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CHAPTER 10

Financial Reporting for Not-for-Profit Organizations

Not-for-profit organizations are important and essential parts of our economy. At least 11% of all employment is in not-for-profit organizations. GAAP for not-for-profit organizations has developed over time in most major segments (i.e., hospitals and universities), but the GAAP in use in not-for-profits differs significantly from GAAP used in private industry.

This chapter examines the fundamental differences between not-for-profit organizations and business enterprises. The financial reporting objectives for not-for-profit organizations are reviewed, as are the primary reporting issues of expense versus expenditure reporting, revenue recognition and segregation of resources, capital assets, expense allocations, and defining the reporting entity.

The alternative approaches to NFP financial reporting (both GAAP and non-GAAP) are addressed and GAAP recommendations as to the financial statements to be prepared are reviewed. The GAAP reporting options are summarized through the use of an illustration. The application of two techniques unique to non-business enterprises – budgetary control accounts and encumbrance accounting – is also addressed.

This chapter deals with not-for-profit organizations exclusively. The reporting issues for governments are addressed in Chapter 11. More information on the mechanics of fund accounting is provided in an appendix to the chapter.

SUMMARY OF ASSIGNMENT MATERIAL

Case 10-1: HOPEStudents are required to recommend accounting policies which comply with GAAP (primarily dealing with the recognition of contribution revenue) for an organization that works with the homeless.

Case 10-2: Reporting ObjectivesThis case requires the comparison of reporting objectives for three quite different organizations, one in the private sector and two not-for-profit organizations. The emphasis is on differences, not similarities.

Case 10-3: Gold Development

Copyright © 2014 Pearson Canada Inc. 227

Chapter 10 – Financial Reporting for Not-for-Profit Organizations

This is a short case that focuses on the restricted fund method of accounting. The student is required to explain the restricted fund method and to discuss the appropriate accounting for selected issues using this method.

Case 10-4: Perth HousingStudents are required to recommend accounting policies which comply with GAAP for a housing corporation for physically handicapped adults.

Case 10-5: Youth SingersThis case requires the student to consider the appropriate accounting policies for a not-for-profit organization after considering the users and objectives.

Case 10-6: Finest Art GalleryThis case provides another example of selection of accounting policies considering the specific objectives and needs of the Board of Directors.

Case 10-7: CKER-FM Ethnic RadioThis case requires the student to consider if a radio station will be viable or not. The student needs to perform a three-year cash flow analysis to evaluate viability and provide recommendations on how to fund the short-term cash shortage. The case also asks the student to recommend accounting policies.

Case 10-8: Safety NetThis is a multi-competency case. Students are asked to write a report to the Boardrecommending accounting policies and setting out reporting requirements. In addition, a separate memo is required for the partner evaluating assurance issues. The memo to the partner could be deleted if students do not have the necessary background in that area.

Case 10-9: Art GalleryThis is a short case that requires the student to discuss the purposes and objectives of a fund accounting system. In addition, the required asks for a recommendation on the different types of funds that would be appropriate.



P10-1 (35 minutes, medium)The student is required to prepare a statement of operations and a statement of financial position, using the deferral method. P10-2 (40 minutes, medium)Journal entries are required for a series of transactions to illustrate the deferral method of accounting and the restricted fund method of accounting.

P10-3 (35 minutes, medium)The appropriate accounting under a GAAP constraint must be explained for four transactions. Two transactions require journal entries.

P10-4 (40 minutes, medium)The student is required to prepare partial financial statements using the deferral method of accounting. The conditions for recognizing the value of volunteers must be explained and supported with a journal entry.

P10-5 (35 minutes, medium)The student is asked to explain encumbrance accounting and illustrate it with journal entries. Students are also asked to provide journal entries under the deferral method of accounting and to explain the accounting for capital assets.

P10-6 (45 minutes, medium)Journal entries are required for a series of transactions using the deferral method of accounting and the restricted fund method of accounting.

P10-7 (30 minutes, easy)Journal entries are required for an entry to illustrate encumbrance accounting. The student is asked to explain the difference between an encumbrance and a liability as well as using the deferral versus the restricted fund method of accounting.

P10-8 (40 minutes, medium)The student is required to explain how donations would be accounted for using deferral accounting. Then the student must explain encumbrance accounting and how it can be used to control spending.

P10A-1 (40 minutes, medium)The student is required to prepare partial financial statements using the restricted fund method of accounting. The conditions for recognizing the value of volunteers must be explained and supported with a journal entry.

P10A-2 (30 minutes, medium)The student is required to explain how donations would be accounted for using the restricted fund method of accounting. The student must explain encumbrance accounting and how it can be used to control spending.

P10A-3 (120 minutes, hard)This is a comprehensive problem on the restricted fund method. The student is required to prepare journal entries and financial statements after the first year of operations for a not-for-profit



association.



ANSWERS TO REVIEW QUESTIONS

Q10-1: Not-for-profit organizations have no owners. In a sense, they are “owned” by society at large, but legally there is no ownership and thus no transferable ownership interest.

Q10-2: The term non-business refers to a broader spectrum of organizations than does the term not-for-profit. Non-business organizations are all organizations that are without owners, but they may have a profit motive (e.g., the provincial liquor control boards). Non-business organizations include not-for-profit organizations, but also include governments and governmental units.

Q10-3: Not-for-profit organizations employ approximately 2 million individuals, representing 11.1% of the economically active population in Canada. The not-for-profit sector represents $79.1 billion or 7.8% of Canada’s GDP. There are approximately 161,000 not-for-profit organizations in Canada. The distribution of these organizations is skewed to many small organizations and very few large organizations. For example, (in Exhibit 10-1), 41% of organizations in the not-for-profit sector had less than $30,000 in revenue, 88% had less than $500,000 in revenue—only 1% had more than $10 million in revenue. In summary, the not-for-profit sector can be divided into two groups: (1) a core group consisting of a large number of relatively small organizations and (2) a second group consisting of a few relatively large organizations. The primary constituents of this second group are hospitals, colleges and universities. Clearly there will be financial reporting implication for the two groups. It is estimated that government funding makes more than 70% of the revenue of hospitals, colleges and universities but makes up only about 20% of the funding of small NFPs. Thus, as an example, the expense basis would seem to be appropriate for hospitals, colleges, and universities (HCU), which account for 64% of the value of activity in the NFP sector. Users of HCU financial statements such as governments would be very interested in being able to evaluate the efficiency of their operations to aid them in their resource allocation decisions. An expenditure basis (non-GAAP) however may be appropriate for other NFPs.

A second example can be found with the CICA Handbook requirement that NFPs capitalize and depreciate all capital assets. Any organization whose average gross annual consolidated revenues of the preceding and current years is less than $500,000 are exempted from this requirement. Given the skewness in the distribution of size, it appears that over 85% of organizations in the NFP sector could take advantage of this exemption.

Finally, the skewness will have implications because organizations will also differ in terms of need for and understanding of sophisticated accounting.

Q10-4: In an open-membership organization, membership is available to anyone who chooses to fulfil the publicly specified membership conditions. In a closed-membership organization, the members are designated by the board of directors and the board thereby retains control of who becomes a member. Q10-5: Any type of organization can offer private goods and services, including private enterprises, not-for-profit organizations and governments.



Q10-6: In a not-for-profit organization, revenue may be obtained from sources other than the consumer or beneficiary of the organization’s goods and services, such as governments or private donors, or both. For many not-for-profit organizations, revenue comes from a different group than where the money is spent.

Q10-7: The primary users of the financial statements of not-for-profit organizations are the suppliers of its funds, mainly (1) members, (2) granting agencies, (3) the general public, and (4) creditors.

Q10-8: The accrual basis recognizes costs when the goods are used versus when they are acquired and thereby allows for an accurate measure of the cost of providing the goods (or services). The accrual method thereby provides a better measure of cash flows than would cash basis reporting.

Q10-9: The disbursement basis reports only outlays of cash (cash basis of reporting); the expenditure basis reports costs of goods and services when they are acquired and the liability incurred, rather than only when paid (accrual accounting applied to liabilities); and the expense basis reports costs in the statement of operations only when the goods and services are used in operations (full accrual basis of reporting).

Q10-10: The alternative approaches to accounting for capital assets include:a. Charge to operations when acquired.b. Capitalize and depreciate.c. Capitalize but not depreciate.

Q10-11: A pledge is a promise to contribute cash or other assets. A pledge can be recognized as a receivable if the amount can be reasonably estimated and ultimate collection is reasonably assured.

Q10-12: A collection is a work of art, historical treasure or similar asset. To qualify as a collection, the following three criteria must be met:

a. The asset must be available to be seen or used by the public.b. The collection needs to be maintained and protected.c. If an asset from the collection is sold, the proceeds from its sale cannot be used for the

operations of the not-for-profit organization. The funds must be used to acquire new pieces for the collection or to help in caring for the collection.

