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Prepared by

James Myers,
C.A.
University of
Toronto
2010 McGraw-Hill
Ryerson Limited
Chapter 12, Slide 1
2010 McGraw-Hill Ryerson
Limited

Chapter 12

Accounting for
Not-for-Profit Organizations and
Governments

Chapter 12, Slide 2


2010 McGraw-Hill Ryerson
Limited

Learning Objectives
1.

2.

3.

4.

5.
6.

Describe the not-for-profit accounting practices


currently mandated in the CICA Handbook
Explain the use and the workings of a budgetary
control system that uses encumbrances
Prepare journal entries and financial statements
using the deferred contribution method of recording
contributions
Prepare journal entries and financial statements
using the restricted fund method
Explain the purpose behind fund accounting
Outline the basics of government financial reporting
Chapter 12, Slide 3
2010 McGraw-Hill Ryerson
Limited

Introduction

Not-for-profit organizations (NFPOs) are defined in the


Handbook 4400.02 as:
entities, normally without transferable ownership
interests, organized and operated exclusively for social,
educational, professional, religious, health, charitable or
any other not-for-profit purpose. A not-for-profit
organizations members, contributors and other
resources providers do not, in such capacity, receive any
financial return directly from the organization

LO 1

Chapter 12, Slide 4


2010 McGraw-Hill Ryerson
Limited

Introduction

NFPOs differ from profit-oriented organizations in the


following ways:

LO 1

In fulfilling their objectives, they typically provide services or


goods to identifiable segments of society without the expectation
of profit
Their resources are provided by individual and government
contributors without the expectation of gain or repayment; often
these contributions have restrictions attached to them
They have no readily identifiable ownership interests that can be
sold, transferred, or redeemed
They are governed by volunteers although some NFPOs also
have paid employees

Chapter 12, Slide 5


2010 McGraw-Hill Ryerson
Limited

The Basics of Fund


Accounting
Funding received by NFPOs can be categorized as

unrestricted or restricted

LO 1

Unrestricted resources can be used for any purpose consistent


with the NFPOs goals and objectives
Restricted resources can only be used as specified by the
external contributor, e.g. a donation may be received with a
condition that it be spent in some specified manner
Endowments are restricted donations that must be maintained in
perpetuity by the organization, only the interest earned on the
endowed funds can be spent

Chapter 12, Slide 6


2010 McGraw-Hill Ryerson
Limited

The Basics of Fund


Accounting
Not for profit organizations require a mechanism to

identify and track restricted funds. Fund accounting


provides such a mechanism

LO 5

Fund accounting comprises a self-balancing set of accounts


for each fund established by legal, contractual, or voluntary
actions of an organization. Elements of a fund can include
assets, liabilities, net assets, revenues, and expenses Fund
accounting involves an accounting segregation, although not
necessarily a physical segregation, of resources. [Handbook
4400.02]
Exhibit 12.1 illustrates a General unrestricted fund and a
Building fund which is restricted

Chapter 12, Slide 7


2010 McGraw-Hill Ryerson
Limited

The Basics of Fund


Accounting

LO 5

Chapter 12, Slide 8


2010 McGraw-Hill Ryerson
Limited

The Basics of Fund


Accounting
In many not-for-profit organizations, a basic objective of

financial reporting is often the tracking of changes in


each fund balance over the year and stewardship over
fund resources
Fund accounting provides a segregation of assets for a
given purpose, a recognition of the set of separate
operations which pertain to those assets, recognition of
the equities which pertain to that fund, and complete
classification by fund of revenue, expense and income
accounts

LO 5

Chapter 12, Slide 9


2010 McGraw-Hill Ryerson
Limited

The Basics of Fund


Accounting
The complete self balancing set of accounts for each

fund removes the emphasis from the overall bottom


line and places it more closely on the individual activity
of each fund
The total of assets less liabilities of the not-for-profit
organization will equal the total of the fund balances, the
same way that assets less liabilities equals owners
equity in a profit-oriented business organization

LO 5

Chapter 12, Slide 10


2010 McGraw-Hill Ryerson
Limited

The Basics of Fund


Accounting
The possible types of funds depends on the nature and

objectives of the organization:

In a university, for example, there are research funds, scholarship


funds, residence funds, athletic funds, and others
In a church, there may be mission funds, memorial funds,
building funds, and operating funds
An organization that uses fund accounting in its financial
statements should provide a brief description of the purpose of
each fund reported

