CHAPTER 18
ACCOUNTING AND REPORTING FOR PRIVATE
NOT-FOR-PROFIT ENTITIES
Chapter Outline
I. Historically, the financial reporting for private not-for-profit entities has differed significantly
according to the type of organization (such as a health care entity versus a college or
university). The reporting of these entities has now been largely standardized by FASB
pronouncements that focus on (a) the reporting of financial statements for the entity as a
whole and (b) significant events such as the receipt of contributions and the recording of
mergers and acquisitions. However, public colleges and universities and similar
organizations still must follow the standards issued by GASB.
A. This chapter examines the financial reporting for private not-for-profit entities with special
emphasis on private colleges and universities, voluntary health and welfare entities, and
health care operations.
B. Reporting for these entities is usually similar to a business enterprise unless critical
differences exist that impact the needs of financial statement users. Several of these
critical differences can be identified.
1. Many private not-for-profit entities receive a significant amount of their financial
resources from contributions rather than from revenues or capital investments.
2. A significant amount of the financial resources given to a private not-for-profit entity
include donor-imposed restrictions.
3. No single indicator of success is present in the financial reporting. No number such
as net income provides a means for evaluation as it does with a for-profit business.
II. FASB has established the following financial statements for private not-for-profit entities.
A. Statement of Financial Position reports assets, liabilities, and net assets.
B. Statement of Activities reports revenues, expenses, gains, and losses.
C. Statement of Cash Flows
D. A voluntary health and welfare entity is also required to present a Statement of
Functional Expenses which indicates the amount of resources spent for program
services (to meet the goals of the entity) and supporting services (to operate the entity
and raise funds).
III. For reporting purposes, all economic resources held by a private not-for-profit entity are
classified within one of three categories.
A. “Unrestricted net assets” indicates the amount of an entity’s resources that are not
subject to external donor restrictions. Entity officials can make whatever use they wish
of these assets.
B. “Temporarily restricted net assets” are restricted by an outside party (often a donor) for a
particular purpose or for use in a future period of time. When the restriction is eventually
satisfied, the classification of these resources is switched to unrestricted net assets. At
that time, on the statement of activities, temporarily restricted net assets are reclassified
as unrestricted net assets when the appropriate time has passed or the resource is used
as stipulated.
C. “Permanently restricted net assets” are expected to remain restricted for as long as the
entity exists. Income from these assets is normally unrestricted or temporarily restricted
based on the specifications of the donor.
IV. Contributions should be recognized as increases in net assets when received.
A. Restricted contributions are reported either within temporarily restricted net assets or
permanently restricted net assets based on stipulations established by the donor.
B. Donated assets are recorded at fair value. Recognition of art works, historical treasures,
and the like is not required (although allowed) if three conditions are all met.
1. The items are added to a collection for public exhibition, education, or research.
2. The items are protected and preserved.
3. If sold, receipts must be used to acquire other collection items.
C. Unconditional promises to give that are received by a private not-for-profit entity should
be reported immediately as both a receivable and an increase in net assets.
1. If not to be collected within one year, the promise is recorded at the present value of
the future cash flows. Subsequent amortization of the discount is recorded as
contribution rather than as interest.
2. Uncollectible balances are also estimated and deducted.
3. Conditional promises are not recognized until the conditions are met.
D. Services contributed to a not-for-profit entity are recognized as increases in net assets if
the services (1) create or enhance a nonfinancial asset or (2) require a specialized skill
possessed by the donor that would have been purchased if not donated. If the donated
service comes from an affiliated group, the amount is recognized at the cost paid to the
employee by the affiliate. If that cost does not reflect the legitimate value of the services
rendered, the charity has the option of reporting fair value.
E. If a not-for-profit entity accepts a donation that must be conveyed to a separate
individual or other beneficiary, the entity normally records the asset along with an
accompanying liability to reflect the accepted responsibility. However, if the entity is
given variance powers to change the beneficiary, an increase in net assets is recognized
instead of a liability because the donation falls under the entity’s control.
