Chapter 19

Not-for-Profit Entities
McGraw-Hill/Irwin Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Learning Objective 1

Understand financial reporting rules and make basic journal entries for private, not-for-profit entities.

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Types of Not-for-Profit Organizations Colleges and Universities Health Care Organizations

Voluntary Health and Welfare Organizations

Certain (or all other) Not-for-profit Organizations

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Excluded Entities The following entities are not NPOs because they solely serve the economic interests of their owners, members, participants, or trust beneficiaries:

Credit unions and mutual banks

Employee benefit and pension plans

Mutual insurance companies Farms and rural cooperatives Trusts
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Characteristics of NPOs No outside ownership interest A mission to provide services

To their users, patients, society as a whole, or members But NOT at a profit

A dependence on significant levels of contributions A significant level of assets that are restricted as to use because of donor stipulations Tax-exempt status. IRS Form 990, 990A, or 990PF
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Dependence on Contributions and Federal Funding

Not-for-profit religious, charitable, and educational groups receive roughly $40 billion annually in federal government grants.

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Tax-Exempt Status Advantages to Tax-Exempt Status for U.S. Income Tax Reporting Purposes (in most states):

No state income tax No local property taxes

No sales taxes on purchases

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Tax-Exempt Status Private NPOs are exempt from U.S. income taxes if the NPO:

Serves some common good. Does not make an accounting profit. Does not primarily benefit its own executives.

Does not function for political purposes.

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Tax-Exempt Status IRS Audits of Tax-Exempt Groups:

Annually, the IRS audits approximately 11,000 of the 1.2 million tax-exempt groups. The IRS assesses taxes & penalties of over $100 million per year.

Such taxes are on business-related income (which is taxable at the highest corporate rate).

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Differences between NPOs and Businesses Revenues and support are often compared to expenses. However, remember that

Expenses are incurred to provide services (rather than to generate revenues as in commercial accounting). The purpose of NPOs is not to maximize return on an ownership interest.

ROE = Not Applicable

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The Reporting Model: Private NPOs The reporting model

Focuses on the flow of all economic resources

Uses the accrual basis of accounting

Recognizes depreciation expense in the operating statement The improvement or deterioration in the NPOs financial condition for the period and Is similar to the model used in the commercial sector
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The use of this reporting model reveals

Who Makes the Rules for Not-for-Profits Entities? The accounting and financial reporting for governmental not-forprofit entities Accounting and financial reporting for nongovernmental notfor-profit entities

GASB

FASB
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Financial Reporting for Private, Not-for-Profit Entities Private, not-for-profit entities must report their net assets in accordance with FAC 6. FAC 6 specifies three mutually exclusive classes of net assets:

Unrestricted net assets Temporarily restricted net assets

Permanently restricted net assets

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Financial Reporting for Private, Not-for-Profit Entities Important FASB Standards

SFAS 93 guides depreciation SFAS 116 guides accounting for contributions SFAS 117 establishes financial display requirements SFAS 124 establishes the accounting for investments

SFAS 136 guides the accounting for transfers of assets to a not-for-profit organization that raises or holds contributions for others
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Financial Reporting for Private, Not-for-Profit Entities Some not-for-profit entities use a fund structure to account for each type of net asset class. Other not-for-profit entities maintain only an accounting record to show the amounts in each net asset class.

The specific identification of any restricted asset must be made when the asset comes into the entity, generally by donation or bequest.

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Financial Reporting for Private, Not-for-Profit Entities Mergers and acquisitionsExposure drafts The proposed standards

Require the recognition of identifiable assets acquired and liabilities assumed at their fair values at the date of the acquisition

Require that intangible assets other than goodwill and goodwill be assigned to reporting units that are acquired Approaches to evaluating goodwill impairment

Qualitative Evaluation Method Fair-Value-Based Evaluation

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Contributions: Scope of FAS 116 FAS 116, Accounting for Contributions applies to ALL 4 types of Private NPOs.
Health Care Organizations

FASB 116

Colleges and Universities Voluntary Health and Welfare Organizations

Certain Other NPOs

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Contributions: Defined Contribution

An unconditional (no strings attached) transfer of 1. Cash or 2. Other Assets

In a voluntary, nonreciprocal transfer.