Q10-13: An externally restricted contribution is restricted by the donor for a specific purpose or use. A board-designated fund is an internal restriction placed by the board of directors. An endowment contribution is a special type of restricted contribution where the principal amount of the contribution cannot be spent. An unrestricted contribution is provided without any restrictions on its use.

Q10-14: Under the deferral method, the recognition of restricted contributions depends on the purpose for which they have been restricted by the donor. If the contribution is for expenses of the current period, the contribution should be recognized as revenue in the current period. If the contribution is for expenses of a future period, it is recorded as deferred revenue until the related expense is recognized. Under the restricted fund method, the restricted contribution is recognized as



revenue in the respective restricted fund in the period received. If there is no separate fund in the restricted fund method, the contribution is recognized in the general fund using the deferral method.

Q10-15: The restricted fund method will result in a higher level of revenue since all contributions are recognized in the current year.

Q10-16: It has two options: it can consolidate the enterprise or it can account for the enterprise using the equity method but additional disclosure is required when the equity method is used.

Q10-17: It is an issue because donors are often interested in the efficiency of the organization in accomplishing its mission. In particular, donors will often focus on the costs reported for fund raising and general support (i.e., non-program costs). NFPs are acutely aware of the fact that they are often evaluated on their ability to control the costs of these two functions. The allocation of expenses is an issue because NFPs have an incentive to minimize the costs reported in these two functions. For example, one practice that has developed is that costs are sometimes allocated out of fund raising and general support to another function like education.

Q10-18: Estimated revenues are a debit because they are offset by actual revenues, which are credits. When an operating statement is prepared, the difference between the debit estimate and the credit actual will show the variance of actual from budget.

Q10-19: An encumbrance is the estimated amount of an expenditure to which the organization has committed itself, but which has not yet accrued.

Q10-20: The purpose of the encumbrance system is to keep track of the total expenditures and commitments for expenditures that the organization has made to date. The system helps to ensure that managers do not commit the organization to more expenditures than those authorized or budgeted.

CASE NOTES

Case 10-1 HOPE

This case directs students to four situations that deal with the recognition of contribution revenue. The following points should be addressed in any discussion of the issues.1. Contributions can only be deferred if they accompanied by externally imposed restrictions. The restrictions can be explicit or implicit. Explicit restrictions will be evidenced by written instructions from the donor. Implicit restrictions may be evidenced by promotional material sent out by the NFP setting out how the monies will be used. In both cases, there is written evidence. In this situation there is no evidence of either explicit or implicit restrictions. The donor did not impose any restrictions on how the funds could be spent. The inability of HOPE to spend the monies before the end of the year does not allow the contribution to be designated as a restricted contribution. Recommendation: The $100,000 will have to be recognized as contribution revenue for the current year.2. This scenario addresses an issue similar to that addressed in scenario 1. Contributions can only be deferred if they are accompanied by externally imposed restrictions. In this case there were no



explicit instructions accompanying the bequest. Myesha may be able to argue successfully that their recent campaign, as evidenced by their promotional material, has created an implicit restriction. Further, if she can show that the donor had been targeted, and given that there is written evidence in the form of promotional material, then it is likely that there was an implicit restriction on the use of the bequest. Recommendation: The $200,000 should be recognized as an endowment contribution.3. The deferral of the $10,000 can only occur if no money is spent on the government lobbying program. Once $10,000 is spent on lobbying, all of the restricted funds should be recognized in revenue regardless of the fact that other “operating funds” were used to pay for the lobbying campaign. It would be easy to imagine how results could be manipulated if the $10,000 could be deferred in these circumstances. Recommendation: The $10,000 should be recognized as contribution revenue.4. The $50,000 would have been recorded as a deferred contribution since it was restricted to pay for a specific program which was to be launched the following year. After the board’s decision to not proceed with the campaign, HOPE could potentially have had a liability if the donor had requested the funds be returned. The decision by the donor to allow HOPE to keep the funds eliminated the potential liability. The issue that arises is that the funds are no longer restricted since the program will not be launched and the donor has indicated that she will not seek a return of the monies. Given that there is no evidence of new restrictions being placed by the donor then the deferred contribution will have to be reversed and the $50,000 will be recognized as contribution revenue of the current period. Recommendation: The $50,000 should be recognized as contribution revenue of the current period.

Case 10-2: Reporting Objectives

Objectives of the Case

This case asks students to compare the financial reporting objectives of three different organizations: (1) a development-stage mining company, (2) a not-for-profit school, and (3) a labour union. The case should help students to understand how reporting objectives can differ between organizations.

Objectives of Financial Reporting

1. The mining company is publicly traded and will have a stewardship reporting requirement. As the company is still in its development stage, the emphasis in reporting will be on the availability of cash (a cash flow objective) and the cumulative impact of expenditures on the balance sheet. Most costs will likely be capitalized to apply to future earnings. The investors in the company will likely rely on other information outside of the financial statements e.g. geological surveys.

2. The performing arts high school will have a stewardship reporting requirement for the ministries that provide the bulk of its support, as well as for the donors. Performance evaluation is also an objective here; the directors, the ministries and the public will want to see how the school is using its resources: what programs are being offered, what resources are going towards these programs, and how productive they are in terms of student numbers and quality. Much of this information is non-financial but will be used in conjunction with the financial information for



evaluation. Therefore, it is important that the information be presented by program so that an analysis can be performed.

3. The labour union will need to emphasize stewardship reporting very heavily. The members of the bargaining unit are paying fees, and they will want to see that these fees are being utilized appropriately. The emphasis in reporting will be on cash flow, with a clear segregation of the strike fund from the general fund. As this is a membership organization, the same people are both providing the funds and receiving the services. Performance evaluation will therefore be on the basis of personal satisfaction rather than on financial analysis. Nevertheless, the statements will be useful to see just what the union executives did with the money the organization received during the year (i.e., stewardship of resources).

It is interesting to note that while both the mining company and the labour union have stewardship as a major objective, the impact of that objective is very different. In the mining company, stewardship implies the matching of costs to revenues. Since the revenues are all in the future, the costs are all capitalized and will be allocated to future periods. In the labour union, however, stewardship implies an accounting for current cash flows and the safeguarding of assets.

Case 10-3: Gold Development


The case asks students to explain the meaning of restricted fund accounting. In addition, they need to provide specific recommendations for issues in the case using the restricted fund method of accounting. The following suggested approach is from the 1995 UFE Report, Paper III, Question 2.

Suggested Approach

Dear Mr. Bilodeau:

Attached is a report discussing the restricted fund accounting basis of reporting and other matters related to the preparation of GD’s financial statements under the proposed recommendations in the CICA Handbook.

Please do not hesitate to call me if you have any questions.

Yours truly, CA

Part 1

Financial statement elements are the individual items presented in a set of financial statements (e.g. cash, capital assets, accounts payable, grants and donations). Fund accounting is a method of financial reporting that results in these financial statement elements being reported in separate funds.

The restricted fund accounting basis of reporting, as defined in the CICA Handbook, is a specialized use of fund accounting that requires the organization to report an unrestricted fund and one or more restricted funds. A restricted fund is a self-balancing set of accounts, the elements of which are externally restricted or relate to the use of restricted resources. An unrestricted fund is a self-



balancing set of accounts, the elements of which may be restricted or unrestricted. There can also be a separate fund for endowment contributions. Under the restricted fund basis of reporting, therefore, the financial statement elements must be grouped in the different funds on the basis of any external restrictions on the use of resources and not necessarily by program or geographic area.

Part 2

Building

If GD decides to report on a restricted fund accounting basis, a restricted capital asset fund must be established to account for the building and the related restricted grant. The apartment building and any other capital assets will be capitalized at cost on GD’s statement of financial position, unless GD’s average gross revenues for this period and the preceding period are less than $500,000, in which case capitalization will not be required.

The amount at which the building will be capitalized is cost, which includes all direct construction costs and any overhead costs directly attributable to construction. Any rent revenue received before the building is substantially complete and ready for use will be netted against the capitalized costs of the building.

Once the building is complete and in use, GD will have to begin depreciating the building’s cost, less any salvage value, over its estimated useful life. Depreciation is to be reported as an expense in GD’s statement of operations and changes in net assets. Depreciation may be reported as an expense of either the restricted capital asset fund or the unrestricted fund. I recommend reporting it as an expense of the restricted capital asset fund since this reporting keeps all the amounts related to capital assets together in one fund.

Grant

The restricted grant received for the construction of the building should be reported in the restricted capital asset fund. Under the restricted fund basis of reporting, this grant will be recognized as revenue in 20X2 since this is when it was received.

Pledges

GD would recognize contributions receivable, including outstanding pledges, if the amounts to be received can be reasonably estimated and ultimate collection is reasonably assured.