Funds established by the NFPOs board of directors


cannot be considered restricted because future boards
can dispose of the fund. Only external restrictions apply

LO 5

Chapter 12, Slide 11


2010 McGraw-Hill Ryerson
Limited

Not-for-profit Reporting
Today
The eight Handbook sections applicable to NFPOs are

as follows:

LO 1

Section 4400, Financial Statement Presentation by


Nor-for-profit Organizations
Section 4410, Contributions Revenue Recognition
Section 4420, Contributions Receivable
Section 4430, Capital Assets Held by Not-for-profit
Organizations
Section 4440, Collections Held by Not-for-profit
Organizations
Section 4450, Reporting Controlled and Related Entities by
Not-for-profit Organizations

Chapter 12, Slide 12


2010 McGraw-Hill Ryerson
Limited

Not-for-profit Reporting
Today
Section 4460, Disclosure of Related Party Transactions by

Not-for-profit Organizations
Section 4470, Disclosure of Allocated Expenses by
Not-for-profit Organizations

A number of other Handbook sections have limited


applicability to NFPOs
In 2010 the CICA expects to make a decision on the
December 2008 Invitation to Comment, Financial
Reporting by Not-for-Profit Organizations.

LO 1

This would allow private-sector NFPOs to choose between IFRS


and GAAP for private enterprises including the eight Handbook
sections above. Public-sector NFPOs could choose between
IFRS and the Public Sector Accounting Handbook
Chapter 12, Slide 13
2010 McGraw-Hill Ryerson
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Not-for-profit Reporting
Today
Section 4420, Contributions Receivable:

LO 1

Contributions are defined as a non-reciprocal transfer to a notfor-profit organization of cash or other assets or a non-reciprocal
settlement or cancellation of its liabilities (4420.02)
A contribution should be recognized as an asset when the
amount to be received can be reasonably estimated and the
ultimate collection is reasonably assured. Because pledges
cannot be legally enforced, recognition should be delayed until
cash is received, unless the organization can estimate
collectibility rates based on historical results

Chapter 12, Slide 14


2010 McGraw-Hill Ryerson
Limited

Not-for-profit Reporting
Today
Section 4450, Reporting Controlled and Related Entities

by NFPOs

Establishes NFPO presentation and disclosure standards for


control, significant influence and joint venture investments or
economic interest type of relationship in other NFPOs or profitoriented organizations

LO 1

Control over other NFPOs (for example by the ability to appoint the
majority of their directors) can be reflected either by consolidation or
by disclosure set out in paragraphs 4450.22 or 4450.26
Control over profit-oriented organizations can be reflected either by
consolidation or by accounting using the equity method with
disclosure described in paragraph 4450.32

Chapter 12, Slide 15


2010 McGraw-Hill Ryerson
Limited

Not-for-profit Reporting
Today
Section 4450, Reporting Controlled and Related Entities

by NFPOs (continued)

Joint control can be reflected either by proportionate


consolidation or accounting using the equity method
Significant influence over another NFPO is reflected with
disclosure since equity accounting is not possible in the
absence of voting shares to determine percentage interest.
Significant influence over a profit-oriented enterprise is
reflected using the equity method of accounting
Other economic interests are reflected by disclosure

LO 1

Other economic interests exist if another NFPO holds


resources for the reporting organization, or if the reporting
organization is responsible for the other NFPOs debts

Chapter 12, Slide 16


2010 McGraw-Hill Ryerson
Limited

Not-for-profit Reporting
Today
Section 4460, Disclosure of Related Party Transactions

by NFPOs

Related parties include those over which control, joint control,


significant influence, or other economic interests exist. Section
4460 provides disclosure standards virtually identical to those set
out in Section 3840 for profit-oriented enterprises

Section 4430, Capital Assets Held by NFPOs

LO 1

Requires that NFPOs capitalize and amortize all capital assets,


but exempts small NFPOs with two-year average annual
revenues less than $500,000 from doing so provided they
disclose information about capital assets that are not capitalized
and amortized

Chapter 12, Slide 17


2010 McGraw-Hill Ryerson
Limited

Not-for-profit Reporting
Today
Section 4440, Collections Held by NFPOs

Collections consist of works of art and historical treasures that


are for public exhibition, education, and research, and the
proceeds from sale of which must be used to acquire similar
items or to protect the remaining collection. Therefore collections
are excluded from the definition of capital assets with the
following choices of accounting permitted:

