Improving disclosure and transparency in nonprofit accounting.

Publication: Management Accounting Quarterly

Publication Date: 22-MAR-03

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COPYRIGHT 2003 Institute of Management Accountants

DISAGGREGATED FUNDS-BASED REPORTING IS AN ESSENTIAL SUPPLEMENT TO THE FINANCIAL STATEMENTS OF NONPROFIT ORGANIZATIONS. A HYPOTHETICAL CASE ANALYSIS ILLUSTRATES IMPROVEMENTS TO NONPROFITS' FINANCIAL DISCLOSURES.

EXECUTIVE SUMMARY: Nonprofit organizations should be required to include supplemental financial statements that would improve disclosure and transparency. Traditional disaggregated funds balance sheets and statements of changes in fund balances should be included as a supplement in financial reporting. More descriptive terminology should be used in the equity section of the FASB-format balance sheet. The term "transfers" should be used to describe flows between funds in the FASB-format statement of activities. The direct rather than indirect method should be used for the statement of cash flows. A comprehensive, hypothetical illustration of a nonprofit hospital's financial reporting and disclosure is offered in support of the proposed changes.

Nonprofit accounting is typically part of advanced accounting in a three-part curriculum consisting of principles, intermediate, and advanced. It is a difficult subject for students to master. Financial Accounting Standards Board (FASB) accounting pronouncements force nonprofit entities to adopt the accounting model of profit enterprises. While this makes it easier for students to learn nonprofit accounting, I question how well this approach meets the needs of users of nonprofit accounting reports.

Accountants are widely debating the merits of the FASB rules on nonprofit accounting, stating their case in articles in accounting journals and in conferences about nonprofit accounting. The text I use for my course at Tel-Aviv University on nonprofit accounting states:

FASB Statement [of Financial Accounting Standards] No. 117 ["Financial Statements of Not-for-Profit Organizations"] requires [nonprofit organizations] to present financial statements showing an aggregate view of the entity. This revolutionary approach effectively moved not-for-profit financial reporting away from the disaggregated, traditional method of fund-based reporting and more toward the commercial for-profit model of financial reporting. Not all users welcomed this change and the impacts of this controversial change will take several years to be assessed. (1)

Robert N. Anthony, professor emeritus at Harvard University and the most prominent critic of FASB pronouncements regarding nonprofit accounting, writes:

In June 1993, 15 years after it accepted responsibility for nonprofit accounting, the Financial Accounting Standards Board (FASB) issued its major standards for financial accounting in nonprofit organizations. In this article, I argue that these standards are incredibly poor, and, if implemented, nonprofit accounting will take a giant step backwards... A major difference between nonprofit organizations and business enterprises is the source of their equity capital. Business enterprises obtain equity capital from shareholders, whereas nonprofit organizations obtain equity capital from contributors in the form of endowment, buildings, works of art, and similar long-lived assets. This difference means that business organizations have transactions not found in nonprofit organizations and vice versa. For example, businesses pay dividends and nonprofit organizations do not. (2)

Anthony is sharply critical of SFAS No. 117. He writes, for example:

SFAS No. 117 challenges the accountant to find a sensible way of preparing an operating statement for nonprofit organizations that have contributed endowment, plant, or museum objects. The statement mixes operating transactions with nonoperating transactions and leads to what many believe to be a useless bottom line. Many nonprofit organizations and their accountants feel the disclosure requirements of SFAS No. 117, "Financial Statements of Not-for-Profit Organizations," may distort the results of their operations. However, the...

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