Understanding and implementing FASB 124.
One of the Financial Accounting Standards Board's objectives in recent years has been to improve the comparability of financial reporting within the not-for-profit sector. Not-for-profit organizations (NPOs) were exempted from FASB Statement no. 115, Accounting for Certain Investments in Debt and Equity Securities, which covered equity securities with readily determinable fair values and all debt securities. FASB Statement no. 124, Accounting for Certain Investments Held by Not-for-Profit Organizations, issued in November 1995, applies to the same securities held by NPOs; however, the accounting it prescribes is significantly different from that in Statement no. 115.
A FASB second goal has been to make the financial reporting standards of NPOs more comparable with those of for-profit entities. Statement no. 116, Accounting for Contributions Received and Contributions Made, standardized the accounting for contributions to NPOs. Similarly, Statement no. 117, Financial Statements of Not-for-Profit Organizations, requires certain minimum financial reporting standards and disclosures for all NPOs.
This article explains Statement no. 124's accounting and reporting requirements, which standardize the accounting for investments of all NPOs and limit the accounting options for endowment funds (see page 93). Previously, the NPO audit guides were inconsistent in accounting for investments. Since some of the definitions and disclosures in Statement no. 124 are the same as those in Statement no. 115, the article begins with a review of Statement no. 115 so readers can compare and contrast the accounting and reporting for investments of for-profit organizations and NPOs.
FASB 115 OVERVIEW
Statement no. 115 established accounting and reporting standards for small investments in equity securities with a readily determinable fair value and all debt investments. Small investments are those not large enough (less than 20%) to use the equity method or consolidated statements.
Under Statement no. 115, debt and equity securities are separated into three categories:
* Held-to-maturity--debt securities the enterprise has the positive intent and ability to hold to maturity. This classification applies only to debt securities, which are reported in the statement of financial position at amortized cost with classification as current or noncurrent based on the debt maturity. Unrealized holding gains and losses are not reported; realized gains and losses are reported in earnings. Interest income and any premium or discount amortization--are included in earnings. Inflows from sales and outflows from purchases are not netted and are reported as investing activities in the statement of cash flows.
* Trading securities--debt and equity securities bought and held principally to be sold in the near term. Unrealized holding gains and losses as well as dividend and interest income are included in earnings. In the statement of financial position, the investments are reported at fair value as current assets. Purchases and sales of investments are included as operating activities in the statement of cash flow.
* Available for sale--debt and equity not classified as either held-to-maturity or trading securities. They are reported in the statement of financial position as a current or noncurrent asset on an individual basis at fair value. Net unrealized holding gains or losses are reported as a separate component of stockholders' equity. Realized gains or losses are included in earnings, as are dividend and interest income and premium and discount amortization on debt securities. Sales and purchases are not netted and are reported in the statement of cash flows as investing activities.
If there is a permanent decline in the value of held-to-maturity and available-for-sale securities, the investments are written down to fair value with the write-down included in realized losses in the income statement. There is no write-up for subsequent price recoveries.
In contrast, Statement no. 124 has one classification of investments for equity securities with readily determinable fair values and for all debt securities. The investments are reported at fair value in the statement of financial position with any unrealized gains and losses reported in the statement of activities.
WHAT FASB 124 DOES
Statement no. 124 establishes the accounting standards for investments in certain equity securities and for all debt securities. These equity securities are those with readily determinable fair values not accounted for under the equity method or as investments in consolidated subsidiaries. The statement considers an equity security's fair value to be readily determinable if one of these criteria is met:
* Sales prices or bid-and-ask quotations are available on a securities exchange or in the over-the-counter market. If prices are quoted in The Wall Street Journal or Barron's, it is a marketable security.
* Securities traded only in foreign markets must trade in those comparable with U.S markets.
* Mutual funds must have a published fair value per unit that is the basis for current transactions.
The FASB defines fair value as the price at which an asset could be exchanged in a current transaction between willing parties. Ifa quoted market price is available, it is the best indicator of fair value. Some debt securities do not have quoted market prices and hence other techniques must be used to determine fair value.
