New AICPA audit and accounting guide for NPOs.

Three recent Financial Accounting Standards Board statements fundamentally change the way not-for-profit organizations (NPOs) prepare external financial statements. They require that promises to give and certain contributed services be recognized as revenue and classified in the statement of activities based on the presence or absence of donor-imposed restrictions. In addition to a statement of cash flows, the FASB standards also require NPOs to report total assets, liabilities and net assets in a statement of financial position, with most investments reported at fair value and net assets reported based on any donor-imposed restrictions. Auditors need to be familiar with these provisions, particularly those governing the distinctions between unrestricted, temporarily restricted and permanently restricted net assets.

In response to these changes, the American Institute of CPAs issued a new audit and accounting guide, Not-for-Profit Organizations, to provide guidelines for preparing and auditing NPO financial statements. The provisions of the new guide, issued in August 1996, generally are effective for financial statements for fiscal years ending on or after December 31, 1996. Earlier application is permitted. The effects of adopting the guide may be reported in a manner similar to the cumulative effect of a change in accounting principle as specified by Accounting Principles Board Opinion no. 20, Accounting Changes, or retroactively.

This article provides an overview of the new guide to help NPOs and their auditors implement its requirements. (See the sidebar on page 65 for a discussion of how an NPO is defined.)

NEED FOR THE PROJECT

FASB Statement no. 116, Accounting for Contributions Received and Contributions Made, Statement no. 117, Financial Statements of Not-for-profit Organizations, and Statement no. 124, Accounting for Certain Investments Held by Not-for-Profit Organizations--and changes in practice since the issuance of the three guides the new NPO guide replaces (see box on page 64)--made much of the existing industry-specific NPO guidance obsolete. As a result, the AICPA completely rewrote its guidance for NPOs other than health care providers and combined it into one guide. (As part of another project, the AICPA revised Audits of Providers of Health Care Services and issued Health Care Organizations.)

The new NPO guide focuses on significant aspects of NPOs' financial statements. It also describes how information from an internal fund accounting system can be used to prepare external financial statements in conformity with generally accepted accounting principles. To help auditors understand an NPO's internal controls, assess control risk and plan and conduct an audit, the new guide includes specific audit objectives, examples of controls and sample audit procedures for matters unique to NPOs.

The guide, which incorporates the requirements of Statement nos. 116, 117 and 124, also covers two SOPs: 87-2, Accounting for Joint Costs of Informational Materials and Activities of Not-for-Profit Organizations That Include a FundRaising Appeal, and 94-2, The Application of the Requirements of Accounting Research Bulletins, Opinions of the Accounting Principles Board, and Statements and Interpretations of the Financial Accounting Standards Board to Not-for-Profit Organizations. (The new guide supersedes both SOPs.) Two other SOPs are included in appendices: 92-9, Audits of Not-for-Profit Organizations Receiving Federal Awards, and 94-3, Reporting of Related Entities by Not-for-Profit Organizations.

ACCOUNTING FOR CONTRIBUTIONS

Distinguishing contributions from other asset transfers. It is often difficult to distinguish contributions from exchange transactions because some asset transfers--including grants, awards and sponsorships provided by foundations, governments and other resource providers--have elements of both. The new guide includes indicators that are useful in differentiating contributions from exchange transactions. For example, one indicator is how the amount of assets a provider transfers to an NPO is determined. If the amount is determined solely by the provider, this suggests the transaction should be accounted for as a contribution. If the amount is based on the value of goods or services the NPO gives the provider or other beneficiaries, this suggests the transaction is an exchange.

Some respondents to the guide's exposure draft wanted more specific help in deciding whether grants and similar transfers of resources from government entities are contributions or exchanges. Because the AICPA not-for-profit organizations committee could not reach consensus on more detailed guidance beyond that in FASB Statement no. 116, the final guide includes only the indicators from the ED.

The guide also discusses how to classify members' dues, which can have elements of both contributions and exchange transactions because members may receive direct benefits in exchange for all or part of their dues. While acknowledging that this distinction often is a matter of judgment, the guide provides useful indicators for determining whether dues are exchange transactions, contributions or both. One indicator is the benefits provided. When an NPO provides few or no membership benefits, dues should be accounted for as contributions. Having significant member benefits that also are available to nonmembers for a fee indicates that the membership dues are, at least in part, exchange transactions.