V. Education institutions (such as private colleges and universities) record tuition revenue at
the gross amount billed and then show the revenue net of scholarships and financial aid in
the statement of activities
VI. Over the years, mergers and acquisitions have become more common in private not-for-
profit entities at least in part because of the economic downturn. The rules for recording
these combinations are different than those applied to a for-profit business because the
transaction can be either an acquisition or a merger.
A. In an acquisition, one entity gains control over another
1. All identifiable assets and liabilities of the acquired company are combined at fair
value on the date of acquisition.
2. If the acquisition value of the acquired company is greater than the sum of the fair
value of all identified assets and liabilities, the difference is often reported as
goodwill.
3. However, if the acquisition value of the acquired company is greater than the sum of
the fair value of all identified assets and liabilities, the excess is charged off
immediately as a reduction in net assets if the acquired company expects to be
predominantly supported by contributions and investment income in the future.
B. In a merger, two not-for-profits come together to form a new entity with a new governing
board. Identifiable assets and liabilities are not adjusted to fair value but retain their
previous carrying amounts.
VII. Health care entities exhibit some unique reporting features that must be addressed in
not-for-profit accounting.
A. Third-party payors such as Medicare and insurance companies have a significant impact
on the reporting process because of their need for usable financial information
B. A net patient service revenue figure is actually reported by these entities but only after
reduction for contractual adjustments. These adjustments are decreases allowed for
some third-party payors based on the approved cost for a particular service in that
geographic region.
C. Charity care services are not included in receivables or revenues if there is no
expectation of collection. The cost of that charity work must be disclosed.
D. FASB requires the inclusion of performance indicators (such as revenues in excess of
expenses) to help show operational effectiveness because net income is not viewed as
applicable for a not-for-profit entity.
Answers to Discussion Questions
Are Two Sets of GAAP Really Needed for Colleges and Universities?
Over the years, a number of differences have appeared between the accounting for public
colleges and universities and for those that are private. GASB holds authority over the reporting
of public schools whereas FASB has authority over private educational institutions.
Because of this division of responsibility, the financial statements for these two types of schools
have developed independently. GASB states that public schools must follow the guidelines of
However, important distinctions do continue to exist. Students can be asked to address the
question of whether a public and a private school need to have comparable financial
statements. Net income is not an issue, rather the sources and utilization of resources is usually
emphasized. Is the adoption of a single set of generally accepted accounting principles
This controversy leads to the important question of user needs. Why does a company or
individual look at the financial statements of a college or university? Donors might have one
Is This Really an Asset?
In theory, accounting for a pledge is a relatively straightforward process. If unconditional, a
process might be much more complicated.
In this case, for example, was a pledge actually made or was this just a superfluous statement
spoken at a moment of overwhelming emotions? Is this a promise to give or an intention to
give? Can the donor change his mind? Does this potential donor really own land in Idaho and
At a minimum, hospital officials need to contact this donor and have a serious discussion. He
needs to understand their reasons for attempting to establish a valuation of this promise. In
class discussion, students can be asked to identify questions that should be posed to this
person. They would probably include the following:
—Does he really plan to give $10 million to the hospital?
—When does he project that the land will be sold and the gift conveyed?
—How did he establish a $30 million price? Could the land ultimately be sold for less and, if
so, how will that impact on the gift to the hospital?
If this individual has supported other charities over the years, is committed to the work of Mercy
Hospital, has adequate financial resources, and the land appears to be worth $30 million, the
hospital should report the pledge as a receivable. However, a large allowance should probably
Answers to Questions
1. The Financial Accounting Standards Board (FASB) has authority for establishing accounting
2. If a user of financial statements is a potential donor, that party is interested in assessing
whether a gift to a not-for-profit entity is a wise use of resources. To make that assessment,
the individual needs to know whether the entity uses its resources appropriately to achieve
3. According to FASB, three financial statements are required to be produced by private
4. Temporarily restricted net assets have been restricted by an external donor or grantor for a
specified purpose or for use at a future point in time. For example, cash might be given to a
5. Permanently restricted net assets have been restricted by an external donor and grantor.
That restriction is expected to last for as long as the entity continues to function. Normally,
6. The two general types of expenses are (a) program service expenses and (b) supporting
service expenses. Program service expenses are those that relate to the goals and
objectives of the not-for-profit entity. Supporting service expenses encompass the costs of
operating the entity (general and administrative) and raising funds.
