NFPs are different from for-profit entities in many ways. This chapter will explore the areas that make NFPs unique. It will also discuss how to report and evaluate an NFP, including using ratios and other evaluation tools.
What makes NFP entities different from normal businesses? Well, there are several things. There are environmental factors related to NFP entities that are different, in a number of ways, from businesses. These differences result in different financial reporting objectives and different financial reporting for NFP entities.
FASB identified three key characteristics of an NFP entity in the FASB Accounting Standards Codification (ASC) glossary. These characteristics are illustrated in exhibit 4-1.
Now let us look at these three major characteristics further:
There are other characteristics of NFP entities, but these are the three key characteristics that FASB identified. These characteristics can be present in an entity in varying degrees, and an NFP entity does not have to have all three. For example, an NFP school may not receive any contributions (nonreciprocal transactions) but may rely for its revenue on fees charged to students.
For the most part, NFP entities enter into many of the same transactions that businesses have. For example, NFP entities have payrolls, buy supplies, sell goods, and do many of the same things that business entities do. In general, accounting and reporting for these types of transactions are accounted and reported the same way for both types of entities.
So why are there accounting and financial reporting differences for NFP entities? To a large extent, it is due to the three aforementioned characteristic differences.
As illustrated in the following, differences in the environment factors result in NFP entities having unique financial reporting objectives:
Notice that these objectives are different from those of a business. Determining profitability and net income are not part of the objectives for NFP organizations.
Because of the special environmental factors and the need to meet the financial reporting objectives stated earlier, several unique accounting and financial reporting practices have evolved for NFP organizations. For the most part, accounting methods used by NFP organizations are the same as those used by businesses. Debits and credits, journals, and ledgers are still used, and many transactions are recorded in the same manner as a business.
However, as illustrated in the following, there are a few major accounting and financial reporting differences and unique transactions for NFP organizations that need to be understood.
Because FASB ASC 958 contains incremental industry-specific guidance specifically for NFP organizations, it is important to be clear about which organizations must follow the industry-specific guidance.
In addition to the three characteristics listed earlier that are typically present in NFPs (contributions, operating purpose, and absence of commercial ownership interest), FASB ASC also discusses entities that fall outside the definition of an NFP organization. Organizations excluded are
FASB ASC 958-10-15-3 provides the following list of nongovernmental NFP entities that should apply the incremental industry-specific guidance included in FASB ASC:
The list is not intended to be all-inclusive. Other entities, if they meet the definition of an NFP entity under FASB ASC, should also follow the incremental industry-specific guidance. It is important to note that additional incremental industry-specific guidance exists for not-for-profit, business-oriented health care entities (see FASB ASC 954).
GASB sets financial reporting standards for governments. It is easy to tell that a city or county is a government, but what about a library or museum? Entities that meet at least one of the following criteria are considered governmental and would follow GASB standards:
If the only criterion met is the ability to directly issue federally tax-exempt debt, the presumption that an entity is governmental may be rebutted based on compelling, relevant evidence.
So it should now be clearer which organizations must follow the incremental industry-specific guidance included in the not-for-profit entities topic of FASB ASC (FASB ASC 958). Exhibit 4-2 illustrates what we have discussed.
Many NFPs use fund accounting for internal recordkeeping purposes. Some include fund information in their external financial reports. Prior to the issuance of FASB No. 117, Financial Statements of Not-for-Profit Organizations, NFP organizations were required to report fund information in their external financial statements.
FASB ASC 958, Not-for-Profit Entities, changed the requirement to report information about funds. Instead, FASB ASC 958 focuses on reporting aggregated information about the entity as a whole. It requires reporting aggregated information about an organization’s net assets that are classified based solely on donor-imposed restrictions. Organizations are allowed to present disaggregated information, such as fund information, as long as the information required by FASB ASC 958 is presented.
Many of the key performance measures for a business do not work for most NFP entities. For example, a key performance indicator for most business entities is the “bottom line” measurement of profit or loss. The bottom line indicates how effective an entity is in achieving its goal of generating profits for the owners. However, generating profits for the owners is not a goal for NFP entities.
These entities have no owners, often provide goods and services to constituents without a fee, and often seek resources from individuals and entities that do not expect economic benefits from the resources provided. Therefore, the “bottom line” is not the key performance indicator for NFP entities. There are several ways to evaluate how an entity is performing. NFP entities have significant flexibility in reporting results in their statement of activities, which can help a user understand the operations of such entities. Users can also utilize ratios and other tools to evaluate financial performance. Input, output, and outcome measures can be used to evaluate effectiveness and efficiency of an organization.
The statement of activities reports revenues, gains, expenses, losses, and reclassifications for the period. The statement of activities focuses on the entity as a whole and must report certain totals for the period.
Entities have significant flexibility in displaying the required information in the statement of activities. The main requirement for this statement is that totals be reported for the amount of change in total net assets, net assets without donor restrictions, and net assets with donor restrictions.
One aspect of this flexibility is to report disaggregated information by using columns in the statement of activities. Entities may use several columns to present information as long as the required totals for the entity are reported.
Another aspect of this flexibility is how items are sequenced in the statement of activities. Revenues, gains, expenses, losses, and reclassifications can be arranged in a variety of orders. In addition, an entity may choose to report some intermediate measure of operations, such as operating revenues over expenses. If a measure of operations is reported, the term “operations” must be clear from the detail provided on the face of the statement or from a description contained in the notes to the financial statement.
