteristics:
1. Their revenues come from contributions.
2. Their operating purpose does not include profit, although there is nothing to preclude the
generation of a profit.
3. Their ownership interests are unlike business enterprises.

1.2 Industries That Use Not-for-Profit Accounting

Not-for-profit entities are generally divided into four separate categories related to various
industries:
Health Care Organizations
y Hospitals
y Nursing homes
y Hospices
Educational Institutions
y Colleges and universities
y Other schools
Voluntary Health and Welfare Organizations
y United Way
y American Red Cross
y March of Dimes
Other Private (Not Governmental) Not-for-Profit Organizations
y Cemetery organizations
y Fraternal organizations
y Labor unions
y Museums, libraries, and performing arts organizations
y Professional organizations (e.g., the AICPA)

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1 Not-for-Profit Financial Reporting: Part 1 FAR 6

1.3 Users of Not-for-Profit Financial Statements

Users of not-for-profit financial statements include donors, members, creditors, and others who
provide resources to the not-for-profit entity (e.g., the government via grants, etc.).

1.3.1 Needs of Users

Users of not-for-profit financial statements have common needs. These common needs include
the ability to assess:
The services the organization provides.
The organization's ability to continue to provide those services.
The method the organization's managers use to discharge their stewardship responsibility.

1.3.2 Financial Statement Information

The following information should be provided in not-for-profit organization financial statements
in order to meet these common needs:
The amount and nature of an organization's assets, liabilities, and net assets (Statement of
Financial Position).
The effects of events and circumstances that change the amount and nature of net assets
(Statement of Activities).
The amount and kinds of inflows and outflows of economic resources occurring within a
period (Statement of Activities).
The relationship between the inflows and outflows (Statement of Activities).
How an organization obtains and spends cash (Statement of Cash Flows).
The service efforts of an organization (Statement of Activities or Notes to Financial
Statements).

1.4 Full Accrual Basis of Accounting

Generally accepted accounting principles require that not-for-profit organizations report using
the full accrual basis of accounting.
The primary reporting emphasis is placed on disclosing the sources of the institution's resources
and how they were expended, rather than on the periodic determination of net income.
The overall emphasis for not-for-profit financial statements is on basic information for the
organization as a whole.

Pass Key

The external financial statements of not-for-profit entities do not present funds. The focus
of the financial statements is on the basic information of the organization taken as a whole.

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FAR 6 1 Not-for-Profit Financial Reporting: Part 1

2 Not-for-Profit Financial Reporting Standards

2.1 FASB ASC

The external financial reporting standards for not-for-profit organizations are outlined in the
FASB Accounting Standards Codification (ASC). General principles of not-for-profit financial
reporting include the following:
All types of private, not-for-profit organizations are required to have consistent external
reporting, making it easier to compare the performance of different not‑for‑profit
organizations.
Fund accounting is not used for external financial reporting, although separate funds may
be maintained for internal purposes.
External financial statements must focus on the basic information for the organization as
a whole.
Governmental not-for-profits (for example, a state university) are governed by the
Government Accounting Standards Board (GASB), not the FASB.

2.2 Required Financial Statements

A complete set of general purpose, external financial statements for a not-for-profit entity
include the following:
Statement of Financial Position (equivalent to a commercial Balance Sheet)
Statement of Activities (equivalent to a commercial Income Statement and Statement of
Changes in Retained Earnings)
Statement of Cash Flows (equivalent to a commercial Statement of Cash Flows using either
the direct or indirect method)

2.3 Reporting Expenses by Nature and Function

All not-for-profit organizations must report information about the relationships between
functional classifications and natural classifications of expenses in one location. Not-for-profits
have the latitude to report in one of three ways:
On the face of the Statement of Activities
As a schedule in the notes to the financial statements
In a separate financial statement (no specific title provided by the FASB)

Pass Key

Functional classifications of expenses categorize costs by major classes of program and

support services. Program services relate to the purpose and mission of the not-for‑profit
organization; support services relate to such activities as management and general,
fundraising, and membership development.
Natural classifications of expenses include such descriptions as salaries, rent, utilities,
interest expense, supplies, etc., similar to general ledger titles for expense.

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1 Not-for-Profit Financial Reporting: Part 1 FAR 6

3 Statement of Financial Position

3.1 Components of the Statement of Financial Position

The not-for-profit statement of financial position is divided into three major components:
Assets
Liabilities
Net assets (equity)

3.2 Sequence of Account Display for Assets and Liabilities

Assets and liabilities should be presented based on the following principles:
Assets and liabilities should be classified as current or non-current;
Assets should be sequenced by nearness to cash, and liabilities sequenced by nearness to
maturity; and
Assets restricted or designated for non-current purposes (e.g., debt liquidation, acquisition
of long lived assets, etc.) should be displayed as non-current.

3.3 Net Assets (With and Without Donor Restrictions)

The components of net assets of not-for-profit organizations may include one or both of the
following two classifications: with donor restrictions or without donor restrictions. Classifications
are based on the existence or absence of donor-imposed restrictions.

3.3.1 Net Assets Without Donor Restrictions

Net assets without donor restrictions are available to finance general operations of a
not‑for‑profit organization and may be expended at the discretion of the governing board.
Net assets without donor restrictions are not otherwise restricted by external donor-
imposed restrictions.
Internal board-designated funds are classified as net assets without donor restrictions and
may include:
y Board-designated endowment funds
y Board-designated net assets (for future expenditure)

3.3.2 Net Assets With Donor Restrictions

Net assets with donor restrictions are subject to specific, externally imposed limitations made
by a donor. Information regarding the nature and amounts of different types of donor-imposed
restrictions should be either reported within the financial statement classification of net assets
with donor restrictions or in the notes to the financial statements. Examples of various types of
donor-imposed restrictions include:
Support of particular operating activity
Investment for a specified term
Use in specified period
Acquisition of long-lived assets

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FAR 6 1 Not-for-Profit Financial Reporting: Part 1

Assets that are to be used for a specified purpose and not sold
Donor-restricted endowments that are perpetual in nature (assets donated with a
stipulation that they be invested to provide a permanent source of income)

Pass Key

Internal board-designated funds are classified as net assets without donor restrictions. The
examiners sometimes try to trick candidates with incorrect answer options that suggest
board‑designated endowment funds created by self-imposed limits should be reported as
net assets with donor restrictions

3.4 Statement of Financial Position Disclosures

Not-for-profit entities must disclose relevant information about the liquidity or maturity of
assets and liabilities including restrictions and self-imposed limits on the use of particular
items. In addition to information displayed on the face of the statement of financial position,
not‑for‑profit organizations must disclose in the notes of the financial statements:
Qualitative information useful in assessing liquidity, including how the organization
manages its liquid resources to meet cash needs for general expenditures within one year
of the statement of financial position date. Additional qualitative disclosures include:
y A description of the type of asset whose use is limited
y Nature and amount of limits
y Contractual limits
y How and when resources can be used
Quantitative information that displays or discloses the availability of its liquid resources as
affected by:
y The nature of the resources
y External limits imposed by donors
y Internal limits imposed by governing boards

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1 Not-for-Profit Financial Reporting: Part 1 FAR 6

3.4.1 Supplemental Disclosures, Net Assets With Donor Restrictions

Not-for-Profit Organization
Notes to Financial Statements
Net Assets With Donor Restrictions
As of December 31, Year 2
(in thousands)

Net assets with donor restrictions are restricted for the following purposes or periods:
Subject to expenditure for specified purpose
Program Alpha activities
Purchase of equipment $ 3,060
Research and seminars 1,190
Program Beta activities
Disaster relief 1,025
Program Gamma activities
Building and equipment 2,150
Research 3,025
Subtotal $ 10,450
Subject to the passage of time
For periods after Year 2 3,140
Subject to Not-for-Profit spending policy and appropriations
Investment in perpetuity, which once appropriated is expendable
to support:
Program Alpha activities $ 33,300
Program Beta activities 15,820
Program Gamma activities 16,480
Any activities of the organization 109,100
Subtotal 174,700
Subject to appropriation and expenditure when a specified event
occurs
Endowment requiring income to be added to original gift until the
fund's value is $2,500 $ 2,120
Paid-up life insurance policy that will provide proceeds upon the
death of insured for an endowment to support general activities 80
Subtotal 2,200
Not subject to appropriation or expenditure
Land required to be used for a recreational area 3,000
Total net assets with donor restrictions $193,490

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FAR 6 1 Not-for-Profit Financial Reporting: Part 1

3.4.2 Supplemental Disclosures, Net Assets Without Donor Restrictions

Not-for-Profit Organization
Notes to Financial Statements
Net Assets Without Donor Restrictions
As of December 31, Year 2
(in thousands)

Not-for-Profit Organization's governing board has designated, from net assets without donor
restrictions of $92,600, net assets for the following purpose as of December 31, Year 2.
Quasi-endowment $36,600
Liquidity reserve 1,300
Total $37,900

Not-for-Profit Organization
Statement of Financial Position
As of December 31, Year 2 and Year 1
(in thousands)

Year 2 Year 1
Assets:
Cash and cash equivalents $ 4,575 $ 4,960
Accounts and interest receivable 2,130 1,670
Inventories and prepaid expenses 610 1,000
Contributions receivable 3,025 2,700
Short-term investments 1,400 1,000
Assets restricted to investment in land, buildings, and equipment 5,210 4,560
Land, buildings, and equipment 61,700 63,590
Long-term investments 218,160 203,500
Total assets $296,720 $282,980
Liabilities and net assets:
Liabilities:
Accounts payable $ 2,570 $ 1,050
Refundable advance – 650
Grants payable 875 1,300
Notes payable – 1,140
Annuities obligations 1,685 1,700
Long-term debt 5,500 6,500
Total liabilities 10,630 12,340
Net assets:
Without donor restrictions 92,600 84,570
With donor restrictions 193,490 186,070
Total net assets 286,090 270,640
Total liabilities and net assets $296,720 $282,980

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1 Not-for-Profit Financial Reporting: Part 1 FAR 6

4 Statement of Activities

4.1 Elements of the Statement of Activities

The not-for-profit statement of activities reports revenues and expenses (shown gross), gains
and losses (often shown net), and reclassification between classes of net assets (for example,
from net assets with donor restrictions to net assets without donor restrictions, once restrictions
have been satisfied).