Since GD has just started up, it will not have the collection history necessary to make a reasonable assessment of collectability for the pledges from individuals. Therefore, pledges from individuals should probably not be recognized until the cash is received.

The pledges from large well-known companies, on the other hand, probably do meet the criteria for recognition because the reputations of these companies mean that collection of the pledged amounts is reasonably assured. These are five-year pledges, however. Because the uncertainty associated with the collectability of any pledge increases with the length of time before the pledge is due, GD should probably only recognize the portions of the pledges to be received in the next fiscal year.

Like other contributions, pledges may be restricted or unrestricted. Any pledges that are unrestricted will be recognized as revenue of the unrestricted fund. Restricted pledges will be recognized as revenue of the appropriate restricted fund.

Contributed services



GD also receives contributed services from Mrs. Bilodeau and the local priest. GD has the option of recognizing the fair value of these services in the financial statements if fair value can be reasonably estimated and if these services would have been purchased otherwise. If recognized, the fair value of contributed services would be reported as a revenue item and an offsetting expense.

[CICA]

Case 10-4: Perth Housing


This case requires students to recommend accounting policies for a housing corporation for physically handicapped adults. The following suggested response is from the June 2002 CGA examination.

Suggested Approach

PHC should adopt the following recommendations for the related accounting issues for its year-end financial statements:

- The accrual basis of accounting should be used in order to properly match revenues to expenses.

- The cost of acquiring and renovating the apartment building should be capitalized as an asset in the capital fund.

- The building should be depreciated over its useful life. Depreciation expense should be reported as an expense of the capital fund.

- The $1,500,000 cash donation from Mr. Smith should be recorded as revenue of the capital fund.

- The salary costs should be expensed as incurred in the operating fund.

- The estimated costs of unpaid sick leave should be set up as a liability and as an expense of the operating fund on an annual basis.

- The value of the volunteers’ time provided for support care services should be set up as a revenue and an expense of the operating fund, if the amount is measurable and such services would have been purchased had they not been provided by volunteers.

- The contributions from the provincial government should be accrued as a receivable and revenue of the operating fund at the end of each month based on actual costs incurred during the month.

- The rent from the tenants should be recognized as revenue of the operating fund in the month in which it is due. At the end of the year, an allowance for doubtful accounts should be set up for any doubtful accounts.

- Donations from door to door canvassing and proceeds received from the bingos should be recognized as revenue of the operating fund as the cash is received.



- The cash received for the planned expenditure on air conditioning equipment should be recorded as revenue in the capital fund or as deferred revenue in the operating fund.

- The pledges received for the planned expenditure on air conditioning equipment should be recorded as pledges receivable and revenue of the capital fund (or as deferred revenue in the operating fund) to the extent the amount to be received can be reasonably estimated and the ultimate collection is reasonably assured.

[CGA]

Case 10-5: Youth Singers


This case requires the student to consider the appropriate accounting policies for a not-for-profit organization after considering the users and objectives.


The members would be interested in evaluating the past performance of Youth Singers (YS) and the performance of management. The provincial government may also rely on the statements to ensure that any funds it provides are being used effectively to provide services to members. To be eligible for grants from the provincial government, audited financial statements will have to be provided and GAAP should be followed in selecting accounting policies.

Issues

The solution should be written as a memo to the Board of Directors considering the following accounting issues:

ContributionsThe organization must select the deferral or restricted fund method of reporting. The deferral method without fund accounting would be the cheapest method which would satisfy an objective to minimize costs. The deferral method with fund accounting may be appropriate considering the different activities, e.g. CD’s, children’s choir, singing lessons. The deferral method would delay recognition of restricted contributions. However, there is no indication of any restricted contributions, therefore, there would be minimal impact on contributions. The government grants may be restricted.

The restricted fund method may not be useful since there is no indication of any specific restricted contributions and there are no endowment contributions. We will need to clarify if the government grants are restricted.



I suggest we select the deferral method of recognizing contributions without fund accounting to minimize costs. If we determine that the government grants are restricted, the amount and nature of these restrictions will need to be separately disclosed on financial statements.

Capital AssetsYS is under the size test of $500,000 since average revenues for the last two years were $250,000 including the donation of $20,000 related to the music stands. YS therefore has the option to capitalize and depreciate its capital assets, expense them or capitalize and not depreciate. Currently, assets are capitalized but not depreciated.

Fair market value is not appropriate if reassessed each year. Assets should be recorded at cost. Additionally, the fair market values were provided by the Finance Director and therefore may not be valid. If it is likely that YS will be over the size test in the future, it may want to capitalize and depreciate assets now to be ready for future years. It is likely there are few assets to consider therefore costs to depreciate may be minimal.

If a decision is made to capitalize and depreciate the assets, a retroactive adjustment will be required since this is a change in accounting policy. I recommend that you continue with the current policy since members are used to that policy and it minimizes costs of reporting.

CollectionsThe historic sheet music may qualify as a collection since it meets all three criteria:

1) It is in a glassed-in case, therefore the public exhibition criteria has been met.

2) The criteria of maintaining the collection appears to be met since it is protected by a glassed-in case.

3) It must be clarified that the BOD has a policy concerning the use of funds if an item of the collection is sold.

The costs of the collection could be expensed or capitalized. It may be difficult to determine the value of the artwork for capitalization. I recommend that we capitalize but do not depreciate the costs to provide information to members on the collection. Alternatively, if we cannot determine fair market values, note disclosure could be provided on this information. This would also be consistent with our accounting policy for capital assets.

PledgesTo recognize the pledges, YS must be able to measure and estimate the amount of pledges which will be received. The Christmas concert is annual, thus past history is available to estimate the amount expected to be received. Note disclosure should be provided for any unrecognized pledges to show members the potential sources of cash in the future.

ContributionsContributions are received from singing lessons and government grants. The revenue for singing lessons should be recognized as the service is performed. As mentioned previously, we need to determine if the grants are restricted. If unrestricted, the grants should be recognized as revenue when received.



Sheet Music StandsThe difference between the direct costs and the fair market value for the music stands would be treated as a contribution. The music stands would be recorded at the fair market value when purchased if we continue to capitalize and not depreciate capital assets.

Fundraising costsThe allocations from fundraising to education will have to be reviewed carefully to ensure that they are consistent with the recently introduced standard on disclosures for allocated expenses by NFPs. If amounts are allocated from fundraising and general support to other areas, the standard requires the following disclosures:- Explanation of allocation policies

- Explanation of the nature of the expenses allocated

- The allocation basis

- The amounts allocated from fundraising and general support

- The amounts and areas the expenses are allocated towards

Any changes to the bases for allocations are to be treated as changes in accounting policy.

In addition, the standard provides three specific criteria that must be met before an amount can be allocated to the education function.

“In the context of a fundraising activity, for information to be regarded as, for example, also contributing to an education objective, it is supplied in an educational manner. To achieve an educational purpose, information supplied meets the following three criteria. The information is:

(a) targeted at individuals or others who can use the information in furtherance of the organization's objectives;

(b) advice on which the recipient can act in an informed manner in furtherance of the organization's objectives; and

(c) related to the educational activities or objectives undertaken by the organization.” (CICA Handbook, Section 4470.A6)

Other IssuesYS needs to disclose its status as a registered charity, the intended community of service and its legal form.

Case 10-6: Finest Art Gallery


This case provides another example of selection of accounting policies considering the specific objectives and needs of the Board of Directors.




The members would be interested in evaluating the past performance of Finest Art Gallery (Finest) and the performance of management. The provincial government may also rely on the statements to ensure that any funds it provides are being used effectively to provide services to members. The board of directors wants to minimize costs. To be eligible for grants from the provincial government, audited financial statements will have to be provided and GAAP should be followed in selecting accounting policies.

Issues

This response should be written as a memo to the board of directors of Finest. The following outlines the accounting issues that should be addressed:

1) ContributionsFinest must select the deferral or restricted fund method of reporting. The deferral method without fund accounting would be the cheapest method and meet the objective of the board of directors to minimize costs. The deferral method with fund accounting is likely not appropriate since there is no indication of a number of distinct activities.

The deferral method would delay recognition of restricted contributions. At this point in time it is unclear of the extent of impact since restricted contributions include amounts segregated by the board of directors. Board-designated funds are not considered restricted contributions since it is an internal restriction. To qualify as a restricted contribution, the restriction must be an external restriction.

Endowment funds would be shown as a change in net assets if the deferral method is selected. If the restricted fund method is selected, endowments would be reported as revenue in their own separate fund.

The restricted fund method may be useful since there are externally restricted contributions and endowment funds. This would provide more information for donors on the use of their contributions.