Estimates of the fair value of debt securities can be made by using
* The market prices of similar debt securities.
* The present value of estimated future cash flows.
* Option-pricing models.
* Matrix pricing.
* Option-adJusted spread models.
* Fundamental analysis.
Statement no. 124 requires that covered investments be reported in the statement of financial position at fair value with any realized or unrealized gains and losses reported in the statement of activities; this complies with Statement no. 117. Investment income (interest and dividends) is recognized as revenue in the period it is earned and gains and losses are recognized as changes in net assets in the accounting periods in which they occur.
NPOs are required by Statement no. 124 to disclose the following for each period a statement of financial position is presented:
* The aggregate carrying value of investment by major types.
* The basis for determining the carrying value for investments other than equity securities with readily available determinable fair values and all debt securities.
* The methods and significant assumptions used to estimate the fair values of investments other than financial instruments if those other investments are reported at fair value.
* The shortfall in the fair value of donor-restricted endowment funds below the amount required by donor stipulations or law.
Finally, for each period for which a statement of activities is presented, the organization should disclose
* The composition of investment return including--at a minimum--investment income, realized gains and losses on investments reported at other than fair value and net gains or losses on investments reported at fair value.
* A reconciliation of investment return to amounts reported in the statements of activities if some but not all of the return is included within a measure of operations. A description of the policy used to determine the portion of the included return and a discussion of circumstances leading to any change in that policy also should be disclosed.
NPOs also must disclose gains and losses realized for investments not accounted for using fair value (unmarketable equity securities). The statement allows but does not require NPOs to distinguish between realized and unrealized gains and losses for securities carried at fair value; it prohibits reporting debt securities at amortized cost.
EFFECTIVE DATE AND TRANSITION
Statement no. 124 is effective for fiscal years beginning after December 15, 1995. Earlier application is encouraged. In the initial year of application, the statement's effect is to be reported as a change in accounting principle. The cumulative effect is to be based on a retroactive computation of unrecognized gains and losses, except the expiration of restrictions on previously recognized gains and losses may be recognized prospectively. The cumulative effect of a change in accounting on each class of net assets will appear in the statement of activities after extraordinary items, if any, and before changes in unrestricted net assets, temporarily restricted net assets and permanently restricted net assets.
Other authoritative accounting pronouncements that still apply to NPOs are FASB Statement no. 105, Disclosure of Information about Financial Instruments with Off-Balance-Sheet Risk and Financial Instruments with Concentration of Credit Risk, Statement no. 107, Disclosures about Fair Value of Financial Instruments, and Statement no. 119, Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments.
Investment income and gains with donor-imposed restrictions may be reported as increases in unrestricted net assets if the restrictions are met in the same accounting period as the income or gain is recognized. An NPO must have a similar policy for contributions, and report consistently from period to period.
DONOR-RESTRICTED ENDOWMENT FUNDS
The FASB limited the options available in accounting for donor-restricted endowment funds. Three paragraphs (11, 12 and 13) in Statement no. 124 and several in appendix B (65 to 82) and appendix C discuss the accounting for donor-restricted endowment funds.
In the absence of donor stipulations or law to the contrary, Statement no. 124 requires losses on endowment fund investments to first reduce temporarily restricted net assets. If the losses exceed such assets, the assets are reduced to zero and any remaining losses reduce unrestricted net assets. Permanently restricted net assets are not reduced for losses below the required amount or historic dollar value in states with the Uniform Management of Institutional Funds Act. When losses have reduced endowment fund assets below the required amount (historic dollar value), gains that restore the endowment fund's fair value to the required amount are classified as increases in unrestricted net assets.
Statement no. 124 requires permanently restricted net assets to equal historic dollar value and temporarily restricted net assets to be zero or a credit balance. If the endowment losses are greater than past gains, the excess will be debited to unrestricted net assets. Future gains will first increase unrestricted net assets until they have a zero balance, then increase temporarily restricted net assets.
The complexity of accounting for endowments can be simplified by using a decision flow chart (see the sidebar on page 63).
