After studying this chapter, you should be able to do the following:

1. Define not-for-profit organizations (NFPOs) and describe how they differ from profit-oriented organizations.
2. Describe and apply the not-for-profit accounting and reporting practices currently mandated in the CICA Handbook.
3. Explain the objectives of fund accounting, and prepare financial statements using fund accounting.
4. Explain how formal recording of a budget and encumbrances helps NFPO managers control operations.
5. Prepare journal entries and financial statements under the restricted fund method.
6. Prepare journal entries and financial statements under the deferral method.
7. Analyze and interpret the financial statements of NFPOs.
8. Identify the main differences following IFRSs and ASPE for NFPOs.
9. Outline the basics of public sector financial reporting.

A substantial portion of Canada’s economic activity is conducted by organizations whose purpose is to provide services (or products) on a non-profit basis — this non-business area contains both the government sector and the not-for-profit organizations (NFPOs) sector including charities, hospitals, and universities.

There are a number of ways in which NFPOs differ from profit-orientated organizations. NFPOs differ from profit-oriented organizations in the following ways:

• They typically provide services or goods to identifiable segments of society without the expectation of profit.
• The resources are provided by contributors without the expectation of gain or repayment. Often a portion of the resources received have restrictions attached that govern the manner in which they can be spent.
• There is no readily defined ownership interest that can be sold, transferred, or redeemed in any way by the organization.
• While many NFPOs have paid employees, they are governed by volunteers who receive little or no remuneration or gain for the time and effort they provide. In some small organizations there are no paid employees and all effort is provided entirely by volunteers.

Not-for-profit Reporting Today
Many sections of the Handbook that previously applied only to profit orientated organizations now apply to NFPOs as well. In 2008, the NFPO Handbook sections underwent a major review. As a result, one new NFPO section was added, many changes were made to other NFPO sections.

In December 2010, the Handbook was restructured into five parts to implement the strategy of the Accounting Standards Board (AcSB) of adopting different sets of standards for different categories of entities. As part of this restructuring, the not-for-profit (NFP) sector was classified into two sectors: the public NFP sector and the private NFP sector. The public NFP sector includes NFPOs (such as hospitals) that are controlled by the government. These NFPOs have a choice to follow the CICA Public Sector Accounting (PSA) Handbook including the 4200 series or the PSA Handbook without the 4200 series.

The private NFP sector includes NFPOs that are not controlled by the government. They have a choice to follow either Part I (International Financial Reporting Standards) or Part III (Accounting Standards for Not-for-Profit Organizations) of the CICA Handbook. It is expected that most private sector NFPOs will adopt Part III of the CICA Handbook.

A NFPO applying Part III of the Handbook also applies Part II (Accounting Standards for Private Enterprises) to the extent that the Part II standards address topics not addressed in Part III. Some of the standards in Part II are of limited or no applicability to NFPOs either, because the topics are specifically addressed in Part III or the standards in Part II relate to transactions or circumstances that do not pertain to NFPOs.

The standards in Part III are based closely on standards in the Handbook prior to the restructuring into the different parts. Part III carries forward the 4400 series of sections from the old Handbook, largely without change, except for the split of Section 4230 into Sections 4231 and 4232. Five new sections were added, containing relevant material from Part II that were customized for the private NFP sector. The new standards became effective for fiscal periods beginning on or after January 1, 2012.

Section 1001: Financial Statement Concepts for Not-for-Profit Organizations

• The mains users of the NFPOs’ financial statements are the members, contributors, and creditors.
• They are interested, for the purpose of making resource allocation decisions, in the entity’s cost of service and how that cost was funded and in predicting the ability of the entity to meet its obligations and achieve its service delivery objectives.
• The excess or deficiency of revenues and gains over expenses and losses can be an important indicator of the entity’s ability to obtain resources to cover the cost of its services.