7. Not-for-profit entities (especially voluntary health and welfare entities) are frequently
8. A statement of functional expense is produced by a voluntary health and welfare entity to
assist the reader of its financial statements in measuring the entity’s efficiency in using
9. When a donor conveys a gift to a private not-for-profit entity (such as the United Way) that
must be conveyed to a separate beneficiary, a question arises as to the recording of the
expense and the contribution. Under normal circumstances, the original donor records an
10. If a donor makes a contribution to a charity for conveyance to a separate beneficiary but can
still revoke or redirect the gift before it is made, the donor records a receivable (rather than
an expense) until the gift is actually transferred to the beneficiary. At that point, the
receivable is reclassified as an expense. The charity initially receiving the gift shows a
11. If a donor makes a contribution to a charity for conveyance to a separate beneficiary but
grants it variance powers to change the identity of the beneficiary, the donor reports an
expense immediately. Because control of the gift now lies with the charity, that party should
eventually, an expense for the contribution even though it was not the original donor.
12. The value of donated services is recognized by a private not-for-profit entity if the service (a)
creates or enhances a nonfinancial asset (such as adding a room to a building) or (b)
13. Except in specified situations, the costs of a direct mailing that contains a solicitation for
funds is classified entirely as a fundraising (supporting services) expense. However, within
certain guidelines, these costs can be allocated in a logical manner between supporting
service costs.
14. Unconditional promises to give must be recorded immediately by a private not-for-profit
15. An unconditional promise to give is recorded immediately by the private not-for-profit entity
that anticipates receiving the gift. Conversely, an intention to give is not recorded. In
16. A number of private not-for-profit entities collect dues from their membership and also
receive contributions. Dues are considered earned revenues rather than contributions if the
member receives a benefit in return. That benefit can take the form of a periodic newsletter
17. If a not-for-profit entity gains control over another entity, combined financial statements
should be prepared. This type of transaction is viewed as an acquisition.
18. Because one party gained control over the other, this transaction is viewed as an
acquisition.
Here, the acquisition value is in excess of the fair value of all identifiable assets and
liabilities by $200,000 ($2.3 million less $2.1 million). In a for-profit consolidation, this
excess is reported as goodwill. The same handling is often true for combined statements
19. If Helping Hand acquires Fancy Fingers, then the reported value of the equipment on
consolidated statements is $2.3 million. That figure is the net carrying value reported by
Helping Hand ($1.1 million) plus the fair value of the property held by Fancy Fingers ($1.2
million).
20. A third-party payor is any outside entity who assumes responsibility for a portion or even all
of a patient’s medical charges. The most commonly encountered third-party payors include
21. A contractual adjustment refers to a portion of a patient’s charged fee that a health care
entity estimates will not be received because of agreements with third-party payors. These
arrangements specify that the provider (the health care entity) is willing to accept an amount
that is less than its normal charge if the third-party payor determines that the lesser figure is
reasonable for the services rendered.
22. Charity care is not recorded by a not-for-profit health care entity because the service was
performed for patients with no real ability to pay. However, the financial impact of that
decision needs to be disclosed. Therefore, the cost of such charity care must be reported
in a disclosure note to the financial statements.
Answers to Problems
1. D (Amounts charged to patients less contractual adjustments and the
provision for bad debts)
6. B (For private schools, financial aid is shown as a direct reduction to the
tuition revenue so that revenues and support here should total only
$780,000.)
7. C (The work of the librarian does not enhance a nonfinancial asset nor does it
require a specialized skill that would be purchased if not donated.)
10.C (The money to be used for the building is temporarily restricted for that
11. C (Although an investment was sold to generate this cash, that asset was
received from a donor and was liquidated almost immediately upon receipt.
FASB has held that this is an operating activity cash inflow.
15.D (The charity must convey the donation to the designated beneficiary. Unless
the charity was given variance powers that allowed it to change the
17.A (Because of the time restriction, the amount spent for playground
equipment remains in temporarily restricted net assets until depreciated.
The equipment was bought at the end of the current year so that no
19. A (When two not-for-profit entities come together to form a new not-for-profit
entity with a new governing board, a merger has occurred. In reporting a