4.1.1 Required Elements

Three required elements are presented in the statement of activities:
1. Change in total net assets.
2. Change in net assets without donor restrictions.
3. Change in net assets with donor restrictions.

4.1.2 Format
Preparers have latitude in presentation formats that sequence data in any number of orders,
including:
Revenues, expenses, gains and losses, and reclassification of assets shown last.
Certain revenues less directly related to expenses, followed by a subtotal, then other
revenues and other expenses, gains and losses, and reclassification of net assets.
Expenses followed by revenues, gains and losses, and the reclassification of net assets.
Other formatting issues to consider include:
Presentation of intermediate totals such as operating income should be disclosed in the
notes to the financial statements.
Prior period adjustments and changes in accounting principle are reported as adjustments
to beginning net assets.
Items classified as other comprehensive income in commercial accounting are presented in
the statement of activities after operating income.

4.2 Classification of Revenue, Gains, and Other Support

Revenues are classified into one of two categories, according to the existence or absence of
donor-imposed restrictions.

4.2.1 Net Assets Without Donor Restrictions

Revenues are classified as net assets without donor restrictions unless the use of the assets
received is limited by donor-imposed restrictions. Examples of revenues received without donor
restrictions include:
Fees from rendering services.
Contributions that have no explicit donor stipulation restricting use.
Gains and losses recognized on investment that are not accompanied with explicit donor
restrictions (investment returns are displayed net of related expenses).

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FAR 6 1 Not-for-Profit Financial Reporting: Part 1

4.2.2 Net Assets With Donor Restrictions

Revenues are classified as net assets with donor restrictions (donor-restricted support) if the use
of the asset received is limited by donor-imposed restrictions. All restricted revenue is included
in the same classification regardless of whether the restriction is perpetual or if the restriction
can be satisfied by the recipient. Classification grouping does not, however, preclude the not-
for‑profit organization from itemizing the character of restrictions on either the face of the
financial statements or the notes. Examples of revenues received with donor restrictions include:
Contributions subject to expenditure for a specified purpose (e.g. programs or capital projects).
Contributions subject to the passage of time.
Contributions associated with restrictions that are otherwise temporary in nature.
Contributions requiring investment in perpetuity with returns eligible for appropriation
(e.g., donor-restricted endowment funds).

4.3 Reclassification of Restrictions

Contributions with donor-imposed restrictions are recognized as donor-restricted support in the
period in which they are received and recognized as an increase to net assets with donor restrictions.
When a donor restriction is satisfied, a reclassification is reported on the statement of activities.
Reclassifications are items that simultaneously increase one net asset class and decrease another.
Donor-imposed restrictions that are met in the same period they are received may be
recorded as an increase to net assets without donor restrictions (contribution revenue),
provided that the organization discloses and consistently applies this accounting policy.
Support that results in perpetually restricted net assets ordinarily are not reclassified,
because the donor restrictions never expire.
Revenue, gains, and other support that result in an increase to net assets without donor
restrictions ordinarily do not become restricted.

Illustration 1 Reclassification

A not-for-profit clinic receives operating subsidies for indigent care under a state contract.
The contract represents a donor-restricted contribution to the clinic; however, the clinic
routinely spends adequate amounts on the state-funded services to reclassify the funding
from net assets with donor restrictions to net assets without donor restrictions in the
year received. Assuming consistent application of its accounting policies, the clinic has
the option of immediately reporting the subsidies received under the state contract as an
increase to net assets without donor restrictions.

4.4 Expense Classification in the Statement of Activities

All expenses (other than investment expenses) are reported as decreases in net assets without
donor restrictions. Investment expense is netted against investment returns and classified
according to the requirements of the investment revenue. Details of functional classifications
and their relationship to natural expense classifications must be presented on the face of the
financial statements or the notes. Examples of functional expense classifications are as follows:

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1 Not-for-Profit Financial Reporting: Part 1 FAR 6

4.4.1 Program Services

Program services (expenses) are the activities for which the organization is chartered. Examples are:
Universities: Education and research
Hospitals: Patient care and education
Union: Labor negotiations and training
Day Care: Child care

4.4.2 Support Services

Supporting services include everything not classified as a program service. Examples are:
Fundraising
Management and general (administrative expenses)
Membership development

4.4.3 Combined Costs

Not-for-profit organizations that combine fundraising efforts with educational (or program)
services should allocate the combined cost between functions.

Not-for-Profit Organization
Statement of Activities
For the Year Ended December 31, Year 2
(in thousands)

Without
Donor With Donor
Restrictions Restrictions Total
Revenues, gains, and other support:
Contributions of cash and other financial assets $ 6,790 $ 7,430 $ 14,220
Contributions of nonfinancial assets 1,850 960 2,810
Fees 5,200 – 5,200
Investment return, net 6,650 18,300 24,950
Gain on sale of equipment 200 – 200
Other 150 – 150
Net assets released from restrictions
Satisfaction of program restrictions 8,990 (8,990) –
Satisfaction of equipment acquisition
restrictions 1,500 (1,500) –
Expiration of time restrictions 1,250 (1,250) –
Appropriation from donor endowment and
subsequent satisfaction of any related
donor restrictions 7,500 (7,500) –
Total net assets released from restrictions 19,240 (19,240) –
Total revenues, gains, and other support 40,080 7,450 47,530

(continued)

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FAR 6 1 Not-for-Profit Financial Reporting: Part 1

(continued)

Expenses and losses:

Program Alpha 13,296 – 13,296
Program Beta 8,649 – 8,649
Program Gamma 5,837 – 5,837
Management and general 2,038 – 2,038
Fundraising 2,150 – 2,150
Total expenses 31,970 – 31,970
Fire loss 80 – 80
Actuarial loss on annuity obligations – 30 30
Total expenses and losses 32,050 30 32,080
Changes in net assets 8,030 7,420 15,450
Net assets at beginning of year 84,570 186,070 270,640
Net assets at end of year $92,600 $193,490 $286,090

4.4.4 Reporting Expenses by Nature and Function

Expense information should include the relationships between functional classifications and
natural classifications.
Functional expenses should be classified as:
y Major classes of program services; or
y Supporting activities
Natural expense components of each functional expense must be presented, including such
classifications as:
y Salaries
y Rent
y Electricity
y Supplies
y Interest expense
y Depreciation
y Awards and grants
y Professional fees
Gains and losses and external and direct internal investment expenses that have been netted
against the investment return should not be included in the functional expense analysis.

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1 Not-for-Profit Financial Reporting: Part 1 FAR 6

Not-for-Profit Organization
Notes to Financial Statements
Expenses Classification
For the Year Ended December 31, Year 2
(in thousands)

The table below presents expenses by both their nature and function.

Program Activities Supporting Activities

Programs Management Fund- Supporting Total
Alpha Beta Gamma Subtotal and General raising Subtotal Expenses
Salaries and benefits $ 7,400 $3,900 $1,725 $13,025 $1,130 $ 960 $2,090 $15,115
Grants to other
organizations 2,075 750 1,925 4,750 ­– – – 4,750
Supplies and travel 890 1,013 499 2,402 213 540 753 3,155
Services and
professional fees 160 1,490 600 2,250 200 390 590 2,840
Office and occupancy 1,160 600 450 2,210 218 100 318 2,528
Depreciation 1,440 800 570 2,810 250 140 390 3,200
Interest 171 96 68 335 27 20 47 382
Total expenses $13,296 $8,649 $5,837 $27,782 $2,038 $2,150 $4,188 $31,970

The financial statements report certain categories of expenses that are attributable to more than one
program or supporting function. Therefore, these expenses require allocation on a reasonable basis
that is consistently applied. The expenses that are allocated include depreciation, interest, and office
and occupancy, which are allocated on a square footage basis, as well as salaries and benefits, which
are allocated on the basis of estimated time and effort.