Section 1101: Generally Accepted Accounting Principles For Not-For-Profit Organizations

• This section describes the primary and other sources of GAAP for NFPOs. The primary sources of GAAP, in descending order of authority, follow: (i) Sections 1470 – 4470 of Part III of the Handbook, including appendices (ii) Sections 1505 – 3870 in Part II, to the extent that the topics in those sections are not specifically discussed in Part III, including appendices (iii) “Accounting Guidelines” in Part II, including appendices.



• A NFPO should present only one set of general-purpose financial statements prepared under Part III of the Handbook in any particular period. If it prepares additional sets of financial statements under Part III for different purposes, these are special-purpose financial statements and should refer to the general-purpose financial statements.

Section 1401: General Standards of Financial Statement Presentation For Not-For-Profit Organizations

• This section describes fair presentation in accordance with GAAP, going concern, financial statements required for NFPOs, and comparative information.



• The general-purpose financial statements consist of the statement of financial position, statement of operations, statement of changes in net assets, and statement of cash flows. Notes to financial statements, and supporting schedules to which the financial statements are cross-referenced, are an integral part of such statements.



• When financial statements are not prepared on a going-concern basis, that fact shall be disclosed, together with the basis on which the financial statements are prepared and the reason why the organization is not regarded as a going concern.



• Financial statements shall be prepared on a comparative basis, unless the comparative information is not meaningful or the standards set out in Part III permit otherwise.

Section 1501: First Time Adoption by Not-For-Profit Organizations

• This section applies when a NFPO is adopting Part III for the first time.



• When converting to Part III for the first time, changes in accounting policies must be applied retrospectively, unless there are exemptions or restrictions as outlined and defined in Section 1501.



• The entity’s first set of financial statements must show comparative numbers for the previous year as if Part III had always been applied. In addition, the entity must present a statement of financial position on the transition date, which is the beginning of the earliest period for which an organization presents full comparative information.



• The entity has an option to not retrospectively adjust when it changes its accounting policies in its first set of financial statements under Part III for certain standards in the following areas: business combinations; fair value for property, plant, and equipment; employee future benefits; cumulative translation differences for self-sustaining foreign operations; financial instruments; and asset retirement obligations. These same elective exemptions are available for private entities transitioning to Part II (ASPE).

Section 3032: Inventories held by Not-For-Profit Organizations

• When a NFPO recognizes donations of materials and services, the inventories should initially be recorded at fair value, which is its deemed cost from that point forward. Without this requirement, the inventory would not be recognized because it had no cost to the NFPO.



• A NFPO may hold inventories whose future economic benefits or service potential are not directly related to their ability to generate net cash flows. These types of inventories may arise when a NFPO distributes certain goods at no charge or for a nominal charge.



• A NFPO measures inventories at the lower of cost and current replacement cost (instead of net realizable value), when they are held for distribution at no charge or for a nominal charge or for consumption in the production process of goods to be distributed at no charge or for a nominal charge.

Section 4400: Financial Statement Presentation by Not-for-Profit Organizations

• An NFPO must present the following financial statements for external reporting purposes:
  • Statement of operations
  • Statement of financial position
  • Statement of changes in net assets
  • Statement of cash flows
  The names provided here are for descriptive purposes only; an organization can choose the titles it wishes to use.
• The primary purpose of a statement of operations is to communicate information about changes in the organization’s economic resources and obligations for the period. Specifically, this statement provides information about the cost of the organization’s service delivery activities for the period and the extent to which these expenses were financed or funded by contributions and other revenue. The information provided in the statement of operations is useful in evaluating the organization’s performance during the period, including its ability to continue to provide services, and in assessing how the organization’s management has discharged its stewardship responsibilities.
• The statement of financial position should show classifications for current assets, non-current assets, current liabilities, and non-current liabilities. Net assets (total assets less total liabilities) must be broken down into the following categories (if applicable):
  • Net assets maintained permanently in endowments
  • Internally restricted and other externally restricted net assets
  • Unrestricted net assets
  Starting in 2009, a reporting entity has three options for reporting net assets invested in capital assets: (1) continue to show it as a separate component of net assets; (2) disclose it in the notes to the statements; (3) do not present or disclose it separately. Many organizations still present or disclose this item separately because it indicates that this portion of net assets is not available for current use.
• A fund basis can be used, but it is not necessary to prepare all statements using this method. For example, the operating statement could be presented on a fund basis while the rest of the statements could be presented on a non-fund basis.
• Revenues and expenses should be reported on a gross basis when the entity acts as a principal in the transactions.
• Expenses may be classified by object (salaries, rent, utilities), by function (administrative, research, ancillary operations), or by program.

