In this video, we walk through 6 FAR practice questions teaching about preparing the statement of financial position. These questions are from FAR content area 1 on the AICPA CPA exam blueprints: Financial Reporting.
The best way to use this video is to pause each time we get to a new question in the video, and then make your own attempt at the question before watching us go through it.
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Preparing the Statement of Financial Position
Introduction
The statement of financial position is a financial document for nongovernmental, not-for-profit entities. It provides a snapshot of the organization’s financial standing at a specific point in time, detailing its assets, liabilities, and net assets. Preparing this statement involves classification of these elements to ensure transparency and accountability, particularly in how donor funds are managed and reported.
Classifying Net Assets
One of the most critical aspects of preparing a statement of financial position is the classification of net assets. For a not-for-profit entity, net assets are divided into two main categories:
- Net Assets Without Donor Restrictions: These are funds that the organization can use at its discretion to support its mission. They include general donations, revenues from services, and other unrestricted resources. For example, if a donor gives $50,000 to support the organization’s general operational expenses, this amount would be classified as net assets without donor restrictions.
- Net Assets With Donor Restrictions: These are funds that come with specific donor-imposed restrictions on their use. They can be time-restricted, purpose-restricted, or even permanently restricted, such as in the case of endowments. For instance, if a donor provides $200,000 for the construction of a new health clinic, this amount would be classified as net assets with donor restrictions until the funds are spent on the clinic’s construction.
Reclassification of Net Assets
When the conditions or restrictions on donor-restricted net assets are met, those funds must be reclassified to net assets without donor restrictions. This process ensures that the financial statements accurately reflect the organization’s available resources.
Example: A not-for-profit entity receives a $300,000 donation restricted for the renovation of a community library. During the fiscal year, $200,000 is spent on the renovation. In the statement of financial position, this $200,000 would be reclassified from net assets with donor restrictions to net assets without donor restrictions, while the remaining $100,000 would stay in the restricted category until it is used.
Conditional Promises to Give
Conditional promises to give are pledges that depend on certain conditions being met before the donation becomes binding. These are not recognized as revenue or liabilities on the statement of financial position until the conditions are satisfied.
Example: Suppose a donor pledges $750,000 for a new arts center, conditional on the organization raising an additional $250,000 in matching funds within 12 months. If the matching funds have not been raised by the end of the fiscal year, the $750,000 pledge would not be recorded on the statement of financial position. It may, however, be disclosed in the notes to the financial statements.
Permanent Endowments
Permanent endowments are a specific type of donation where the principal amount is to be maintained in perpetuity, with only the investment income available for use. These funds are always classified as net assets with donor restrictions.
Example: A donor provides $500,000 to establish a permanent endowment for scholarships. The principal cannot be spent, but the income generated from the investment can be used to support the scholarships. The $500,000 would be reported as net assets with donor restrictions, reflecting the permanent nature of the restriction.
Unconditional Promises and Restrictions
Unconditional promises to give, such as pledges to contribute funds over several years, are usually classified as net assets with donor restrictions until the funds are received. This classification reflects the fact that these resources are not yet available for immediate use.
Example: If a donor promises $100,000 over the next two years to support the organization’s primary mission, this amount would be recorded as net assets with donor restrictions until the funds are collected.
Consistent Use of Restricted Funds
In some cases, contributions that are restricted by donors but consistently used within the same reporting period for their intended purpose can be classified as net assets without donor restrictions. This approach is permissible if the organization consistently applies this policy.
Example: A not-for-profit entity receives an annual $75,000 donation restricted for a fundraising event that occurs every year. If the event consistently uses up the funds within the same period they are received, and this is an established practice, the organization may classify these funds as net assets without donor restrictions.
Conclusion
Preparing a statement of financial position for a nongovernmental, not-for-profit entity requires careful attention to the classification of net assets, the treatment of conditional promises, and the handling of endowments. By following these principles, not-for-profit organizations can ensure their financial statements accurately reflect their financial health and the stewardship of donor funds. This transparency is crucial for maintaining the trust of donors, stakeholders, and the public, ensuring the organization can continue to fulfill its mission effectively.