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2
MODULE

Not-for-Profit Financial
Reporting: Part 2 FAR 6

1 Statement of Cash Flows

A statement of cash flows is required for all not-for-profit organizations. FASB ASC 230 is
applicable to not-for-profit organizations, to the extent that it does not conflict with industry
guidance. Identical to commercial standards, the primary purpose of the statement of cash
flows is to provide relevant information about the cash receipts and cash payments of the
not‑for‑profit organization during a period. The statement classifies cash receipts and cash
payments as operating, investing, and financing activities, and either the direct or the indirect
method may be used. The use of the direct method, however, does not require presentation of
the reconciliation of net income to cash flows from operations.

1.1 Classification of Sources and Uses of Cash

1.1.1 Operating Activities
Sources and uses of cash classified by a not-for-profit organization as operating activities include
receipts and payments that do not stem from transactions defined as investing or financing,
such as:
Receipts or payments for the settlement of lawsuits.
Proceeds from insurance settlements (other than those specifically associated with investing
activities such as the destruction of a building).
Refunds from suppliers or refunds to customers.
Charitable contributions (and disbursements) made by the not-for-profit.
Specifically identified transactions to be classified as cash flows from operations also include:
Reported activity by major class of gross receipts (when the direct method is used), including
contributions, program income, and interest or dividend income.
Receipts of unrestricted resources designated by the governing body to be used for
long‑lived assets.
Proceeds from the sale of financial assets not restricted for long-term purposes.
Cash payments to suppliers and employees.
Cash payments for interest.
Cash activity associated with agency transactions.

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2 Not-for-Profit Financial Reporting: Part 2 FAR 6

Pass Key

Contributions of unrestricted revenue later earmarked (board designated) for construction

or purchase of long-lived assets is classified as cash flows from operating activities.

1.1.2 Investing Activities

Sources and uses of cash classified by a not-for-profit organization as investing activities include
receipts and payments for such items as:
Investments in property, plant, and equipment.
Proceeds from the sale of works of art or disbursements for purchases of works of art.
Proceeds from the sale of assets that were received in the prior period and whose sale
proceeds were restricted to investment in equipment.

1.1.3 Financing Activities

Sources and uses of cash classified by a not-for-profit organization as financing activities include
receipts and payments for such items as:
Proceeds from issuing bonds, mortgages, notes, and other short- or long-term borrowing.
Repayment of amounts borrowed.
Receipts from contributions restricted for the purpose of acquiring, constructing, or
improving property, plant, and equipment or other long-lived assets.
Receipts from contributions restricted for the purpose of establishing or increasing a
donor‑restricted endowment fund.

Pass Key

Cash flows from financing activities not only include the cash transactions related to
borrowing that are typically found in a commercial statement of cash flows, but also
include cash transactions related to certain restricted contributions. Cash flows from
financial activities may be segregated on the face of the financial statements as follows:
— Proceeds from Donor-Restricted Contributions (for long-lived assets)
— Other Financing Activities

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FAR 6 2 Not-for-Profit Financial Reporting: Part 2

1.1.4 Cash and Cash Equivalents

The statement of cash flows will explain the change during the period of total cash and
cash equivalents and amounts generally described as restricted consistent with commercial
accounting. Transfers among cash, cash equivalents, and amounts generally described as
restricted are not reported as cash flow activities in the statement of cash flows.

Pass Key

Note that in not-for-profit reporting, the statement of cash flows has the three typical
commercial classifications: operating activities, financing activities, and investing activities.

1.1.5 Noncash Transactions

Noncash transactions that should be disclosed in the statement of cash flows include:
Contributed securities.
Construction in progress and other fixed asset purchases included in accounts payable.
Contributions of beneficial interests (unconditional promises to receive specified cash flows
from a charitable trust or other identifiable pool of assets).
Noncash debt refinancing transactions (e.g., changes in interest rates or other terms, etc.).

1.1.6 Direct Method (Supplemental Reconciliation of Cash Flow

From Operations Not Required)
Not-for-profits that use the direct method of reporting net cash flows from operations are not
required to provide a reconciliation of change in net assets to net cash flows from operating
activity. This is in contrast to an entity other than a not-for-profit organization (a commercial
entity), which is required to provide the reconciliation in a separate schedule.

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2 Not-for-Profit Financial Reporting: Part 2 FAR 6

Not-for-Profit Organization
Statement of Cash Flows
For the Year Ended December 31, Year 2
(in thousands)

Cash flows from operating activities:

Change in net assets $15,450
Adjustments to reconcile change in net assets to net cash
used by operating activities:
Depreciation 3,200
Fire loss 80
Actuarial loss on annuity obligations 30
Gain on sale of equipment (200)
Increase in accounts and interest receivable (460)
Decrease in inventories and prepaid expenses 390
Increase in contributions receivable (325)
Increase in accounts payable 1,520
Decrease in refundable advance (650)
Decrease in grants payable (425)
Contributions restricted for long-term investment (2,740)
Interest and dividends restricted for reinvestment (300)
Realized and unrealized gains on investments (15,800)
Net cash used by operating activities $(230)
Cash flows from investing activities:
Proceeds on sale of equipment 200
Insurance proceeds from fire loss on building 250
Purchase of equipment (1,500)
Proceeds from sale of investments 76,100
Purchase of investments (75,000)
Net cash used by investing activities 50
Cash flows from financing activities:
Proceeds from contributions restricted for:
Investment in perpetual endowment $ 200
Investment in term endowment 70
Investment in land, buildings, and equipment 1,210
Investment subject to annuity agreements 200
1,680
Other financing activities:
Interest and dividends restricted for reinvestment 300
Payments of annuity obligations (145)
Payments on notes payable (1,140)
Payments on long-term debt (1,000)
(1,985)
Net cash used by financing activities (305)
Net decrease in cash, cash equivalents, and restricted cash (485)
Cash, cash equivalents, and restricted cash at beginning of year 5120
Cash, cash equivalents, and restricted cash at end of year $4,635

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FAR 6 2 Not-for-Profit Financial Reporting: Part 2

Note H
The following table provides a reconciliation of cash, cash equivalents, and restricted cash
reported within the statement of financial position that sum to the total of the same such
amounts shown in the statement of cash flows:

12/31/Yr 2
Cash and cash equivalents $4,575
Restricted cash included in assets restricted to
investment in land, buildings, and equipment 60
Total cash, cash equivalents, and restricted cash shown
in the statement of cash flows $4,635

Assets restricted to investment in land, buildings, and equipment on the statement of

financial position include restricted cash received with a donor-imposed restriction that
limits use of that cash to long-term purposes.

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2 Not-for-Profit Financial Reporting: Part 2 FAR 6

NOTES

F6–20 Module 2 Not-for-Profit

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3
MODULE

Not-for-Profit
Revenue Recognition FAR 6

1 Revenue From Exchange Transactions

An exchange transaction is one in which the not-for-profit organization earns resources in
exchange for a service performed. Revenues from not-for-profit exchange transactions are
recognized when realized or realizable and earned.
Revenues from exchange transactions are classified as increases to net assets without
donor restrictions.
The following are examples of revenues earned by not-for-profits in exchange transactions:
Student tuition and fees earned by not-for-profit educational institutions.
Patient service revenue earned by not-for-profit health care organizations.
Membership fees earned by not-for-profit membership organizations.

2 Contributions Received
A contribution is defined as an unconditional transfer of cash or assets (collection is certain) to
a new owner (title passes) in a manner which is voluntary (the donor is under no obligation to
donate) and is nonreciprocal (the donor gets nothing in exchange). Contributions may include
cash, services, and other assets.

2.1 Recognition
Unconditional contributions are recognized as revenues or gains and reported as either an
increase to net assets without donor restrictions or donor-restricted support in the period
received and as assets, decreases of liabilities, or expenses, depending on the form of the
benefits received. A contribution is classified as revenue if it is part of the ongoing major
or central activities of the not‑for‑profit organization. A contribution is classified as a gain if
the transaction is incidental to the purpose of the not-for-profit organization. Conditional
contributions are not recognized. Conditions are indicated by the existence of both barriers and
the right of the donor to demand return of the contribution.

2.1.1 Barriers That Indicate a Conditional Contribution

The existence of measurable performance-related barriers or other barriers that may indicate a
condition include:
Specified levels of service (e.g., the provision of a specific number of meals at a facility).
Specific outputs or outcomes (e.g., the construction of a building to an exact architectural
design, the achievement of specific program objectives, or the conditioning of revenue on
incurring specific eligible expenses).
Matching (e.g., revenue conditioned on the collection or accumulation of community match).
Outside event (e.g., the satisfaction of a contingency outside the control of the not-for-profit
receiving the contribution).

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2.1.2 Right of Return

The donor has the right to require return of the donation from the recipient not-for-profit
organization.

2.2 Cash Contributions

Cash contributions should be recognized as revenues or gains and reported as contributions
that increase net assets without donor restrictions or donor-restricted support in the period in
which they are received, and they should be measured at their fair value at the date of the gift.

