Not-for-Profit Accounting: Net Assets, Contributions, and Financial Statements

How NFP Accounting Differs From Commercial GAAP

Both commercial entities and NFPs follow US GAAP — but the specific standards applicable to NFPs are found in ASC 958 (Not-for-Profit Entities) rather than the commercial entity standards. The most fundamental differences: NFPs have no owners or shareholders, so there is no equity section. Instead, net assets represent the residual interest. There are no dividends, no earnings per share, and no retained earnings. Revenue includes contributions — gifts of resources — which have no commercial equivalent. And the classification and reporting of expenses is governed by functional categories rather than nature alone.

Net Assets: The NFP Equity Equivalent

Under ASC 958 (updated by ASU 2016-14), net assets are classified into two categories based on donor-imposed restrictions:

Net assets without donor restrictions — Resources the NFP can use for any purpose at management's discretion. Operating surpluses and deficits flow here. Board designations (where the board sets aside funds internally) are a subset of net assets without donor restrictions — they are not a separate restricted category because the board can undesignate them.

Net assets with donor restrictions — Resources that donors have restricted to specific purposes (purpose restrictions) or specific time periods (time restrictions). Permanently restricted endowments — where the principal must be kept intact forever — are also within this category. When a restriction is met (the purpose is fulfilled or the time period arrives), net assets are released from restriction and reclassified to without donor restrictions.

Recognising Contribution Revenue

Contributions — unconditional gifts of cash, property, or services — are recognised as revenue when received (for unconditional contributions) regardless of when the cash will be used. This differs from the commercial exchange transaction model where revenue is recognised when performance obligations are satisfied.

A conditional contribution has a barrier the recipient must overcome before the contribution is theirs (e.g., "we will donate $50,000 if you raise $100,000 from other sources"). Conditional contributions are not recognised until the condition is substantially met — they are recorded as a liability (refundable advance) until then.

Contributions of services are recognised if the services create or enhance a nonfinancial asset, or if the services require specialised skills that the NFP would typically purchase. Volunteer labour that does not meet these criteria is not recorded.

Donor Restrictions: With and Without

When a restricted contribution is received, it is recorded as revenue in the with-donor-restrictions category. The cash (or other asset) is available immediately, but it must be spent for the restricted purpose. Tracking this properly requires a system that links restricted gifts to permitted uses and monitors whether restrictions have been satisfied.

Many exam questions test whether a contribution is restricted or unrestricted. Key rule: restrictions come from donors — not from the board. A board-designated reserve fund is unrestricted (with donor restrictions: No), even if the board intends to hold it for a specific purpose, because the board can change its mind. Only the original donor can impose donor restrictions. This distinction is heavily tested on the FAR section of the CPA exam. See the FAR exam strategy guide for how to handle this topic area efficiently.

The NFP Financial Statements

ASC 958 requires three financial statements for NFPs:

Statement of Financial Position — The NFP equivalent of a balance sheet. Assets and liabilities are the same as commercial entities, but the equity section is replaced by net assets (with and without donor restrictions). Total assets must equal total liabilities plus total net assets.

Statement of Activities — The NFP equivalent of the income statement. Revenues, gains, and other support are presented in columns (or sections) for with and without donor restrictions. Expenses always reduce net assets without donor restrictions — even when funded by restricted gifts — because expenses are incurred after restrictions are released. The bottom line is the change in net assets, not net income.

Statement of Cash Flows — Follows the same indirect or direct method framework as commercial entities, with one NFP-specific rule: restricted cash gifts received for long-term purposes are classified as financing activities, not operating activities.

NFPs are also encouraged (but not required) to present a statement of functional expenses, which displays expenses in a matrix format showing both functional classification (program services vs management & general vs fundraising) and natural classification (salaries, rent, depreciation, etc.). Voluntary health and welfare organisations are required to present this statement.

Expense Classification in NFPs

All NFP expenses must be reported by functional classification:

• Program services — Expenses that directly accomplish the NFP's mission (e.g., for a food bank: food distribution, nutrition education)
• Management and general — Oversight, business management, financial reporting, legal, HR
• Fundraising — Expenses of soliciting contributions (gala events, direct mail, donor cultivation)

When one cost serves multiple functions — for example, a salary that is split between program delivery and administrative management — it must be allocated across the functions. ASU 2016-14 requires disclosure of the method used for cost allocations, which has increased scrutiny of how NFPs categorise expenses between program and overhead.

Donors and rating agencies like Charity Navigator pay close attention to the ratio of program expenses to total expenses. An NFP that spends 80%+ on program services is generally viewed favourably; one that shows 50% in management and fundraising raises concerns about efficiency.

CPA Exam Focus

NFP accounting typically represents 5–10% of the FAR section. The highest-frequency exam topics are: (1) classification of contributions as with or without donor restrictions — especially board designations; (2) conditional vs unconditional contributions; (3) the statement of activities format and how restricted gifts and releases are presented; (4) recognition of contributed services; and (5) permanently restricted endowments and the total return policy for investment income.