ROCKY ROAD TO IMPLEMENTATION
Implementing Statement no. 124 will be time-consuming and burdensome. But there are some steps CPAs can recommend to make the process go more smoothly.
* Endowment funds should be carefully reviewed to ascertain that (1) all donor-imposed conditions have been met, (2) any restrictions on investment income are respected and (3) any restrictions on investment gains are recognized.
* Endowment fund assets should be catalogued as of the beginning of the fiscal year to enable the NPO to recognize appropriate gains and losses for the period.
* Accounting policies and procedures should be modified to reflect Statement no. 124 provisions on establishing historic dollar values of gifts and tracking investment income, gains and losses.
* CPAs--both in public practice and in the not-for-profit sector--should meet with top NPO management and development directors to explain the new requirements, accounting policies and procedures.
* CPAs should conduct educational sessions with governing boards to explain Statement no. 124's implications. They also should help development directors (1) structure new gifts to best meet the organization's needs (for example, immediate or long-range) and (2) explain to donors how the accounting for their gifts will be handled.
Accounting for Endowment Funds
Endowment funds can have permanent, temporary or no restrictions on spending investment income or on spending gains. The flow chart on page 65 illustrates the accounting for endowment fund investments under FASB Statement no. 124. It shows the accounting process for an NPO that has received an unconditional gift that permanently restricts the spending of the corpus (the fund's historic dollar value). Earnings and gains above historic dollar value must be spent on program A, which receives no other resources or funding.
Statement nos. 116 and 124 allow temporarily restricted income and contributions to be accounted for as unrestricted income if the restriction is met in the same accounting period. If the temporarily restricted income equals the program expenditures, the restriction is assumed to be met and is considered an increase in unrestricted net assets. If the investment income is greater than the program expenditures, the temporary restriction on income on the expenditures is met and is an increase in unrestricted net assets. The excess of investment income over expenditures increases temporarily restricted net assets.
If the investment income is less than the program expenditures, the temporary restriction on the income is met on all of the investment income and unrestricted net assets increase by the amount of investment income. In prior years all of the earnings may not have been spent on program A. Some may be spent during the current year on program A, which would reduce temporarily restricted net assets and increase unrestricted net assets by this expenditure. If the contribution agreement and spending policy permit the sale of appreciated investments above the historical dollar value of the corpus, and temporarily restricted net assets have been sold, then temporarily restricted net assets should be reduced by the amount of the proceeds spent on the program, and unrestricted net assets will increase by this amount.
* THE FASB HAS ISSUED STATEMENT NO. 124, Accounting for Certain Investments Held by Not-for-Profit Organizations, which standardizes the accounting for investments of all NPOs and limits the options in accounting for endowment funds.
* STATEMENT NO. 124 ESTABLISHES THE accounting standards for investments in certain equity securities and for all debt securities. These equity securities are those with readily determinable fair values not accounted for under the equity method or as investments in consolidated subsidiaries.
* COVERED INVESTMENTS MUST BE reported in the statement of financial position at fair value with any realized or unrealized gains and losses reported in the statement of activities. Investment income is recognized as revenue in the period it is earned and gains and losses are recognized as changes in net assets in the accounting periods in which they occur.
* THE STATEMENT IS EFFECTIVE FOR fiscal years beginning after December 15, 1995, with earlier application encouraged.
* FOR SOME NPOs, IMPLEMENTATION WILL be time-consuming. CPAs in both public practice and the not-for-profit sector should meet with management and development directors to explain the new requirements and the resulting changes to accounting policies.
DAVID T. MEETING, CPA, DBA, is associate professor of accounting at James J. Nance College of Business Administration, Cleveland State University', Cleveland. RAN1)ALL W. LUECKE, CPA, CMA, is vice-president of administration and chief financial officer of International Approval Services, Cleveland. EDWARD J. GINIAT, CPA, is a partner in the Chicago office of Arthur Andersen.
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|Title Annotation:||Financial Accounting Standards Board Statement no. 124|
|Author:||Giniat, Edward J.|
|Publication:||Journal of Accountancy|
|Date:||Mar 1, 1996|
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