By a person or entity acting other than as an owner of the NPO Examples of Other Assets: Equipment, vehicles, land, and promises of cash.
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Contributions: Promises, Promises Unconditional transfers include unconditional promises to give cash or other assets in the future. Promises may be

Oral or

Written

Unconditional promises result in reporting Contributions Receivable in the balance sheet (subject to an allowance for uncollectibles).
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Contributions: Recognizing Unconditional Promises Recognizing unconditional promises in the financial statements requires

having sufficient evidence in the form of verifiable documentation that a promise was made

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Contributions: Conditional Promises to Give Conditional promises

The conceptual opposite of unconditional promises to give Not contributions (as defined by FAS 116) Depend on the occurrence of a specified future and uncertain event that

Must occur to bind the promissor and Thus transform the promise from conditional to unconditional status.

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Contributions: Conditional Promises That May Be Deemed Unconditional

A conditional promise may be deemed unconditional if:

The possibility that the future event will not be met [occur] is remote.

Event not likely to occur = Event likely to occur =

Conditional Unconditional

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Contributions: Conditional Use of Assets Received If assets have been received and the retention and use of such assets is conditional upon a future event that is not likely to occur,

The offsetting credit is to a Refundable Advance account (a liability) Until the conditional event occurs.

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Contributions: Manner of Reporting By Category

Contributions are reported in the Statement of Activities (the operating statement) by category

Unrestricted Temporarily restricted

Permanently restricted

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Contributions: Manner of Reporting By Category

Donor-restricted contributions whose conditions are fulfilled in the same period in which the contribution is recognized

May be reported in the unrestricted category of the operating statement (O/S) if the entity:

Consistently follows this policy and

Discloses this policy.

Note: This option negates the need to show transfers between categories in the Operating Statement.
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Contributions: Endowments Endowments

A contribution that cannot be spent.

The unspendable amount is called the principalit is invested in perpetuity.

Donor stipulations dictate the reporting classification (unrestricted, temporarily restricted or permanently restricted).

Income on Endowments

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Contributions: Temporary Restrictions

Contributed Assets
that are restricted as to either
Purpose

or

Time Period
Temporarily Restricted Assets
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are classified as

Contributions: Expirations of Restrictions Manner of Reporting Expirations of Restrictions:

Where: In the statement of activities. How: As a separate line item reclassification as shown below.
Unrestricted Temporarily Restricted $(77,000)

Expirations of restrictions

$77,000

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Contributions: Delayed Discussion of Additional Issues The following issues

Are covered after we discuss FAS 117 Financial Statements of Not-for-Profit Organizations So that you may more readily see the close interrelation-ship that exists between FAS 116 and FAS 117.

Valuation Contributed services

Collection items

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Financial Statements: Scope of FAS 117 FAS 117, Financial Statements of Notfor-profit Organizations applies to ALL 4 types of Private NPOs.
Health Care Organizations

FASB 117

Colleges and Universities

Voluntary Health and Welfare Organizations Certain Other NPOs
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Financial Statements: FAS 117The Basic Requirements

FAS 117 specifies:

What financial statements are to be presented.

What specific information, as a minimum, is to be shown.

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Financial Statements: Which Financial Statements FAS 117 requires for the NPO as a whole:

A Statement of Financial Position

A Statement of Activities
A Statement of Cash Flows. In a separate statement Expenses by Natural Classification in a matrix format.

VH&WOs must also report

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Financial Statements: The Three Classifications of Net Assets The three mandated classifications of net assets are:

Unrestricted. Temporarily restricted. Permanently restricted.

Note that these are the same three classifications used for reporting contributions.

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Contributions: Additional Issues Contributions of monetary and nonmonetary assets are valued at the fair value of the assets received. Determining the fair value may require

Obtaining quoted market prices.

Using independent appraisals.

Using other appropriate methods.

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Contributions: Additional Issues Use of Present Value Procedures:

Can use for estimated future cash flows on unconditional promises to contribute that are expected to be collected over a period of longer than one year. If used, subsequent recognition of the interest element is reported as contribution incomenot as interest income.

