Key Takeaways
- Nonprofit financial reporting is primarily governed by FASB ASC 958, which establishes a distinct set of financial statement requirements that differ materially from for-profit GAAP in structure, terminology, and presentation.
- The two net asset classes under ASC 958 (without donor restrictions and with donor restrictions) drive the core presentation logic of every nonprofit financial statement. Misclassifying restricted funds or improperly releasing restrictions creates both a GAAP error and a potential compliance problem with the donor or grantor.
- Functional expense reporting, which requires nonprofits to allocate expenses across program services, management and general, and fundraising, is one of the most judgment-intensive areas of nonprofit financial reporting and one of the most scrutinized by funders, auditors, and watchdog organizations.
- Bottom line: Nonprofit financial statements are not simplified versions of for-profit statements. They reflect a fundamentally different accounting model, and organizations whose controllers are learning this model on the job inherit the errors that accompany that learning curve.
The assumption that nonprofit accounting is simpler than for-profit accounting gets organizations into trouble every year. The GAAP framework governing nonprofit financial statements is not a stripped-down version of the standard model. It is a specialized framework within GAAP with its own logic, terminology, and sector-specific areas of complexity. CFOs and controllers from commercial backgrounds who move into nonprofit finance often discover this for the first time when they prepare for an audit.
FASB ASC 958 is the authoritative standard for nonprofit financial reporting. Understanding what it requires and why the requirements exist is the foundation of competent nonprofit financial management.
The Core Financial Statements Required Under ASC 958
Nonprofit organizations subject to GAAP are required to present, at a minimum, three primary financial statements: the statement of financial position, the statement of activities, and the statement of cash flows. Voluntary health and welfare organizations are additionally required to present a statement of functional expenses; other nonprofits must present expense information by both natural and functional classification, either on the face of the financial statements or in the notes..
The statement of financial position is the nonprofit equivalent of a balance sheet. It presents assets, liabilities, and net assets, with net assets disaggregated into the two classes required under ASC 958.
The statement of activities is the equivalent of an income statement. It presents revenues, gains, expenses, and losses, and shows the change in each class of net assets during the period.
The statement of cash flows follows the same general structure as for-profit cash flow statements, classified into operating, investing, and financing activities. Nonprofits may use either the direct or indirect method of presentation, though the direct method is generally considered more informative.
Net Asset Classification: The Central Organizing Principle
The most fundamental structural difference between nonprofit and for-profit financial reporting is the net asset framework. Under ASC 958, net assets are classified into two categories based on the presence or absence of donor-imposed restrictions.
Net assets without donor restrictions include resources that are available for the organization’s general use at the discretion of the board. This category includes unrestricted operating funds as well as amounts designated by the board for specific purposes (sometimes called board-designated funds), though board-designated funds remain technically available for other uses at the board’s discretion.
Net assets with donor restrictions include resources subject to stipulations imposed by donors or grantors. These stipulations may be purpose restrictions (the funds must be used for a specified program or activity), time restrictions (the funds may not be used until a future period), or endowment restrictions (the gift corpus must be maintained in perpetuity, subject to donor intent and applicable law). Restricted funds remain in the “with donor restrictions” class until the restriction is satisfied, at which point they are reclassified to “without donor restrictions” through a net asset release.
Proper management of the restriction release process requires close coordination between the accounting function and program staff, because the timing of the release must correspond to when the underlying restriction has actually been met. Premature releases, or failures to release restrictions in a timely manner both constitute reporting errors.
Functional Expense Allocation
The functional expense requirement is the area of nonprofit financial reporting that demands the most judgment from the controller. All expenses must be presented by function: program services (broken down by individual program), management and general, and fundraising. They must also be reported by natural classification: salaries, rent, supplies, depreciation, and so on.
The intersection of these two dimensions yields the functional expense matrix required by ASC 958. Many expenses are directly attributable to a single function. Salaries of program staff, for example, are typically allocated to program services based on time. But many other expenses, particularly those related to shared services and facilities, must be allocated across multiple functions using a reasonable, consistently applied allocation methodology.
Compensation is typically the largest allocation challenge. When employees perform activities across multiple functions, their time must be tracked or reasonably estimated and allocated accordingly. Organizations that allocate all salary costs to program services without contemporaneous time documentation are likely overstating program expense ratios, a problem that surfaces in audits and creates reputational risk when funders analyze the Form 990.
The Grant Compliance Overlay
Grant reporting adds a layer of financial reporting obligation that exists alongside the GAAP statements. Many foundation and government grants require periodic financial reports showing expenditures against an approved budget, typically in formats specified by the funder rather than in GAAP statement format. These reports must reconcile to the general ledger, and the chart of accounts needs to be structured to support both GAAP reporting and grant-specific reporting without requiring manual reconciliation work at every reporting cycle.
Organizations managing multiple active grants benefit from systems that track activity by grant or funding source, alongside the standard general ledger, producing grant-specific reports without disrupting the integrity of the organization’s GAAP financial statements.
Liquidity and Availability Disclosures
ASC 958 includes a disclosure requirement added in 2018 that continues to catch some organizations unprepared: the liquidity and availability disclosure. This disclosure requires nonprofits to provide both qualitative and quantitative information about their available financial resources and how they manage liquidity to meet general expenditure needs within the next twelve months.
The quantitative portion of the disclosure typically presents total financial assets, less amounts not available within the next year (such as board-designated reserves, long-term receivables, and restricted funds), arriving at the amount of financial assets available to meet general expenditure needs. Organizations with tight operating liquidity or significant restricted balances find that this disclosure requires careful thought about how the numbers are presented and explained.
Wiss works with nonprofit CFOs and controllers on financial statement preparation, audit readiness, and grant compliance reporting. Organizations with questions about specific ASC 958 requirements, functional expense allocation methodology, or the structure of their grant reporting processes are welcome to contact the Wiss nonprofit advisory team.
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