Solution manual advanced accounting 11th edition joe ben hoyle chap018

Chapter 18 - Accounting and Reporting for Private Not-for-Profit Organizations CHAPTER 18 ACCOUNTING AND REPORTING FOR PRIVATE NOT-FOR-PROFIT ORGANIZATIONS Chapter Outline I Historically, the financial reporting for private not-for-profit entities has differed significantly according to the type of organization (such as a health care entity versus a college or university) The reporting of these entities has now been largely standardized by FASB pronouncements that focus on the reporting of financial statements for the entity as a whole and on significant events such as the receipt of contributions and the recording of mergers and acquisitions However, public colleges and universities and similar organizations still must follow the standards issued by GASB A This chapter looks at the financial reporting for private not-for-profit organizations with special emphasis on private colleges and universities, voluntary health and welfare organizations, and health care entities B Reporting for these organizations should be similar to a business entity unless a critical difference exists that impacts the needs of financial statement users Several critical differences can be identified Many private not-for-profit organizations receive a significant amount of their financial resources from contributions rather than from revenues or capital investments Some of the resources given to a private not-for-profit organization include donor-imposed restrictions No single indicator of success is present in the financial reporting No number such as net income provides a means for evaluation as it does for a for-profit business entity II FASB has established the following financial statements for a private not-for-profit organization A Statement of Financial Position reports assets, liabilities, and net assets B Statement of Activities and Changes in Net Assets reports revenues, expenses, gains, and losses C Statement of Cash Flows D A voluntary health and welfare organization is also required to present a Statement of Functional Expenses which indicates the allocations of resources to program services (to meet the goals of the organization) and supporting services (to operate the organization and raise funds) III For reporting purposes, the economic resources held by a private not-for-profit organization are classified within one of three categories A "Unrestricted net assets" indicates the amount of an entity's resources that are not subject to external donor restrictions Officials of the organization can make whatever use they wish of these assets 18-1 Chapter 18 - Accounting and Reporting for Private Not-for-Profit Organizations B "Temporarily restricted net assets" are restricted by an outside party (often a donor) for a particular purpose or for use in a future period of time When the restriction is satisfied, these resources are switched to unrestricted net assets Thus, on the statement of activities and changes in net assets, temporarily restricted net assets are shown as being reclassified as unrestricted net assets when the appropriate time has passed or the resource is used as stipulated C "Permanently restricted net assets" are expected to remain restricted for as long as the organization exists Income from these assets is normally unrestricted or temporarily restricted based on the specifications of the donor IV Contributions should be recognized as revenues when received A Restricted contributions are recognized as revenue either within temporarily restricted net assets or permanently restricted net assets based upon the stipulations of the donor B Donated assets are recorded at fair value Recognition of art works, historical treasures, and the like is not required (although still allowed) if three conditions are all met The items are added to a collection for public exhibition, education, or research The items are protected and preserved If sold, receipts must be used to acquire other collection items C Unconditional promises to give that are received by a private not-for-profit organization should be reported immediately as both a receivable and revenue If not to be collected within one year, the promise is recorded at the present value of the future cash flows Subsequent amortization of the discount is recorded as contribution revenue rather than as interest Uncollectible balances are also estimated and deducted Conditional promises are not recognized until the conditions are met D Services contributed to a not-for-profit organization should be recognized as revenue if the services (1) create or enhance a nonfinancial asset or (2) require a specialized skill possessed by the donor and would be purchased if not donated E If a not-for-profit organization accepts a donation that must be conveyed to a separate individual or other beneficiary, the organization normally records the asset along with an accompanying liability to reflect the accepted responsibility However, if the organization is given variance powers to change the beneficiary, revenue is recognized instead of a liability because the donation is under that party’s control V Education institutions record tuition revenue at the gross amount billed and show revenue net of scholarships and financial aid in the Statement of Activities VI Mergers and acquisitions have become common in private not-for-profit organizations at least in part because of the economic downturn Recording is different than for a for-profit business combination because the transaction can be either an acquisition or a merger A In an acquisition, one entity gains control over another All identifiable assets and liabilities of the acquired company are combined at fair value on the date of acquisition 18-2 Chapter 18 - Accounting and Reporting for Private Not-for-Profit Organizations If the acquisition value of the acquired company is greater than the sum of the fair value of all identified assets and liabilities, the difference is often reported as goodwill However, if the acquisition value of the acquired company is greater than the sum of the fair value of all identified assets and liabilities, the difference is charged off immediately if the acquired company expects to be predominantly supported by contributions and investment income in the future VII Health care organizations exhibit some unique reporting features that must be addressed in not-for-profit accounting A Third-party payors such as Medicare and insurance companies have a significant impact on the reporting process because of their need for usable financial information B A net patient service revenue figure is actually reported by these organizations but only after reduction for contractual adjustments These adjustments are decreases allowed for some third-party payors based on the approved cost for a particular service in that geographic region C Charity care services are not included in receivables or revenues if there is no expectation of collection D FASB requires the inclusion of performance indicators (such as revenues in excess of expenses) to help show operational effectiveness because net income is not viewed as