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Contributions: Additional Issues

Contributed Services

Recognize as revenues only if:

Nonfinancial assets are created or enhanced. Specialized skills are provided by individuals possessing these skills (e.g., carpenters, electricians, plumbers, lawyers, CPAs).

Required Disclosures for Contributed Services:

A description of the nature and extent The amounts recognized as revenues The programs or activities in which the services were used
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Contributions: Additional Issues Contributed Services:

Recognizable contributed services are usually recorded as revenues at the fair value of the services contributed. Allowed alternative valuation method for the creation or enhancement of nonfinancial assets:

May value at the fair value of

the asset created or

asset enhancement

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Contributions: Additional Issues Collection items (the exception):

Consist of contributed works of art, historical treasures, and similar assets. Need not be recognized in the financial statements if three conditions are satisfied [how used, how cared for, and use of proceeds upon sale]. Cannot be capitalized on a selective or arbitrary basis.

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Practice Quiz Question #1

How do not-for-profit entities differ from forprofit businesses: a. Not for profit entities are prohibited from charging more than cost for goods or services provided while for-profit businesses may include a mark up. b. Both for-profit businesses and not-forprofit organizations are tax exempt. c. Not-for-profit entities rely heavily on contributions and grants while for-profit businesses rely on profitable operations for survival.
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Learning Objective 2

Understand financial reporting rules and make basic journal entries for not-for-profit colleges and universities.

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Colleges and Universities Special conventions of revenue and expenditure recognition

Tuition and fee remissions/waivers and uncollectible accounts

The full amount of the standard rate for tuition and fees is recognized as revenue Accounting for university-sponsored scholarships, fellowships, tuition and fee remissions or waivers depends on whether the recipient provides any services to the university

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Colleges and Universities Special conventions of revenue and expenditure recognition

Tuition and fee reimbursements for withdrawals from coursework

Accounted for as a reduction of revenue Accounted for as revenue in the fiscal year in which the term is predominantly conducted, along with all expenses incurred NACUBO recommended the use of the accrual basis of accounting
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Academic terms that span two fiscal periods

Colleges and Universities Board-designated funds

The board may designate unrestricted current fund resources for specific purposes. FASB 117 specifies that these funds may not be reported as restricted net assets because only external, donor-imposed restrictions can result in restricted net assets.

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Colleges and Universities Public colleges and universities

Accounting and reporting is specified by the GASB. GASB 35 requires that they follow the standards for governmental entities as specified in GASB 34. Most public institutions will be special-purpose government entities engaged in only businesstype activities. These entities present only the financial statements required for enterprise funds and then are included as component units of the state government.
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Colleges and Universities Private colleges and universities

The FASB specifies the accounting and financial reporting standards. The three financial statements required are:

The Statement of Financial Position The Statement of Activities The Statement of Cash Flows

They are free to select any account structure that best serves their management and financial reporting needs.
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Colleges and Universities

Overview of the Accounting and Reporting of Colleges and Universities

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Colleges and Universities

Overview of the Accounting and Reporting of Colleges and Universities

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Practice Quiz Question #2

Which of the following statements accurately describes differences between the accounting public and private universities? a. Both public and private universities follow FASB rules. b. Both public and private universities follow GASB rules. c. Public universities follow GASB rules while private universities follow FASB rules. d. Public universities follow FASB rules while private universities follow GASB rules.
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Learning Objective 3

Understand financial reporting rules and make basic journal entries for not-for-profit health care providers.

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Health Care Providers Hospital accounting

Investor-owned hospitals provide the same types of financial reports as commercial entities. Not-for-profit hospitals present their financial results using a specific format required by the FASB. Governmental hospitals follow the GASBs accounting and reporting requirements and are considered special-purpose entities engaged in business-type activities.
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Health Care Providers Hospital fund structure

Although not required to do so, many hospitals have used a fund accounting structure for accounting purposes. Operating activities are carried on in the general fund, and a series of restricted funds can be used to account for assets whose use has been restricted by the donor.