Reporting contributions of goods. Some NPOs receive inventory, equipment and other nonmonetary assets as contributions that sometimes are called gifts-in-kind. Statement no. 116 requires that all contributed assets, including gifts-in-kind, be recorded at fair value. The guide provides more detailed guidance by requiring that when measuring fair value, NPOs consider the quality and quantity of the assets received, including any discounts that normally would be available had the assets been purchased.

Contributions of inventory--such as used clothing or furniture donated to a thrift shop--should be reported as contributions and measured at fair value unless they cannot be used or sold by the NPO. Because of the difficulty of obtaining information about the fair value of such items, the guide allows NPOs to use estimates, averages and approximations, provided the methods are applied consistently and the results are reasonably expected not to be materially different from detailed measurements.

Promises to give. The guide clarifies the difference between unconditional promises to give and other communications that should not be reported as contributions. For example, communications with potential donors that clearly include wording such as "information to be used for budget purposes only" or that allow such donors to change their minds result in "intentions to give," which should not be reported as contributions until the NPO receives either an unconditional promise or the assets themselves.

Promises to give securities. To illustrate the unique problems of accounting for unconditional promises to give securities, consider a situation in which a donor unconditionally promises on October 21, 19 x 1, to give an NPO 100 shares of XYZ, Inc. common stock in five years. Under Statement no. 116, this promise should initially be recognized at fair value when it is made. The committee believes that, conceptually, the promise should be measured on October 21, 19 x 1, at the present value of the shares' expected fair value in five years. Because of the obvious difficulty of estimating the future fair value of securities, the guide allows NPOs to use the fair value at the date the promise to give was initially recognized.

Uncollectible promises to give. Another practical problem is uncollectible promises. The guide says that on initial recognition, estimated uncollectible promises should not be recognized as expenses. Instead, unconditional promises to give cash should be measured at fair value, based on the present value of estimated future cash flows, excluding amounts expected to be uncollectible.

Consistent with Statement no. 116, promises expected to be collected within one year of the financial statement date may be recorded at their net realizable value. The estimated future cash flows should be based on the donor's creditworthiness, the NPO's past collection experience and any other relevant factors. Because the estimated future cash flows take into account the promises' collectibility, they should be discounted using a risk-free rate of return.

Split interest agreements. Arrangements in which donors specify that NPOs share a contribution's benefits with others have become popular. A wide variety of such arrangements--called split interest agreements or planned giving--currently exist. One example is a charitable remainder trust under which a donor establishes and funds a trust. He or she designates a beneficiary, perhaps the donor's spouse, to receive a specified payout over a specified period of time (for example, a fixed dollar amount annually until the spouse's death). At the end of the period, the NPO gets the remaining trust assets.

The guide devotes an entire chapter to guidance on recognizing, measuring 'and disclosing information about split interest agreements. An appendix includes journal entries illustrating how that guidance can be applied to five common arrangements--charitable lead trusts, perpetual trusts held by a third party, charitable remainder trusts, charitable gift annuities and pooled (life) income funds.

Noncompliance with donor-imposed restrictions. Donors often make contributions with restrictions on how and when an NPO may use the contributed assets. At times, an NPO may not be in compliance with such restrictions, for example, by not maintaining an adequate amount of cash and marketable securities required under a foundation grant. The guide provides that noncompliance be disclosed if a reasonable possibility of a material contingent liability exists as of the financial statement date or at least a reasonable possibility exists that the noncompliance could result in a material loss of revenue or in the NPO's inability to continue as a going concern.

HOW TO HANDLE INVESTMENTS

Statement no. 124 prescribes fair value measurement principles for NPO investments in equity securities with readily determinable fair values (except those accounted for under the equity method and those representing investments in consolidated subsidiaries) and for all investments in debt securities. For all other investments, including real estate, limited partnerships and equity securities with no readily determinable fair value, the guide retains and incorporates the provisions of the AICPA pronouncements it supersedes.