applicable for a not-for-profit organization Answers to Discussion Questions Are Two Sets of GAAP Really Needed for Colleges and Universities? Over the last few years, a number of differences have appeared between the accounting for public colleges and universities and for those that are private GASB holds authority over the reporting of public schools whereas FASB has authority over private educational institutions Consequently, GASB statements not apply to private schools and FASB Statements not apply to pubic schools unless specifically made applicable by GASB For this reason, FASB pronouncements on depreciation, pledges, contributions, and financial statement format for not-for-private organizations not affect public schools until and unless so stated by GASB Because of this split, the financial statements for these two types of schools have developed several significant, unique differences GASB states that public schools must follow the guidelines of GASB 34 which created financial statements for state and local governments However, these guidelines are not as radically different from private schools as might be first imagined Public colleges and universities are allowed to label themselves as solely Enterprise Funds if they meet the required criteria If this decision is made, the school need report only fund financial statements as would be produced by a proprietary fund These statements have a definite resemblance to the statements prepared by private schools However, important distinctions continue to exist Students can be asked to address the question of whether a public and a private school need to have comparable financial statements Net income is not an issue, rather the sources and utilization of resources is usually emphasized Is the adoption of a single set of generally accepted accounting principles necessarily essential? Will a decision-maker care if the University of North Carolina at Chapel Hill (a public school) has one statement format but Duke University (a private school) has another? 18-3 Chapter 18 - Accounting and Reporting for Private Not-for-Profit Organizations This controversy leads to the important question of user needs Why does a company or individual look at the financial statements of a college or university? Donors might have one answer to that question while creditors could have an entirely different response Once that question has been addressed, the need for comparability is easier to assess No ultimate answer for that query currently exists but students can be asked to develop their own list of user needs and then note whether the existence of two different sets of GAAP has an adverse impact on those needs Is This Really an Asset? In theory, accounting for a pledge is a relatively straightforward process If unconditional, a receivable is established (at present value if not to be received within the year) along with an adequate allowance for doubtful collections However, in practice, the process might be much more complicated In this case, for example, was a pledge actually made or was this just a superfluous statement spoken at a moment of overwhelming emotions? Is this a promise to give or an intention to give? Can the donor change his mind? Does this potential donor really own land in Idaho and can it be sold for $15 million? How can an adequate allowance be determined for this pledge? If the indivdiual's mother should die, would he lose interest in supporting the hospital? If the $5 million is reported as a receivable and then is not collected, what is the impact on the readers of the financial statements? How much time and energy should the hospital invest in attempting to arrive at a proper method of financial reporting for this item? The accountant must address all of these questions (and more) to determine the appropriate accounting treatment At a minimum, hospital officials need to contact this donor and have a long discussion He needs to understand their reasons for attempting to establish a valuation of this promise In class discussion, students can be asked to identify questions that should be posed to this person They would probably include the following: —Does he really plan to give $5 million to the hospital? —When does he project that the land will be sold and the gift made? —How did he establish a $15 million price? Could the land be sold for less and, if so, how will that impact on the gift to the hospital? —How does he want the $5 million to be used? —Is there any chance that he will change his mind? —What other charities has he supported? Has he previously made such large gitfs? —Would he be willing to furnish financial statements as well as a list of references who could verify his intentions and his ability to carry out those intentions? —Does the hospital have legal recourse for the promise since it is in writing and signed? If this individual has supported other charities over the years, is committed to the work of Mercy Hospital, has adequate financial resources, and if the land appears to be worth $15 million, the hospital should report the pledge as a receivable However, a large allowance should probably be established simply because of the uncertainties involved with collecting this amount of money 18-4 Chapter 18 - Accounting and Reporting for Private Not-for-Profit Organizations over an extended period of time Conversely, if too much uncertainty exists (a value for the land cannot be determined or the individual refuses to provide information about his ability to meet this commitment), the hospital may decide that this is not a pledge at all but merely the promise of a possible future pledge the donor intends to give In that case, the information should be adequately spelled out in a footnote Unless clear evidence exists to substantiate the pledge, disclosure is most likely Answers to Questions The Financial Accounting Standards Board (FASB) has authority for establishing accounting standards for private not-for-profit organizations In addition, audit and accounting guides produced by the AICPA provide further guidance for the preparation of financial statements by these organizations If a user of financial statements is a potential donor, that party is interested in assessing whether a gift to a not-for-profit organization is a wise use of resources To make that assessment, the individual needs to know whether the organization uses its resources appropriately to achieve its stated goals In this way, donors can decide which organization deserves to receive support and how much will be donated That is a reason that the division between the amount spent on program services and supporting services can be so helpful If a user of financial statements is a creditor, that company or person is primarily interested in whether the organization can generate sufficient cash flows to pay its debts as they come due According to FASB, three financial statements are required to be produced by private not-for-profit organizations: a statement of financial position, a statement of activities and changes in net assets, and a statement of cash flows A voluntary health and welfare organization must also produce a statement of