LO 1

Expense when acquired


Capitalize but do not amortize
Capitalize and amortize

The nature of the collection should be disclosed together with the


accounting policy, the amount spent on the collection during the
period, the proceeds from any sales of collection items, and a
statement of how such proceeds were used
Chapter 12, Slide 18
2010 McGraw-Hill Ryerson
Limited

Not-for-profit Reporting
Today
Section 4470, Disclosure of Allocated Expenses by

NFPOs

When an NFPO classes its expenses by function on the


statement of operations, it may need or want to allocate certain
related expenses to those functions
Certain expenses, however, may relate directly to more than one
function, in particular fundraising expenses and general support
expenses

LO 1

When these two types of expenses are allocated to other functions,


disclosure is required of the allocation accounting policy, the nature of
the expenses, the basis on which the allocations have been made,
the amounts of each that have been allocated, and the functions to
which they have been allocated

Chapter 12, Slide 19


2010 McGraw-Hill Ryerson
Limited

Not-for-profit Reporting
Today
Sections 4400 and 4410, Financial Statement

Presentation by NFPOs and Contributions Revenue


Recognition

LO 1

Restrictions on an organizations resources should be clearly


stated in the financial statements
The matching concept for NFPOs must be applied in the
measurement of yearly results. In NFPO matching for restricted
revenues when the fund method of accounting is not used,
expenses are recognized first and then revenues are matched to
expenses
Section 4410 defines the nature of unrestricted, restricted, and
endowment contributions as discussed in a previous slide

Chapter 12, Slide 20


2010 McGraw-Hill Ryerson
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Financial Statements

A NFPO must present the following financial statements:

A statement of financial position (i.e. balance sheet)


A statement of operations (i.e. statement of revenues and
expenses)
A statement of changes in net assets
A statement of cash flows

A fund basis can be used in one or more statement, but not


necessarily on all statements

The statement of financial position must show:

LO 1

Current and non-current classification of assets and liabilities


Net assets subject to endowments
Internally restricted and externally restricted net assets
Unrestricted net assets
Chapter 12, Slide 21
2010 McGraw-Hill Ryerson
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Financial Statements

Prior to 2009 net assets invested in capital assets had to


be shown as a separate component of net assets. There
are now three options for reporting this item:

Continue to report as a separate component of net assets


Disclose in the financial statement notes
Do not present or disclose separately

The statement of operations will show the revenues and


expenses for the period and may classify these by
function

LO 1

Other comprehensive income does not apply to NFPOs


Revenues and expenses will be shown separately, and not
netted, when the NFPO acts as a principal in a transaction
Chapter 12, Slide 22
2010 McGraw-Hill Ryerson
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Financial Statements

The statement of changes in net assets must show


changes in each of the three net asset categories
reflected on the statement of financial position
The statement of cash flows must report changes in
cash under the normal three classifications:

LO 1

Cash flows from operations


Cash flows from investing and
Cash flows from financing activities

Chapter 12, Slide 23


2010 McGraw-Hill Ryerson
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Accounting for Contributions

To capture the matching concept that is unique to


NFPOs, the Handbook has defined two methods of
accounting for contributions: - - the deferral method and
the restricted fund method
If an NFPO does not wish to report on a fund accounting
basis, it will use the deferral method which shows all
activities under one financial statement column
If an NFPO reports on a fund accounting basis, it will
normally choose the restricted fund method which
provides a separate financial statement column for each
activity as illustrated in Exhibit 12.1

LO 1, 3, 4

Chapter 12, Slide 24


2010 McGraw-Hill Ryerson
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Accounting for Contributions

The deferral method matches contributions revenues


with related expenses

LO 3

Unrestricted contributions are reported in income when received


Endowment contributions are not shown on the operating
statement because they are restricted in perpetuity
Restricted contributions are matched against related expenses
Restricted contributions for future expenses are deferred and
recognized in revenue in the same periods as related expenses
Restricted contributions for acquisition of capital assets are
deferred and amortized to income on the same basis as the
assets are depreciated; when the related asset is not depreciated
(e.g. land) the restricted contribution is reflected on the statement
of changes in net assets
Chapter 12, Slide 25
2010 McGraw-Hill Ryerson
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Accounting for Contributions