To meet the board of directors' objective of minimizing costs, I recommend the deferral method without fund accounting be used for reporting. The amount and nature of all restricted contributions should be separately disclosed to allow donors to identify which funds are available for specific purposes.

2)_Capital AssetsFinest is over the size test of $500,000 in gross revenues. Therefore, it has to capitalize and depreciate capital assets. Capitalizing will not meet the board of directors' objective of minimizing costs. Unless it wants a qualified audit opinion, which may impact government funding, it will need to change accounting policies. A retroactive adjustment will need to be made this year. It may be difficult to obtain this information. In that case, it can argue that it is unable to reasonably determine the amount for a retroactive adjustment.



The replacement of the roof would be seen as a betterment since it would extend the life of the building. Therefore, these costs should be capitalized instead of expensed. In addition, the cost of the new air conditioning system will also be capitalized.

3) CollectionsThe artwork may qualify as a collection since it meets the following criteria:

1) Finest is a museum. Therefore, the public exhibition criteria is met.2) The criteria for maintaining the collection appears to be met, e.g. purchase new air-

conditioning system. 3) The funds used to purchase the new air-conditioning meet the criteria of selling work and

using the funds for maintaining the collection. We must ensure that the board of directors has a policy concerning the use of funds.

Finest is allowed to expense or capitalize the costs of the collection. It may be difficult to determine the value of the artwork since the board of directors says it was unable to determine a value. For this reason, I suggest providing note disclosure on the extent and nature of the collection. This also meets the board of directors' objective of minimizing costs.

4) VolunteersThe fair value of volunteer service may be difficult to estimate thereby providing support for not recording the services. This would also minimize costs for the board of directors. Note disclosure should be provided so members are aware of the extent to which the organization relies on volunteers.

5) PledgesFinest must be able to measure and estimate the amount of pledges to recognize as receivable. The current policy of recognizing as soon as the pledge is made may be too aggressive. It must be determined if Finest has sufficient past history to recognize the pledges immediately. This is likely since the art gallery has been in existence for a number of years. The fundraising campaign for the new children’s program would have no past history, therefore, recognition would need to be delayed. Note disclosure should be provided for any unrecognized pledges to show members the potential sources of cash in the future.

(6) Membership Fees / Admission FeesBoth are fees for a service not a contribution. It makes sense to continue to recognizing admission fees when money is collected. It must be determined if membership fees are for one year or more than one year. If membership is for one year and the year matches the fiscal year, recognition when paid would match to service provided. If membership is for more than one year, only the relevant portion should be recognized in the current year.

(7) Government GrantsGovernment grants are classified as a contribution. The method would depend on the method of reporting selected and whether there are restrictions.

(8) Fundraising costsThe allocations from fundraising to education will have to be reviewed carefully to ensure that they



are consistent with the recently introduced standard on disclosures for allocated expenses by NFPs. If amounts are allocated from fundraising and general support to other areas, the standard requires the following disclosures:- Explanation of allocation policies- Explanation of the nature of the expenses allocated- The allocation basis- The amounts allocated from fundraising and general support- The amounts and areas the expenses are allocated towards

Any changes to the bases for allocations are to be treated as changes in accounting policy.

In addition, the standard provides three specific criteria that must be met before an amount can be allocated to the education function.

“In the context of a fundraising activity, for information to be regarded as, for example, also contributing to an education objective, it is supplied in an educational manner. To achieve an educational purpose, information supplied meets the following three criteria. The information is:

(a) targeted at individuals or others who can use the information in furtherance of the organization's objectives;

(b) advice on which the recipient can act in an informed manner in furtherance of the organization's objectives; and

(c) related to the educational activities or objectives undertaken by the organization.” (CICA Handbook, Section 4470.A6)

(9) Other IssuesA statement of cash flows is required unless it contains no new information that would not be apparent from the statement of operations. Note disclosure should be provided on Finest’s status as a registered charity, the intended community of service and its legal form.

Case 10-7: CKER-FM Ethnic Radio


This case requires the student to consider if a radio station will be viable or not. The student needs to perform a three-year cash flow analysis to evaluate viability and provide recommendations on how to fund the short-term cash shortage. The case also asks the student to recommend accounting policies. The following is the suggested response from the 1996 UFE Report, Paper II—Question 2.

Suggested Response

CKER Committee MembersCKER-FM Ethnic RadioAnytown, Canada

Dear Committee Members:



We enclose our report which addresses several issues related to the start-up of your proposed radio station, CKER-FM Ethnic Radio (CKER). For purposes of our analysis, several assumptions were made and are stated in the report. If these assumptions are inappropriate, please advise us, as changes in assumptions may change our recommendations. If you have any questions in the interim, please do not hesitate to contact me.

Yours sincerely,Maria and Casano, Chartered Accountants

Report to CKER

Your committee has presented an application to the CRTC to obtain a radio license and start a not-for-profit, ethnic community radio station for your area. As requested, we have prepared a report which:

- assesses CKER’s viability over its initial three-year period,

- identifies other significant issues that the station will face after it commences operations, and

- recommends accounting policies for the transactions that CKER is contemplating.

The assessment of CKER’s future viability is the most important consideration: can the proposed station generate enough cash over the first three years of its operations to fund its annual cash requirements? Since the success of the application depends on its viability, recommending accounting policies is of lesser importance at this stage.

Overall Conclusion

Based on the information provided, CKER will not generate sufficient cash flows to fund its annual cash requirements (see Appendix I). It will require additional financing in year one of approximately $283,000 and in year two of $62,000. In year three, positive cash flows totaling $177,000 are generated. The funding shortfall is primarily due to the capital acquisitions to start up the station as well as fixed overhead expenses. In order to ensure the station’s future success, we must concentrate out efforts on finding ways to finance the shortfall. We have provided you with a list of possible sources of funding which you can consider. If you are unable to finance the shortfall, and therefore cannot present a viable proposal to the CRTC, your license may not be granted.

Viability of CKER

The amount of additional funding required by CKER to operate the radio station over the first three years of operations is calculated in Appendix I. This calculation is based on information that you provided to us. We have not assessed the plausibility or reasonability of the figures provided, nor are we expressing an opinion on CKER’s future viability.

If required by the CRTC, we can provide limited assurance on the cash flow statement. This would add some credibility to your cash flow analysis. However, we cannot express an opinion on CKER’s future viability.



Viability

You asked us to assess the station’s viability over its initial three years of operations. Viability must be defined in order to ensure that we have a consistent understanding of the term. For example, if we take viability to mean whether CKER can fund its expenses in its first year, then the station is not viable because of the shortfall in year one. However, if we take a longer term view and consider the cash generated in year three and subsequently, as well as other cash resources that may be available, the project would appear to be viable.

For purposes of this report, we have defined viability as the ability of CKER to fund its operations over a three-year period. Therefore, additional financing must be found in order to help ensure the success of the station’s application for a license.

Cash Flow Analysis

As discussed above, an additional $345,000 of funding is required over the first two years of CKER’s operations. The primary problem is that CKER’s costs are fixed, with the small exception of sales commissions, while revenues are variable and difficult to predict. As a result, fluctuations in advertising revenues will have a direct effect (positive or negative) on the funding shortfall. The future of the station is thus very risky.

To the extent possible, CKER should attempt to reduce the fixed costs and thus reduce the uncertainty. For example, part of the building rental cost could be based on a percentage of sales.

Reasonability of the Assumptions Provided

As explained, we have based our cash flow analysis on the assumptions and facts you presented. However, a number of concerns and other factors that have not been factored into the cash flow analysis could significantly change the amount of the shortfall. They are as follows:

- Inflation. We have not factored in an inflation rate, which would likely increase expenses over time. While some expenses could increase due to inflation, others may stay constant due to competitive pressures.

- Past history and experience. It is difficult to determine whether the assumptions and facts used in our analysis are reasonable as CKER has no prior history or experience. For example, why have you assumed that advertising minutes sold will increase over the first two years, and how was the increase determined? More important, you are expecting that CKER will sell all of its available advertising time. These assumptions could be overly optimistic for the first and second year of operations. We should also consider whether a 25% discount in advertising rates will be sufficient to sell all of the available advertising spots. If revenues stay constant for the first two years, the total shortfall would increase by approximately $230,000. It is also difficult to determine how inclusive the administrative cost estimate is. Additional information is required.

- Start-up costs. We have assumed that you will not be paying the $50,000 of start-up costs out of operating cash flows. Therefore, we have not included these costs in our cash flow analysis.

- Capital improvements and additions. Capital improvements and additions are likely to be required over the next several years as the station expands and technology changes. We have not factored any capital additions or repairs, except for the original investment required in year one, into the cash flow analysis.



- Pledges. For now, we have not included cash flows from pledges in our analysis. Unless these amounts are considered written commitments, they may not be collected and therefore should not be relied upon.

We will need additional information on these matters in order to provide a more precise cash flow analysis.