functional expenses Temporarily restricted assets have been restricted by an external donor or grantor for a specified purpose or for use at a future point in time For example, cash might be given that had to be spent to buy a bus to be used by the organization or that could not be spent for three years Such restrictions are eventually lifted when the intended usage is fulfilled or when the time limit has been met Permanently restricted assets have been restricted by an external donor and grantor That restriction is expected to last for as long as the organization continues to function Normally, any income generated by these assets can be used by the organization although its specific usage may be restricted For example, investments worth $3 million could be given to a private not-for-profit organization with the stipulation that that could never be sold However, the income produced by these investments over time could be designated by the donor for the purchase of computer equipment or might be available to the organization’s officials for whatever purpose they deemed necessary 18-5 Chapter 18 - Accounting and Reporting for Private Not-for-Profit Organizations Private not-for-profit organizations report (a) program service expenses and (b) supporting service expenses Program service expenses are those that relate to the goals and objectives of the organization Supporting service expenses encompass the costs of operating the organization (general and administrative) and raising funds Not-for-profit organizations are frequently evaluated based on the ratio of program service expenses to total expenses This ratio tells the readers of the statements what portion of each dollar of expense can be attributed to achieving the goals identified by the organization A statement of functional expense is produced by a voluntary health and welfare organization to assist the reader of the statements in measuring its efficiency in using resources The assumption is that an entity should use a greater portion of its resources to meet stated goals and a smaller part for administrative costs and fund raising This statement provides a simple way of evaluating one not-for-profit organization in comparison to another When an organization conveys a gift to a private not-for-profit organization (such as the United Way) that must be conveyed to a separate beneficiary, a question arises as to the recording of the expense and the contribution revenue Under normal circumstances, the original donor records an expense at the time of the gift while the charity reports both an asset and a liability until the gift can be conveyed to the beneficiary At the same time, the eventual beneficiary should record a receivable and contribution revenue because action has been taken that will lead to the receipt of this gift The organization that initially collected and then conveyed the gift recorded neither expense nor revenue Other possibilities exist if the donor has given the initial charity variance powers that allow for a change in beneficiaries 10 If a donor makes a contribution to a charity for conveyance to a separate beneficiary but can still revoke or redirect the gift before it is made, the donor records a receivable (rather than an expense) until the gift is actually conveyed to the beneficiary At that point, the receivable is reclassified as an expense The charity initially receiving the gift shows a liability but, in this situation, it is directed to the donor and not to the beneficiary Because the beneficiary is not completely certain that the gift will be received, no recording is made until the time of receipt The donor has retained a significant degree of control which impacts the method by which the gift is reported 11 If a donor makes a contribution to a charity for conveyance to a separate beneficiary but grants it variance powers to change the identity of the beneficiary, the donor reports an expense immediately Because control of the gift now lies with the charity, that party should record contribution revenue instead of a liability The beneficiary makes no entry until the gift is received because of the uncertainty involved The identity of the ultimate recipient may still change Here, the charity initially receiving the gift records both a revenue and, eventually, an expense for the contribution even though it was not the original donor 18-6 Chapter 18 - Accounting and Reporting for Private Not-for-Profit Organizations 12 The value of donated services is recognized by a private not-for-profit organization if the service (a) creates or enhances a nonfinancial asset (such as adding a room to a building) or (b) requires a specialized skill possessed by the donor that would have been purchased by the organization except for the gift An example of this second criterion is the donation of medical services by a surgeon to a children’s hospital 13 Normally, the costs of a direct mailing that contains a solicitation for funds will be classified entirely as a fund-raising (supporting services) expense However, under a specific set of circumstances, these costs can be allocated in a logical manner between supporting services and program services This allocation is allowed where the mailing has a specific call for action that would have been made even without the fund raising solicitation This call for action must further the mission of the organization and the appeal cannot be made purely to potential donors For example, if a mailing was made by a private not-for-profit blood service asking all previous blood donors to donate blood during the next six weeks and was accompanied by a request for donations, the direct mail costs should probably be allocated between program service costs and supporting service costs 14 Unconditional promises to give must be recorded immediately by a private not-for-profit organization at present value (if not to be received within the next year) and net of an allowance for uncollectibles An unconditional promise requires no future service or action by the charity 15 An unconditional promise to give is recorded immediately by the private not-for-profit organization that anticipates receiving the gift Conversely, an intention to give is not to be recorded In practice, the difference between the two can be rather subtle If donors have the ability or the right to change their minds, the assumption is that they have only expressed their intention to make a gift at some time in the future but have not yet made an unconditional promise If an action is required of the charity in advance of the gift, the promise is not unconditional 16 A number of private not-for-profit organizations assess dues of their membership and also receive contributions Dues are considered earned revenues rather than contributions if the member receives a benefit in return That benefit can take the form of a periodic newsletter or journal or can be the use of the facilities (such as at the YMCA) and services of the organization However, if nothing of value is really being given to the member, the dues are considered to be merely donations Here, earned revenues indicate some type of exchange transaction 17 If a