The restricted fund method requires a NFPO to report


a general fund, at least one restricted fund, and, if it has
endowments or receives endowment contributions, an
endowment fund

LO 4

The restricted funds will be used to record externally restricted


revenue as well as any restricted income generated from
endowment fund investments
The endowment fund, which must be maintained in perpetuity,
will show only contribution revenue and no expenses
The general fund reflects all unrestricted contributions and
investment income including any unrestricted income generated
from endowment fund investments. Using the deferral method,
the general fund also reports restricted contributions and
investment income for which no separate restricted fund exists
Chapter 12, Slide 26
2010 McGraw-Hill Ryerson
Limited

Net Assets Invested in


Capital
Net assets (orAssets
fund balance) may include a separate

category called Net assets invested in capital assets

LO 1

Net assets invested in capital assets represents resources spent


on capital assets and therefore not available for future spending
Under the restricted fund method, it equals the unamortized
balance of all capital assets purchased from restricted and
unrestricted resources, less any related debt
Under the deferral method, it equals the unamortized balance of
capital assets purchased from unrestricted resources, less any
related debt
Transfers to and from the net assets invested in capital assets
balance (or fund) from unrestricted net assets (or general fund)
are shown in the statement of changes in fund balances, not as
revenues and expenses
Chapter 12, Slide 27
2010 McGraw-Hill Ryerson
Limited

Donated Capital Assets, Materials,


and Services

A NFPO is required to record the donation of capital


assets at fair value. If fair value cannot be determined, a
nominal value will be used

Under the deferral method the donation will be credited to


deferred contributions-capital assets which will be amortized to
future income as the asset is depreciated, or if the asset is not
depreciable (e.g. land) it will be credited to net assets invested in
capital assets

A NFPO has the option of reporting or not reporting


donated material and services;

LO 1

Reporting is permitted only if fair value can be determined, and if


materials and services would normally be used in the
organizations operations and would have been purchased if they
have not been donated
Chapter 12, Slide 28
2010 McGraw-Hill Ryerson
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Donated Capital Assets, Materials,


and Services

The Handbook section makes it clear that the fair value


of the services of volunteers are not normally recognized
due to the difficulty in determining such value

An organization would probably not record donated


materials if it acts as an intermediary for immediate
distribution and therefore will not retain the materials
(e.g. food bank)

LO 1

Chapter 12, Slide 29


2010 McGraw-Hill Ryerson
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Budgetary Control and


Encumbrances

Budgetary Control with Encumbrance and Commitment


Accounting

It is a common practice in not-for- profit organizations to set up


the approved budget in the accounts

LO 2

This practice permits actual expenditures to be tracked against


budget, so that the difference may be tracked for management
purposes
Additional control is maintained by recording various expenditures
when first approved, rather than when completed
These approved expenditures, when recorded, are referred to as
"encumbrances. The related expected obligation is referred to as an
"estimated commitment"

Chapter 12, Slide 30


2010 McGraw-Hill Ryerson
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Budgetary Control and


Encumbrances

The recording of approved future expenditures in the


accounts enables the computation of a "free" balance
at any time

LO 2

This free balance is the amount which may be expended on


other contracts or purchases, as at that point in time
This system also provides budgetary control with commercial
enterprises, especially on large, fixed price projects (such as
shipbuilding or large commercial construction projects)
The encumbrances entered into are generally shown as
expenditures (with the commitments shown as if liabilities)

Chapter 12, Slide 31


2010 McGraw-Hill Ryerson
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Budgetary Control and


Encumbrances
The free balance must be readily available in the

LO 2

accounts so that managers may promptly access this


information when required for expenditure decisions
Knowledge of the free balance (especially when it is
limited) and associated planned expenditures for the
remainder of the fiscal year helps not-for- profit
organizations to meet budgetary objectives
Accounts for outstanding encumbrances are netted
and not reported in the NFPOs external financial
statements since encumbrances are executory
contracts and not completed transactions
Chapter 12, Slide 32
2010 McGraw-Hill Ryerson
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Budgetary Control and


Encumbrances
Setting up the Budget

When the budget is approved by the directors, budgeted


amounts are recorded in a separate set of "budgetary accounts

LO 2

normal debit and credit rules are reversed, and the budgeted surplus
or deficit is also entered