Alternatives available for funding the cash flow deficiency

A number of possible alternatives are available to help fund the cash deficiency. Although not exhaustive, the following list provides a starting point.

- Government funding and grants may be available.

- Additional reverse lifetime contributions (RLTC’s) could be sold given that interest has already been expressed.

- Fundraising programs targeting both individuals and local businesses could be initiated.

- Membership fees or advertising rates could be increased. For example, increasing the rate per minute for advertising by $5 increases revenues by $44,000 each year.

- The number of advertising minutes available each hour could be increased.

- Advertising time could be traded for supplier services to increase cash flows.

- The station equipment required to start operations could be leased rather than purchased.

- The 25% discount currently contemplated on advertising rates could be reduced, depending on advertising demand. If current market rates are charged, the station would gain an additional $400,000 in cash receipts each year.

Accounting Policies — Recommendations

CRTC regulations, commercial lenders, or CKER members may request some form of assurance be attached to CKER’s financial statements. In addition, other users of the financial statements may want to know how their contributed funds are being allocated. Most users will be concerned with assessing CKER’s cash flows and its ability to fund ongoing operations. To this end, the accounting policies recommended below focus on providing users with information needed to predict future cash flows.

Donated goods and services

Recording donated goods and services in the financial statements would be useful to the users of the financial statements and would provide information on CKER’s reliance on this form of donation - the opportunity cost of not having to hire employees to perform these services. However, recording donated goods and services would not be practical because of the difficulty in determining the amount of time donated and determining a fair value for that time. Although time sheets could be used to track the amount of tine, determining a fair value would be highly subjective.

For this reason, to reduce the complexity of the accounting system, and because there are no cash flows associated with this cost, donated goods and services should not be recorded in the financial statements.



Start-up costs

Since the users of the financial statements will be primarily interested in cash flows, capitalizing the start-up costs would not provide useful information to them. However, in order to issue a tax receipt to those paying these expenses, CKER must eventually account for the expense in its income statement. If capitalized, the expenses should be depreciated over the period of benefit. In order to capitalize these costs, CKER must also account for the contributions as a donation in the period in which the amount is expensed in the income statement.

We recommend that CKER expense these costs in the first year and record the full amount as a donation. Either way, there will be no net impact on the income statement.

Reverse life-time contributions (RLTC’s)

Basically, the RLTC is an endowment fund with a repayable feature and becomes a bequest at death. The RLTC could be treated in one of two ways:

- The entire amount could be set up as a liability upon receipt. Upon the death of the contributor, the balance accruing to CKER would be recognized as donation revenue. This is the more conservative approach.

- Alternatively, we could estimate the RLTC revenue by using mortality tables. The balance expected to be repaid would be recorded as a liability. The payments made to the individual if he or she outlives the expected life span would be recorded as expenses in the year in which they are paid. If the individual dies before the expected date of death, the remaining balance would be recorded as donation revenue in the year of death.

We recommend the first alternative. It is less complicated and with adequate note disclosure, will allow users of the financial statements to predict future cash flows.

Member borrowings on behalf of the station

This amount could be disclosed as a contingent liability, representing the legal form of the transaction. CKER has a pay interest and principal arrangement, but it does not have a loan from a legal perspective. This approach may make obtaining additional external financing easier to get; however, it overstates the balance sheet.

Taxation Issues

If not-for-profit status is granted, CKER will not have to pay income taxes. CKER must obtain charitable status so that donors will receive a tax credit; otherwise, donations may be more difficult to generate. Not-for-profit status is also critical to selling RLTC’s. Further research must be conducted to confirm that the RLTC’s would qualify as a charitable donation. Finally, CKER will have to collect GST on advertising.

Appendix 1CKER-FM Ethnic Radio

Cash flow Analysis

Year 1 Year 2 Year 3



Cash receiptsAdvertising (Note 1)

Prime time ($40 × 6 hrs × 365 days) $ 350,400 $ 438,000 $ 525,600Regular time ($30 × 10 hrs × 365 days) 438,000 547,500 657,000Off-peak ($25 × 8 hrs × 365 days) 292,000 365,000 438,000

Total advertising revenue 1,080,400 1,350,500 1,620,600Miscellaneous revenue (Note 2) 26,400 30,000 36,000Annual membership fee (120 × $125) (Note 3) 15,000 18,000 21,600Loan financing ($25,000 × 4 people) (Note 4) 100,000RLTC program 78,000

Total cash receipts 1,299,800 1,398,500 1,678,200

Cash operating disbursementsSales commissions (15% of advertising revenue) 162,060 202,575 243,090Administration and other costs 1,237,000 1,237,000 1,237,000Interest expense ($100,000 × 8%) 8,000 8,000 8,000RLTC repayment ($78,000/(90-64) 3,000 3,000 3,000

1,410,060 1,450,575 1,491,090

Capital disbursementsTransmission equipment 61,000Broadcast studio 62,000Production studio 40,000Total cash outflows 1,573,060 1,450,575 1,491,090Net cash inflows/(outflows) before loan repayment (273,260) (52,075) 187,110Less: loan repayment (Note 4) 10,000 10,000 10,000Net cash inflows/(outflows) $ (283,260) $ (62,075) $ 177,110

Notes:1. Advertising minutes per hour will be four minutes in Year 1, five minutes in Year 2, and six

minutes in Year 3.2. Miscellaneous revenue is expected to be $2,200 per month in Year 1, $2,500 per month in

Year 2, and $3,000 per month in Year 3.3. In Year 1, 120 memberships are expected to be sold. Membership is expected to grow by

20% each year.4. The loan principal is expected to be repaid over a 10-year period. The rate of interest is

assumed to be 8% annually.

[CICA]

Case 10-8: Safety Net


This is a multi-competency case. Students are asked to write a report to the Board



recommending accounting policies and setting out reporting requirements. In addition, a separate memo is required for the partner evaluating assurance issues. The memo to the partner could be deleted if students do not have the necessary background in that area. The following suggested response is from the 2001 CICA examination.

Suggested Approach

TO: Board of Directors of Safety Net

As requested, we have prepared the report that follows addressing the questions raised concerning the operation of Safety Net (SN). The report outlines the reporting requests that the Board should be making of management, and advises on the selection of accounting policies and on financial statement disclosure where appropriate.

Reporting Requests of Management

In order to properly assess the operation of Safety Net (SN) as well as the performance of management, we suggest that you make the following requests of management:

- A monthly financial information package, including statement of financial position, operations, and changes in cash flows. The financial information should be tracked against an approved budget. This package will enable the Board of Directors to assess the financial health of the organization, foresee any cash flow difficulties, and evaluate management’s effectiveness in running the organization while respecting the annual budget.

- The financial information package should include reporting by major activity, such as the costs of the soup kitchen or of the shelter for the homeless. This breakdown will enable the Board of Directors to better track the costs that are covered by the government grant, as well as assess the net result of each activity independently.

- Benchmarks such as the number of families sheltered, meals served, individuals receiving counseling, and runaways transported back to their homes should be maintained. Once again, these statistics should be measured against an approved target. This package will enable the Board of Directors to evaluate the effectiveness of the organization in meeting the needs of the community, as well as management’s effectiveness in running the organization.

- The status of the government grants, including likelihood of repayment and measures to obtain grants in the future. Continued funding by the government may be key to the survival of SN, and the status of the grants, as well as constant exploration of new possibilities, should be followed up on an ongoing basis.

Accounting Policies and Financial Statement Disclosure

Accrual accounting will provide more accurate information to the Board of Directors.

Non-profit organizations generally use fund accounting to record the results of their operations. Fund accounting consists of a self-balancing set of accounts for each fund. This method of accounting enables the organization to review the operations of each fund separately. Typical funds



may include an operating fund, for the day-to-day operating activities, a capital acquisition fund, an endowment fund, and so on. Different operating activities (such as the shelter and the soup kitchen) may be reported in separate funds. In your case, financial statement users will require reporting by major activity, either by way of a separate fund or by special report. It may be best to report the operations of the shelter and the soup kitchen separately from the general operating fund, in order to simplify the calculation of the grant. The government grants will be maximized by ensuring all costs related to the shelter and soup kitchen are recorded as such (of which 50% is reimbursed by the government).

There are two basic approaches to recording contributions to a non-profit organization: the deferral method and the restricted fund method. Under the deferral method of accounting for contributions, restricted contributions related to expenses of future periods are deferred and recognized as revenue in the period in which the related expenses are incurred. Under the restricted fund method of accounting for contributions, restricted contributions are recognized as revenue in a separate restricted fund. The purpose of a restricted fund is to record the receipt and use of resources that are subject to restrictions separately.