not-for-profit organization gains control over another organization, combined financial statements should be prepared This type of transaction is viewed as an acquisition If two not-for-profit organizations come together to form a new, third not-for-profit with a new governing board, combined statements are also needed However, this event is viewed as a merger 18 Because one party gained control over the other, this transaction is viewed as an acquisition 18-7 Chapter 18 - Accounting and Reporting for Private Not-for-Profit Organizations Here, the acquisition value is in excess of the fair value of all identifiable assets and liabilities by $200,000 ($2.3 million less $2.1 million) In a for-profit consolidation, this excess is reported as goodwill, an intangible asset The same is true for many combined statements created when a not-for-profit entity gains control over another organization However, if this acquired entity is expected to be predominantly supported by contributions and investment income, then the extra $200,000 is reported as a reduction in unrestricted net assets on the statement of activities Thus, the amount is not capitalized as goodwill 19 If Helping Hand acquires Fancy Fingers, then the reported value on consolidated statements for the equipment will be $2.3 million That is the book value reported by Helping Hand ($1.1 million) plus the fair value of the property held by Fancy Fingers ($1.2 million) If Fancy Fingers acquires Helping Hand, then the reported value for the equipment will be $2.4 million That is the book value reported by Fancy Fingers ($1.0 million) plus the fair value of the property held by Helping Hand ($1.4 million) If the two companies are brought together to form a new, third entity under a new governing board, the equipment will be reported at $2.1 million This is a merger and the carryover method is used so that this is the combination of the book value of these assets on both sets of financial statements ($1.1 million plus $1.0 million) 20 A third-party payor is any outside party who assumes responsibility for a portion or even all of a patient's medical charges The most commonly encountered third-party payors would include insurance companies, Medicare, and the like Because third parties bear such a significant portion of the medical costs in this country, they require extensive as well as accurate financial information Health care organizations have long been required, therefore, to develop and maintain accounting systems that will provide this needed data 21 A contractual adjustment refers to a portion of a patient's charged fee that the health care organization estimates will not be received because of agreements with third-party payors These arrangements specify that the provider (the health care entity) is willing to accept an amount that is less than its normal charge if the third-party payor determines that the lesser figure is reasonable for the services rendered As an example, if a hospital charges $212,000 for a specific service but the third-party payor responsible for payment remits only $185,000 (based on its determination of reasonable costs for this service in this area of the world), the hospital must accept that amount as payment in full The $27,000 reduction is recorded by the hospital as a contractual adjustment These reductions may take an extended period of time to finalize Thus, the expected amount of these reductions is estimated by the health care organization and recorded (for matching purposes) at the time that the original invoice is submitted 18-8 Chapter 18 - Accounting and Reporting for Private Not-for-Profit Organizations Answers to Problems C (Amounts charged to patients less contractual adjustments) A B (Private NFPs report depreciation expense A public university is normally reported as an Enterprise Fund Enterprise Funds also record depreciation expense.) B (Permanently restricted net assets have increased by only $120,000.) B (Because the donor continues to have control, an asset [a receivable] will be reported until conveyed to Charity Two As a result of this uncertainty, Charity Two reports nothing until the money is actually collected.) B (For private schools, financial aid is shown as a direct reduction to the tuition revenue so that revenues and support here should total only $780,000.) C (The work of the librarian does not enhance a nonfinancial asset nor does it require a specialized skill that would be purchased if not donated.) D (If the other information that is included contains a call for a specific action that will help accomplish the mission of the charity and if the mailing is not directed solely to potential donors, a portion of the costs can be allocated to program service expenses Otherwise, they are entirely assigned to supporting services.) A (FASB wanted to get away from financial reporting based on fund accounting so that the statements provide information about the private not-for-profit organization as a whole.) 10 C (The money to be used for the building is temporarily restricted for that purpose whereas the other $2 million is permanently restricted so that only the subsequent income earned can be used.) 11 D (The charity must convey the donation to the designated beneficiary Unless the charity was given variance powers that allowed it to change the beneficiary, this amount represents a liability to the Jones family The money is simply being passed through the charity to the ultimate beneficiary.) 12 B 18-9 Chapter 18 - Accounting and Reporting for Private Not-for-Profit Organizations 13 A (Because of the time restriction, the amount spent for playground equipment remains in temporarily restricted net assets until depreciated The equipment was bought at the end of the year so that no depreciation was recorded and no reclassification was made for this period.) 14 A (The new organization is expected to be predominantly supported by contributions Thus, future exchange revenues will likely be minor The acquisition value ($1 million) in excess of the fair value of all assets and liabilities ($700,000) is $300,000 Because most support comes from contributions and investment income, the $300,000 is charged off against unrestricted net assets on the statement of activities No goodwill is recognized.) 15 A (When two not-for-profit organizations come together to form a new not-forprofit organization with a new governing board, a merger has occurred In a merger, the carryover method is used Thus, book value is retained The $300,000 book value for BC plus the $500,000 book value for OP gives a reported land account of $800,000.) 16 B (This is an acquisition and the acquired company is not predominantly supported by contributions or investment income Thus, the difference in the acquisition value of Northeast ($980,000) and the fair value of the two recognized assets ($950,000 or $150,000 plus $800,000) is recognized as the intangible asset goodwill.) 17 D 18 C 19 C 20 D (The charity care work should not be recorded in any way because there is no expectation of collection That reduces the reported amounts to $600,000 The contractual adjustment is reported as a contra balance to the revenue reducing it to a net amount of $400,000 The bad debt amount is shown separately as an expense.) 