As expenditures are made, they are recorded in the normal


manner
Comparison of the approved budget with actual expenditures will
indicate a free balance
This system is supplemented by the recording of encumbrances

Chapter 12, Slide 33


2010 McGraw-Hill Ryerson
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Budgetary Control and


Encumbrances
Encumbrances and Commitments

LO 2

An additional layer of control is provided by generating an entry


to a third set of accounts (using normal debit and credit rules) at
the time a purchase order is issued or a contract is entered
The estimated expenditure or encumbrance is debited to these
accounts; the expected future obligation or commitment is
credited
The free balance in such a system is computed by comparing the
budgeted expenditure limit to the total of actual expenditures plus
encumbrances

Chapter 12, Slide 34


2010 McGraw-Hill Ryerson
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Budgetary Control and


Encumbrances
When goods are received or services are delivered,

LO 2

the related invoice will be recorded in the accounts


On completion of the contract, the related
encumbrance and commitment are reversed
Discrepancies are investigated
Expenditures should not be approved which exceed
the free balance available for expenditure

Chapter 12, Slide 35


2010 McGraw-Hill Ryerson
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Budgetary Control and


Encumbrances
Closing entries in Fund Accounting Systems

In a not-for-profit organization, as with a business, all temporary


accounts are closed at the end of the fiscal period:

LO 2

Close the budgetary accounts, to provide for the "set up" of next
year's budget
Close outstanding encumbrances to expenditures for the period, so
that encumbrances are charged against the budget in the year
approved (entry is reversed at the beginning of the next period)
Close actual revenue and expenditure accounts, updating the fund
balances and clearing the accounts for the following years
expenditures

Chapter 12, Slide 36


2010 McGraw-Hill Ryerson
Limited

Budgetary Control and


Encumbrances
Note that commitments are not reported in the balance

sheet on the external financial statements; they may be


disclosed in the notes to the financial statements.
As the entry to close encumbrances was reversed, when
invoices are actually received and expenditures entered,
encumbrances are cancelled against commitments in the
normal manner

LO 2

Chapter 12, Slide 37


2010 McGraw-Hill Ryerson
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Budgetary Control and


Encumbrances
Example of Budgetary Control the following is the

summarized budget that was approved by the board of


directors:
Budgeted revenues (in detail)
Budgeted expenses (in detail)
Budgeted surplus

LO 2

$900,000
890,000
$ 10,000

Chapter 12, Slide 38


2010 McGraw-Hill Ryerson
Limited

Budgetary Control and


Encumbrances
If the organization records the budget in its accounting

records, the following journal entry is made at the start of


the fiscal year:
Estimated revenues (control account)
Appropriations (control account)
Budgetary fund balance

900,000
890,000
10,000

At the end of the fiscal year the budget accounts are


reversed as part of the closing journal entries and these
amounts are not reflected in the organizations external
financial statements

LO 2

Chapter 12, Slide 39


2010 McGraw-Hill Ryerson
Limited

Budgetary Control and


Encumbrances
Example of Encumbrance Accounting

Purchase order 3056A is issued for the acquisition of


office supplies expected to cost $950. The journal entry
to record the purchase order is:
Encumbrances
Estimated Commitments

LO 2

950
950

Chapter 12, Slide 40


2010 McGraw-Hill Ryerson
Limited

Budgetary Control and


Encumbrances
When the supplies ordered are received at an invoiced
cost of $954, the journal entries required are:
Estimated commitments
Encumbrances

950

Supplies expense
Accounts payable

954

LO 2

950

954

Chapter 12, Slide 41


2010 McGraw-Hill Ryerson
Limited

Accounting for Governments

Governments differ from businesses in many ways,


principally that governments do not exist to make profit but
to provide services and revenues are derived principally
from taxation
CICAs Public Sector Accounting Board (PSAB) sets the
standards for government accounting in the Public Sector
Accounting Handbook, first issued in 1998

LO 6

The Public Sector Accounting Handbook applies to all


governments in Canada and contains 30 sections and 7
accounting guidelines
Requires four financial statements: consolidated statement of
financial position, consolidated statement of operations,
consolidated statement of change in net debt, and a consolidated
cash flow statement
Chapter 12, Slide 42
2010 McGraw-Hill Ryerson
Limited

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