The restricted fund method may be the best method in your situation, as you have received restricted donations. The restricted fund method will, however, recognize endowment funds and restricted contributions in the current period, which may be used by the fundraiser as a basis for arguing for a bonus. The choice of methods will not affect the amount of the government grant, which is based on operating expenses and not on revenue recorded.

Donated University Residence

Donated capital assets should be recorded at their fair market value. Organizations having average revenues for the current and preceding fiscal period of less than $500,000 have the option of not recording capital assets. These organizations must disclose the policy followed in accounting for capital assets, and must provide information as to the nature of the capital assets donated, if expensed or not recorded. The government grant may cover the depreciation amount charged to operations related to the university residence if it is capitalized. Alternative depreciation methods are available and management should choose a depreciation method, such as the declining balance method, that maximizes the depreciation charge in early years, as there is no guarantee the grant will be available indefinitely.

Donated Goods and Services

The basic rules of recognizing donated goods and services are that the fair value can be reasonably estimated, that SN uses the donated goods and services in the normal course of operations, and that it would have otherwise purchased the goods or services.

Soup kitchen staff appear to meet the criteria, as food preparation staff are an integral component of any food service operation. The chefs’ time could be valued based on normal wage levels for chefs in that area. It could be argued that a soup kitchen would likely hire short order cooks instead of chefs and their wage levels would be more appropriate. It will be necessary to establish the number of hours worked to calculate the cost. Management should initiate some sign-in sheet or log book to provide a record of hours.



University food service providers and food science students should be recorded at minimum wage. There is no other verifiable wage level to utilize. This approach will allow for some cost to be recorded. As with the chefs, it will be necessary to track hours volunteered to calculate the expense.

Donated food is an integral part of the soup kitchen operation. It is likely that food products would have to be purchased if they were not donated. It should be relatively easy to establish a cost for donations by corporations. These goods could be recorded at wholesale cost, or retail cost. Wholesale cost would be the easiest to establish, but retail cost will meet SN’s objective of maximizing the operating costs. It will be necessary to establish a means to track the nature and volume of fresh produce donated by individuals. This may not be worth the effort. We can help management assess whether the cost of implementing this system outweighs the benefits derived.

The donated frequent flyer points would also appear to meet the criteria, as a stated goal of the organization is to help runaways and street kids to get back home. The organization would certainly have to purchase tickets in order to return kids to their families. The frequent flyer points could be valued by reference to the fair market value of the tickets that would otherwise have had to be purchased, although this valuation may be somewhat high. It is difficult to say whether the organization would purchase plane tickets if they were not able to use frequent flyer points. Kids would perhaps be returned home by bus or some other less expensive method of transportation. Donated but unused points would be difficult to value at year end and are likely to be immaterial from year to year. I recommend recording only the donated points that have been used.

If the donated goods and services are not recorded because they do not meet the criteria, the nature of the donated goods and services should be disclosed in the notes to the financial statements.

Donated goods and services should be recorded as both a contribution and as an offsetting operating cost. The fundraiser will argue that recognizing the contribution for accounting purposes means these amounts should be included in the bonus calculation. It would be beneficial for SN to record these amounts, as the bonus is 10% and the minimum grant amount is 30%.

Fundraising

Revenue from the door to door campaign is currently being recognized net of costs. The gross proceeds of the campaign should be recorded separately from the offsetting costs. This method of recording the fundraising efforts would help maximize the government grant by increasing operating costs. It will also increase the bonus to the fundraiser, since the gross revenue recorded will be higher than the net amount currently recorded. By contrast, only the net proceeds should be recorded for the charity golf tournament, as the fundraising costs do not relate to SN’s operations.

Pledges

Pledges are recognized as revenue only if there is reasonable expectation of collection and the amount can be reasonably estimated. It is likely that the pledges by car dealers will be honoured before year-end, since there is still two months to collect these pledges. Accrual at the pledge date or recording when received will not affect the year-end financial statements. The number of personal pledges increased substantially this year. SN has no history of such a large number of pledges, and it may therefore be impossible to reasonably estimate the amount that will be collected from individual pledges. Industry statistics on similar telethons could be reviewed to derive a reasonable estimate of



the percentage that will ultimately be collected. Not recording these pledges will minimize the bonus this year.

Restricted Contributions

Both the large bequest received this year and the second government grant restrict the use of the funds received. The bequest is to be used for capital acquisitions only and the government grant is to be used for capital costs related to the shelter. The revenue from these restricted contributions can be recognized either under the deferral method or the restricted fund method. Under the deferral method, the revenue would be recognized on the same basis as the depreciation expense of the capital assets acquired with the contributions. The deferral of revenue would not affect the amount of the government grant since it is based on operating expenses. Under the restricted fund method, the contribution would be recognized as revenue in a separate restricted fund when it is received or receivable. In the future, the amortization expense would be recorded in the restricted fund. This method of accounting may affect the amount of the grant, as the grant will not take into account the depreciation expense recorded in the restricted fund. Recognition of the contribution in the restricted fund may result in a higher bonus to the fundraiser, as revenue is recognized sooner.

The furniture acquired with the funds from the bequest should be recorded at fair market value, with the difference between cost and fair market value recognized as a contribution to SN. The resulting higher depreciation may increase the value of the government grant in the future.

The use of the funds for the second government grant must be closely monitored. If the terms of the grant are not followed, an accrual for the possible repayment of the grant may be required.

Other

The lease of the former church meets the criteria of a capital lease. The leased asset should be recorded at no more than the fair market value, and it could be depreciation over the remaining 15-year life. The interest amounts inherent in the lease payment and the depreciation expense should be included in operating costs and as a result will increase the grant amount. The recording of the lease as a capital lease instead of an operating lease may affect the timing of the grant, as expenses are not recorded in the same period.

Memorandum

To: PartnerFrom: CARe: Audit of Safety Net and Other Service Opportunities

I have provided below my analysis of the various engagement issues regarding SN, as well as any other assistance that our firm could provide to SN.

This will be a high-risk engagement due to the following factors:- SN is a new client and we are not familiar with their systems;



- SH has never been audited;

- The accounting systems may be questionable, since revenues and expenses are currently recorded on a cash basis;

- Duties in the accounting department do not appear to be segregated;

- There have been significant changes in SN’s operations during the year; and

- The government department responsible for administering the grants may scrutinize operation.

A major user of the financial reports will be the Board of Directors of SN. It is assumed that the Board’s primary objective is to maximize the funds available for charitable operations. A government grant is available that provides for cost recovery of 50% of operating costs for the shelter and the soup kitchen and 30% of other operating costs. The government will therefore be interested in reviewing the financial information in order to administer the grant and monitor fulfillment of the grant requirements. Other donors may also be interested in SN’s reports in order to monitor stewardship of restricted donations. Another user will be the fundraiser who appears to have a bonus based on 10% of funds in excess of $500,000.

Audit Issues

The shelter must operate under GAAP, since the second government grant requires audited financial statements.

A major component of the audit work will involve valuation of donated goods and services. The value of donated services by chefs and food science students can be established by reference to normal pay levels. It may be difficult to establish the number of hours, as it is unlikely that hours worked are being tracked at this time. The value of donated food supplies can be established by reference to wholesale or retail prices. The corporations probably required a donation receipt, so there may be documentation to support those numbers. It will likely nearly be impossible this year to establish the quantities and value of fresh produce donated by individuals. The value of the donated frequent flyer points can be established by confirming with the airline the number of points donated and then valuing those by reference to likely flight usage.

We can confirm the net proceeds of the golf tournament fund raiser. We could also confirm significant pledges (in particular, the car dealer pledges) and assess the collectibility of the pledges. It is likely that the car dealer pledges will be honoured by year end and will be a non-issue. The viewer pledges present a more interesting challenge. The presence of the superstar may positively or negatively affect pledge redemption rates. We should obtain industry statistics to assess the reasonableness of recorded amounts.

We will need to pay particular attention to the allocation of costs, as the allocation will affect the cost recovery grant. We will need to determine the definition of qualifying costs for the government grant. In addition, we must check the accrual for this cost recovery on the year-end financial statements. We will need to ensure that the terms of the second government grant are being met. We should ensure that proper accruals are made if the terms of the grant are violated. We must ensure that the bonus, if valid, is properly accrued at year end. This will be difficult as the agreement is verbal and very vague. We will need to clarify the basis of the calculation.



Reporting Issue

The strategy for this engagement will be primarily substantive. There are no control systems to support reliance. It is highly unlikely that we will be able to substantiate opening balances so we should inform the client that there will be a qualification on the initial financial statements to establish a starting point for future audits. It will also be necessary to establish a reasonable system of internal controls to obtain unqualified audit reports in the future.

It will probably not be possible to give an unqualified audit report, as part of the fundraising involves canvassing by volunteers and it is impossible to establish completeness of revenues. It should be explained to the client that most non-profit entities are faced with this situation.

