Not-for-Profit Accounting
Not-for-profit (NFP) accounting is a high-frequency FAR topic that tests your ability to distinguish NFP financial statements from commercial ones, classify net assets, recognize contributions, and handle specialized revenue streams. NFP entities — hospitals, universities, museums, charitable organizations — follow GAAP under FASB ASC guidance and use the full accrual basis of accounting.
Financial Statements Overview
NFPs prepare three required financial statements (compared to four for commercial entities):
| NFP Statement | Commercial Equivalent |
|---|---|
| Statement of Financial Position | Balance Sheet |
| Statement of Activities | Income Statement |
| Statement of Cash Flows | Statement of Cash Flows |
:::tip Exam rule
NFPs do not prepare a statement of stockholders' equity. They have no owners — net assets replace equity.
::: There is no separate "Statement of Functional Expenses" requirement for all NFPs, but voluntary health and welfare organizations (VHWOs) must present expenses by both functional and natural classification. Other NFPs may present this information on the face of the statement of activities, in the notes, or as a separate schedule.
Functional vs. Natural Classification
| Classification Type | Examples |
|---|---|
| Functional (what the money was spent on) | Program services, management and general, fundraising |
| Natural (what type of cost) | Salaries, rent, depreciation, supplies |
Statement of Financial Position
The statement of financial position reports assets, liabilities, and net assets. Net assets are divided into two categories:
Net Assets Without Donor Restrictions
These are resources with no donor-imposed restrictions. The governing board may internally earmark funds (called board-designated or quasi-endowment funds), but these are still classified as without donor restrictions because the board can reverse the designation at any time.
Board-designated funds are not donor-restricted. They remain in the "without donor restrictions" class, though they may be disclosed separately.
Net Assets With Donor Restrictions
These are resources subject to donor-imposed stipulations that are either:
- Time or purpose restrictions — the donor specifies when or how the funds may be used (e.g., "use for scholarships in 2026").
- Perpetual restrictions — the donor requires that the principal be maintained indefinitely (endowments). Only the investment return may be spent, subject to any additional restrictions.
Reclassification of Net Assets
When a donor restriction is satisfied (by passage of time or by fulfilling the stated purpose), the NFP reclassifies the amount:
This entry appears on the statement of activities as "Net assets released from restrictions."
If a contribution is received and the restriction is satisfied in the same reporting period, the NFP may report it as without donor restrictions (an accounting policy election that must be disclosed).
Statement of Activities
The statement of activities reports the change in each class of net assets and the change in total net assets. It is organized around revenues, expenses, gains, and losses.
| Line Item | Description |
|---|---|
| Change in net assets without donor restrictions | Unrestricted revenues and gains minus expenses |
| Change in net assets with donor restrictions | Restricted contributions, investment returns, less reclassifications out |
| Change in total net assets | Sum of both classes |
Program Services vs. Support Services
Expenses are reported by function:
| Category | Examples |
|---|---|
| Program services | Direct mission activities — education, patient care, research |
| Support services — Management & general | Accounting, HR, executive office |
| Support services — Fundraising | Donor solicitation, special events, grant writing |
Combined Costs Allocation
When a single activity serves both program and support functions (e.g., a direct-mail campaign that educates the public and solicits donations), the cost must be allocated. The allocation is acceptable only if the criteria of purpose, audience, and content are all met.
- Illini Community Foundation
- Bear Valley Hospital
Illini Community Foundation mails 100,000 brochures about childhood literacy (program purpose) that also include a donation envelope (fundraising purpose). Total cost is $200,000. The foundation determines that 60% relates to the educational content and 40% to fundraising.
| Function | Allocation |
|---|---|
| Program — Education | $120,000 |
| Fundraising | $80,000 |
Bear Valley Hospital sends a health-awareness mailer that also asks for annual fund contributions. Total cost is $75,000, allocated 70% program / 30% fundraising.
| Function | Allocation |
|---|---|
| Program — Community health | $52,500 |
| Fundraising | $22,500 |
Statement of Cash Flows
NFPs follow the same ASC 230 rules as commercial entities. Cash flows are classified as operating, investing, or financing.
| Activity | Examples |
|---|---|
| Operating | Cash received from service recipients, contributions used for operations, interest and dividends received |
| Investing | Purchase/sale of investments, purchase of equipment |
| Financing | Proceeds from borrowing, donor-restricted contributions for long-term purposes |
:::tip Exam rule
Contributions that donors restrict for the acquisition of long-lived assets are classified as financing activities, not operating. However, board-designated contributions for construction with no donor restriction remain operating activities.
::: Example: Gies University receives a $500,000 unrestricted donation. The board votes to set it aside for a new library wing. On the statement of cash flows, the $500,000 is an operating cash inflow because the restriction is internal, not donor-imposed.
Revenue Recognition for NFPs
NFP revenue falls into two broad buckets: exchange transactions and contributions.
Exchange Transactions
An exchange transaction is one in which each party receives and gives up approximately equal value (e.g., tuition, patient fees, membership dues with substantial benefits). These follow the same revenue recognition rules as commercial entities — revenue is recognized when it is realized or realizable and earned.
Exchange revenue is generally classified as without donor restrictions.
Contributions — General Rules
A contribution is a voluntary, unconditional, nonreciprocal transfer in which a resource provider does not receive equal value in return. Key rules:
| Concept | Rule |
|---|---|
| Unconditional promise (pledge) | Recognize as revenue when the pledge is made, net of estimated uncollectible amounts |
| Conditional promise | Do not recognize until the condition is substantially met |
| Cash contributions | Recognize at amount received |
| Noncash contributions | Recognize at fair value on the date of the gift |
:::info Conditional vs. Unconditional
A condition requires both a barrier (something the recipient must do or that must occur) and a right of return or right of release if the barrier is not met. A mere restriction on how to use the funds is not a condition.
:::
Unconditional Promises to Give (Pledges)
When a donor makes an unconditional pledge, the NFP records a receivable and revenue immediately.
Example: On November 15, a donor pledges $100,000 to Illini Community Foundation, payable in full on March 1 of the following year. The foundation estimates 3% will be uncollectible.
Long-term pledges are recorded at the present value of estimated future cash flows.
Conditional Promises
A conditional promise is not recognized as revenue or a receivable until the condition is substantially met.
Example: BIF Partners pledges $200,000 to Bear Valley Hospital on the condition that the hospital raises $500,000 in matching funds by December 31. Until the hospital reaches the $500,000 threshold, no revenue or receivable is recorded. Once the condition is met:
Donated Services
Donated services are recognized as both a revenue and an expense only if either of these criteria is met:
- The services create or enhance a nonfinancial asset (e.g., a contractor builds a wall for a charity), or
- All three of the following are true: the services require specialized skills, the person providing them possesses those skills, and the services would typically need to be purchased if not donated (e.g., an attorney donates legal work).
Volunteer time at a soup kitchen or gift shop generally does not meet recognition criteria because the services are not specialized and do not enhance a nonfinancial asset.
- Recognized
- Not Recognized
A licensed CPA donates 40 hours of audit services to Gies University. The CPA's normal billing rate is $250/hour.
Fifteen volunteers donate 200 total hours sorting donations at the Illini Community Foundation warehouse. Although valuable, the services do not require specialized skills and do not enhance a nonfinancial asset. No journal entry is recorded.
Donated Collection Items
Works of art, historical treasures, and similar items need not be capitalized if all three conditions are met:
- The items are held for public exhibition, education, or research.
- The items are protected, kept unencumbered, cared for, and preserved.
- Proceeds from any sale of items are used to acquire other collection items.
If the NFP elects not to capitalize, neither an asset nor revenue is recorded. The policy must be applied consistently and disclosed.
Donated Materials and Supplies
Donated materials that are significant are recognized at fair value as both an asset (or expense, if used immediately) and contribution revenue.
Donor-Imposed Restrictions
Contributions with donor restrictions are recognized as revenue with donor restrictions in the period received or pledged — not deferred until the restriction is met.
When the restriction is later satisfied, a reclassification moves the amount to "without donor restrictions."
Fundraising Activities
When an NFP runs a fundraising campaign that provides donors with a premium (e.g., a tote bag, dinner, or concert ticket):
| Component | Treatment |
|---|---|
| Cost of the premium | Fundraising expense |
| Difference between donation and FV of premium | Contribution revenue |
| FV of the premium received by donor | Exchange revenue |
Example: MAS Inc. (an NFP) holds a gala dinner. Tickets cost $500 each. The fair value of the dinner is $120. For each ticket sold:
- Contribution revenue = $500 − $120 = $380
- Exchange revenue = $120
The cost of the dinner (say $80 per plate) is recorded as fundraising expense:
NFP Educational Institutions
Tuition revenue at NFP colleges and universities is displayed at gross, with scholarships treated as either:
- A contra-revenue (allowance) reducing gross tuition, or
- An expense if the student performs a service (e.g., a teaching assistantship).
Example: Gies University bills $10,000,000 in tuition. It awards $1,500,000 in merit-based scholarships (no service required) and $400,000 in assistantship stipends (service required).
| Item | Amount |
|---|---|
| Gross tuition revenue | $10,000,000 |
| Less: scholarship allowance | ($1,500,000) |
| Net tuition revenue | $8,500,000 |
| Assistantship expense | $400,000 |
NFP Health Care Organizations
NFP health care entities (hospitals, clinics) have specialized revenue presentation rules:
| Item | Treatment |
|---|---|
| Patient service revenue | Reported at gross charges, then shown net of contractual adjustments and discounts on one line |
| Charity care | Not recorded as revenue at all — disclosed in the notes only |
| Bad debts | Reported as an operating expense or as a deduction from revenue, depending on whether the patient was assessed for ability to pay |
| Other operating revenue | Cafeteria, parking, gift shop |
| Nonoperating revenue | Unrestricted gifts, investment income, gains on sale of assets |
:::tip Exam rule
Charity care is never recognized as revenue. The NFP discloses the level of charity care provided (measured at cost or at charges foregone) in the notes to the financial statements.
::: Example: Bear Valley Hospital provides services with gross charges of $5,000,000. Contractual adjustments total $1,200,000. Charity care at standard rates would have been $300,000. Bad debts are estimated at $150,000.
| Line | Amount |
|---|---|
| Patient service revenue (gross) | $5,000,000 |
| Less: contractual adjustments | ($1,200,000) |
| Net patient service revenue | $3,800,000 |
| Provision for bad debts | ($150,000) |
| Net patient revenue after bad debts | $3,650,000 |
The $300,000 of charity care is excluded from revenue and disclosed in the notes.
Transfers of Assets to Other Entities
When a donor makes a contribution through an intermediary (such as a community foundation), the accounting depends on two key factors:
Key Definitions
| Term | Meaning |
|---|---|
| Variance power | The recipient can redirect the assets to a beneficiary other than the one specified by the donor |
| Financially interrelated | The recipient and beneficiary have (1) the ability of one to influence the operating and financial decisions of the other, and (2) an ongoing economic interest in the other's net assets |
| Specified beneficiary | The entity the donor intends to ultimately receive the assets |
Recipient Entity Accounting
- With Variance Power
- Financially Interrelated
- Neither
Kingfisher Industries donates $300,000 to Illini Community Foundation, specifying Bear Valley Hospital as the beneficiary. The foundation has variance power and may redirect the funds.
The foundation records contribution revenue:
Kingfisher Industries donates $300,000 to Illini Community Foundation for Bear Valley Hospital. The foundation has no variance power but is financially interrelated with the hospital.