2.3 Promises to Give (Pledges)

2.3.1 Unconditional Promises
An unconditional promise to give (also known as a pledge) is a contribution and is recorded at
its fair value when the promise is made. An unconditional promise may be written or verbal.
However, verbal pledges should be documented by the organization internally and may be more
difficult to collect.

2.3.2 Conditional Promises

A conditional promise to give (or pledge) is a transaction that depends on an occurrence of a
future and uncertain event. Recognition does not occur until the conditions are substantially met
(or when it can be determined that the chances of not meeting the conditions are remote) and
the promise becomes unconditional.
Good faith deposits that accompany a conditional promise are accounted for as a refundable
advance in the liability section of the statement of financial position.
To recognize a good faith deposit received before the conditions of a conditional promise are met by
the not-for-profit:

DR Cash $XXX
CR Refundable advance $XXX

Pass Key

Conditions are not synonymous with donor restriction. Donor restrictions are satisfied by
the not-for-profit organization by use of the donated resources consistent with restrictions.
Conditions are satisfied by the resolution of barriers used to condition the contribution by
the donor.

2.3.3 Multiyear Pledges

Multiyear pledges are recorded at the net present value at the date the pledge is made. Future
collections are considered donor-restricted revenues and net assets (time-restricted). The
difference between the previously recorded present value and the current amount collected is
recognized as contribution revenue, not interest income.

2.3.4 Placed-in-Service Approach

In the absence of specific donor restrictions, not-for-profits must use the placed-in-service
approach to report the expiration of restrictions on contributions associated with long-lived assets.

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Illustration 1 Placed-in-Service Approach

Community Not-for-Profit Inc. receives a building from Gerry Generous at the beginning
of the year and immediately begins to use it in a manner consistent with its mission. Gerry
places no restrictions on the building. The building has a value of $200,000 and it has a
20‑year life. Community Not-for-Profit Inc. would recognize the entire $200,000 donation as
a contribution without donor restriction using the placed-in-service approach.
Community Not-for-Profit Inc. also receives a building from the River City. The building
is also valued at $200,000 with a 20-year life. The City stipulates that the building must
be used for specific community programs and, if it is not used for that purpose, the
building's ownership will revert to the City. Community Not-for-Profit Inc. would record the
building as an asset and donor-restricted support of $200,000. Each year that Community
Not‑for‑Profit met its restrictions, it would record depreciation expense of $10,000 and
would reclassify $10,000 from net assets with restrictions to net assets without restrictions.

2.3.5 Allowance for Uncollectible Pledges

An allowance for uncollectible pledges should be recorded in accordance with commercial
accounting principles for accounts receivable in order to present the pledge at its net realizable
value. However, in contrast to commercial accounting principles, there is no bad debt (or bad
contribution) expense recognized at any point. Instead, both the pledge and related contribution
revenue are reported net of any allowance.

2.4 Split-Interest Agreements

Split-interest agreements represent donor contributions of trusts or other arrangements under
which the not-for-profit organization receives benefits that are shared with other beneficiaries.
Examples include:
y Charitable lead trust
y Perpetual trust held by a third party
y Charitable remainder trust
y Charitable gift annuity
y Pooled life income fund
During the term of the agreement, changes in the value of split-interest agreements should
be recognized for:
y Amortization of discounts
y Revaluations
Assets and liabilities recognized under split-interest agreements should be disclosed
separately from other assets and liabilities in the statement of financial position.
Contributions and changes in the value of split-interest agreements should be disclosed as
separate line items in the statement of activities (or the related notes).
Split-interest contributions should be:
y measured at their fair values at the date of acquisition;
y estimated based on the present value of the estimated future distributions; and
y displayed as donor-restricted.

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Pass Key

Do not confuse the net asset classification concept of with versus without donor
restrictions with the revenue recognition concept of conditional versus unconditional.
Unconditional pledges are assured of collection and may be recognized as either with or
without donor restrictions. Conditional pledges are still subject to important contingencies
and are not recorded.

2.5 Donated Services

Donated services received by a not-for-profit organization are generally not recorded because
of the difficulty in placing a monetary value on donated services (and the absence of control
over them). However, donated services should be recorded as a contribution and expense at fair
value if the services meet one of the following criteria:
They create or enhance a nonfinancial asset (e.g., land, building, inventory, etc.); or
They require specialized skills that the provider possesses and would otherwise have been
purchased by the organization (e.g., attorney, accountant, and doctor services, etc.).

Pass Key

Contributions of services that do not enhance nonfinancial assets are recognized only
SOME of the time:
— Specialized skills are required and possessed by the donor
— Otherwise needed by the organization
— Measurable
— Easily (at fair value)

Donated services that qualify for recognition are displayed as nonoperating.

The following journal entry is used to record contributed services that meet the criteria for recognition:

DR Expense or asset $XXX

CR Contributions—without donor restrictions $XXX

2.5.1 Examples
An attorney provides general counsel services to a not-for-profit organization. Services
would be recognized at an appropriate market rate.
A doctor provides services to a clinic for a vastly reduced fee. The difference between the
market rate of the service and the amount paid would be recognized as a contribution.
An individual volunteers to fill a budgeted position doing general office work. The time
will be recognized as a contribution at an appropriate rate. Another individual offers to
volunteer to do general office work, but there is no budget for the work performed. The
unbudgeted time will not be recognized as a contribution.

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Illustration 2 Donated Services

A storm damaged the roof of a new building owned by K-9 Shelters, a not-for-profit
organization. A supporter of K-9, a professional roofer, repaired the roof at no charge. The
value of the repairs was $10,000.
In K-9's statement of activities, the repair of the roof should be reported as an increase to
expenses and contributions using the following journal entry:

DR Expense $10,000
CR Contribution without donor restrictions $10,000

2.5.2 Volunteer Recruitment

Costs of soliciting contributed services are considered fundraising expenses regardless of
whether services meet recognition criteria.

2.6 Donated Collection Items

Donated collection items are contributed works of art or historical treasures. They are not
required to be recorded by the recipient not-for-profit organization if all of the following
requirements are met:
1. The item is part of a collection, which is held for public viewing, exhibition, education, or
research (and not for investment or financial gain);
2. The collection is cared for, preserved, and protected by the organization; and
3. The organization has a policy that requires any proceeds from the sale of donated items
to be reinvested in other collection items or used to support the direct care of existing
collections.
Note: If the preceding requirements are not met, the donation must be recognized as an asset
and revenue. The policy may not be selectively applied and must be used for all assets.

2.7 Donated Materials

If significant in amount, donated materials should be recorded at their fair value on the date of receipt
if the fair value can be objectively determined.

DR Asset $XXX
CR Contribution—support $XXX

Donated materials that merely pass through the organization to an ultimate beneficiary, such as
used clothing, should not be recorded, unless the amounts involved are substantial.
Assuming that donated materials are substantial, they should be recorded as a contribution with an
offsetting entry to expenses and appropriately disclosed in the financial statements.

DR Expense $XXX
CR Contributions—supplies $XXX

When donated items are sold at greater than fair value, the amount received in excess of fair
value is considered an additional contribution.

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2.8 Gifts-in-Kind
Noncash contributions, such as donated investments, are called gifts-in-kind. A gift-in-kind is
recognized as a contribution at fair value.
Gifts-in-kind that are donated as part of a fundraising appeal are valued at fair value when
received and revalued upon their sale as part of the fundraising appeal. The difference between
the fair value at the time of donation and the value at the time of sale is accounted for as an
additional contribution.

2.9 Presentation and Disclosure of Nonfinancial Assets

Contributed nonfinancial assets are displayed as a separate line item on the statement
of activities.
The value of contributed nonfinancial assets and their anticipated disposition should also be
disclosed. The notes should state whether contributed assets will be sold (monetized), what
donor-imposed restrictions may be associated with the donation, and the manner in which the
donation is valued.

3 Accounting for Promises to Contribute

and Other Support Transactions

3.1 Contributions Without Donor Restrictions

Unconditional promises to contribute in the future are reported as donor-restricted support
(implied time restriction), at the present value of the estimated future cash flows using a
discount rate commensurate with the risks involved. If the unconditional promises are expected
to be collected or paid in less than one year, they may be measured at net realizable value since
that amount is a reasonable estimate of fair value.
Pledges without donor restriction (with implied time restriction and thus initially recognized as
donor‑restricted):

DR Pledge receivable—with donor restriction $XXX

CR Allowance for doubtful accounts $XXX
CR Contributions—with donor restriction XXX

Later, when collected, assets with donor restrictions are adjusted:

DR Cash—with donor restriction $XXX

CR Pledge receivable—with donor restriction $XXX
DR Satisfaction of time restriction—
with donor restriction XXX
CR Cash—with donor restriction XXX

Assets without donor restrictions:

DR Cash—without donor restriction $XXX

CR Satisfaction of time restriction—without
donor restriction $XXX

Collection of the pledge satisfies the time restriction and results in a reclassification.