Certified Documentation for Government Grants

The Board has asked to perform an audit to meet a condition of one of the government grants and to provide the certified documentation for both grants, for the year ended March 31, 20X8.

The government will want information that allows officials to assess the proper level of funds to disburse under the operating cost grant. They will undoubtedly also want information on the nature of the costs included as operating costs. SN will need to provide information to facilitate this calculation. Possible alternatives would include reporting results by program (shelter/soup/kitchen/other) within the operating fund or providing a special report to the government that states that the operating costs as defined under the agreement are a certain amount and provides the calculated amount of the reimbursement. We could offer to provide such a report.

The government will also want assurance that the terms of the lump-sum contribution grant are being met. We can provide a report that attests to whether the terms of the contractual agreement are being met (Section 5815 report on Compliance with Contractual Agreement). We may suggest trying to negotiate with the government to permit other than audited financial statements.

OtherThere are a number of additional ways in which we could assist SN. Its most pressing concern is the absence of a reasonable internal control system. In addition to detailing internal control weaknesses in a management letter, we could suggest an engagement to review and suggest improvements to create an effective internal control system.

The bonus calculation is likely to become a contentious issue. There may be a need for a CAS 805 and 9100 report (audits of single financial statements and specific elements, accounts or items of a financial statement and reports on the results of applying specified auditing procedures to financial information other than financial statement). We could also suggest to the client that the bonus arrangement be formalized and put in writing because the bonus amount, depending on interpretation, could turn out to be very material. We could help SN define the terms of the bonus arrangement and formalize the agreement.

We should also work with management on developing reports to the Board of Directors, such as



those reports suggested in my report to the Board.[CICA]

Case 10-9: Art Gallery


This is a short case that requires students to discuss the purposes and objectives of a fund accounting system. In addition, the required asks for a recommendation on the different types of funds that would be appropriate. The following suggested response is from the CGA exam of December 1997.



Suggested Response

To: Members of the Board of Directors

I am pleased to provide a report to the Board of Directors of the art gallery. It is recommended that the art gallery use fund accounting to account for its various activities. This report provides a brief description of fund accounting. This report also describes the types of different funds that may be used by the art gallery and key accounting policies to be used by the art gallery.

Fund Accounting

Fund accounting is focused on keeping track of the resources that are designated for a specific purpose. By creating separate funds for specific activities, the acquisition and disposition of resources may be specifically accounted for. As a result, a not-for-profit organization may require several different funds to account for its diverse activities.

Fund accounting has three main attributes:

1. The segregation of funds by purpose or restriction

2. The ability to account for commitments.

3. Incorporation of budgetary accounts directly into the accounting system.

Types of Funds

The art gallery would have four different types of funds:

1. Operating fund. The operating fund would account for fundraising activities and general operating activities of the art gallery.

2. Capital fund. The capital fund would account for the long-lived assets of the gallery, including the building, maintenance equipment, office furniture and fixtures.

3. Acquisition fund. The acquisition fund would be used to account for the acquisition of the modern and contemporary pieces of art acquired by the gallery.

4. Enterprise fund. An enterprise fund would be used to account for the activities of the gift shop.

Accounting policies

The art gallery has a diverse set of activities which require a variety of accounting policies:

1. Volunteers. The gallery makes use of a number of volunteers. If the volunteers provide services that the gallery would normally have paid for, these service should be recognized in the accounting records at their fair market value. For most not-for-profit organizations, such services are not recorded.

2. Pledges. The gallery receives pledges for a major fundraising activity. Such pledges should be accounted for on an accrual basis, which provides a provision for uncollectible accounts based on past collection experience.

3. Capital assets. The building, maintenance equipment, office furniture and fixtures should be capitalized and depreciated over their estimated useful lives.



4. Artwork. The artwork should be capitalized but because it is a collectible item, it should not be amortized.

5. Donated goods and services. Goods and services that the gallery normally would have paid for should be recognized in the accounting records at their fair market value. These would include the building, utilities and property taxes.

6. Accrual accounting. Accrual accounting is recommended for not-for-profit organizations.

7. Budgetary accounts. The gallery should include its annual budget as part of its accounting and reporting system.

8. Encumbrances. An encumbrance system could be used to assist with the control of expenditures.

[CGA]

SOLUTIONS TO PROBLEMS

P10-1WESTSIDE LODGE

Statement of Operationsten months ended October 31, 20X4

RevenuesGovernment grant (70% × total expenses of $177,000) $ 123,900Donated services ($72,000 × 2/12) 12,000Contributions from individuals and businesses($90,000 – $22,500) 67,500

203,400ExpensesLeasehold improvements 45,000Furniture and equipment 36,000Rent 15,750Office supplies 7,500Wages and benefits ($42,000 + $4,500 + $72,000 × 2/12) 58,500Other expenses ($12,750 + $1,500) 14,250

177,000Excess of revenues over expenses $ 26,400



WESTSIDE LODGEStatement of Financial Position

October 31, 20X4AssetsCash $ 36,000Due from provincial government (70% × $177,000 – $105,000) 18,900

$ 54,900LiabilitiesAccrued liabilities ($4,500 + $1,500) $ 6,000Deferred contributions 22,500

28,500Fund balanceUnrestricted funds 26,400

$ 54,900 [CGA]

P10-2 Part 1. (i) Deferral method

January 1, 20X4

Vehicle 40,000Deferred contributions - capital assets 40,000

June 30, 20X4

Depreciation expense 5,000Accumulated depreciation 5,000[(40,000/4)(6/12) = 5,000

Deferred contributions—capital assets 5,000Contribution revenue 5,000

(ii) Restricted Fund MethodCapital Fund

January 1, 20X4Vehicle 40,000

Revenue – contributions 40,000

June 30, 20X4Depreciation expense 5,000

Accumulated depreciation 5,000[(40,000/4)(6/12) = 2,500

Part 2.

(i) Deferral method



September 30, 20X3

Cash 4,000,000Net assets—endowment 4,000,000

October 1, 20X3

Investment in bonds 4,000,000Cash 4,000,000

June 30, 20X4

Interest receivable 150,000Interest revenue 90,000Net assets—endowment 60,000

(ii) Restricted Fund MethodEndowment Fund

September 30, 20X3Cash 4,000,000

Revenue – contributions 4,000,000

October 1, 20X3 Investment in bonds 4,000,000

Cash 4,000,000

June 30, 20X4Interest receivable 60,000

Revenue - contributions 60,000[4,000,000 × 2% × 9/12 = 60,000]

General FundJune 30, 20X4

Interest receivable 90,000Revenue - investment income 90,000[4,000,000 × (5% – 2%) × 9/12]

[CGA]

P10-3

1. Equipment 64,000Deferred contributions—capital assets 64,000

Depreciation expense 16,000



Accumulated depreciation 16,000[64,000/4 =16,000]

Deferred contributions—capital assets 16,000Contribution revenue 16,000

2. If not-for-profit organizations have the ability to estimate the collectibility of pledges based on historical results, they should recognize the pledges as receivables with an allowance for doubtful accounts. Because Small does not have the ability to estimate the collectibility of its “first pledge ever” based on non-existent historical results, the pledge should be accounted for as revenue as the related cash is received.

3. Endowment FundCash 1,200,000

Contribution revenue—endowment fund 1,200,000

General FundCash 60,000

Revenue—general fund 60,000

4. No, you would not stop amortizing the building. Depreciation must be recorded on cost less residual value over the useful life of the asset using a rational and systematic manner. Therefore, even if the fair value had increased over time, depreciation must still be recorded annually.

[CGA]



P10-4

1. Partial balance sheet

AssetsCash $ 17,500Bingo Hall 600,000Accumulated depreciation (1) (5,000)

$ 612,500

LiabilitiesDeferred contribution—bingo hall $ 595,000Deferred contribution—maintenance 17,500

612,500Fund balance—unrestricted 0

$ 612,500(1) [$600,000/40 × 4/12 =$5,000]

2. Under expenditure accounting, the $600,000 cost of the bingo hall would be expensed in the statement of operations when the bingo hall was built. Under expense accounting, the $600,000 cost of the bingo hall would be expensed over its 40-year useful life.

3. The services of volunteers could be reported as revenue and an offsetting expense recognized on the income statement if the following conditions were met:

• The value of the services can be reasonably estimated; and

• The services were used in the course of the organization’s operations and would have otherwise been purchased.

4. If the services were recorded the following journal entry would be prepared:

Volunteer labour hours expense 5,000Revenue from volunteer services 5,000

P10-5

1. (a) Encumbrance accounting would require all commitments made by YOU to be formally recorded at the time the commitment is made on a transaction-by-transaction basis. By contrast, budgetary accounts are expectations that are generally recorded at the beginning of the year, in total, via control accounts.

