Financial Statements: How useful is your information? (Accounting).

One of the criticisms often leveled at today's nonprofit financial statements, at least those prepared in accordance with generally accepted accounting principles (GAAP), is that they don't capture the true picture of the organization's activities.

And, by the way, in preparation for the increasing internationalization of financial information for use around the world, effective this past July 1, auditors' reports on financial statements, both commercial and nonprofit, now make reference to "accounting principles generally accepted in the United States of America."

Nonprofit financial statements certainly don't look the way they once did, but are they less useful now than they were, say, 10 years ago? Or, are they more useful?

Most people would agree that there are fundamental differences between a company that exists to make a profit and provide a return on investment to its shareholders and a nonprofit entity, the raison d'etre for which is to fulfill its mission. There is less agreement as to whether the financial statements of the two entities, should also be fundamentally different.

However, recent years' changes in accounting and reporting principles have made it clear that the accounting standard-setters believe that the two types of organizations' financial statements should provide much of the same information, in much the same format. Indeed, GAAP requires that there be the same basic financial statement package for both - a balance sheet (statement of financial position), an income statement (statement of activities), a statement of cash flows, and supporting notes.

Authoritative guidance

The Financial Accounting Standards Board (FASB) and its sibling entity, the Governmental Accounting Standards Board (GASB) provide the primary level of GAAP in the United States. Some nonprofit organizations, such as certain universities, hospitals, museums, and human-services organizations, may be subject to significant governmental funding and/or control.

Because FASB and GASB guidance for essentially the same area of focus may differ in various ways, those organizations must look carefully at both sets of pronouncements to be sure of proper compliance. Although it had addressed so-called "nonbusiness" issues in a series of nonauthoritative documents during the 1980s, quite honestly, the nonprofit sector was not high on the list of the FASB's priorities in the first years of its existence.

That changed in 1987, however, when the FASB released Statement No. 93, Accounting for Depreciation by Not-for-Profit Organizations. Up until then, many nonprofits did not capitalize and depreciate their property and equipment, the so-called "fixed" assets.

The logic was that depreciation was a non-cash expense, and a lot of organizations believed it distorted an entity's "surplus" or "difference" between revenue and support and expenses (none dared call it "income". Unfortunately, if the financial impact of not depreciating was significant for an entity, then the independent auditors "qualified" their reports on the financial statements, noting that the accounting was not in accordance with GAAP Most affected nonprofits were not too concerned about the auditors' negative language, though, because they had a lot of fellow organizations with the same qualification.

Statement No. 93 changed the ballgame. Slowly but surely, nonprofits began to comply with the capitalization of property assets and depreciation. And there grew to be an appreciation for the fact that, to truly understand an organization's costs, non-cash expenses such as depreciation and bad debts have to be considered.

Also, as the number of qualified opinions began to dwindle, nonprofit managements often found it more time-consuming to explain to board members, contributors and creditors why there was an audit qualification than it was to begin depreciating their assets. Now, the auditors' qualification for nondepreciation is a relatively rare one.

Then, in June 1993, the FASB followed up with the heavy artillery - its landmark Statements No. 116, Accounting for Contributions Received and Contributions Made, and No. 117, Financial Statements of Not-for-Profit Organizations, followed in November 1995 by Statement No. 124, Accounting for Certain Investments Held by Not-for-Profit Organizations.

Statement No. 116 establishes the principles of accounting for contributions, with the requirements for recognition as revenue of an enforceable pledge (regardless of when cash or other assets are received) and of certain donated services being the most controversial. Statement No. 117 sets the criteria for constructing general-purpose, external financial statements. Statement No. 124 requires that most investments be reported at fair value. Together, these three pronouncements constitute the lion's share of the guidance for today's nonprofit accounting and financial reporting.

The nonprofit community did not accept the FASB's actions quietly. There were many efforts to influence the board's determinations -- both before and after their issuance. Some nonprofits were determined not to follow the new guidelines. But, the FASB had dealt with controversy before. Depreciation was now largely a nonprofit fact-of-life, after all - and it held politely, but firmly, to the rules it created.

For the most part, prior to the FASB's actions, nonprofit accounting and reporting had been a Mulligan's stew of concepts and methodologies appropriated from the commercial sector, from the existing nonprofit literature promulgated by the American Institute of Certified Public Accountants (AICPA), and from the practices that had been established over time by individual nonprofit industry segments.

"Fund" accounting was the order of the day, and nonprofit financial officers and staff often wrestled with hundreds, sometimes thousands, of yearly transactions and transfers as they struggled to keep those funds in balance.

Nonprofit financial statements were all too often multi-columned nightmares that hardly anyone understood. For better or worse, the FASB had begun the process of simplification (believe it or not) and of making nonprofit financial statements look very much the same from one entity to the next.

Have accounting and reporting improved?

The FASB's objective in producing the changes of the mid-1990s was to improve the relevance, understandability and comparability of general-purpose, nonprofit financial statements. The board believes that, even though net income, per se, was not a goal of a nonprofit organization, donors, members and creditors of nonprofit entities benefit from financial data presented in a format and structure similar to that in which they would be presented by a commercial enterprise.

Over the long haul, every enterprise has to bring in more resources than it pays out, and a strong argument can be made that the structure of today's nonprofit financial statements show that reasonably well. They also permit the reasonably informed reader to compare how the local school, church and charity go about achieving that end, no matter how diverse their missions.

The FASB has actually provided significant latitude to organizations in preparing their financial statements, so long as certain key benchmarks, such as the annual changes in unrestricted, temporarily restricted and permanently restricted net assets, are included. There is no prohibition of fund accounting, just the firm belief that nonprofit organizations will ultimately find the new approach more valuable and the ability to hold on to the detailed data of "funds" increasingly more difficult.

For many entities, the activities in individual donor funds may serve a "political" purpose, but from an accounting standpoint, and usually a legal one, the painstaking tracking of earnings and expenses by fund has no basis in GAAP. Moreover, it does not usually provide particularly meaningful information to a reader.

Of course, for those nonprofit governing boards and managements that rely on periodic, cash-based budget-to-actual comparisons as a stewardship tool, there is no reason to depart from that process. GAAP-based financial statements are not intended to replace it.

Instead, the intention is to help nonprofits benefit from yet another tool -- a set of financial statements that reflects the organization's activities very much from an outside, economic standpoint. As for the federal Form 990, it was restructured concurrently with the FASB's statements, to make a reconciliation between GAAP financial statements and tax-compliance requirements relatively simple.

The good news is that there appear to be no major changes in nonprofit accounting and reporting on the horizon from either the FASB or AICPA. Perhaps the better news is that financial statements have been growing increasingly more useful -- and more readily understood -- all the time.

D. Edward Martin, MBA, CPA, is the partner-in-charge of the Not-for-Profit Industry Group at the accounting and consulting firm of Richard A. Eisner & Company, lip. Julie L. Floch, CPA, is a partner and the director of Not-for-Profit Services at Eisner. Martin is an adjunct professor at Pace University and Baruch College/CUNY Floch is adjunct faculty at Baruch College and the New School University is a member of several not-for-profit task forces of the American Institute of CPAs, and chairs the Not-for-Profit Committee of the New York State Society of CPAs.