21 B 22 B (Donated service here meets the rules for recognition so that both the expense and the contribution revenue are reported.) 18-10 Chapter 18 - Accounting and Reporting for Private Not-for-Profit Organizations Temporarily Restricted Net Assets – Category Increases by $180,000 Because of the restriction on the time use of the asset, the $200,000 is initially recorded in Temporarily Restricted Net Assets The $20,000 reclassification discussed above reduces that net increase to $180,000 Operating Expenses – Category increases by the $20,000 in depreciation expense for the year Part (3) Unrestricted Net Assets – Category increases by $1.6 million The tuition revenue of $2 milion is reduced by the $700,000 in financial aid for a net increase of $1.3 million However, because $300,000 of previously restricted net assets was used here, a reclassification of that amount from Temporarily Restricted Net Assets to Unrestricted Net Assets causes the overall increase to be $1.6 million Operating Expenses – There are no operating expenses Financial aid is a reduction to tuition revenue and not an operating expense Temporarily Restricted Net Assets – Category decreases by $300,000 Money that had previously been restricted was properly utilized Thus, a reclassification of this amount is reported 42 (65 Minutes) (Prepare financial statements for a private not-for-profit organization.) a Entries for this not-for-profit organization are presented below The numbers in parenthesis indicate account totals at that point in time during the period This method is used as an easy way to gather account balances Pledges receivable 20,000 Contribution revenue—interest unrestricted net assets Cash 100,000 Allowance for uncollectible pledges 4,000 Pledges receivable Cash 180,000 Contributions revenue—unrestricted net assets Salary expense Cash Reclassification - temporarily restricted net assets Reclassification - unrestricted net 18-26 (220,000) 20,000 (200,000) 104,000 (net of 120,000) (380,000) 180,000 (180,000) 90,000 ( 90,000) (290,000) 90,000 15,000 ( 20,000) ( 15,000) Chapter 18 - Accounting and Reporting for Private Not-for-Profit Organizations assets Cash 12,000 Contributions revenue—temporarily restricted (To record gift to go to a specified beneficiary Organization reports revenue because it has variance powers.) Land, buildings, and equipment 500,000 Note payable Cash Reclassification - temporarily restricted net assets Reclassification - unrestricted net assets (To record reclassification of restricted amount properly spent.) Cash 30,000 Investment revenue—unrestricted net assets (Income is earned on permanently restricted net assets but use of the income is unrestricted.) 12,000 (302,000) ( 12,000) 450,000 50,000 (700,000) (450,000) (252,000) ( 65,000) 50,000 ( 65,000) 30,000 (282,000) ( 30,000) 30,000 (312,000) ( 30,000) 43,000 ( 12,000) ( 15,000) ( 16,000) (269,000) 12,000 15,000 16,000 Pledges receivable 149,000 Contributions revenue—temporarily restricted net assets (Although pledge is unrestricted, it will not be collected for five years and, therefore, the proceeds are viewed as temporarily restricted.) 18-27 ( 15,000) 50,000 Cash 30,000 Membership revenue—unrestricted net assets (Membership dues are listed as revenues and not contributions because members receive substantial benefits.) Rent expense Advertising expense Utilities expense Cash 15,000 (269,000) 149,000 (161,000) Chapter 18 - Accounting and Reporting for Private Not-for-Profit Organizations Pledges receivable 6,000 Contribution revenue—interest temporarily restricted net assets Depreciation expense Land, buildings, and equipment 40,000 Interest expense Cash 15,000 (275,000) 6,000 ( 6,000) 40,000 ( 40,000) (660,000) 15,000 ( 15,000) (254,000) 42 (continued) Based on the final balances computed above, the following statements can be prepared WATSON ORGANIZATION STATEMENT OF ACTIVITIES For Year Ending December 31, 2013 Unrestricted Net Assets Contributions revenue $ 180,000 Contributions interest revenue 20,000 Investment revenue 30,000 Membership revenue 30,000 Total revenues $ 260,000 Net assets released from restriction 65,000 Total revenues and net assets released from restriction $ 325,000 Expenses: General and administrative —Rent —Salary —Advertising —Utilities —Depreciation —Interest $ (12,000) (90,000) (15,000) (16,000) (40,000) (15,000) 18-28 Temporarily Restricted Net Assets $ 161,000 6,000 _ $ 167,000 ( 65,000) $ 102,000 Permanently Restricted Net Assets Chapter 18 - Accounting and Reporting for Private Not-for-Profit Organizations Total expenses $(188,000) Excess of total revenues and net assets released from restriction over expenses $137,000 Net assets at beginning of year Net assets at end of year $102,000 -0- 400,000 100,000 $300,000 $537,000 $202,000 $300,000 42 (continued) b WATSON ORGANIZATION STATEMENT OF FINANCIAL POSITION December 31, 2013 ASSETS Cash Pledges receivable (net) Investments Land, buildings, and equipment (net) Total assets $ 254,000 275,000 300,000 660,000 1,489,000 LIABILITIES Notes payable 450,000 NET ASSETS - Unrestricted - Temporarily restricted $537,000 202,000 - Permanently restricted 300,000 $1,039,000 43 (40 minutes) (Accounting for mergers and acquisitions) a In an acquisition, the assets and liabilities of the acquired organization are included at fair value Thus, the buildings and equipment reported by Swim For Safety must be increased by $140,000 from $590,000 to $730,000 Because the acquisition value ($1 million) exceeds the total fair value recognized for the individual assets and liabilities ($1,470,000 plus $140,000 less $690,000 or $920,000), the excess ($80,000 in this case) is reported as goodwill 18-29 Chapter 18 - Accounting and Reporting for Private Not-for-Profit Organizations Cash held by Help & Save must be reduced by the $1 million payment as must the balance shown for its unrestricted net assets The increases in the buildings & equipment ($140,000) as well as the increase in goodwill ($80,000) are reflected by increases in unrestricted net assets since no external restriction is in place for these assets Balances To Be Reported: Cash - $1,100,000 ($1,600,000 less $1,000,000 plus $500,000) Pledges receivable (net) - $280,000 ($70,000 plus $210,000) Investments - $470,000 ($300,000 plus $170,000) Buildings & equipment - $1,430,000 ($700,000 plus $730,000) 43 (continued) Goodwill - $80,000 (above) Total assets - $3,360,000 (summation) Accounts payable and accrued liabilities - $180,000 ($110,000 plus $70,000) Notes payable - $1,720,000 ($1,100,000 plus $620,000) Total liabilities - $1,900,000 (summation) Unrestricted net assets - $740,000 ($1,100,000 less $1,000,000 payment plus $140,000 increase in buildings and equipment plus $80,000 in goodwill plus $420,000 from Swim for Safety) Temporarily restricted net assets - $440,000 ($250,000 plus $190,000) Permanently restricted net assets - $280,000 ($110,000 plus $170,000) Total net assets - $1,460,000 (summation) Total liabilities and net assets - $3,360,000 ($1,900,000 plus $1,460,000) b In an acquisition, the assets