The ability to report a measure of operations in the statement of activities allows an entity to provide important information about its financial performance for the period. It provides a means for an entity to “tell its story” about how it operated financially for the period. For example, an entity may consider some sources of revenues to be available to support operations and other sources of revenues to be invested to provide investment income long-term.
When a measure of operations is not used, revenues, gains and losses, and reclassifications are typically reported separate from expenses. The difference between the two categories is simply reported as change in net assets.
Consider the following examples of entities that may want to report certain items separately from the items included in a measure of operations:
To illustrate the preceding, consider the following information for Entities A, B, and C:
| Contributions | $20,000 |
| Bequest | $30,000 |
| Fee revenue | $70,000 |
| Investment income | $40,000 (for Entity B, assume the 5% limit equates to $25,000) |
| Total expenses | $145,000 |
A partial statement of activities for the three entities with a performance measure would appear as shown in exhibit 4-3.
Note that exhibit 4-3 is reflecting the different results from the use of different measures of operations between three entities in one exhibit. Had only one entity been presented, the financial statement line items and captions would have appeared differently (for example, Entity C would not have had a contributions line in the operating revenues section).
Many stakeholders are interested in the financial performance of NFP entities. Resource providers (for example, individual donors, foundations, and creditors), boards of directors, and other oversight bodies are just some examples. However, financial statements contain a lot of numbers and can be difficult to analyze. Numbers by themselves contain little information. There is limited value to saying that items such as cash, net assets, or certain revenues or expenses are of some amount.
Comparing the financial statements among different NFP entities can have limited value because entities can vary greatly in size and scope, making direct dollar value comparisons difficult. However, as illustrated in the following, there are tools that can be used to bring more meaning to the numbers presented on financial statements.
Exhibit 4-4 provides a list of some of the ratios an NFP entity may want to use.
Several ratios for NFP entities are closely monitored by organizations such as the Better Business Bureau, American Institute of Philanthropy, and GuideStar. These organizations are often interested in ratios that reflect how much of an NFP’s resources are going to program service and how efficient entities are in fund-raising activities. The websites of these organizations can be found at the following web addresses:
There are several ways to judge the performance of an NFP organization. The previous section describes evaluating the performance of an entity based on the amount of resources an entity spends on providing program services (the amount an entity spends to carry out its purpose) versus management and general expense and fund-raising activities. For most entities, a higher percentage of resources spent on program services is considered a positive performance indicator.
Although this type of measure is useful, it lacks the ability to indicate how effectively an entity uses it resources to meet its objectives. For example, an entity may spend 80% of its resources on providing a particular program service but may be ineffective in reaching the goals of that program. Just spending resources on providing a service is not an effective measure of performance.
FASB recognizes the limitations of traditional financial statements for assessing performance of NFP entities. In FASB Concepts Statement No. 4, the need for a different type of information to measure the performance of NFP entities is identified. The statement calls for reporting information about service efforts (how resources are used to provide different programs or services) in the financial statements.
The statement also discusses the idea that, ideally, information about service accomplishments should be provided as part of financial reporting. The statement recognizes the difficulties in measuring and reporting program accomplishments and the need for research to determine whether service effort and accomplishment measurements can be developed that meet the characteristics required to be included in the financial statements of NFP entities.
The measures in the preceding chart can provide information on the amount of effort expended to carry out a program (inputs), the level of services provided (outputs), what effect that service has had on the stated objectives of the program (outcomes), and comparison of the level of inputs with outputs or outcomes (efficiency).
Entities are very accustomed to reporting input measures. For example, financial resources dedicated to specific programs are reported in the financial statements. Many entities also report nonfinancial information about effort expended, such as hours expended to meet a program goal.
Output measures are often stated in nonfinancial terms. For example, a university may report the number of students that graduated, or a homeless shelter may report the number of people housed.
Outcome measures should gauge the level of accomplishment of a program goal. For example, a program designed to teach reading to adults may use the literacy rate for the area served as an outcome measure. These measures strive to assess the effectiveness of a program at meeting its goal. A limitation of outcome measures is that they can be affected by many factors other than a specific program. However, when used over a period of time, they can become a key performance measure of a program’s effectiveness.
Often, the final step an entity can take in using service efforts and accomplishments is to measure efficiency. This process computes inputs, outputs, or outcome indicators and provides a measure of how efficient an entity is in achieving program goals.
So inputs, outputs, outcomes, and their relative ratios all can be used in assessing the performance of NFPs. Many foundations and other funding entities are requiring NFPs to report this type of information in their funding requests.
Tax-exempt organizations have annual reporting requirements with the IRS; those requirements are as follows:
It is important that all exempt organizations stay apprised of the information provided at https://www.irs.gov/charities-non-profits/. Most states also have their own registration and filing requirements, some of which include audited financial statements.
Another source of regulation that NFPs often encounter is the requirement for audits performed under Government Auditing Standards (the Yellow Book) and the Uniform Guidance. These are most commonly required due to the receipt of federal funding or by law. Numerous publications and CPE courses have been written about this topic.
NFP organizations have different environmental factors than do business organizations. They receive contributions, have an operating purpose other than making a profit, and typically have no owners. Because of these differences, NFP organizations have different reporting objectives.
NFPs have several ways to report and evaluate how they are performing. Organizations have significant flexibility in reporting results in their statement of activities, which can help a user understand the operations of such organizations. Users can also utilize ratios and other tools to evaluate financial performance. Input, output, and outcome measures can be used to evaluate effectiveness and efficiency of an organization.