The Basics of Fund Accounting
The resources that an NFPO receives can be broadly categorized as unrestricted or restricted. Unrestricted resources can be used for any purposes that are consistent with the goals and objectives of the organization. Restricted resources can be used only in accordance with the wishes of the contributor. In some situations the original donation must be invested, and only the interest earned on the funds invested can be spent by the organization. A donation of this type is called an endowment. Quite often, restrictions are also placed on how the endowment interest can be spent. The restrictions imposed by the board or management are referred to as internal restrictions. They are reported differently than the restrictions imposed by external parties mainly because future boards could reverse the designation. In accordance with the CICA Handbook’s definition, restricted contributions are those that may be spent only in accordance with the wishes of the donor (or, in the case of endowments, may never be spent). Fund accounting is often used to convey information about restricted resources. For presentation purposes, the columnar approach presents the various funds side-by-side and then presents a total for all the funds. An alternative that gained some prior acceptance was the layered approach, which presented funds one after another, so that the first page would show the operating fund statements, the second page would show the building fund, and so on. Under the provisions of the new CICA Handbook sections, the columnal approach is preferred because of a requirement to show totals for each financial statement item for all funds presented. NFPO accounting has shifted from reporting the cost of resources spent to provide services, to reporting the cost of services provided.

Section 4410: Contributions — Revenue Recognition

• There are two very key points embodied in these two sections: (1) restrictions on an organization’s resources should be clearly stated in the financial statements, and (2) the matching concept as it applies to NFPOs must be applied in the measurement of yearly results under the deferral method.
• For an NFPO that has restricted revenues, the concept of revenue and expense matching is the exact opposite to that for a profit-oriented enterprise. With the latter, revenues are recognized and then expenses are matched with those revenues. With an NFPO, restricted revenues are matched to expenses.
• Handbook Section 4410 describes three different types of contributions: restricted, endowment, and unrestricted.
• Restricted contributions are subject to externally imposed stipulations as to how the funds are to be spent or used. The organization must use the resources in the manner specified by the donor. There may be times when the directors of an organization decide to use certain contributions for certain purposes, but these are considered to be internally imposed restrictions and do not fall within the definition of restricted contributions.
• Endowment contributions are a special type of restricted contribution. The donor has specified that the contribution cannot be spent, but must be maintained permanently. Endowment contributions are often invested in high-grade securities.
• Unrestricted contributions are those that are not restricted or endowment contributions.

Section 4420: Contributions Receivable

• Contribution revenue is a type of revenue that is unique to NFPOs, because it is non-reciprocal. Included here are donations of cash, property or services, government grants, pledges, and bequests.
• A contribution receivable should be recognized as an asset when it meets the following criteria: (a) the amount to be received can be reasonably estimated; and (b) ultimate collection is reasonably assured. [4420.03]
• Pledges are promises to donate cash or other assets to an NFPO, but they are legally unenforceable.
• Bequests are normally not recorded until a will has been probated since the will are sometimes subject to legal challenges.

Section 4431: Tangible Capital Assets Held by Not-for-Profit Organizations

• Section 4431 requires a large NFPO to capitalize all tangible capital assets in the statement of financial position and to amortize them as appropriate in the statement of operations.
• When a capital asset is donated, it is recorded at fair value (if known), and the resultant credit is recorded based on the requirements for contributions.
• If the entity paid less than fair value, the asset is recorded at fair value and the difference between fair value and cost is recorded as a contribution.
• Capital assets of limited useful life are to be amortized on a rational basis over their estimated useful lives. No maximum period of amortization is specified.
• When an asset no longer contributes to the organization’s ability to provide services, it should be written down to estimated residual value, with the resulting loss reported as an expense in the statement of operations. Note that this is not the same impairment test as prescribed in Part II Section 3063.
• Small NFPOs – An exemption from the requirement to capitalize is granted to small NFPOs (those whose two-year average revenues are less than $500,000). When an NFPO no longer meets the exemption test, it must capitalize and amortize its capital assets and apply the new policy on a retroactive basis.

