Statement of Activities (Classification of Revenues, Expenses, Support)

4.3 Statement of Activities (Classification of Revenues, Expenses, Support)

The Statement of Activities is one of the key financial statements prepared by nongovernmental not-for-profit (NFP) entities under U.S. GAAP. This statement is central to conveying how a not-for-profit acquires resources (revenues, support) and expends those resources (expenses) for mission-oriented programs and other necessary functions. In this section, we delve deep into how revenues, support, and expenses are classified and presented, illuminating best practices and common pitfalls. You will also discover illustrative examples, diagrams, and references to authoritative guidance under FASB Accounting Standards Codification (ASC) 958.

Purposefully designed to meet the unique needs of not-for-profit organizations, the Statement of Activities demonstrates how the entity’s mission is funded and executed over a given reporting period. This is in contrast to for-profit statements, which emphasize profitability, retained earnings, and shareholder equity. Not-for-profits aim to maintain liquidity to further charitable, educational, or other philanthropic missions. Because of these unique objectives, special rules guide the classification of transactions in the Statement of Activities.

This section covers: • How to report and classify different revenue streams (contributions, grants, and program or service revenues).
• How support (contributions and other inflows of resources) is presented and distinguished from exchange transactions.
• How expenses should be displayed, including the requirement to show them by function (program vs. supporting services) and by nature.
• Best practices in note disclosures and presentation to ensure transparency.

Core Structure of the Statement of Activities

The fundamental framework of the Statement of Activities revolves around changes in net assets. For not-for-profit entities, net assets are categorized into two primary classes:
• Net Assets Without Donor Restrictions
• Net Assets With Donor Restrictions

Changes in these categories result from the inflow of resources (revenues or support) and outflow through expenses. The net change ultimately impacts the total net asset balance at the end of the period. This statement bears similarities to a for-profit income statement but incorporates unique considerations specific to donations, grants, and donor restrictions.

To paint a clearer picture, consider the schematic diagram using Mermaid.js below, illustrating the logical flow of how resources move into the not-for-profit entity and how they are presented:

    flowchart LR
	    A(Contributions, Grants, