Not-for-profit organizations are required to use restricted fund method or deferral method of recording contributions. The restricted fund method recognizes contributions as revenue when they are received. Deferral method matches restricted contribution revenues with related expenses. The timing treatment restricted donation is primary difference among two methods. So the different result will be presented in financial statements. Using deferral method, the externally restricted contributions are deferred until the related expenses have taken place. When the expenses have taken place, the corresponding deferred contributions decrease and revenue is increase. Endowment contributions and land are recorded as increase in net assets. The restricted fund method allows that external restricted contributions are recognized as revenue in a corresponding existed restricted fund in the period the contributions are received. If there is no corresponding restricted fun is presented, the contributions are recognized in the general fund in accordance with the deferral method. Each method has advantages and disadvantages for its use. Choosing an appropriate accounting method is important for nonprofit. It can attract more donations to support organization activities. The executive director and board of nonprofit should oversee and assess the financial statements' health. The financial statements are important communication information to donors, government and creditors. The nonprofit once select a method, all contributions must been applied that method consistently.
2.0 Introduction
The purpose of this report is to identify which accounting method should be used to record contributions when Not-for-Profit organizations prepare their finance statement. The report will focus on analyzing the different between deferred method and restricted fund method by providing some examples to illustrate. The report is significance because adoption of different accounting method will affect results of financial statement presented. Financial statements are important communication information about NFPO to members, contributors and creditors. Financial statements satisfy their and others interested needs, like the financial condition of organizations and how the management has discharged its stewardship responsibility to those that have provided resources to the organizations, especially important as resources are contributed for specific purposes and management is accountable for the appropriate utilization of such resources. The study is limited to not-for-profit organizations (NFPO), which have characteristics (Section 4400):
Do not have transferable ownership interest
Operate exclusively for social, educational, professional, religious, health, charitable or other not-for-profit purposes.
Resource providers (volunteers or members) do not get an extra benefit because of their status.
Exclude government entities(CICA Public Sector Accounting Handbook applies and not Section4400)
The potentially benefit from this report for all not-for-profit organizations. Many not-for-profits are subject to reporting requirements such as the production of audited statements or mandatory reporting to funders. Effective financial report help build an organization's reputation. They can make a support, and can be a key means of reaching new do partners and volunteers.
3.0 Background
Contributions are important in Canadian economy. From 2007 to 2010, a financial contribution to a charitable or non-profit organization is total about $10.6 billion every year. Contributions are often the primarily resources for a non-profit organizations.
Non-profit organizations usually report financial efficiency to demonstrate they spend contributions on intended programs, fundraising and administrative functions. Donors use such efficiency information to make their donation decisions. Thus, I will analysis which accounting method of recording contributions can make financial statement more efficiency and effectiveness.
4.0 Definition & Analysis two methods
Not-for-profit organizations have three types of contributions to report: unrestricted contributions, restricted contributions and endowment contributions. Flowing is a description of each type of restriction and the difference between for accounting purposes reporting with the deferred method and restricted fund methods.
4.1 Deferred Method
Under the deferred method, unrestricted contributions are automatically recorded as revenue. Restricted contributions for operating expenses that are to be incurred in a future period are deferred and realized as revenue in the future periods as related expenses are incurred. Endowment contributions are shown in the statement of changes in net assets. Especially, contributions for the purchase of depreciable capital assets are deferred; the revenue is realized as the asset is being amortized. Non-depreciable capital assets are shown in the statement of changes in net assets.
4.1.1Advantages
Using matching principle, the recorded deferred contributions as liabilities are transferred to the income statement as revenue. It is considered useful for evaluating the ability of organizations to generate net income and thus for performance evaluation.
4.1.2Pitfalls
The concern of deferred method is restricted contributions for which the related restrictions remain unfulfilled are accumulated as deferred contributions. As a result, the organization's excess of revenue over expenses for the period represents the increase in resources that are not restricted to cover specific expenses of a future period.
4.2 Restricted Fund Method
The restricted fund method requires the entity must have a general fund and at least one restricted fund. Most restricted contributions and endowment contributions are reported as revenue by using restricted funds and an endowment fund. Unrestricted contributions and investment income, including unrestricted endowment fund income record as revenue in general fund.
4.2.1Advantages
Restricted fund method using fund accounting system to record contributions can help to ensure that organizations use their resources in accordance with the stipulations donors; granting agencies and governing boards impose. Fund accounting segregates the account balances related to its purpose and keeps these funds from mingling with the other accounts of the organization. This ensures that the assets assigned to each fund remain available for the purpose of that fund. Another advantage of using fund accounting is keeping the organization accountable to the donors who support the organization. Each donor wants to see the nonprofit serve the individuals who need its assistance. When the nonprofit organization issues its financial statements at the end of the year, the contributors can review the performance of each fund. The financial statements identify the money received for each fund and how the organization distributes those funds.
4.2.2Disadvantages
The concern of restricted fund method: an organization would choose which restricted funds to report. Because of this choice, two organizations following the restricted fund method may each report similar kinds of restricted contributions differently. For example, one organization may present contributions restricted for purchasing equipment in a separate restricted capital fund. Another organization may not report a separate capital fund. It results in lacking comparability on similar contributions of two organizations. An organization must recognize all similar contributions in a consistent manner year to year. If the organization changes its method of accounting for contributions, the change would be treated as a change in accounting policy in accordance with accounting changes. (CICA Section1506)
5.0 Comparison on two Deferred Method and Restricted Method
The different between deferred method and restricted fund method is revenue recognition of restricted contributions. Recognition differences deal with whether or not an item appears in a financial statement. For example: Restricted cash contributions: under restricted fund method, restricted cash contributions are recognized as either temporarily or permanently restricted based on whether the restriction can be met or not. Contributions are reported as revenue in Operations Statement. Under deferred method, time restricted cash contributions are recognized as deferred contributions until the restriction is met. Contributions are recorded as revenue until the related expense as been incurred. This affects the amount of liabilities and revenues reported. Restricted net investment income: under restricted fund method, restricted net investment income as revenue is reported in endowment fund in Statement of operations. Under deferred method, it must be added to resources held for endowment in net assets. An example shows a NFP organization records the contributions through using deferral method and restricted fund method separately blow.
SMB prepares their own set of financial records and is also required by the agreement with the Province of Manitobato ensure that the sport partners that are funded are complying with all terms and conditions of funding. SMB received $100,000 from the Province to establish the Princess Royal Scholarship endowment. This amount was invested in debt securities, which generated the $50,000 of investment income. The investment income is restricted for use to provide annual scholarships. $900,000 received from a wealthy and grateful benefactor on Jan 1, 2012 the beginning of its fiscal year. He requested that the money was to be used for purchasing and maintaining a property to house the administrative offices and operating facility. At the July 1, the following item were purchased in cash: Land $400,000; operating facility $300,000, it estimated life of 20 years. At the November 21, a donor contributes $10,000, without restriction for the operation of SMB. $ 25,000 of investment income paid out for Scholarship. In addition, SBM spent $16,000 for the year on maintenance costs for the operating facility.
Donations
Restricted Fund Method
Deferral Method
Scholarship fund
Included in revenue of endowment fund
Recognize in net assets
Facility cash
Recognize as revenue in
restricted fund(capital) when received
Recognized as deferral
contribution until
facility expensed
Interest income
on endowment
From scholarship fund, recognize
as revenue; Otherwise deferred in
general fund until scholarships paid
Deferred revenue;
Recognized when the
Scholarships paid out
Land
As an asset in capital fund
Recognize as net asset
Amortize
In capital fund
Stat to amortize deferred
contribution
Presentation
requirements
Must show at least one general fund;
at least one restricted fund;
at least endowment fund
One fund or
fund accounting
6.0 What are the effects on Financial Statements?
Primarily the nonprofit organization must produce three important annual financial statements: the statement of financial position, the statement of operation, and the statement of cash flow. Each component of a nonprofit organization's existence, like organization's programs or projects, is dependent on the organization's financial feasibility. Financial feasibly is accounted for through primarily those three financial statements. One of the principle differences in nonprofit financial statements compared to for-profit entities is the objective of a nonprofit is to realize its socially desirable goals and objectives for the community it serves, rather than to realize a net profit. According to example above, financial statements are showed blow.
6.1 Deferral Method
SMB
The Statement of Operation
For the year ended December 31, 2012
Revenue
Contributions 58,500
Expense
Maintenance expense 16,000
Amortization 7,500
Scholarship 25,000
48,500
Excess revenues over expenses 10,000
SMB
Statement of Changes in Net Assets
For the year ended December 31, 2012
Unrestricted Investment in Restricted for Total
Funds Capital Assets Endowment
Net assets at the
Beginning of the year --- --- --- ----
Add: Excess revenues
Over expenses 10,000 10,000
Investment in
Land 400,000 400,000
Endowment 100,000 100,000
Net assets at end of year 10,000 400,000 100,000 510,000
SMB
Statement of Financial Position
For the year ended December 31, 2012
Assets
Cash and investment 319,000
Capital assets
Land 400,000
Operating facility 300,000
Accumulated amortization (7,500) 692,500
1011,500
Liabilities
Deferred contributions 501,500
Net assets
Invested in capital assets 400,000
Restricted for endowment 100,000
Unrestricted net assets 10,000 510,000
1011,500
6.2 Restricted Fund Method
If the SBM using restricted fund method to record contribution, the format and the result of operating statement are totally different.
SMB
Statement of Operation
For the year ended of December 31, 2012
General Capital Endowment Total
Fund Fund Fund
Revenues
Contributions 10,000 900,000 100,000 1010,000
Interest income 50,000 50,000
Expenses
Maintenance 16,000 16,000
Amortization 7,500 7,500
Scholarship 25,000 25,000
Excess of revenues
Over expenses 10,000 876,500 125,000 1011,500
SMB
Statement of Position
For the year ended of December 31, 2012
General Capital Endowment Total
Fund Fund Fund
Assets
Cash and investment 10,000 184,000 125,000 319,000
Capital assets
Land 400,000 400,000
Operating facility 300,000 300,000
Accumulated amortization (7,500) (7,500)
10,000 876,500 125,000 1,011,500
Liabilities
Deferred contributions --- --- ---
Fund balances
Invested in capital assets 692,500 692,500
Externally restricted 184,000 184,000
Endowment 125,000 125,000
Unrestricted 10,000 10,000
10,000 876,500 125,000 1,011,500
(Fund balance=Asset-Liability)
Under deferral method, the effect on the income statement is that when the facility and scholarship expenditure have taken place, the corresponding revenue increase. The revenue over expense shows $10,000 which is received unrestricted contribution. Other received contributions are recorded as liabilities on the balance sheet. The liabilities "deferred contributions" are decrease when the related revenues are recorded. Land and endowment are recorded direct increase in net asset. Under restricted fund method, the contributions are distributed to three related funds. Each fund has a self-balancing separately. There, any expenditure related to that fund is deducted from the balance. All Contributions are recorded as revenues on the income statement immediately when received. In this case, using the restricted fund method to record contributions is better than using deferral method. Because the restricted fund method is more clearly shows the nonprofit how to spend received restricted contribution. The restricted fund method makes SMB easy to report activity to its constituents, and also to any government entity that is charged with the responsibility of overseeing its operation.
There are some special situations should be know when nonprofit record contributions. For example, sometimes organizations make a transaction or trade that does not involve cash. Organizations may choose to recognize non-monetary contributions, but should do only when a fair value can be reasonably estimated and when the materials or services are used in the normal course of the organization's operations and would otherwise have been purchased.
7.0 Recommendation
Which accounting method is best? This is a matter of what the entity wants to communicate in the financial statements. "The best system is a system that gives the members of an organization control over its financial health and portrays this health through their records."(Kelly Bourgeo. June, 2003. Nonprofit organization statement. p16). So the executive director and board of nonprofit should assess the financial health thought that the financial statements should be easily comprehensible so that any person taking the time to read them will understand the financial picture; they should be concise and they should clearly show the relationship among the each transaction without confusing detail involving transfers.
First, I recommend that using fund accounting. Because the fund accounting approach is more clearly presents information regarding restrictions that may exist and how the organizations' resources can be spent. And it can be effective, especially when accounting reports must be sent to more than one government agency. For example, if a charity receives an endowment for the childcare program, a contribution restricted to support homeless shelter and a grant for providing meals to stray pets, each of these programs is to fall into the jurisdiction of a different government agency. So by creating funds for each program, it is provide each monitoring agency with an accounting of what has been done with the donations received to support each program.
The organizations determine an appropriate accounting method should determine who the uses of the statements will be and what their needs. For a nonprofit that receives recurring restricted contributions, so in my opinion, the restricted fund method is better than deferral method. Because the restricted fund method reflects a more accurate accrual basis of revenue recognition for the funds presented. It provides donors with simply but robust information on how their contributions are be used. It let users clearly to understand the financial pictures. The deferral method may be more difficult for the users to understand. Because under deferral method, the contributions for future periods are deferred and not reported until used. Deferral of external restricted contributions to a liability may be confusing to the basic users. This is only a personal opinion. Each method has advantages and disadvantages separately for its use. So organizations should seek the help of professionals to assist it in implementing its accounts.
8.0 The argument in making accounting standards
The argument considered by AcSB in making decision for not-for-profit organizations' accounting standards in Part III is the Board assessment that a stand-alone set of standards should not be developed for not-for-profit organizations. AcSB's position is there should be no differences in accounting between profit-oriented enterprise and not-for-profit organizations when the circumstances and transactions are the same. AcSB in Canada invited not-for-profit organizations to comment on a proposal that would see them use the same system of financial reporting that publicly traded corporations would soon be using. Some respondents opposed change the rules governing the way they report their financial information. "when you try to put charitable organizations in the same realm as publicly traded organizations it becomes a challenge because the users of the financial statements have very different needs than a shareholder would have." said Michael Herrea, interim treasurer for the Anglican Church of Canada. If the church was required to use IFRS, Mr. Herrera said it would greatly increase the amount of financial reporting required, and the accounting and audit costs associated with it would increase, the additional information generated would be of no benefit to end users. Received replies from not-for-organizations and their stakeholders generally supported existing standards for non-profit organizations. Respondents also supported giving not-for-profit organizations the option of adopting IFRSs. According to comments received, the AcSB determined that not-for-profit organizations reporting in accordance with Canadian GAAP may use the standards applicable to publicly accountable enterprises or the accounting standards for not-for-profit organizations in Part III of the Handbook. And AcSB decided to consolidate the specific standards applicable to not-for-profit organizations in Part III and to link those standards to the accounting standards for private enterprises in Part II of the Handbook for transitions and circumstances that are not dealt with in Part III.
9.0 Conclusion
The fundamental accounting of nonprofit is different with profit-oriented companies. For a not-for-profit organization, the objective of financial statements are to assess management stewardship and to communicate information that is useful to members, contributors, creditors and other users in making their resource allocation decisions. Users want to assess whether the organization is achieving its objectives at the lowest possible cost. As we know, contribution is the primary resource for nonprofit organizations. The information of contribution is important. It can help external users to assess the organization's economic relationship with other entities and to predict its ability to generate future cash flow. It may be desirable to individual or entities providing significant levels of support. Choosing an appropriate contribution revenue recognition policy is significant. The choice depends on the financial reporting objective and on the motivations of its manager. Nonprofit organizations are required to record contributions using either the restricted fund method or the deferral method. According to analysis above, the timing restriction treatment is the primary cause for some of the more significant reporting and recognition differences. Using restricted fund method, the restricted contributions are recognized as revenue when they are received. Deferral method recognizes contributions until they are spent. Each method has its advantages and disadvantages. The accounting method, once selected, all received contributions must been applied that method consistently. The accounting policy seems be changed if the organization changes its method. There is not required to, I recommend that nonprofit organizations use fund-based structure. If no such fund has been established, restricted contributions are treated the same way as under the deferred contribution method.