and liabilities of the acquired organization are included at fair value Thus, the buildings and equipment reported by Swim For Safety must be increased by $140,000 from $590,000 to $730,000 Because the acquisition value ($990,000) exceeds the total fair value recognized for the individual assets and liabilities ($1,470,000 plus $140,000 less $690,000 or $920,000), the excess ($70,000 in this case) is normally reported as goodwill However, one exception is made If the acquired company is predominantly supported by contributions and investment income (as is the case here), then the excess $70,000 is not recognized as an asset Instead, the excess $70,000 within the $990,000 payment is a reduction in unrestricted net assets with no accompanying increase in goodwill 18-30 Chapter 18 - Accounting and Reporting for Private Not-for-Profit Organizations Cash held by Help & Save must be reduced by the $990,000 payment as must the balance shown for its unrestricted net assets The increase in the buildings & equipment ($140,000) is reflected by an increase in unrestricted net assets since no external restriction is in place for these assets Goodwill is not recognized so that no additional increase in unrestricted net assets is needed Balances To Be Reported: Cash - $1,110,000 ($1,600,000 less $990,000 plus $500,000) Pledges receivable (net) - $280,000 ($70,000 plus $210,000) Investments - $470,000 ($300,000 plus $170,000) Buildings & equipment - $1,430,000 ($700,000 plus $730,000) Total assets - $3,290,000 (summation) 43 (continued) Accounts payable and accrued liabilities - $180,000 ($110,000 plus $70,000) Notes payable - $1,720,000 ($1,100,000 plus $620,000) Total liabilities - $1,900,000 (summation) Unrestricted net assets - $670,000 ($1,100,000 less $990,000 payment plus $140,000 addition to buildings and equipment plus $420,000 balance for Swim for Safety) Temporarily restricted net assets - $440,000 ($250,000 plus $190,000) Permanently restricted net assets - $280,000 ($110,000 plus $170,000) Total net assets - $1,390,000 (summation) Total liabilities and net assets - $3,290,000 ($1,900,000 plus $1,390,000) c This transaction is a merger: two not-for-profit organizations are brought together to form a new not-for-profit under a newly-formed governing body As a merger, the carryover method is used Book values are simply added together to get the new balances to be reported No cash was spent and no adjustments to fair value are made 18-31 Chapter 18 - Accounting and Reporting for Private Not-for-Profit Organizations Balances To Be Reported: Cash - $2,100,000 ($1,600,000 plus $500,000) Pledges receivable (net) - $280,000 ($70,000 plus $210,000) Investments - $470,000 ($300,000 plus $170,000) Buildings & equipment - $1,290,000 ($700,000 plus $590,000) Total assets - $4,140,000 (summation) Accounts payable and accrued liabilities - $180,000 ($110,000 plus $70,000) Notes payable - $1,720,000 ($1,100,000 plus $620,000) Total liabilities - $1,900,000 (summation) Unrestricted net assets - $1,520,000 ($1,100,000 plus $420,000) Temporarily restricted net assets - $440,000 ($250,000 plus $190,000) Permanently restricted net assets - $280,000 ($110,000 plus $170,000) Total net assets - $2,240,000 (summation) Total liabilities and net assets - $4,140,000 ($1,900,000 plus $2,240,000) 44 (10 minutes) (Adjusting totals for incorrectly reported student tuition) a The tuition was properly recorded as revenue However, the financial aid figure should have been a direct reduction to the tuition revenue rather than an expense In either case, the aid reduces unrestricted net assets so the $400,000 total computed at the end of the year is correct b As indicated in (a), the financial aid should not have been an expense but, rather, a reduction in the tuition revenue Removing the $140,000 from the recognized amount of expenses reduces that total from $500,000 to $360,000 18-32 Chapter 18 - Accounting and Reporting for Private Not-for-Profit Organizations 45 (15 minutes) (Adjusting totals for incorrectly recorded restricted giving) a Because the use of the interest was specified by the donor, both interest balances should have been recorded initially as increases within Temporarily Restricted Net Assets Later, when properly spent, these amounts would have been reclassified into Unrestricted Net Assets Instead, the organization recorded these amounts immediately in Unrestricted Net Assets Since the amounts have now been properly spent, they did wind up in the category where they were supposed to be reported The $400,000 shown as unrestricted net assets is correct b Each amount was reported as expenses in unrestricted net assets and that handling was correct No change is needed so that the $500,000 reported as expenses is shown properly c As indicated in (a), the $5,000 and the $7,000 should have gone to Temporarily Restricted Net Assets and then been removed through a reclassification leaving no net effect Because nothing was recorded by the organization in Temporarily Restricted Net Assets, the total of $300,000 is correct 46 (15 minutes) (Adjusting the incorrect recording of a donation and subsequent expenditure) a Because a time restriction has been assumed, only $5,000 ($50,000/10 years) should have been reclassified from Temporarily Restricted Net Assets into Unrestricted Net Assets However, the organization increased Unrestricted Net Assets by $50,000 The final balance being reported, therefore, is $45,000 too high Removing this $45,000 inflation reduces the final Unrestricted Net Asset figure from $400,000 down to $355,000 b Depreciation expense of $5,000 ($50,000/10 years) was recorded within the Unrestricted Net Assets That handling is appropriate so that the $500,000 expense figure that is reported is correct c The problem says that the correct entry was made in Year One Thus, a $50,000 balance resides in Temporarily Restricted Net Assets as a result of the gift Because a time restriction was assumed, only an amount ($5,000) equal to the depreciation recorded should have been reclassified to Unrestricted Net Assets That $5,000 amount was never removed Reclassifying the $5,000 reduces Temporarily Restricted Net Assets from the reported $300,000 to $295,000 The $50,000 reclassification error does not affect this category 18-33 Chapter 18 - Accounting and Reporting for Private Not-for-Profit Organizations 47 (5 minutes) (Incorrect reporting of membership dues) In this case, because nothing was received in exchange for the members’ dues, these dues should have been recorded as a $100,000 per year contribution revenue which would increase Unrestricted Net Assets Instead, the dues were recorded as membership (or earned) revenue which is incorrect but it does properly increase Unrestricted Net Assets by the correct amount So, the source is wrongly reported but the total Unrestricted Net Assets is correctly stated at $400,000 48 (15 minutes) (Reporting of donated services) a The problem here is that an expense of $70,000 was reported when the donation was a garage that should have been capitalized as an asset Subsequently, though, this asset would have been depreciated at the rate of $7,000 per year For