Many NPOs have assets that, based on donor restrictions, must be invested in perpetuity. (The assets often are referred to as endowment.) Accounting for net appreciation of those assets, has been a source of controversy. Statement no. 124 requires that, unless the donor or applicable law requires that its use be restricted, net appreciation on donor-restricted endowment should be reported as a change in unrestricted net assets. Because donors stipulate their intentions in different ways and state laws and interpretations vary, accounting practices for net appreciation on endowment are diverse. The guide says auditors should obtain an understanding of issues surrounding net appreciation on endowment as they apply to the reporting NPO. Auditors also should (1) obtain management's representations about interpretations made by the reporting NPO's governing board concerning whether laws limit the amount of net appreciation on endowment that may be spent and (2) ask the reporting organization to get a legal opinion if there are questions about applicable laws or when legal interpretations conflict.

DEALING WITH EXPENSES

The guide expands on FASB Statement no. 117 by requiring that if the components of total program expense are not evident from the details provided on the face of the statement of activities--for example, if cost of sales is not separately identified as either program expense or supporting services--notes to the statements should disclose total program expense and explain why it does not articulate with the statement of activities.

Many NPOs incur fundraising costs as part of solicitation efforts. Some of those costs may be incurred in one period but provide benefits (in the form of contributions) in future periods. The committee concluded that assessing the potential future benefits of fundraising costs was too speculative and the guide requires all such costs to be expensed as incurred.

Organizations that solicit and receive contributions to be distributed to several other organizations--called federated fundraising organizations--should classify all expenses related to soliciting and receiving contributions--including those incurred in raising funds on others' behalf--as fundraising expenses. All NPOs should disclose total fundraising expenses on the face of the statement of activities or in the notes to the financial statements.

AUDITING ISSUES

Auditing standards (Statement on Auditing Standards no. 67, The Confirmation Process) require confirmation of"accounts" receivable, which by definition do not include contributions receivable. Nevertheless, the committee acknowledged that auditors may wish to use confirmations to gather evidence about the existence of contributions receivable, about donor-imposed conditions and restrictions on those contributions and about the timing of expected receipt of promised assets. The guide notes that such evidence may be obtained through confirmations from donors and auditors should follow SAS no. 67 if they use confirmations.

The guide requires auditors to adapt the language in the opinion paragraph of their standard reports to NPOs. In the standard report, the term results of operations generally is understood to refer to an entity's net income and other changes in net worth, a measurement not part of an NPO's statement of activities. As a result, the guide requires that the opinion paragraph of the standard auditor's report on an NPO's financial statements refer to changes in net assets rather than results of operations.

Another auditing issue that surfaced was reporting on comparative financial statements that do not include the minimum information required by GAAP. For example, some NPOs may wish to present comparative information from prior periods in total rather than by net asset class. If the prior periods' financial statements contain the minimum information prescribed by Statement no. 117 and the guide, they are not "summarized information" and the auditor should report on them. If prior periods' financial statements do not include the required information, however, the auditor should ascertain whether the nature of the .prior period information is labeled with an appropriate title on the face of the statement and described in a note to the financial statements. If it is not, the auditor ordinarily should add a paragraph to the audit report calling the omitted or incomplete disclosure to the readers' attention.

WHAT REMAINS TO BE DONE?

One task that must still be completed is the development of industry-specific illustrative financial statements beyond those in Statement no. 117. The committee decided not to focus on such statements at this time, concluding that industry groups and others will develop their own specialized statement formats. The committee did not want the guide to inhibit that development by providing detailed statements that might subsequently become industry standards. The committee also was concerned that the time necessary to develop illustrative statements for the wide variety of NPOs covered by the guide would have delayed its publication.

The guide provides much information useful in preparing and auditing NPO's financial statements. Other issues are surfacing as practice develops and more remains to be done to ensure that all NPO's financial statements provide relevant and reliable information to external users.

EXECUTIVE SUMMARY

* THE ISSUANCE OF FASB STATEMENT no. 116, Accounting for Contributions Received and Contributions Made, Statement no. 117, Financial Statements of Not-for-Profit Organizations, and Statement no. 124, Accounting for Certain Investments Held by Not-for-Profit Organizations, has changed how not-for-profit organizations (NPOs) prepare external financial statements.

* IN RESPONSE TO THESE CHANGES, the American Institute of CPAs issued a new audit and accounting guide, Not-For-Profit Organizations, that includes guidelines for preparing and auditing NPOs' financial statements. The guide generally applies to financial statements for fiscal years ending on or after December 31, 1996.

* THE NPO GUIDE FOCUSES ON UNIQUE and significant aspects of NPOs' financial statements and describes how information from an internal fund accounting system can be used to prepare external financial statements that conform to GAAP.