The foundation records contribution revenue:
Kingfisher Industries donates $300,000 to Illini Community Foundation for Bear Valley Hospital. The foundation has no variance power and is not financially interrelated with the hospital.
The foundation records a liability, not revenue:
Specified Beneficiary Accounting
The specified beneficiary (e.g., Bear Valley Hospital) recognizes a right to the assets (a receivable and contribution revenue) unless the recipient entity has been granted variance power.
Financial Instruments and Investments
NFPs report debt and equity investments at fair value on the statement of financial position (with limited exceptions for certain equity method or consolidation situations).
Gains and Losses
| Type | Reporting |
|---|---|
| Realized gains/losses | Statement of activities |
| Unrealized gains/losses | Statement of activities |
| Default classification | Without donor restrictions, unless the donor or law restricts investment returns |
Both realized and unrealized gains and losses flow through the statement of activities — there is no OCI concept for NFPs.
Investment Return Reporting
Investment returns (interest, dividends, realized and unrealized gains/losses) are reported net of external and direct internal investment expenses.
Underwater Endowments
An endowment is underwater when its current fair value falls below the original gift amount (the historic dollar value).
Example: A donor gave $1,000,000 to Illini Community Foundation as a permanent endowment. Due to market declines, the endowment's fair value drops to $920,000 — an unrealized loss of $80,000.
The $80,000 loss is reported in net assets with donor restrictions (staying with the endowment). The endowment continues to be classified as net assets with donor restrictions even though it is underwater.
Underwater endowments require specific disclosures: the fair value of underwater funds, the original gift amounts, and the aggregate amount by which they are underwater. The governing board's policy on spending from underwater endowments must also be disclosed.
Comprehensive Example
Illini Community Foundation reports the following activity for the year ended December 31:
| Transaction | Amount | Classification |
|---|---|---|
| Unrestricted contributions received | $800,000 | Without donor restrictions |
| Donor-restricted contribution for scholarships | $200,000 | With donor restrictions |
| Scholarships awarded (satisfying restriction) | $120,000 | Reclassification |
| Unrestricted investment return, net of fees | $45,000 | Without donor restrictions |
| Unrealized loss on endowment (underwater) | $30,000 | With donor restrictions |
| Program services expense | $600,000 | Without donor restrictions |
| Management and general expense | $110,000 | Without donor restrictions |
| Fundraising expense | $55,000 | Without donor restrictions |
Statement of Activities (simplified):
| Without Donor Restrictions | With Donor Restrictions | Total | |
|---|---|---|---|
| Contributions | $800,000 | $200,000 | $1,000,000 |
| Investment return | 45,000 | (30,000) | 15,000 |
| Net assets released from restrictions | 120,000 | (120,000) | — |
| Total revenues and gains | 965,000 | 50,000 | 1,015,000 |
| Program services | (600,000) | — | (600,000) |
| Management and general | (110,000) | — | (110,000) |
| Fundraising | (55,000) | — | (55,000) |
| Change in net assets | $200,000 | $50,000 | $250,000 |
:::note Key takeaway
Expenses are always reported in the "without donor restrictions" column. When restricted funds are spent, the reclassification entry moves the amount into "without donor restrictions" first.
:::
Summary of Key Exam Points
- NFPs use two net asset classes: without donor restrictions and with donor restrictions.
- Board-designated funds remain without donor restrictions.
- Unconditional pledges are recognized as revenue when pledged; conditional pledges wait until the condition is met.
- Donated services require specialized skills or must enhance a nonfinancial asset to be recognized.
- Charity care is never recorded as revenue — notes disclosure only.
- Contributions with restrictions are recognized as revenue when received, not when spent.
- All investment gains/losses (realized and unrealized) go through the statement of activities.
- Underwater endowments remain in net assets with donor restrictions with required disclosures.
- Recipient entities record a liability when they lack both variance power and financial interrelation with the beneficiary.
- Donor-restricted contributions for long-lived asset purchases are financing activities on the cash flow statement.