this reason, the expenses are overstated by $63,000 ($70,000 minus $7,000) which causes Unrestricted Net Assets to be understated by $63,000 Instead of an Unrestricted Net Assets balance of $400,000, the organization should have reported $463,000 b The organization has reported no assets as a result of the contributed garage The organization should have reported a $70,000 garage less $7,000 in accumulated depreciation The net balance of $63,000 should be added to the reported total for assets of $900,000 to arrive at a corrected figure of $963,000 c As indicated in (a) above, the expenses were overstated by $63,000 Removing this $63,000 drops the expense total from $500,000 to $437,000 49 (10 minutes) (Reporting a gift that must be transferred to another party) a This money is still under the control of the donor Consequently, the organization should have recorded a liability back to the donor until a final resolution Instead, the charity recorded contribution revenue which served to increase Unrestricted Net Assets That $40,000 should be removed so that Unrestricted Net Assets are $360,000 and not $400,000 b The issue in this problem is about whether a contribution or a liability should be reported by the organization The total amount reported as assets is not in question and is, thus, correctly stated at $900,000 18-34 Chapter 18 - Accounting and Reporting for Private Not-for-Profit Organizations Develop Your Skills Research Case This is an excellent assignment to demonstrate the wealth of information that is available on the Internet about charities and other not-for-profit organizations Many individuals want to be generous and help organizations that deserve their assistance Determining, though, whether an organization is truly worthy of support is not necessarily easy Every organization will claim that it is effectively helping to improve some element of society that is in need Obviously, the information that a student finds at this website will depend upon the specific charities that are examined However, some of the information that is normally available includes:  stated purpose of the organization,  year it was started,  Website address,  the existence of any affiliated organizations,  whether this organization has met all of the standards of the group that created the website and, if not, what was the problem,  a discussion of the organization’s programs along with the program expenses,  identification of the chief executive officer (along with compensation),  number of individuals on the board and the number of staff members working in the organization,  methods used for fund-raising,  tax status,  sources of funding, including dollar amounts From this type of information, a student should be able to write a detailed overview of the organization and its operations and finances Research Case This case is designed to introduce students to the information that can be found on the Form 990 that must be made public by tax-exempt organizations Much of the information is the same as is shown on the organization’s financial statements but the availability of the Form 990 ensures that such information is made public Most not-for-profit organizations that a student might research will qualify as Section 501(c)(3) charities 18-35 Chapter 18 - Accounting and Reporting for Private Not-for-Profit Organizations The salary information will give an opportunity to discuss whether officials of these organizations made too much or too little Do the amounts seem reasonable in comparison to the amount of revenues generated or the amount of assets held? What, for example, would the president of a comparable for-profit business make in salary and other compensation? Throughout the chapter, mention was made of the statement of functional expenses and the amount expended by an organization for program service expenses One possibility is to make a list in class of a number of well known charities and compare their ratio of program service expenses to total expenses just to see the range present Another exercise that can be done is to simply list on the classroom board the types of information that the students uncover Which of these is most important and why is each of the items listed included? Research Case Students often have trouble envisioning the amount of evolution that can take place in accounting and financial reporting By comparing the 1987 financial statements for Georgetown University to the current statements, students should note how much change has taken place Here are just a few of the more obvious examples that students may list The influence of government accounting at that time is obvious These statements resemble fund financial statements for the Governmental Funds of a state or local government more than they resemble the current financial statements of a private not-for-profit organization Instead of a statement of activities, the university reports a statement of changes in fund balance The statements have multiple columns that include Current Funds, Loan Funds, and Plant Funds Current funds are separated into “unrestricted” and “restricted” but the type of restriction (temporarily restricted or permanently restricted) is not evident Expenditures are listed rather than expenses Scholarships and fellowships are listed as expenditures and not as reductions in tuition revenue Transfers between funds are listed There is no statement of cash flows 18-36 Chapter 18 - Accounting and Reporting for Private Not-for-Profit Organizations Analysis Case Many times a potential donor may be interested in an array of information that can best be found by studying the actual financial statements of a not-for-profit organization The purpose of financial statements is to provide a complete picture of the financial operations and position of the organization to help outsiders make decisions Students can observe the construction of financial statements in textbooks but only by actually making use of these statements can they come to appreciate the information that is available One way to approach this assignment is to ask the students to list the five most interesting pieces of information that they uncover about a particular charity The web site for many not-for-profit organizations can be found by going to www.give.org and then clicking on “Charity Reports and Standards” and then clicking on “List of National BBB Wise Giving Reports.” At that spot, a large number of charitable organizations are listed By clicking on a specific charity, the student can get considerable information including the organization’s website address The exact information that is found will, obviously, depend on the particular notfor-profit organization that is studied As just one example, the following information comes from recent financial statements for the American Heart Association for the year ended June 30, 2010: This not-for-profit organization has four different program services listed in its financial statements: research, public health education, professional education and training, and community services The charity reported total expenses for 2010 in excess of $591 million Of that total, more than $141 