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Health Care Providers

Overview of the Hospital Accounting and Reporting

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Health Care Providers Financial statements for a not-for-profit hospital

Separate, not-for-profit hospitals issue four basic financial statements

The Balance Sheet The Statement of Operations The Statement of Changes in Net Assets The Statement of Cash Flows

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Health Care Providers Not-for-profit hospital: The Balance Sheet

Presents the total assets, liabilities, and net assets of the organization as a whole Receivables Investments

Major accounts

Initially recorded at cost if purchased or at fair value at the date of receipt if received as a gift Property, plant, and equipment reported with any accumulated depreciation
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Plant assets

Health Care Providers Not-for-profit hospital: The Balance Sheet

Assets whose use is limited

Separate disclosure should be made for assets that have restrictions placed on their use The hospital must also account for its long-term debt and pay the principal and interest as it becomes due

Long-term debt

Net Assets
1. Unrestricted net assets available 2. Temporarily restricted net assets available for use 3. Permanently restricted net assets
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Health Care Providers Not-for-profit hospital: The Statement of Operations

Also often termed the statement of activities

Includes the revenues, expenses, gains and losses, and other transactions affecting the unrestricted net assets during the period Only general fund transactions are reported Should report an operating performance indicator

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Health Care Providers Not-for-profit hospital: Major accounts in The Statement of Operations

Net patient service revenue

Contractual adjustments Income from ancillary programs Interfund transfers General fund expenses

Donations

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Health Care Providers Not-for-profit hospital: The Statement of Changes in Net Assets

It presents the changes in all three categories of net assets

Unrestricted Temporarily restricted Permanently restricted

Statement of Cash Flows

Its format is similar to that for commercial entities

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Health Care Providers Summary of hospital accounting and financial reporting

Major operating activities take place in the general fund. The restricted funds are holding funds that transfer resources to the general fund for expenditures upon satisfaction of their respective restrictions. General fund uses the accrual basis of accounting. Patient services revenue is reported at gross amounts measured at standard billing rates.
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Health Care Providers Summary of hospital accounting and financial reporting

A deduction for contractual adjustments is then made to arrive at net patient services revenue.
Other revenue is recognized for ongoing nonpatient services. Charity care services are presented only in the footnotes; no revenue is recognized for them.

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Health Care Providers Summary of hospital accounting and financial reporting

Operating expenses in the general fund include depreciation, bad debts, and the value of recognized donated services that are in support of the basic services of the hospital.
Not all donated services are recognized. Donated property and equipment are typically recorded in a restricted fund until placed into service, at which time they are transferred to the general fund. Donated assets are recorded at fair values at the date of gift.
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Practice Quiz Question #3

Which of the following is false with respect to not-for-profit hospital accounting? a. Not-for-profit hospitals follow FASB rules. b. Not-for-profit hospitals usually use fund accounting. c. Not-for-profit hospitals do not prepare a statement of cash flows. d. The general fund of not-for-profit hospitals uses the accrual basis of accounting.
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Learning Objective 4

Understand financial reporting rules and make basic journal entries for not-for-profit voluntary health and welfare organizations.

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Voluntary Health and Welfare Organizations Voluntary health and welfare organizations (VH&WOs) provide a variety of social services

They solicit funds from the community at large and typically provide their services for no fee.

VH&WOs are typically audited.

The federal government normally provides them tax-exempt status.

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Voluntary Health and Welfare Organizations Accounting for a VH&WO

Similar to other not-for-profit organizations except for special financial statements that report on the important aspects of VH&WOs. The accrual basis of accounting is required. VH&WOs have been free to use fund accounting in their accounting and reporting processes.

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Voluntary Health and Welfare Organizations Financial statements for a VH&WO

Statement of Financial Position Statement of Activities Statement of Cash Flows

Statement of Functional Expenses

The statements are designed primarily for those who are interested in the organization as outsiders.

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Voluntary Health and Welfare Organizations The Statement of financial position for a VH&WO

Major balance sheet accounts:

Pledges from donors Investments Land, buildings, and equipment Liabilities Net assets

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Voluntary Health and Welfare Organizations Statement of activities

The overall structure of the statement of activities for voluntary health and welfare organizations and other not-for-profit entities should be very similar as a result of FASB 117.