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Example 1 Accounting for Pledges Receivable

Facts: The League, a not-for-profit organization, received the following pledges:

Without donor restrictions $200,000
Donor-restricted for capital additions 150,000
All pledges are legally enforceable; however, the League's experience indicates that
10 percent of all pledges prove to be uncollectible.
Required: Determine the amount the League should report as pledges receivable, net of
any required allowance account.
Solution: Net pledges receivable are gross pledges receivable ($350,000) less allowance for
uncollectible (10% × $350,000), or $315,000.

3.2 Donor-Restricted Support (Contributions With Donor Restrictions)

A contribution may be restricted by the donor. Donor-imposed restrictions limit the use of
contributed assets. They are recognized as revenues, gains, and other support in the period
received and as assets, decreases of liabilities, or expenses, depending on the form of the
benefits received.
Increases to net assets with donor restrictions:

DR Pledge receivable—with donor restrictions $XXX

CR Allowance for doubtful accounts $XXX
CR Donor-restricted support XXX

Later, after receivable is collected and when money is spent on restricted purpose, net assets with
donor restrictions will be reduced:

DR Reclassification—satisfaction of donor $XXX

restriction
CR Cash—with donor restrictions $XXX

Net assets without donor restrictions are simultaneously increased and decreased:

DR Cash—without donor restrictions $XXX

CR Reclassification—satisfaction of donor $XXX
restriction
DR Operating expense XXX
CR Cash—without donor restrictions XXX

4 Fundraising

When a not-for-profit offers premiums (e.g., calendars, coffee mugs, tote bags, etc.) to donors as
part of a fundraising campaign, the cost of the premiums is classified as a fundraising expense.
The cost of premiums given to acknowledge donations is also classified as a fundraising expense.
Generally, the difference between the contribution made by the donor and the fair value of any
premiums transferred is classified as contribution revenue.

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Pass Key

The general rule, for CPA Exam questions, for amounts recognized as contributions
received through fundraising appeals, is:
Total contribution received
< Fair value of premiums >

Contribution revenue

5 Industry-Specific Revenue Recognition

5.1 Educational Institutions

5.1.1 Revenues
Revenues consist of all increases in net assets without donor restrictions and all donor-restricted
resources that were actually expended during the period, such as:
Student tuition and fees.
Government aid, grants, and contracts.
Gifts and private grants.
Endowment income.
Sales and services of educational departments, such as publications and testing services.
Revenues of auxiliary enterprises, such as food service, residence halls, campus store,
and athletics.

Pass Key

Student tuition and fees are reported at the gross amount. Many prior CPA Exam questions
have required students to compute gross revenue from tuition and fees:
Assessed student tuition and fees
< Canceled classes >

Gross revenue from tuition and fees

Scholarships, tuition waivers, and similar reductions are considered either expenditures or
a separately displayed allowance reducing revenue.

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5.1.2 Gains and Losses

Gains and losses on investments and other assets, classified as with or without donor
restrictions, are reported in the statement of activities.

5.2 Revenue Recognition in Health Care Organizations

5.2.1 Patient Service Revenue
Patient service revenue should be accounted for on the accrual basis at established standard
rates (usual and customary fees), even if the full amount is not expected to be collected.
Although patient service revenue is recorded on a gross basis, deductions are made from gross
revenue to recognize patient service revenue net of deductions. Central transactions include
medical services such as doctors, surgery, recovery room, and room and board.
Charity Care
Charity care is defined as health care services that are provided but never expected to result
in cash flows to the hospital.
y Management's policy for providing charity care (as well as the level of charity care
provided) should be disclosed in the financial statements.
y Charity care is not recognized as a receivable or as revenue.
y Charity care is not recognized as a bad debt expense.
Deductions
Deductions from patient service revenue to arrive at "net patient service revenue" include
the following for uncompensated services:
y Contractual adjustments for third-party payments.
y Policy discounts.
y Administrative adjustments.
y Bad debts associated with services billed prior to the organization's assessment of the
patient's ability to pay (e.g., emergency room services provided and billed at full cost
before the likelihood of collection can be determined).

Pass Key

Bad debt may be afforded one of two treatments, depending on the character of the bad debt.
1. Operating expense: Bad debt resulting from failure to collect revenues that the health
care organization anticipated earning (e.g., a self-pay patient screened for ability to pay
is billed and does not pay).
2. Deduction from revenue: Bad debt resulting from inability to collect large volumes of
revenue that the health care organization never assessed for quality or collectibility.

Premium Revenue for Capitation Agreements

Capitation revenues are the fixed amount per individual that is paid periodically, usually
monthly, to a provider as compensation for providing health care services for that period.

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Pass Key

Prior CPA Exam questions have required candidates to compute "Patient Service Revenue";
use this formula to answer these questions correctly:
Gross patient service revenue
< Charitable services >
Patient service revenue

5.2.2 Other Operating Revenue

Other operating revenue of a health care organization may include:
Tuition from schools
Revenue from educational programs
Donated supplies and equipment
Specific purpose grants
Revenue from auxiliary activities
Cafeteria revenue
Parking fees
Gift shop revenue
Medical transcription fees
5.2.3 Nonoperating Revenue and Support Gains and Losses
Nonoperating revenue and gains and losses of a health care organization may include the
following transactions that are recognized without donor restrictions:
Interest and dividend income from investment activities
Gifts and bequests
Grants
Income from endowment funds
Income from board-designated funds
Donated services

Pass Key

Many prior CPA Exam questions have required candidates to identify which of the three
categories of revenue a particular item of income is to be reported in:
1. Patient service revenue
2. Other operating revenue (includes donated supplies)
3. Nonoperating revenue (includes donated services)

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Not-for-Profit
MODULE

Transfers of Assets and

Other Accounting Issues FAR 6

1 Transfers of Assets to a Not‑for‑Profit Organization

or Charitable Trust That Raises or Holds
Contributions for Others

An important issue in not-for-profit accounting is the accounting for asset transfers to other not-
for-profit organizations, such as foundations, and the circumstances under which those transfers
should be accounted for as (1) a contribution, (2) a liability, or (3) a change in interest in net assets.

1.1 Financially Interrelated Organizations

Financially interrelated organizations are defined as organizations related by both of the
following characteristics:
1. One organization has the ability to influence the operating and financial decisions of the
other; and
2. One organization has an ongoing economic interest in the net assets of the other.

1.2 Recipient Accounting

A not-for-profit is a recipient entity when it accepts assets from a resource provider and agrees
to use the assets on behalf of, or transfer the assets (and/or the return on the assets) to,
a specified beneficiary. The accounting by the recipient entity depends on whether the recipient
has variance power and whether the recipient and the beneficiary are financially interrelated.

1.2.1 Not Financially Interrelated: Without Variance Power

An organization that accepts assets from a resource provider and agrees to use or manage
them on behalf of a specified beneficiary without variance power and without any financial
interrelationship accounts for assets received as follows:
Assets are valued at fair value.
The recipient recognizes a liability to the beneficiary.

DR Asset $XXX
CR Refundable advance liability $XXX

Assets transferred to recipient organizations are not contributions and are accounted for as
liabilities when any one of the following conditions are met:
y The resource provider can change the beneficiary.
y The resource provider's asset transfer is conditional or otherwise revocable or repayable.
y The resource provider controls the recipient organization and specifies an unaffiliated
beneficiary.
y The resource provider specifies itself or its affiliate as the beneficiary and does not
qualify for equity accounting.

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1.2.2 Not Financially Interrelated: With Variance Power

When there is no financial interrelationship between the recipient and the beneficiary, an
organization that accepts assets from a resource provider and agrees to use or manage them
on behalf of a beneficiary follows donee accounting if it is granted variance power, the unilateral
authority to redirect assets to another beneficiary.
Assets are valued at fair value.
Assets are recognized as a contribution when received and expensed when distributed to
the beneficiary.

DR Asset $XXX
CR Contribution $XXX

1.2.3 Financially Interrelated: With or Without Variance Power

An organization financially interrelated with a beneficiary that accepts assets from a resource
provider and agrees to use or manage them on behalf of a beneficiary follows donee accounting.
Regardless of whether variance power is granted:
Assets are valued at fair value.
Assets are recognized as a contribution when received and expensed when distributed to
the beneficiary.

DR Asset $XXX
CR Contribution $XXX

1.3 Beneficiary Accounting

Specified beneficiaries recognize their rights to assets held by the recipient unless the recipient
is explicitly granted variance power. Rights, when recognized, will be recorded as a receivable
and contribution, a beneficial interest, or a change in interest in the net assets of the recipient.

1.3.1 Receivable and Contribution

In cases that do not involve financial interrelationship or beneficial interests, the beneficiary
recognizes a receivable and a contribution consistent with treatment of all other unconditional
promises to give.

DR Receivable $XXX
CR Contribution $XXX

1.3.2 Not Financially Interrelated: Beneficial Interest

Beneficiaries recognize a beneficial interest in an unconditional right to receive specified cash
flows from a pool of assets as contribution revenue, or when donations held by the recipient
are nonfinancial.

