The accounting profession has done a huge disservice to the nonprofit world.
One need look no further than the accounting rule that used to go by the name of FASB 116*. If you have ever tried to read and understand financial reports for a nonprofit organization that has received multi-year awards, you know what I mean.
FASB 116 forces accountants to ignore the longstanding “matching principle” in which revenue and related expenses are matched by showing them in the same time period. Instead, with FASB 116, if you receive a multi-year grant, pledge, or other award, and if the award meets certain accounting requirements, all of the revenue must be shown in the first year even though expenses related to that award continue to be incurred in subsequent years.
This creates the bizarre set of circumstances in which, during the first year of the multi-year award, the organization shows what appears to be a huge windfall in its budget and financial reports, while in subsequent years losses are shown from continuing expenses even though the organization received the funds to pay them!
For an example of how this all works, see my previous blog called, “The Single Biggest Problem With Nonprofit Accounting Rules.” (See https://ericyptc.com/2013/01/20/the-single-biggest-problem-with-nonprofit-accounting-rules/ )
For a real-life example of how this rule ensnared the Clinton Foundation, see my blog, “Bill Clinton Feels Your Pain.” (See https://ericyptc.com/2013/09/01/bill-clinton-feels-your-pain/ )
Without going too far into the accounting details, it is helpful to understand for comparison purposes how multi-year awards used to be treated prior to FASB 116.
Prior to 1993, when FASB 116 was passed (effective for fiscal years beginning after December 15, 1994), future years’ funds from multi-year awards were simply shown on the balance sheet as a liability. Each subsequent year the liability was reversed, thereby showing the revenue that should be matched against that year’s expenses.
This pre-FASB 116 treatment was easy to account for. It was easy to explain. It made it easy for nonprofit organizations to develop their budgets. It made it easy for readers of financial reports (e.g., board members, funders, management, etc.) to read and understand their numbers.
Because of this rule, accountants, like me, have spent the last 20 years explaining the consequences of this rule to our nonprofit clients and to the readers of their financial reports. Over the years we have had to develop a variety of workarounds to help our clients with this accounting fact of life when preparing their budgets and when presenting and explaining their financial reports.
The management teams and boards of nonprofits all across America treat this accounting rule with disdain, and derisively ridicule the accounting profession which foists rules like this upon them. Why, our clients want to know, must they show a deficit for programs in the second and subsequent years of an award when they were awarded the funds to cover the costs? Logically, it makes no sense either to the lay person or to the accounting professionals. How much time is wasted every year by organizations as they try to figure out how to portray and reflect these so-called “carry-over” funds, a phrase we hear often, in their budgets and financial reports? While there are various techniques we use with our clients to help them through this, most organizations view the accounting rules, and the profession that promulgates them, as something they are forced to put up with, something that hinders their ability to properly manage their organizations.
Organizations put up with this accounting rule because they have to. If a nonprofit is audited by a certified public accountant and wants to receive a “clean” unqualified audit opinion, the organization must follow this rule, among all other generally accepted accounting principles. As a result, accountants and their rules are often viewed as a necessary evil. (I exempt my firm, Your Part-Time Controller, from this since our clients appreciate our advice about how to understand and deal with the problems created by this rule.)
The FASB states on its website that its mission is to:
“…establish and improve standards of financial accounting and reporting that foster financial reporting by nongovernmental entities that provides decision-useful information to investors and other users of financial reports.”
FASB 116’s required treatment of multi-year awards does not provide decision-useful information to anyone.
We, the accounting profession, have created this problem. Fortunately, there is a simple solution.
FASB, repeal this provision of FASB 116.
Eric Fraint, President and Founder
Your Part-Time Controller, LLC
The NONPROFIT accounting specialists
Washington, DC – New York, NY – Philadelphia, PA
*As of 2009, the FASB’s (Financial Accounting Standards Board, a group of people based in Norwalk, CT) numbering system was replaced by the ASC (Accounting Standards Codification) numbering system. Those of us who have been working in the accounting field for long still refer to the subject of this blog as FASB 116. Also note that FASB 116 deals with a variety of topics related to nonprofit accounting. This blog is concerned with just one aspect of this rule, that which deals with the treatment of multi-year awards.