Section 4432: Intangible Assets Held by Not-for-Profit Organizations

• This section was introduced to clarify that Part II (ASPE), Section 3064: Goodwill And Intangible Assets applies to a NFPO’s intangible assets. The same requirements as discussed above for tangible capital assets also apply for intangible assets.

Section 4440: Collections Held by Not-for-Profit Organizations

• Collections are works of art and historical treasures can been excluded from the definition of capital assets because they meet all of the required criteria.
• Collections have been excluded from the definition of capital assets, and NFPOs are allowed three alternative reporting options (expense when acquired, capitalize but do not amortize, capitalize and amortize).
• NFPOs that have collections are required to include in their disclosures a description of the accounting policies followed with regard to collections, a description of the collection, any significant changes made to the collection during the period, the amount spent on the collection during the period, the proceeds from any sales of collection items, and a statement of how the proceeds were used.

Section 4450: Reporting Controlled and Related Entities by Not-for-Profit Organizations

• Control Investments — A control investment is one that gives an NFPO control over both profit-orientated organizations and other NFPOs. Because an NFPO does not issue shares, control of such an entity is normally evidenced by the right to appoint the majority of the board of directors as allowed by that entity’s by-laws or articles of incorporation.
• Control over NFPOs — Consolidation of an NFPO is one of three alternatives allowed (consolidation, by providing the disclosure set out in Paragraph 4450.22, or if the controlled organization is one of a large number of individually immaterial organizations, by providing the disclosure set out in Paragraph 4450.26). The alternatives apply to each controlled NFPO. Since three alternatives are allowed, the management of the organization has to determine the accounting policy to be used. Note that the alternatives listed above are for each controlled entity. This means that if an organization has control over three NFPOs, all of which are material, it could choose to consolidate only one, and provide the required disclosure for the other two, provided that it reports consistently on a year-to-year basis. Paragraph 22 requires the disclosure of the totals of all of the assets, liabilities, net assets, revenues, expenses, and cash flows of any controlled NFPOs that are not consolidated. Paragraph 26 requires the disclosure of the reasons that the controlled organizations have been neither consolidated nor included in the disclosure set out in paragraph 4450.22. Possible reasons could include cost/benefit considerations and the decision not to exercise financial control.
• Control over Profit-oriented Companies — A controlled profit-orientated organization can either be consolidated or reported using the equity method. (Once again, it should be noted that the requirements here are also applicable to each controlled entity, which could result in some subsidiaries being reported under the equity method and others being consolidated.)
• Joint Control — A jointly controlled organization can be either proportionately consolidated or reported using the equity method. (Consistent with the requirements for controlled entities, the alternatives here apply to each joint venture, so that some may be proportionately consolidated and others may not, depending on the accounting policy determined by management.)
• Significant Influence – A significant-influence investment in a profit oriented organization is reported using the equity method. A significant influence investment in another NFPO requires only full disclosure of the relationship.
• Economic Interest – An economic interest in another NFPO exists if that organization holds resources for the reporting organization or if the reporting organization is responsible for the other organization’s debts. When an organization has an economic interest in another NFPO over which it does not have control or significant influence, the nature and extent of this interest should be disclosed.
• An investment in a profit-oriented organization that is not subject to control, significant influence, or joint control, is reported at fair value or using the cost method as per the requirements in the Part II (ASPE), Section 3856: Financial Instruments.