(b) An encumbrance is recorded based on the intention to purchase an item, which would generally occur when a purchase order is issued. By contrast, an accounting liability is generally recorded only when title passes and the risks and rewards of ownership have transferred to YOU.



(c) Encumbrances 260,000Estimated commitments............................................................ 260,000

Estimated commitments 260,000Encumbrances ............................................................ 260,000

Operating expenses 259,200Accounts payable ........................... 259,200

2. (a) Cash (or Prepaid supplies)................................................... 10,000Supplies expense ................................................................. 10,000

Contribution revenue ............................................................ 10,000Deferred contribution revenue .............................................. 10,000

(b) Land..................................................................................... 200,000Fund balance —capital assets (net assets) ........................... 200,000

3. (a) SFK would not have to capitalize and depreciate its capital assets if its 2-year average revenues were less than $500,000 per year.

(b) If SFK did not capitalize and depreciate, it would either expense or capitalize, but not depreciate, its capital assets. It would be required to disclose its accounting policy, the amount expensed in the current period and information about any capital assets not shown in the balance sheet.

(c) Arguments against capitalization and depreciation include:

• It would change the nature of the operating statement from one that reflects resources spent to one that reflects the cost of resources used.

• Users may not understand the new accounting because they were used to seeing capital asset acquisitions as expenditures.

• Most other assets in a balance sheet represent spendable resources, unlike undepreciated capital assets.

• Capitalization and depreciation would be costly to apply.

• Small NPO financial statement users are most interested in seeing what money has been spent, and how much money is left over.



P10-6

1. Deferral method:

Cash 1,000,000Net assets—endowment 1,000,000

Cash 60,000Deferred revenue 60,000

Scholarship expense 40,000Cash 40,000

Deferred revenue 40,000Scholarship revenue 40,000

2. Restricted fund methodEndowment Fund

Cash 1,000,000Donation revenue—scholarship 1,000,000

Cash 60,000Interest revenue 60,000

Scholarship expense 40,000Cash 40,000

3. The following entries would be made in the operating fund:

Bus 80,000Deferred revenue 80,000

Depreciation expense 10,000Accumulated depreciation 10,000[(80,000 – 20,000)/6]

Deferred revenue 10,000Revenue 10,000

4. Restricted Fund MethodCapital Fund

Bus 80,000Revenue—contributions 80,000

Depreciation expense 10,000Accumulated depreciation 10,000[(80,000 – 20,000)/6]



[CGA]

P10-7

1. November 20X4Encumbrances 3,000

Estimated commitments 3,000

December 20X4Estimated commitments 3,000

Encumbrances 3,000

Prepaids 3,285Accounts payable 3,285

2. The difference between an encumbrance and a liability is that an encumbrance is recorded on the basis of the intention to purchase before the item is received and before there is a legal (or accounting) liability to pay for it. In contrast, there is little or no discretion to avoid a liability, which represents a transaction or event which has already occurred.

3. (a) Restricted contributions for expenses of future periods are deferred and recognized as revenue in the same periods as the related expenses are incurred.

(b) For capital assets subject to depreciation, the related expense is the yearly depreciation. The restricted contribution is deferred and recognized as revenue on the same basis as the asset being depreciated.

(c) Restricted contributions for expenses of the current period are recognized as revenue in the current period. Matching is achieved, and there is no need for deferral.

[CGA]

P10-8

1. (a) The $45,000 donation would be considered unrestricted and would be recorded as revenue in fiscal 20X3.

(b) The $75,000 donation, considered restricted, would be recorded as a deferred contribution in 20X3 (assuming that the receivable of $22,500 is considered fully collectible). The contribution would be recognized in revenue on the same basis as the related expense (that is, the depreciation of the contribution would be recognized in revenue on the same basis as the depreciation of the building).

(c) The $900,000 donation would be reported in the statement of changes in net assets (that is, an increase in net assets, not as revenue). Interest on the $900,000 of bonds would be recorded as



revenue as it is earned.

2. (a) With encumbrance accounting, entries are made in the accounting records as purchase orders for goods and services are issued. The amounts recorded represent estimates of the actual costs to be incurred. When the goods and services are received, the original entry to record the encumbrance is reversed and the cost of the goods or services is recorded. Outstanding encumbrances are not reflected as elements of financial statements, but should be disclosed if material.

(b) Encumbrance accounting can serve as a device to control spending because it shows that the spending has occurred when a purchase order is issued, rather than when the goods or services are received or paid for. This helps to prevent the further issuance of purchase orders when there are insufficient funds remaining in the budget.

[CGA]



Appendix 10A

SOLUTIONS TO PROBLEMS

P10A-1

1. Partial statement revenues and expenses

Donations for bingo hall $ 1,200,000Donations for maintenance 50,000

1,250,000

Depreciation expense-bingo hall 10,000Maintenance expense 15,000

25,000

Excess of revenues over expenses $ 1,225,000

2. If the services were recorded, the following journal entry would be prepared:

General fundVolunteer labour hours expense 10,000

Revenue from volunteer services 10,000

P10A-2

(i) The $30,000 donation would be considered unrestricted and would be recorded as revenue in the general fund in fiscal 20X3.

(ii) The $50,000 donation would be recorded as revenue in the capital fund, assuming that the receivable of $15,000 is considered fully collectible.

(iii) The $600,000 donation would be recorded as revenue in the endowment fund. Interest on the $600,000 of bonds would be recorded as revenue in the general fund.

[CGA]

P10A-3

1. Capital Fund



Cash 960,000 Contribution revenue—Government grant 500,000 Contribution revenue—Corporate grant 460,000To record government and corporate grants to construct arena (see cash flow worksheet).

Land 100,000 Contribution revenue – Land donation 100,000To record donation of land (see item #2).

Arena 960,000 Cash 960,000To record construction of arena (see cash flow worksheet)

Depreciation expense—arena 8,000 Accumulated depreciation—arena 8,000To record depreciation on arena (see item #1): (960,000 × 1/40 ×4/12)

Equipment 60,000 Contribution revenue—Equipment donation 60,000To record donation of equipment (see item #3)

Depreciation expense—equipment 2,000 Accumulated depreciation—equipment 2,000To record depreciation on equipment (see item #3): (60,000 × 1/10 ×4/12)

Closing entries for capital fundContribution revenue 1,120,000 Depreciation expense 10,000 Fund balance 1,110,000

Operating Fund

Cash 90,000Accounts receivable 10,000 Contribution revenue—Operating grant 100,000To record government grant for operating costs (see item #5)

Cash 50,000 Contribution revenue—registration fees 25,000 Unearned revenue—registration fees 25,000To record registration fees received (see item #6)

Cash 70,000 Contribution revenue—arena rental 35,000



Unearned revenue—arena rental 35,000To record arena rental fees received (see item #6)

Operating expense 7,000 Accounts payable 7,000To accrue for services received in December (see item #7)

Operating expense 205,000 Cash 205,000To record operating expenses paid during year (see cash flow worksheet)

Closing entries for operating fundContribution revenue 160,000 Fund balance 52,000 Operating expense 212,000

Endowment Fund

Cash 50,000 Contribution revenue—endowment 50,000To record endowment donation for tournaments (see item #4)

Bond investment 50,000 Cash 50,000To record investment in bonds of endowed funds (see cash flow worksheet and item #4)

Cash 3,000 Interest revenue 3,000To record interest earned and received on bonds (see cash flow worksheet)

Travel expense 3,000 Cash 3,000To record tournament travel funded by endowment

Closing entries for endowment fundContribution revenue 50,000 Interest revenue 3,000 Travel expense 3,000 Fund balance 50,000

2.Perch Falls Minor Hockey Association

Statement of Revenue and Expensesyear ended December 31, 20X5

(in $000s)



Operating fund

Capitalfund

Endowment fund

RevenueOperating grant (90 + 10) $100Capital grant $500Corporate donations 460Contribution of land 100Contribution of equipment 60Registration fees (50 / 2) 25Contribution of endowment $50Rental income (70 / 2) 35Interest income 3

160 1,120 53ExpensesOperating expenses (205 + 7) 212Travel costs for tournament 3Depreciation of arena 8Depreciation of equipment 2

212 10 3Excess (deficiency) of revenues over expenses $(52) $1,110 $50



Perch Falls Minor Hockey AssociationStatement of Financial Position

December 31, 20X5(in $000s)

Operating fund

Capitalfund

Endowment fund

Cash $ 5Accounts receivable 10Investment in bonds $ 50Land $ 100Hockey arena 960Equipment 60Accumulated depreciation (10)

$ 15 $1,110 $ 50

Accounts payable $ 7Unearned revenue 60Fund balance (52) 1,110 50

$ 15 $1,110 $50


ch10 beechy ism

Business

notforprofit organizations

organizations chapter

short case

financial reporting

gaap reporting options

expenditure reporting

reporting entity

nfp financial reporting