million was incurred in connection with supporting services Thus, approximately 24 percent of each dollar of expense was incurred in connection with supporting services Notice that expenses were down significantly from 2009 which was probably an indication that the recession was having an impact on the work of the charity In the statement of activities, the American Heart Association recognized $52.1 million in contributed services and materials for the year ended June 30, 2010 The biggest single source was public service announcements Note 1, section i, spells out additional information about these donations as well as other donated services that were not recognized 18-37 Chapter 18 - Accounting and Reporting for Private Not-for-Profit Organizations A question that is raised in connection with virtually any charitable organization has to with the amount of resources that are expended to raise more resources In the year ended June 30, 2010, the American Heart Association, incurred $95.4 million in fund-raising expenses That amount makes up approximately 16 percent of the organization’s total expenses for the period The financial statements at June 30, 2010 show that the American Heart Association held $175.7 million in unrestricted net assets, $226.9 million in temporarily restricted net assets, and $149.6 million in permanently restricted net assets 6—For the year ended June 30, 2010, $118.3 million of temporarily restricted net assets were reclassified as unrestricted Either the related purpose restriction had been satisfied ($78.5 million) or a time restriction expired ($39.8 million) Analysis Case Most private colleges and universities now place their latest audited financial statements on their Web site However, in some cases, a bit of searching is needed to locate these statements The method by which the statements are made available is certainly not standardized The information that will be uncovered by reading through these financial statements will depend entirely on the school being used Here are the answers to the posed questions for the University of Richmond as of June 30, 2010, and the year then ended (http://controller.richmond.edu/common/pdf/about/annualfinancial-reports/financial-stmt-10.pdf) Tuition and fee revenue for the period totaled $146.1 while the school’s “scholarship allowance” was $62.5 million Hence, this financial aid covered approximately 42.8 percent of the tuition charged to students To put this information another way, the “average” student paid 57.2 percent of the school’s tuition charges The University’s balance sheet shows pledges receivable of over $20.8 million A look at note five to the financial statements indicates that over 79 percent of that money is expected to be received beyond one year into the future Because a lot of these gifts will not be received for some time, the actual amount reported is the present value of the expected future cash flows discounted at rates ranging from 2.4 percent to 10.6 percent 18-38 Chapter 18 - Accounting and Reporting for Private Not-for-Profit Organizations This is an extremely difficult question for any school to answer because the costs of “educating the students” can be included within several different accounts: instruction, libraries, academic support, institutional support, and the like So, no exact comparison between educational costs and research costs is possible here However, considerable information can be determined about the school’s priorities simply by comparing instruction expenses ($64.7 million) and research expenses ($7.3 million) For 2010, the University of Richmond shows $7.0 million in operating contributions and $3.4 million in non-operating contributions (such as for buildings and equipment) At the end of the 2010 fiscal year, the University of Richmond reported $859 million in unrestricted net assets, $593.3 million in temporarily restricted net assets, and $306.3 million in permanently restricted net assets For these last two figures, the restrictions had to have been put in place by an outside party (probably the donor) The statement of activities shows a total of both realized and unrealized gains for the year of $120.0 million The problem with this computation is determining exactly what is meant by “education expenses.” One way to compute that figure for the University of Richmond for 2010 is as follows: Net Tuition and Fees Education Expenses (one way that term can be defined) —Instruction $64,695,696 —Libraries 12,533,338 —Academic Support 23,755,148 —Student Services 18,009,427 —Institutional Support 37,320,019 Net Loss on Educating Students $83,640,871 (156,313,628) $(72,672,757) Many students feel that, because of the high amounts being charged, colleges and universities should be making a great profit from tuition Depending on how education costs are defined, most schools will show a monetary loss (and often a considerable loss) from the process of educating students This is one computation that can really interest a college student 18-39 Chapter 18 - Accounting and Reporting for Private Not-for-Profit Organizations Communication Case Under the Core Concepts, there is a considerable amount of practical guidance available at this Web site for the accountant of a private not-for-profit organization Students will already expect some of these recommendations based on their education and their own experiences but much of it may be new to them What they focus on will depend on their personal interests Here are some of the Core Concepts that they may discuss It is important for the staff to keep complete, accurate, and current financial records and share appropriate records with the board in a timely manner The board should review financial statements at least quarterly Some organizations are required by law to have an audit Almost every organization should consider the benefits of having an audit, review, or compilation by an independent CPA Separating the audit committee from the finance committee provides a check and a balance The auditor reports to the board, not to the staff A budget is the financial expression of an organization’s yearlong plan As bearers of fiduciary responsibility for the organization, the full board should approve the budget, and receive regular financial statements to monitor the implementation of the budget The board approves and reviews reports to ensure the organization is following sound financial practices Whatever the level of operating reserves or an endowment, the board needs to establish policies for managing and investing these funds 18-40 ... Questions The Financial Accounting Standards Board (FASB) has authority for establishing accounting standards for private not-for-profit organizations In addition, audit and accounting guides produced... reports both an asset and a liability until the gift can be conveyed to the beneficiary At the same time, the eventual beneficiary should record a receivable and contribution revenue because action... charity variance powers that allow for a change in beneficiaries 10 If a donor makes a contribution to a charity for conveyance to a separate beneficiary but can still revoke or redirect the gift