DR Beneficial interest $XXX

CR Contribution $XXX

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1.3.3 Financially Interrelated: Interest in the Net Assets of the Recipient

Beneficiaries recognize a change in their interest in the net assets of the recipient when the
organizations are financially interrelated.

DR Interest in recipient net assets $XXX

CR Change in interest in recipient
net assets $XXX

Example 1 Financially Interrelated Recipient and Beneficiary

Facts: Farleigh State University, a private not-for-profit institute of higher learning,

established the Farleigh State Foundation Inc. (FSF), a not-for-profit corporation, to raise
funds for the university and to account for and manage the investments of the university.
The university and the foundation are financially interrelated. During the current year,
an alumnus donated investments with a fair value of $25,000,000 to the foundation and
specified that the earnings from the investments must be used to fund scholarships at
Farleigh State University.
Required: Determine how the university and the foundation should account for this donation.
Solution:
Farleigh State Foundation
The foundation is the recipient of the donation and does not have variance power because
the donation must be used to fund university scholarships. The foundation will record the
following journal entry because it is financially interrelated with the university:

DR Investments $25,000,000
CR Contribution $25,000,000

Farleigh State University

The university is the beneficiary and will recognize an interest in the change in net assets
of the foundation because it is financially interrelated with the foundation:

DR Interest in FSF net assets $25,000,000

CR Change in interest in FSF net assets $25,000,000

2 Other Accounting Issues

2.1 Financial Instruments

2.1.1 Fair Value
All debt securities and those equity securities that have readily determinable fair values are
measured at fair value in the statement of financial position.

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2.1.2 Gains and Losses

Realized and unrealized gains and losses on investments are reported in the statement of
activities as increases or decreases in net assets without donor restrictions unless the use of the
investment is donor-restricted, either temporarily or in perpetuity, by explicit donor stipulations
or by law. Gains and losses that are limited to specific uses by donor stipulations may be
reported as increases in net assets without donor restrictions if the stipulations are met in the
same reporting period as the gains and income are recognized.

2.1.3 Derivatives
A not-for-profit organization should recognize the change in fair value of all derivatives in the
period of the change. Not-for-profits are not permitted to use special hedge accounting rules.

2.1.4 Dividends, Interest, and Other Investment Income

Investment income (e.g., dividends and interest) is reported in the period earned as increases
in unrestricted net assets unless the use of the investment is restricted by explicit donor
stipulations or by law. Investment returns are reported net of any related investment expense.

2.2 Endowment Funds

Endowment funds are used to account for assets established to provide income for the
maintenance of a not-for-profit entity and may be classified as either net assets without donor
restrictions or net assets with donor restrictions. Issues surrounding endowment funds typically
relate to their duration, the source of any restriction on them (internal or external), and the
accounting issues related to the treatment of changes in value.

2.2.1 Duration
Endowment funds may be established in perpetuity or for a specified period of time (sometimes
referred to as a term endowment).

2.2.2 Source of Restriction

Although endowment funds may be established by a governing board from resources without
donor restrictions, they are generally established by a donor-restricted gift. Types of endowment
funds include:
Board-Designated Endowment Funds
y Board-designated endowment funds are created by a not-for profit entity's governing
board by designating a portion of its net assets without donor restrictions to provide
income for a long but not necessarily specified period of time.
y Alternative names include funds functioning as endowment or quasi-endowment funds.
Donor-Restricted Endowment Funds (Most Common)
y An endowment fund created by a donor stipulation requiring investment of the donor's
gift in perpetuity or for a specified term.

2.2.3 Accounting and Reporting for Endowment Funds

A not-for-profit organization would report an endowment fund in the statement of financial
position in one of the following two classes of net assets based on the existence or absence of
donor-imposed restrictions:

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1. Net Assets With Donor Restrictions

Donor-restricted endowments would be accounted for under net assets with donor restrictions.

Illustration 1 Donor-Restricted Endowment Fund

Ben Benefactor gives $10,000,000 to his alma mater, Private University, a private
not‑for‑profit university, with the stipulation that the principal would not be spent and that
earnings from the donation would be used to fund an accounting professor's salary and
accounting research. Benefactor's donation would be accounted for as an increase to net
assets with donor restrictions and would represent a donor-restricted endowment fund
established in perpetuity.

2. Net Assets Without Donor Restrictions

Board-designated endowment funds resulting from an internal designation of net assets
without donor restrictions would be classified as net assets without donor restrictions.

Illustration 2 Board-Designated Endowment Fund

The governing board of Private University, a private not-for-profit university, sets aside
$8,000,000 from its net assets without donor restrictions to be invested for the next
20 years with related income to be used for a finance professor's salary. The act of the
governing board would be accounted for within net assets without donor restrictions and
would represent a board-designated endowment established for a specified period of time.

2.2.4 Specific Issues Regarding Changes in Value of Donor-Restricted Endowments

Inception
y The original gifted amount and (generally) related returns shall be initially classified as
net assets with donor restrictions.
y Unless a purpose or other donor restriction exists on the use of the income, investment
income is deemed available for spending and is classified as net assets without
donor restrictions.
Returns on the Endowment Assets Subject to Donor Restriction
y Investment returns subject to restriction by donor or by law shall be reported within net
assets with donor restriction until appropriated for expenditure.
y Investment returns are commonly restricted by either time (until appropriated for use)
or purpose (until appropriated and expended on the specified purpose described by
the donor).
y Upon approval for expenditure (meeting the requirements of the donor restriction), the
funds are deemed to have been appropriated for expenditure.
Underwater Endowments
y An underwater endowment is a donor-restricted endowment fund for which the fair value
of the fund at the reporting date is less than either the original gift amount or the amount
required to be maintained by the donor or by a law that extends donor restrictions.

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y Underwater endowment funds will report accumulated losses together with the
endowment fund in net assets with donor restrictions.
y Underwater endowments require the following disclosures in total:
—The fair value of the underwater endowment;
—The original endowment gift amount or level required to be maintained by donor
stipulations or law; and
—The amount of the deficiencies of the underwater endowment fund.

Pass Key

Underwater endowments must disclose how hard it will be for their intended beneficiaries
to be FED:
— Fair value of the underwater endowment
— Endowment gift's original amount
— Deficiency

Illustration 3 Underwater Endowment

Ben Benefactor gives a $10,000,000 endowment to Private University, a private

not‑for‑profit entity. The endowment is properly accounted for as an increase in net assets
with donor restrictions. At year-end, the endowment had a fair value of $9,750,000. Private
University would need to disclose:

Fair value of Ben Benefactor's original gift $ 9,750,000

Ben Benefactor's original gift 10,000,000
Deficiency $ (250,000)

2.2.5 Required Disclosures for All Endowment Funds

The governing board's interpretation of the requirements that underlie the net asset
classification of the endowment and the ability to spend from underwater endowment funds.
Policies for the appropriation of endowment assets.
Investment policies.
Composition of the not-for-profit endowment by net asset class.
A reconciliation of the beginning and ending balance of the not-for-profit's endowments by
net asset class.

2.3 Basis of Assets

Purchased fixed assets are carried at cost, as required by GAAP. Donated fixed assets are
recorded at fair value at the date of the gift. Depreciation is recorded in accordance with GAAP
for nongovernmental not-for-profit organizations. However, works of art and historical treasures
are not depreciated.

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5
MODULE

Governmental
Accounting Overview FAR 6

1 Governmental Accounting and Reporting Concepts

1.1 Objectives of Governmental Reporting

Governmental financial reporting is designed to demonstrate the accountability of each
organization for the stewardship of the resources in their care. Although the accountability for
privately owned enterprises may be clearly measured in either the net income of the entity or
the increased wealth of its shareholders, governmental organizations are focused on providing
efficient and effective delivery of services with public resources in compliance with applicable
laws. Identifying and displaying the accountability objectives of governmental organizations is
integral to related accounting.

1.2 Objectives of Fund Accounting and Reporting

Foundational to governmental accounting is the concept of fund accounting. Fund accounting
enables service and mission-driven organizations to easily monitor and report compliance with
spending purposes (fund restrictions), spending limits (budget), and other fiscal accountability
objectives. Governments use fund accounting to demonstrate fiscal accountability in their
external reporting and use funds for internal accounting.

2 Industries That Use Governmental Accounting

and Reporting Principles

Governmental, not-for-profit, and commercial accounting are applied to entities consistent with
their basis of organization and their funding sources, not their industries.

Illustration 1 Basis of Organization

Hospitals could be governmentally funded and accounted for using an enterprise fund,
could be organized as a not-for-profit organization, or could be organized as private
businesses that report income and profitability to their shareholders. Although this can be
confusing in practice, the CPA Exam is generally very clear as to the manner in which an
entity is organized and the applicable accounting principles.

The following industries commonly have the organizational characteristics and funding streams
that lend themselves to the accountability objectives met by governmental reporting models.