A summary of the various types of investment that an NFPO can have and the reporting requirements for each follows:

Investment	Required reporting
Control of NFPO	Consolidate or disclose
Control of profit entity	Consolidate or equity method
Joint venture	Proportionately consolidate or equity method
Significant Influence
NFPO	Full disclosure
Profit entity	Equity method
Economic interest	Full disclosure
Other investment
Profit entity	Fair value method or cost method or amortized cost method

Section 4460: Disclosure of Related Party Transactions by Not-for-Profit Organizations

• Related parties exist where one party is able to exercise control, joint control, or significant influence over another party. The other party may be either another NFPO or a profit-oriented enterprise. If one NFPO has an economic interest in another NFPO, the two parties are related. A related-party transaction has occurred when there has been a transfer of economic resources or obligations or services between the parties.
• An NFPO must disclose all related-party transactions with another NFPO or a profit-oriented entity. (Unlike CICA Handbook, Part II (ASPE), Section 3840, which prescribes both measurements and disclosures, this not-for-profit section prescribes only disclosures for related-party transactions.)

Section 4470: Disclosure of Allocated Expenses by Not-for-Profit Organizations

• When an organization classifies its expenses by function on the statement of operations, it may need or want to allocate certain expenses to a number of functions to which the expenses relate.
• An NFPO must disclose details related to any allocation of fundraising and general support costs to different functions.

Accounting for Contributions
Rather than mandating a single reporting model, the new standard gives NFPOs the choice between the deferral and restricted fund methods of financial statement presentation and allows them the flexibility to use a mix of both methods if they feel that it will result in a better presentation. While these changes have moved not-for-profit more toward a business approach of reporting and away from the stewardship-of-resources approach that was previously used, not-for-profit reporting is still very distinct, and certainly far more complex than it was before. Detailed examples of the accounting for both of these methods are illustrated in the textbook.

• The Deferral Method — The deferral method matches contribution revenues with related expenses. Unrestricted contributions are reported as revenue in the period received or receivable, because there are no particular related expenses associated with them. Endowment contributions are not shown in the operating statement; rather, they are reflected in the statement of changes in net assets. This is because endowment contributions, by definition, will never have related expenses. Restricted contributions must be matched against related expenses. This matching principle has different implications for different kinds of restricted contributions.



• The Restricted Fund Method — This method requires an NFPO to report a general fund, at least one restricted fund, and, if it has endowments or receives endowment contributions, an endowment fund. The general fund reports all unrestricted revenue and restricted contributions for which no corresponding restricted fund is presented. The fund balance represents net assets that are not subject to externally imposed restrictions. The restricted funds will be used to record externally restricted revenue.

Net Assets Invested in Capital Assets
An NFPO can report “net assets invested in capital assets" as a separate component of net assets. The Handbook provides an option to report “net assets invested in capital assets” as a separate component of net assets. This amount represents resources spent on and tied up in capital assets and therefore not available for future spending. The amount shown depends on the method used to account for contributions. If the restricted fund method is used, the amount represents the unamortized portion of all capital assets less associated debt, regardless of whether they were purchased from restricted or unrestricted resources. If the deferral method is used, the amount presented represents the unamortized portion of capital assets (net of associated debt) that were purchased with unrestricted resources.

Donated Capital Assets, Materials, and Services

• Donated Capital Assets – An NFPO is required to record the donation of capital assets at fair value. If fair value cannot be determined, a nominal value will be used. A donated depreciable asset is reported as deferred contributions under the deferral method. A donated depreciable asset is reported as contribution revenue under the restricted fund method.



• Donated Materials and Services – The requirements for the reporting of donated materials and services are different from those for donated capital assets. An NFPO has the option of reporting or not reporting donated material and services; however, it should do so only if fair value can be determined and if the materials and services would normally be used in the organization’s operations and would have been purchased if they had not been donated. The Handbook section also makes it clear that the fair value of the services of volunteers is normally not recognized due to the difficulty in determining such values. Furthermore, an organization would probably not record donated materials if it acts as an intermediary for immediate distribution. Donated materials and services should be reported as contribution revenue when the materials and services are expensed.