* TO HELP AUDITORS UNDERSTAND AN NPO's internal controls, assess control risk and plan and conduct an audit, the guide includes specific audit objectives, examples of controls and sample audit procedures for matters unique to NPOs.

ALAN S. GLAZER, CPA, PhD, is professor of business administration at Franklin & Marshall College, Lancaster, Pennsylvania. HENKY R. JAENICKE, CPA, PhD, is C. D. Clarkson Professor of Accounting at Drexel University, Philadelphia. Both served as consultants to the American Institute of CPAs not-for-profit organizations committee. JOEL TANENBAUM, CPA, is a technical manager in the AICPA accounting standards division. KENNETH D. WILLIAMS, CPA, is a partner of Coopers & Lybrand, LLP, in Syracuse, New York, and chairman of the AICPA not-for-profit organizations committee.

Mr. Tanenbaum is an employee of the American Institute of CPAs and his views, as expressed in this article, do not necessarily reflect the views of the AICPA. Official positions are determined through certain specific committee procedures, due process and deliberation.

Superseded Guidance

The new NPO audit and accounting guide supersedes three NPO guides issued by the AICPA: Audits of Colleges and Universities (including Statement of Position 74-8, Financial Accounting and Reporting by Colleges and Universities), Audits of Voluntary Health and Welfare Organizations and Audits of Certain Nonprofit Organizations (including SOP 78-10, Accounting Principles and Reporting Practices for Certain Nonprofit Organizations).

Defining an NPO

The new NPO guide applies to all nongovernment NPOs (such as nongoverment not-for-profit museums, libraries and foundations) except health care organizations subject to the audit and accounting guide Health Care Organizations. (The new guide also applies to providers of health-care services that meet the definition of a voluntary health and welfare organization in FASB Statement no. 116.) Statement no. 116 describes NPOs as having three characteristics in varying degrees. They

* Receive significant contributions.

* Do not operate for profit.

* Have no ownership interests.

That definition expressly excludes all entities that provide lower costs or other economic benefits directly and proportionately to their owners, members or participants. However, some organizations traditionally considered NPOs--most country clubs and trade associations--also provide lower costs or other economic benefits. The guide says the organizations that were covered by the superseded NPO pronouncements meet the FASB definition and are included in its scope.

Definition of government. Some concern was expressed about the need to distinguish nongovernmental organizations (included in the guide's scope) from governmental organizations (subject to Governmental Accounting Standards Board requirements and not included in the guide's scope). To deal with those concerns, the FASB and GASB agreed on a definition of government that was included in the guide. All NPOs (except health care services providers) not meeting that definition fall within the guide's scope.

CASE STUDY

What the NPO Guide Means for Higher Education 

As associate comptroller for the University of Chicago, John Kroll, CPA, is responsible for accounting, financial reporting and cash management at the university, which has an annual budget of $800 million. (The university's consolidated financial statements also include the hospital it operates, which has a $600 million budget.)

THE IMPACT ON HIGHER EDUCATION

As a representative of the National Association of College and University Business Officers (NACUBO), Kroll sat in on some of the AICPA not-for-profit organizations committee discussions of Not-for-Profit Organizations when the guide was being finalized. From this perspective, he outlined four major changes he thinks will have an impact on higher education.

Split interest agreements. Kroll said the single biggest change higher education will have to go through when implementing the guide concerns split interest agreements (in which a contribution's benefits are shared with others), giving the example of a life income annuity trust. Assume a donor gave the University of Chicago $100,000 in exchange for the promise to pay her $6,000 a year until her death. Before the NPO guide was issued, the entry to record a life income annuity trust would have been to record a $100,000 contribution, increasing net assets by that amount. Under the guide, the accounting has changed; in addition to the $100,000 contribution, the institution also must acknowledge that it has to pay $6,000 annually over an extended period discounted to the present. Assume the discounted liability was $35,000; rather than debiting both cash and crediting gifts for $100,000 each, the university would still debit cash for $100,000 but would credit gifts for $65,000 and credit payables for $35,000. Kroll said the new rules could have a major implementation impact depending on how active an institution is in the life income arena, since the entity's net assets could be reduced significantly. He also said an institution dealing with hundreds of such agreements would find the calculations now required will take extra time, thus increasing workload.

