The basics about nonprofits: a beginner's guide for CPAs.
Nonprofits make up a substantial portion of the U.S. economy. As noted in The Urban Institute's Nonprofit Sector in Brief 2014, the sector contributed an estimated $887.3 billion to the U.S. economy in 2012, or 5.4% of GDP (Brice McKeever, Sarah Pettijohn, The Nonprofit Sector in Brief (2014: Public Charities, Giving, and Volunteering, http://www.urban.org/UploadedPDF/413277-Nonprofit-Sector-in-Biief- 2014.pdf). In addition, nonprofits had more than $4.84 trillion in assets under their control and generated more than $2 trillion in revenue. Lastly, more than one quarter of U.S. adults volunteered through a nonprofit organization in 2013, contributing a total of 8.1 billion hours during the year (worth approximately $163 billion). In 2013, the total of charitable giving from individuals, businesses, and foundations was worth more than $335 billion
Nonprofit versus Charity
There is a legal difference between a charity and a nonprofit, although the two terms are often--wrongly--used interchangeably. Nonprofit status is a state designation, and may make a nonprofit eligible for certain tax exemptions within that state (IRS, "Applying for Exemption-Difference between Nonprofit and Tax-Exempt Status," http://www.irs. gov/Charities-&-Non-Profits/Applying-for-Exemption-Difference-Between- Nonprofitand-Tax-Exempt-Status). In order for nonprofit organizations to be exempt from federal income tax, they must meet the requirements outlined in IRC section 501(a).
Charitable organization (charity) status is conferred under IRC section 501(c)(3). About 75% percent of all federally exempt nonprofits meet 501(c)(3) status and with it receive the added benefit of eligibility to receive tax-deductible contributions (National Center for Charitable Statistics, "Number of Nonprofit Organizations in the United States, 2003-2013," http://nccsweb.urban.org/PubApps/profile1php?state =US). Thus, under federal tax laws, all charities are nonprofits, but not all nonprofits are charities.
Spending and Efficiency
Nonprofits are allowed to--and often do--earn a profit. Although there is no prohibition on earning profits, profits must be reinvested in the organization, rather than distributed to the individuals who oversee the organization. The requirement that no one may own the residual value of a nonprofit is known as the "non-distribution constraint" (Henry Hansmann, "The Role of Nonprofit Enterprise," Yale Law Journal, vol. 89, no. 5, 1980, pp. 835-901).
Most federally tax-exempt nonprofits are required to file an annual return with the IRS: This return is considered an informational return rather than a tax return. Larger nonprofits (gross receipts normally greater than $50,000) file Form 990 or Form 990-EZ. Form 990 provides information about a nonprofit's finances, mission, and programs and is used by the IRS and the public to evaluate a nonprofit's operations (Mollie Cullinane, "Nonprofit Law Basics: Do Nonprofits File Tax Returns? What is a 990?" http://cullinanelaw.com/nonprofit-law- basics-does-ournonprofit-have-to-file-tax-returns-or-an-annual-reporting- return-with-the-irs/). Smaller nonprofits (gross receipts normally $50,000 or less) file Form 990-N (a short electronic return referred to as the "e-postcard"). Private foundations file Form 990-PF. Failure to file the appropriate form three years in a row results in automatic revocation of federal tax-exempt status. (For more discussion of nonprofit filing requirements, see "Twenty Frequently Asked Questions About Nonprofits," by Peter Karl, page 22.)
Two common measures of nonprofit financial efficiency include the program spend ing ratio (program expenses divided by total expenses) and the fundraising efficiency ratio (fundraising expenses divided by total contributions). The users of nonprofit financial data include donors, charity watchdog groups, the press, and boards of directors; they look to these ratios (typically calculated using Form 990 data) to make decisions and judgments about nonprofits. As a result, nonprofits have incentives to manage their results, just as for-profits do.
