The Objective of Financial Statements
Members, contributors and creditors of non-profit organizations are often segregated from management, and need information that will assist them in making funding and other decisions. Financial statements provide information that assists such parties in understanding how management has discharged its responsibilities, and financial statements provide information about the assets that are available to meet future obligations or to provide services.
The Statements and Notes that make up Financial Statements
Financial statements of non-profit organizations normally include a statement of financial position, a statement of operations, a statement of changes in net assets, and a statement of cash flows.
Where a statement of cash flows would not provide additional useful information, this statement can be dropped. Such a case would exist where the organization has few investing and financing activities, and where the cash flows bear close resemblance to the transactions on the statement of operations.
The statement of changes in net assets may sometimes be combined with the statement of operations.
The names assigned to the statements may be altered. For example the statement of financial position may be called the "balance sheet", and the statement of operations may be called the "statement of revenues and expenses."
The notes are an integral part of the financial statements, and provide a mechanism for disclosing information that cannot be practicably presented in the statements themselves. However, presenting information in the notes cannot be used as a means to forego proper accounting.
The Elements of Financial Statements
The basic elements of a set of financial statements are the assets, liabilities, net assets, revenues, expenses, and gains/losses. The following defines and explains the characteristics of each:
- An asset embodies a future benefit, the direct or indirect ability to provide services. To be considered an asset of the reporting organization, the reporting organization must be able to control access to the benefit of the asset, and the transaction or event giving the organization a right to the benefit must have already occurred.
- A liability embodies a responsibility to transfer assets or services at some determinable (or reasonably estimated) date. The transaction or event obligating the entity has occurred and the entity has little or no discretion, either morally or otherwise, to avoid the obligation.
- The net assets of an entity are its residual interest in assets after deducting liabilities. This residual interest may be further defined according to any restrictions in the use of net assets.
- Revenues and expenses are increases or decreases in economic resources resulting from the ordinary activities of an entity. Gains and losses are increases or decreases in economic resources that result from peripheral events, an example being the gain or loss on the sale of facilities.
Materiality and the Presentation of Events, Transactions and Balances
An essential goal in reporting is "fair presentation" of the financial position, results of operations and cash flows. (1401.03) The entity must comply with GAAP, and must provide sufficient understandable information so that the reader can understand without undue effort. Financial statements should be cross-referenced to the supporting notes and schedules. (1401.10)
Two limitations to the presentation of information are the cost of providing the information and the significance or materiality of information. The cost of providing information should not exceed the benefit of providing such information. For this reason, non-profit organizations, particularly, are given significant latitude in the accounting required of them. Generally accepted accounting principles do not have to be followed for immaterial items.
An item or transaction is considered material if its omission would influence the user of the statements. Materiality is both a quantitative and a qualitative consideration. Typically, an auditor of financial statements will express materiality in quantifiable terms, for example as a percentage of expenses. However, there are also qualitative reasons to consider items material: a fraudulent transaction or a transaction with a related party may not be significant in dollar terms but may be significant to the reader of the financial statements. The concept of materiality also comes into play in the presentation of financial statement items. Similar items of insignificant amount may be grouped together.
Management must assess whether the enitity can continue as a "going concern" (ie it won’t wind up in the near future). If the entity is still a going concern, the accounting should be prepared on that basis, in other words, assets should not be devalued and so on. If management has significant doubts about the ability to continue as a going concern, the reasons shouild be disclosed, and if appropriate the financial statements would not be prepared on a going concern basis, and this would be disclosed. (1401.07,.18,.19).
Prior period figures corresponding to the current year’s presentation should be presented except where they are not meaningful. (1401.13)
Describing Purpose, Community of Service, Income Tax Status, and Legal Form
The reporting entity is required to describe its purpose, community of service, status under the Income Tax Act, and legal form. (4400.04) Normally, this is done in the first note to the financial statements. The description should be concise as in this example:
Condominium A is a condominium corporation registered under the Condominium Property Act of Alberta. Its function is to regulate the use of the property, and to provide repairs, maintenance and other services to the common areas of the condominium project, located in Edmonton, Alberta. The corporation is a non-profit corporation under the Income Tax Act, and is therefore exempt from income taxes.
Disclosing Accounting Policies
The organization must disclose that it is following generally accepted accounting principles for not-for-profit organizations. (1401.17)
Where the organization has a choice of acceptable accounting policies, or where the policy followed is peculiar to certain organizations, the policy should be described in a concise fashion. (1505.03,.06). Preferably, a description of accounting policies would be made in the second note to the financial statements, or in a separate summary.
Changing Accounting Policies
Bearing in mind that two desirable characteristics of financial reporting are consistency and comparability, an organization may change its accounting policies if it feels the change will result in better presentation, or if the change is recommended by the CICA, or required by statute, an explanation of the change and the effect on current and prior periods would be disclosed in the notes (1506.06,.08,.09,.34,.35)
In effecting a change in policy, the organization would restate the results for prior periods as if the policy had been followed from the beginning. There would have to be disclosure of the fact that prior period numbers have been restated, and the change would be described along with the effect on the current and prior periods. In those cases where it is not possible to specify the effect on individual prior periods, the change would be accounted for as a cumulative adjustment to the opening retained earnings, and the amount of the adjustment would be disclosed along with a statement that prior period results have not been restated. Where it is not possible to determine any prior impact, the change would be applied in the current and future periods only, and this treatment would be disclosed. If the effects on prior periods are known, prospective treatment must be expressly permitted by the CICA. (1506.10,.13-.16)
As mentioned earlier, the disclosure of a change in policy is not required for immaterial items. However, in this consideration, it is expressly forbidden to net changes when considering materiality. Also, where the future effects of a change may be material, the change must be disclosed.
Unlike a change in policy, a change in estimate is to be treated prospectively. The nature of the change and effect on the current period would be disclosed. (1506.23, .24,.36) A change in the method of depreciation, for example, would be treated as a change in estimate if the new method of depreciation resulted in a better estimate of the service being provided by the asset.
The Correction of Prior Period Errors
Where a material error in the prior year statements is discovered, the results of the prior period should be restated. Disclosure should be made of the fact that the prior year figures have been restated, and the error giving rise to the restatement would be described along with the effect of the restatement on the current and prior periods. (1506.27,.37)
Restating Prior Year Figures
The excess of revenues over expenses of prior periods may only be adjusted where there is an error, or a change in accounting policy. However, prior period classifications between categories of expenses, assets, and so on should be restated to conform to changes in the current year’s presentation.
First Time Adoption
When an organization adopts NPO standards, it must apply those standards to each year presented, and any effect of prior period restatement would be reflect in net assets, and the amount of the adjustment would be disclosed with a reconciliation to the net assets previously presented. (1501.05,.07,.32.33) Previous estimates would only be revised if they were in error. The estimates of the prior period would continue to reflect the conditions at that date, in other words, they would not be adjusted for changes in exchange rates, or market values, or fires after that date. (1501.28,.29,.30) If certain exemptions under GAAP were applied retroactively this would be disclosed. (1501.08,.34)