Tuition discounting. When students pay tuition but also get financial aid, how should the transaction be reported? In just a few sentences, Kroll said, the guide "threw higher education into a tizzy." He believes the NPO committee did not intend to prescribe what tuition discounting means for higher education. Rather, the committee decided to let universities define it for themselves. "As you might suspect," Kroll said, "there are varying opinions about tuition discounting in the higher education community." NACUBO has solicited members' views about what transactions should affect discounting. The preliminary position is that a discount should be the "difference between the stated charge for goods and services provided by the institution and the amount expected to be collected from students or third parties making payments on students' behalf."

Kroll offered this example. If a university alumnus donates $10,000 for scholarships, the transaction is recorded as revenue--as a gift. The university in turn bills someone $10,000 for tuition--another revenue event--and then records the application of the gift as an expense--scholarships and fellowships. "What we have is a transaction that has been recorded twice in terms of revenue: once as a gift and again as tuition." Some argue application of the gift should be shown net--tuition less discount equals zero--so there is only one revenue event. Kroll said the question of whether scholarships and fellowships should be shown gross or net against tuition in the financial statements has been discussed for some time. "Although this isn't a new issue, it is articulated for the first time in the guide, giving the industry an incentive to look at it more closely" Kroll, who holds a self-described "minority opinion," differs from the position of NACUBO's accounting principles committee. "I believe tuition and financial aid are separate transactions."

Distribution of functional expenses. Under FASB Statement no. 117, Financial Statements of Not-for-Profit Organizations, an entity is required to show in the notes to the financial statements, or in the statement of activities, information about expenses reported by functional classification, such as major classes of program services and supporting activities. Kroll said that before the guide was issued, colleges and universities reported all expenses by function, including instruction, research, scholarships and fellowships. Other categories included depreciation, operation and maintenance of physical plant and interest expense. Under Statement no. 117, it was unclear how certain nonfunctional expenses such as interest or depreciation should be allocated between major program services and supporting activities. What the guide does, Kroll said, is provide examples that will allow institutions to do a more thorough job of allocation, to "be more meticulous."

Market value. For heavily endowed institutions such as the University of Chicago (its endowment was $1.7 billion as of June 30, 1996), FASB Statement no. 124, Accounting for Certain Investments Held by Not-for-Profit Organizations, had a direct impact on how all debt securities and marketable equity securities were valued. What the statement did not cover, however, was the other investments typically included in endowment portfolios such as real estate, venture capital, international equities and derivatives. According to Kroll, the prior audit guide Audits of Colleges and Universities spoke of obtaining fair value estimates for these less-easy-to-value investments. The new NPO guide acknowledges that Statement no. 124 fell short by applying to only part of the total portfolio, and the new guide therefore incorporates the section from the old guide that covered these other investments.

EASE OF IMPLEMENTATION

It will not be difficult for the University of Chicago to follow the new guide. Kroll said the biggest time factor will be accounting for split interest agreements. The university will not, however, need to take on additional staff. "It will just be a matter of struggling through it the first time, taking the high road in terms of implementing the guide without more staff" Kroll said anyone who thinks an NPO needs to buy new computer systems, hire new staff or develop new software to implement the guide probably is viewing it the wrong way. "The guide is nothing more than a different way of aggregating existing numbers."

ENOUGH IS ENOUGH

Kroll does hope this guide is the end of the big changes for NPOs. He said, "In higher education we have experienced as much change in accounting and reporting in the last 3 years as we have in the last 50 or 100 years. I don't think any of us will ever see anything of this magnitude again." Kroll thinks the new guide will raise many specific questions that were not addressed earlier and expects the AICPA will respond to them by issuing either technical practice aids or omnibus clarifications as needed.

A COMMON UNDERSTANDING

With any standard, including the new NPO guide, Kroll and his staff stay on top of the guidance and provide their own interpretations of what should be done--identifying the theory and applying it practically to ensure they get the work done properly. Once they have an plan, they sit down with their external auditors to "explain our understanding of the document and how we plan to implement it using existing staff." This is Kroll's way of making sure what he is doing is acceptable from a third-party audit standpoint. "This approach has worked extremely well for us in the past," Kroll said. "I always tell others not to let the external auditors dictate implementation. Think it through carefully yourself and come up with the best plan, given the resources you have."