Nonprofit Accounting and Auditing
Beginning in 1995 with SFAS 117, Financial Statements of Not-for-Profit Organizations (now incorporated into ASC 958), the focus of nonprofit external financial statement reporting changed from reporting activity by individual fund groups to reporting for the entity as a whole. Fund accounting has not gone away, however; SFAS 117 permits, but does not require, reporting by fund groups in the external financial statements, as long as aggregated information about the entity as a whole is also presented, and many nonprofits continue to use the fund accounting method for internal and grant-reporting purposes (Jacqueline Reck, Suzanne Lowensohn, and Earl Wilson, Accounting for Governmental and Nonprofit Entities, vol. 16, 2013, McGraw-Hill/Irwin). In April 2015, FASB released an exposure draft, "Presentation of Financial Statements of Not-for-Profit Entities." The proposed amendments would result in significant changes to the current nonprofit financial statement reporting model. (For further discussion, see "A New Reporting Landscape on the Horizon," by Alexander K. Buchholz, page 6.)
Nonprofits that receive federal government grants or contracts are required to undergo a special audit if they expend in excess of $750,000 in federal monies in a single year (recently increased from $500,000). This Single Audit, also commonly known as an A-133 Audit, consists of a traditional audit and additional procedures related to internal controls and federal funding (Michelle Yetman, Robert Yetman, "The Effects of Governance on the Accuracy of Charitable Expenses Reported by Nonprofit Organizations," Contemporary Accounting Research, vol. 29, no. 3,2012, pp. 738-767). It is intended to subject a qualifying entity to only one audit as opposed to multiple audits of individual programs (Office of Management and Budget, "Office of Federal Financial Management Single Audit," http://www.whitehouse.gov/omb/financial_ fin single audit). The name is derived from OMB Circular A-133, which established the rules and guidelines for the single audit. Note that in December 2013, the OMB issued final guidance for Uniform Administrative Requirements, Cost Principles, and Audit Requirements for Federal Awards, which combines and streamlines Circular A-133, along with seven other OMB circulars related to federal awards management, into one "super circular" document (http://www. gpo.gov/fdsys/pkg/FR-2013-12-26/pdf/ 2013-30465.pdf). (For a more in-depth discussion, see "Seven Suggestions for a Successful Single Audit," by David C. Ashenfarb, page 10.)
Fraud and Dissolution
Upon dissolution, 501(c)(3) nonprofits must give their remaining assets to another 501(c)(3) nonprofit, or to the local, state, or federal government (IRS Publication 557, Tax-Exempt Status for Your Organization, http://www.irs.gov/pub/irs-pdf/p557.pdf). Research conducted by Chuck McLean, vice president of research at GuideStar, a nonprofit agency that gathers and disseminates information about all nonprofits registered with the IRS, indicates that in the past three years, approximately 157,000 nonprofits disappeared from the IRS's files, many likely because they have gone out of business (https://non- profitquarterly.org/policysocial-context/25380-vital-records-births- anddeaths-in-the-nonprofit-sector.html).
The philanthropic nature of most nonprofits does not preclude them from wrongdoing; they are not immune from scandal. Nonprofit managers sometimes become embroiled in self-serving schemes, just like their for-profit counterparts. Notable nonprofit financial scandals in recent history involved exorbitant executive spending (e.g., Oral Roberts University, the Smithsonian Institution, Community Action of Minneapolis, and American University), embezzlement of funds (e.g., New York's Metropolitan Council on Jewish Poverty, Cancer Fund of America, Acorn, D.C. United Way, Angel Food Ministries, Soundview Healthcare Network, Birmingham Health Care, the Ohio Division of the American Cancer Society), and pyramid schemes (e.g., Baptist Foundation of Arizona, New Era Philanthropy).
It is unfortunate that nonprofits seem to make headlines more often for scandal than for all the good work they do--a major reason why financial professionals should become aware and educated about nonprofits, which provides services that the public depends on, but sometimes undervalues.
Sarah Garven, PhD, CPA, is an assistant professor of accounting at Ohio University's School of Accountancy in Athens, Ohio.
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|Title Annotation:||News & Views: not-for-profit organizations; certified public accountants|
|Publication:||The CPA Journal|
|Date:||Jun 1, 2015|
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