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Voluntary Health and Welfare Organizations Statement of activities

Public support

The primary source of funds is likely to be contributions from individuals or organizations that do not derive any direct benefit from the VH&WO for their gifts. Funds received in exchange for services provided or other activities Gain or loss on sale of investments and other assets
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Revenues

Gains

Voluntary Health and Welfare Organizations Statement of activities

Donated materials and services

Should be recorded at fair value when received Information about the major costs of providing services to the public, fund-raising, and general and administrative costs

Expenses

Costs of informational materials that include a fund-raising appeal

Many VH&WOs prefer to classify such costs as program rather than fund-raising
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Voluntary Health and Welfare Organizations Statement of Cash Flows

The format of this statement is similar to that for hospitals.

Statement of Functional Expenses

Details the items reported in the expenses section of the statement of activities

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Voluntary Health and Welfare Organizations Summary of Accounting and Financial Reporting for VH&WOs

Reporting requirements are specified in FASB 116, FASB 117, and the AICPA Audit and Accounting Guide for Not-for-Profit Organizations.
The accrual basis of accounting is used. Primary activities are reported in the unrestricted asset class.

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Voluntary Health and Welfare Organizations Summary of Accounting and Financial Reporting for VH&WOs

Resources restricted by the donor for specific operating purposes or future periods are reported as temporarily restricted assets. Assets contributed by the donor with permanent restrictions are reported as permanently restricted assets.

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Practice Quiz Question #4

Which of the following is false with respect to the accounting for voluntary health and welfare organizations? a. VH&WOs solicit funds from the community and typically provide their services for no fee. b. VH&WOs use the modified accrual basis of accounting. c. VH&WOs must provide a statement of cash flows. d. VH&WOs primary activities are reported in the unrestricted asset class.
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Learning Objective 5

Understand financial reporting rules and make basic journal entries for other not-for-profit organizations.

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Other Not-for-Profit Entities

Examples of other not-for-profit organizations (ONPOs):

Cemetery organizations Civic organizations Fraternal organizations Labor unions Libraries Museums Other cultural institutions Performing arts organizations Political parties Private and community foundations

Private elementary and secondary schools Professional associations Public broadcasting stations Religious organizations Research and scientific organizations Social and country clubs Trade associations Zoological and botanical societies
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Other Not-for-Profit Entities Accounting for ONPOs

In addition to FASB 116 and FASB 117, the AICPA Audit Guide for Not-for-Profit Organizations provides guidance for accounting and financial reporting standards.

While accrual accounting is required for all ONPOs, some small organizations operate on a cash basis during the year and convert to an accrual basis at year-end.

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Other Not-for-Profit Entities Accounting for ONPOs

With the adoption of FASB 116 and FASB 117, the procedures used by ONPOs and VH&WOs may move away from the traditional funds used They may account for all transactions in a single entity or by establishing separate accounts for unrestricted, temporarily restricted, and permanently restricted net assets

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Other Not-for-Profit Entities Financial Statements of ONPOs

Explains how the available resources have been used to carry out activities. They should disclose the nature and source of the resources acquired, any restrictions on the resources, and the principal programs and their costs. They should also provide information on the ability to continue to carry out objectives. FASB 117 requires 1. A Statement of Financial Position 2. A Statement of Activities, and 3. A Statement of Cash Flows
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Other Not-for-Profit Entities Summary of Accounting and Financial Reporting

Accounting is similar to that for VH&WOs.

The accrual basis of accounting is used . When a large number of programs or a number of very different types of programs are part of the operations, it may be desirable to prepare a statement of expenses by functional area or major program as well. As a result of FASB 116 and FASB 117, the reporting requirements of ONPOs are substantially the same as VH&WOs.
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Practice Quiz Question #4

Which of the following is false with respect to the accounting other not-for-profit organizations? a. While accrual accounting is required for all ONPOs, some small organizations operate on a cash basis during the year and convert to an accrual basis at year-end. b. Accounting is similar to that for VH&WOs. c. ONPOs may account for all transactions in a single entity or by establishing separate accounts for unrestricted, temporarily, and permanently restricted net assets d. ONPOs follow GASB rules.
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Conclusion

The End

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