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5 Governmental Accounting Overview FAR 6

2.1 Governmental Units

Governmental units include federal, state, county, municipal, and a variety of local governmental
units (e.g., townships, villages, and special districts) and entities (e.g., hospitals and universities)
that are run by governments and use governmental accounting and reporting principles.

2.2 Colleges and Universities

Colleges and universities may be governmental entities or nongovernmental entities, depending
on whether they are financially accountable to a primary government. In addition, some colleges
and universities are organizations operated to earn a profit (i.e., "for-profit" entities); thus,
they follow FASB standards for commercial entities rather than the standards developed for
governmental entities or not-for-profit entities.

2.3 Health Care Organizations

Organizations that provide health care services to individuals include hospitals, nursing
care facilities, home health agencies, and clinics. Health care providers can be organized as
governmental, not-for-profit, or commercial entities. If the health care entity is financially
accountable to a primary government, it could be classified as a component unit of
the government. If a health care entity is organized as a not-for-profit or commercial
organization, it follows applicable FASB standards rather than the standards developed for
governmental entities.

Pass Key

Not-for-profit organizations not run by governments (e.g., hospitals, universities, voluntary

health and welfare organizations, and research organizations) do not use governmental
accounting and reporting principles.

3 Generally Accepted Accounting Principles

for Governmental Entities

3.1 Governmental Accounting Principles and Standards

The Governmental Accounting Standards Board (GASB), which is the governmental counterpart
of the FASB, establishes accounting and reporting standards for governments. The hierarchy of
GAAP as it relates to governments was established by GASB 76 as follows:
GASB Accounting Standards Board Statements (most authoritative—category A)
GASB Technical Bulletins, GASB Implementation Guides, and literature of the AICPA cleared
by the GASB (category B)
Governmental entities should consult guidance in category B documents in the event treatment
for a transaction is not specified by a pronouncement in category A.

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3.2 GASB Conceptual Framework

The GASB has outlined its conceptual framework for governmental financial reporting in GASB
Concept Statements Nos. 1–6. These concept statements establish the objectives and concepts
that underlie governmental financial reporting but do not establish standards for governmental
financial reporting.
According to the conceptual framework, governmental financial reporting communicates
financial information to users and fulfills a government's duty to be publicly accountable.

3.2.1 Information Used by Financial Report Users

Financial statements are a part of the overall financial reporting done by governments. The
information needs of users of governmental financial reports include all of the following:

All Information Used to Assess Accountability

All Financial Reporting
General Purpose External Financial Reporting
GASB 34 Reporting Requirements Budgets and
other special
Basic financial Required Annual purpose reports Other information
statements supplementary comprehensive (e.g., to grantor (e.g., economic
(including notes) information financial report agencies indicators)

Financial reporting objectives identified by the framework pertain to general purpose

external financial reporting, which includes the basic financial statements and required
supplementary information, as well as the annual comprehensive financial report (ACFR).
Financial reporting objectives identified by the framework may not fully address budgets,
other special purpose reporting or other information (such as stand-alone budget
documents or reports to grantor agencies).

3.2.2 Governmental-Type and Business-Type Activities

Government entities engage in both governmental-type and business-type activities. Each
type of activity requires accounting and reporting standards that address their individual
characteristics and user needs. Governmental-type activities are typically supported by taxes
and business-type activities are supported by user fees.

3.2.3 Users of Governmental Financial Reports

The three groups of primary users of governmental financial reports are:
1. Citizens, including taxpayers, voters, recipients of services, the media, researchers, etc.
2. Legislative and oversight bodies, including state legislators, county and city commissioners,
and executives with oversight authority.
3. Investors and creditors, including institutional investors, bond rating agencies, bond
insurers, financial institutions, etc.

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5 Governmental Accounting Overview FAR 6

3.2.4 Uses of Financial Reports

Governmental financial reports are used to make economic, social, and political decisions and to
assess accountability by:
Comparing actual financial results to budget
Assessing financial condition and results of operations
Assisting in determining compliance with finance-related laws, rules, and regulations
Assisting in evaluating operating efficiency and effectiveness

3.2.5 Accountability and Interperiod Equity

Accountability is the cornerstone of governmental financial reporting. Interperiod equity, or the
concept of balancing the budget on an annual basis, is a significant part of accountability.
Accountability
y Governments provide financial information to the citizenry to justify the raising of
resources and demonstrate the purposes for which they are used.
y Financial reporting plays a major role in fulfilling a government's duty to be publicly
accountable.
y Minimum disclosure includes whether the government operated within the legal
constraints imposed by the citizens.
Interperiod Equity
y Balanced budgets contribute to interperiod equity by enabling a government to meet its
commitment to live within its means.
y Financial reporting should help users assess whether current year revenues are
sufficient to pay for the services provided that year and whether future taxpayers will
be required to assume burdens for services previously provided.

3.2.6 Characteristics of Information in Governmental Financial Reports

Financial information included in governmental financial reports should have the following
characteristics:
Understandability
Information in financial reports should be expressed as simply as possible so the reports can
be understood by individuals who may not have detailed knowledge of accounting principles.
Reliability
Reports should be verifiable and free from bias and should faithfully represent the subject
matter. Reliability does not imply precision or certainty.
Relevance
Information provided should have a close logical relationship to the purpose for which it is
needed. Relevance implies reported information will make a difference to users.
Timeliness
Reported information should be issued in time to have an effect on decisions. Timeliness
may supersede absolute precision or detail.

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FAR 6 5 Governmental Accounting Overview

Consistency
The accounting principles used to prepare financial reports should not change year
over year. Accounting principles relate to such issues as transaction valuation, basis of
accounting, and the determination of the financial reporting entity.
Comparability
Financial reports should be comparable. Differences between financial reports should be
due to substantive differences in underlying transactions or government structure rather
than the selection of methods.

Pass Key

Remember the characteristics in financial reporting for government.

U R MICE

Understandability
Reliability
Make a difference—relevance
In timeliness
Consistency year over year
Entity-to-entity comparability

3.2.7 Limitations on Governmental Financial Reporting

There are some limitations on the information that governmental financial reporting can
provide, such as:
Financial reports use approximate measures that are often based on judgments or estimates.
Financial reporting is only one source of information for users and might be more useful
when used in combination with other pertinent data.F9_Graphic 1_Mice
Financial reports may not meet the diverse needs of all users.
Cost-benefit relationships must be considered.

3.2.8 Financial Reporting Objectives

Accountability is the primary objective of governmental financial reporting and is implicit in the
following main objectives of governmental financial reporting:
Financial reporting should assist in fulfilling a government's duty to be publicly accountable
and should enable users to assess that accountability by:
y Demonstrating whether current year revenues were sufficient to pay for current
year services.
y Demonstrating budgetary and legal or contractual compliance.
y Providing information that allows users to assess service efforts, costs, and
accomplishments of the governmental entity.

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5 Governmental Accounting Overview FAR 6

Financial reporting should assist users in evaluating the operating results of the
governmental entity for the year by providing information about:
y Sources and uses of financial resources
y How the governmental entity financed its activities and met its cash requirements
y Whether financial position has improved or deteriorated
Financial reporting should assist users in assessing the level of services that can be provided
by the governmental entity and its ability to meet obligations as they come due by providing
information about:
y The financial position and condition of the governmental entity
y Noncurrent physical assets available to the government and their service potential for
future periods
y Legal or contractual restrictions on resources and risks of potential loss of resources

4 Key Concepts in Governmental Accounting and Reporting

Governmental accounting generally revolves around three themes that differentiate it from
commercial and not-for-profit accounting:
1. Fund structure
2. Fund accounting
3. External reporting

Pass Key

A fund is a sum of money or other resource segregated for the purpose of carrying on a
specific activity or attaining certain objectives in accordance with specific regulations,
restrictions, or limitations, constituting an independent fiscal and accounting entity. Each
fund is a self-balancing set of accounts.

4.1 Fund Structure

GASB 34 defines a fund structure for governments. Eleven fund types are classified in the
following three generic categories:
1. Governmental funds
2. Proprietary funds
3. Fiduciary funds
Fund financial statements should be separately presented for governmental, proprietary, and
fiduciary funds to report additional and detailed information about the primary government.
A government will establish the minimum number of funds consistent with legal requirements and
sound financial administration. A government is not required to have a specific number of funds.

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4.2 Fund Accounting

Fund classifications within the fund structure defined by the GASB affect the basis of accounting
(when revenues and expenditures/expenses are recognized) and the measurement focus
(how transactions are recognized; either assuming flow of funds or net income determination)
principles associated with each fund category. The application of different accounting principles
to the funds in each generic fund grouping described below provides financial data consistent
with the reporting accountability objectives of each fund. This feature of governmental
accounting is a frequent source of exam questions.

4.3 External Reporting

GASB 34 (as amended) establishes minimum reporting requirements to be in compliance
with GAAP. Reporting requirements include both fund-based and government-wide financial
statement presentations supported by notes to the financial statements and a variety of
required supplementary information.
Presentation of a reconciliation of fund financial statements to government-wide financial
statements is also required.

