Auditing

FAS 117

What is FASB 117?

Statement of Financial Accounting Standard 117 “Financial Statements of Not-for-Profit Organizations” (FASB117) is the primary guidance relating to the financial statements of not-for-profit organizations (NFPs).  The Financial Accounting Standards Board issued it in 1993.  FASB117 created new standards relating to the nature and format of the financial statements that NFPs must produce to be in compliance with generally accepted accounting principles.
 

Who is covered by FASB117?

FASB117 is applicable to all not-for-profit organizations.  
 

Importance of FASB117

FASB117 standardized the financial statement presentation for NFPs.  In addition it mandated “functional reporting” of expenses.  This requires NFPs to show expenses based on the functions they benefited.
 

What statements are required by FASB117?

FASB117 requires all NFPs to prepare the following:

  1. Statement of Financial Position (Balance Sheet)
  2. Statement of Activities (Income Statement / Profit & Loss Statement)
  3. Statement of Cash Flows (for accrual basis entities)
  4. Statement of Functional Expenses (for voluntary heath and welfare organizations)

Statement of Financial Position:

This report is known as the balance sheet in the for-profit universe and shows the assets, liabilities and net assets of the NFP.  This statement shows the balances at a specific date (such as December 31, or June 30) and essentially is a snapshot of the organizations financial health on that date.

FASB117 mandates that the statement of financial position be “classified” between current and non-current report assets and liabilities.  Typically, current assets include: cash and cash equivalents, equity investments, bonds or CD’s with original maturities of less than 1 year, prepaid expenses and accounts/grants/pledges receivables that are expected to be collected within one year.  Liabilities that are classified as current usually include: accounts payable, accrued salaries, accrued vacation, deferred revenue that is to be earned within one year.  In addition, the total principal payments that are due within one year on loans, notes payable or capital leases are to be classified as current.

In addition, FASB117 requires that the statement of financial position report net assets based on the existence of donor-imposed restrictions.  The total net assets are to be categorized as unrestricted, temporarily restricted and permanently restricted.  More detailed description of each of these items is provided in the FASB116 section.  In addition, FASB117 allows for more detailed segregation of net assets.  Many organizations will breakout their unrestricted net assets into various board-designated funds, such as board endowment, reserve for capital improvements or building funds.
 

Statement of Activities:

This report is also known as the income statement or the profit and loss statement.  The statement reports the revenue, expenses, gains and loss of an NFP for a specified period, usually one year.  

FASB117 stipulates that the statement of financial position report the amount of change in each category of net assets – unrestricted, temporarily restricted and permanently restricted.  Under FASB117 all revenue or support received with donor imposed restricted is reported as temporarily or permanently restricted revenue.  However, expenses incurred to satisfy the restriction are not reported as temporarily restricted.  All expenses are reported as unrestricted and a separate line “amounts released from restriction” is included in the statement of activities.  The line would include amounts used to satisfy both purpose restrictions and time restrictions.  Typically this line is either included in the revenue/support section of the financial statements or as its own section.

Another item to note is that unless the donor specifies otherwise, all investment earning on temporarily restricted assets are to be considered unrestricted.

A third significant item relating to the statement of activities is that FASB117 prohibits netting of revenue and expenses, except in a few limited cases.  It is permissible to net investment fees with investment income, as long as the expenses are properly disclosed.  Additionally, revenue and expenses that result from activities that are beyond the NFPs control may be netted.  For example if an NFP sells property the revenue and related expenses can be reported net on the statement of activities.
 

Functional Expense Reporting:

The final, and most significant, element of FASB117 is that it requires NFPs to report expenses by functional classification.  FASB117 requires that the functional categories include at least program services, management & general and fundraising; however, more detailed reporting is encouraged.  For example many NFPS will report various functions under program services so that the readers of the financial statements will be able to get a clear understanding of the NFPs activities.

FAS117 stipulates that the information on functional expenses can be presented either on the statement of activities or in the footnotes to the financial statements, however; organizations classified as “voluntary health and welfare” are required to present a Statement of Functional Expenses.  This is a statement in matrix format that reports the natural expenses (salaries, rent, telephone…) incurred under each functional activity.

The primary effect of this requirement is that NFPs must develop a methodology for allocating indirect costs (administrative personnel costs, rent, telephone, utilities…) to the various functions and then must implement a procedure to put the methodology in practice.  One common method is to utilize timesheets and then allocate expenses using the percentage of time allocated to each function.  This is especially important because the allocation of expenses between program, management & general and fundraising is also reported on the Form 990 for NFPs who are exempt under section 50(c)(3) of the Internal Revenue Code.  Since the Form 990 is open to public inspection donors and various charity-rating services use this information as an evaluation tool.
 

Statement of Cash Flows:

FASB117 also mandates that all NFPs that prepare accrual based financial statements include a statement of cash flows.  The first task involved in preparing a cash flow statement is determining what is to be considered cash and what is considered investments.  While clearly, checking, savings and money market accounts should be considered cash, what about other short-term investments.  A common practice is that fixed income investments – mostly CDs – with original maturities of less than 3 months are considered cash.  Those items with long maturities are typically classified as investments.  

This report essentially reconciles the accrual basis change in net assets to the changes in the cash reported on the statement of financial position.  There are three sections of the statement – operating activities, investing activities and financing activities.  Each section is explained below.  While there are 2 methods of presenting the cash flow – direct and indirect  - most NFPs use the indirect method.  That is the method that is discussed here.
 

Investing activities –

This section reports that amount of cash used to acquire assets to received through the sale or disposition of assets.  The most common items included in this section are purchases and sales of property and purchases and sales of investments.  This activity is required to be reported net – i.e. the purchase of property and proceeds from the sale of property are shown separately.

Financing activities -

This section reports that amount of cash used to settle liabilities or received by incurring liabilities.  The most common items included in this section are principal repayments of notes payable or capital leases.  This activity is required to be reported net – i.e. the principal repayment on notes and the cash received at the commencement of the note payable are shown separately.

One cash flow statement item that is unique to NFPs is that restricted contributions are reported as financing activities.

Operating activities –

Essentially this section includes all items not included in investing or financing activities.  In addition, non-cash items – depreciation, donated property, net appreciation of investments… - are included in this section as reconciling items.