Budgetary Control and Encumbrances

• Governments and many NFPOs often use a formal budget recording system together with an encumbrance system as a device to help control spending.
• The actual recording of the budget in the records, along with the use of an encumbrance system, is a device used by NFPOs and governments to control spending.
• NFPOs and local governments do not (and in the case of many local governments, are not allowed to) budget for a deficit in any one year unless they have a surplus from prior years. Because both types of organizations raise money each year and then spend it, any deficit spending in a particular year eventually must be offset by surplus spending in later years.
• If deficits are to be avoided, the managers of NFPOs must have timely information regarding actual results compared with amounts budgeted.
• Budget accounts are used as a control device, and the amounts are not reflected in an NFPO’s external financial statements.
• Encumbrance accounting involves the actual recording of purchase orders at the time of issuance. From a control standpoint, a budget item has been spent at this moment.
• Amounts for outstanding encumbrances are considered to be executory contracts and therefore are not recorded in an NFPO’s external financial statements.

The PSAB has exerted considerable effort on the establishment of a new financial reporting model covering federal, provincial, territorial, and local governments. The resultant standards exhibit significant differences from those required for businesses and NFPOs. Differences will always exist because the operations and user needs of governments, NFPOs, and business organizations are different. While separate standards previously existed for local governments, recent amendments have eliminated any differences so that no one set of standards applies to all government organizations.

Some key points to remember regarding GAAP for the public sector:

• Governments differ from business organizations in a number of ways.



• Some governments in Canada have failed to adopt new government accounting standards for a number of reasons (a list of reasons is provided in the textbook).



• Governments are required to present four financial statements: a consolidated statement of financial position, a consolidated statement of operations, a consolidated statement of change in net debt, and a consolidated cash flow statement.



• Statement of financial position — This statement presents financial assets and then deducts liabilities, with the resultant difference presented as “net debt.” Then non-financial assets are added or subtracted to arrive at a final line called “accumulated surplus/deficit.” Non-financial assets are tangible capital assets, inventories held for consumption or use, and prepaid expenses. Tangible capital assets are assets used by the government to provide services and include land, buildings, equipment, roads, and so on. They do not include intangible assets, natural resources, and Crown lands.



• Statement of operations — The operating statement must show revenues, expenses, and the year’s surplus or deficit. Comparative amounts for the previous year are required to be shown as well as the current year’s budget.



• Statement of Remeasurement Gains and Losses — This statement should report the remeasurement gains and losses during the period, distinguishing between amounts arising during the period and those reclassified to the statement of operations; any other comprehensive income that arises when a government includes the results of government business enterprises and government business partnerships in its summary financial statements; and the accumulated remeasurement gains and losses at the beginning and end of the period. The remeasurement gains and losses should be segregated between exchange gains and losses on items in the amortized cost category denominated in a foreign currency, and changes in the fair value of (i) derivatives, (ii) portfolio investments in equity instruments that are quoted in an active market, and (iii) financial instruments designated to the fair value category. The accumulated remeasurement gains are reported as a separate category in the accumulated surplus section of the statement of financial position.



• Statement of change in net debt — A statement showing the year’s changes in net debt is required in comparative form with both the budget and the previous year. This statement is designed to provide information about the extent to which expenditures for the year have been met by the year’s revenues. An increase in net debt indicates that revenues of future periods will have to be raised to pay for this year’s spending.



• Statement of cash flow — The cash flow statement shows operating, capital, investing, and financing transactions. Either the direct or the indirect method can be used to arrive at cash from operations, but the direct method is strongly encouraged because it provides details of cash receipts from a number of categories and therefore is much more informative than the indirect method. This statement is similar to the statement used by business organizations except that the latter would report capital asset acquisitions as an investing activity, while this one reports such acquisitions as a separate category.

PS 1300: The Financial Reporting Entity, requires the consolidation of the financial statements of all organizations controlled by the government. Controlled business organizations (called government business enterprises) are not consolidated but rather are reported using the modified equity method. The modified equity method is exactly the same as the equity method described in Chapter 2 except that the business enterprise’s accounting principles are not adjusted to conform to the accounting principles used by the government.