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5 Governmental Accounting Overview FAR 6

NOTES

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6
MODULE

Governmental Fund Structure

and Fund Accounting FAR 6

1 Fund Structure
A governmental entity, although a single entity, consists of a number of separate funds. Funds
are generally classified into three generic categories:
Governmental funds
Proprietary funds
Fiduciary funds

1.1 Governmental Funds

1.1.1 Fund Accounting
Governmental funds are accounted for using the:
Modified accrual basis of accounting
Current financial resources measurement focus
The source, use, and balance of the government's current financial resources and the related
current liabilities are accounted for through the use of governmental funds. Governmental funds
often have a budgetary focus, and seek to measure financial position and the changes therein.
The focus of financial reporting is on the statement of revenues, expenditures, and changes in fund
balance, which is used to demonstrate the use of resources in compliance with laws, rules, and
regulations. Accounts are of a "current" nature; thus, the balance sheet of governmental funds
contains no fixed asset or long-term debt accounts.

1.1.2 Fund Types

Governmental fund types include the following:
General Fund: The general fund is set up to account for the ordinary operations of a
governmental unit that is financed from taxes and other general revenues. All transactions
not accounted for in other funds are accounted for here.
Special Revenue Funds: Special revenue funds are set up to account for revenues from
specific taxes or other earmarked sources that (by law) are restricted or committed to
finance particular activities of government.
Debt Service Funds: Debt service funds are set up to account for the accumulation of
resources and the payment of interest and principal on all "general obligation debt," other
than that serviced by enterprise funds or by special assessments in another fund. Resources
of the fund are restricted, committed, or assigned to debt service expenditures.
Capital Projects Funds: Capital projects funds are set up to account for resources restricted,
committed, or assigned for the acquisition or construction of major capital assets by a
governmental unit, except those projects financed by an enterprise fund.
Permanent Fund: Permanent funds are used to report resources that are legally restricted
to the extent that income, and not principal, may be used for purposes supporting the
reporting government's programs (i.e., for the benefit of the public).

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6 Governmental Fund Structure and Fund Accounting FAR 6

Statement of Revenues, Expenditures,

Balance Sheet and Changes in Fund Balance
Current assets + Deferred outflows Revenues

Current liabilities + Deferred inflows of resources < Expenditures >

+ Fund balance Other financing sources < uses >

Total current liabilities, deferred inflows of Net change in fund balance

resources, and fund balances

1.2 Proprietary Funds

1.2.1 Fund Accounting
Proprietary funds account for business-type activities, and their accounting is similar to
commercial accounting. Proprietary funds should be accounted for using the:
Full accrual basis of accounting
Economic resources measurement focus

1.2.2 Fund Types

Proprietary funds include:
Internal Service Funds: Internal service funds are set up to account for goods and
services provided by designated departments on a cost-reimbursement fee basis to other
departments and agencies within a single governmental unit or to other governmental
units. Customers of the internal service fund are primarily internal.

Illustration 1 Internal Service Funds

A central motor pool or building maintenance department may be accounted for with an
internal service fund.

Enterprise Funds: Enterprise funds are set up to account for the acquisition and operation of
governmental facilities and services that are intended to be primarily (more than 50 percent)
self‑supported by user charges. Customers of the enterprise fund are primarily external.

Illustration 2 Enterprise Funds

Enterprise funds are often used for utilities (water and sewer), airports, and transit systems.

Enterprise funds are required when any one of three criteria is met:
The activity of the fund is financed by debt secured by a pledge of fee revenue;
Laws require collection fees adequate to recover costs; or
Pricing policies are established to produce fees to recover costs.

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Statement of Revenues, Expenses,

Statement of Net Position and Changes in Fund Net Position
All assets + Deferred outflows of resources Operating revenue
< All liabilities + Deferred inflows of resources > < Operating expenses >

Net position Nonoperating revenue < expenses >

Change in net position

1.3 Fiduciary (Trust) Funds

1.3.1 Fund Accounting
Fiduciary funds account for assets controlled by a government in the capacity of a trust on behalf
of beneficiaries with whom a beneficiary relationship exists. Financial statements of fiduciary
funds should generally be accounted for using the:
Full accrual basis of accounting
Economic resources measurement focus.

1.3.2 Fund Types

Fiduciary funds include:
Custodial Funds
Custodial funds usually account for resources in temporary custody of the governmental unit
(e.g., taxes collected for another governmental entity) and any fiduciary activities that are
not required to be reported in other fiduciary fund classifications.
Investment Trust Funds
Investment trust funds account for external investment pools.
Private Purpose Trust Funds
Private purpose trust funds are used for activities not properly accounted for either as
pension or investment trust funds, in which assets are dedicated to providing benefits to
recipients in accordance with benefit terms and assets are legally protected from creditors
of the government.
Pension (and Other Employee Benefit) Trust Funds
Pension trust funds account for resources of defined benefit plans, defined contribution
plans, post-employment benefit plans, and other long-term employee benefit plans.

Statement of Changes
Statement of Fiduciary Net Position in Fiduciary Net Position
All assets + Deferred outflows of resources Additions
< All liabilities + Deferred inflows of resources > < Deductions >

Net position Change in net position

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6 Governmental Fund Structure and Fund Accounting FAR 6

2 Fund Accounting

The measurement focus and basis of accounting used in government-wide and fund financial
presentations facilitate the reporting of accountability objectives unique to each fund and to the
government-wide presentation. The measurement focus of a fund is complemented by the basis
of accounting used.
The modified accrual basis of accounting is used with the current financial resources
measurement focus.
The accrual basis of accounting is used with the economic resources measurement focus.

2.1 Measurement Focus

Measurement focus determines the items to be reported on the balance sheet.

2.1.1 Current Financial Resources (GRaSPP)

Under the current financial resources measurement focus, fund balance is a measure of
available, spendable, or appropriable resources. Only current assets and current liabilities are
included on the balance sheet.
No fixed assets are reported.
No non-current liabilities are reported.

Pass Key

Adding fixed assets excluded from governmental fund financial statements and subtracting
non-current liabilities (also excluded) are two of the most significant reconciling items
between governmental funds and government-wide financial statements.

2.1.2 Economic Resources (SE-CIPPOE and Government-wide)

Under the economic resources measurement focus, financial reporting centers on the costs
of services and the efficiency and effectiveness with which invested capital has been used. All
assets and all liabilities (current or non-current) are included on the balance sheet, including
certain transactions classified as deferred outflows/inflows of resources. Net position is analyzed
and reported in three components: net investment in capital assets, restricted (distinguishing
between major categories of external restrictions), and unrestricted.
Fixed assets are reported.
Non-current liabilities are reported.

2.2 Basis of Accounting

The basis of accounting determines when revenues and expenditures or expenses are
recognized and reported in the financial statements.

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2.2.1 Modified Accrual (GRaSPP)

The modified accrual basis of accounting is used with the current financial resources
measurement focus. It is a blend of accrual and cash basis accounting concepts.
Revenue is recognized when measurable and available to finance the expenditures of the
current period. The only difference between the timing of revenue recognition under the
modified accrual and full accrual basis of accounting is the manner in which each basis
defines the word available.
y Available, under modified accrual, means collectible within the current period or soon
enough thereafter to be used to pay liabilities in the current period (generally within 60
days after year-end).
y Measurable means quantifiable in monetary terms.
Expenditures are generally recorded when the related fund liability is incurred, with
some exceptions. Most notably, debt service expenditures (both principal and interest) are
not recognized until either due or paid. Incurred but unpaid debt service expenditures are
not accrued.

Pass Key

Addition of accrual basis revenues in excess of modified accrual revenues along with
subtraction of accrued interest expenses not recognized in governmental financial
statements are frequent reconciling items between the governmental fund financial
statements and the government-wide financial statements.

2.2.2 Full Accrual (SE-CIPPOE and Government-wide)

The full accrual basis of accounting is used with the economic resources measurement focus. It
is identical to the accrual basis used in commercial enterprises.
Revenue is recognized when earned.
Expenses are recognized when incurred.

2.3 Fund Accounting Summary

2.3.1 Modified Accrual Basis of Accounting and Current Financial Resources
Measurement Focus
Modified accrual basis of accounting and current financial resources measurement focus are
used in connection with the governmental funds (GRaSPP).
General
Special Revenue
and
Debt Service
Capital Projects
Permanent

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6 Governmental Fund Structure and Fund Accounting FAR 6

2.3.2 Economic Resources Measurement Focus and Full Accrual Basis of Accounting
The economic resources measurement focus and full accrual basis of accounting is used for
both the government-wide financial statements as well as the fund presentations of the fiduciary
and proprietary funds (SE-CIPPOE).
Service (internal)
Enterprise
Custodial
Investment trust
Private purpose trust
Pension (and Other Employee benefit) trust

Pass Key
To help remember the differences in focus and accounting, use the following:

Governmental funds are MAC-GRaSPP Proprietary and fiduciary funds SCARE

Modified SE
Accrual accounting CIPPOE
Current financial resources measurement focus Accrual accounting
GRaSPP Record non-current assets and liabilities
Economic resources measurement focus

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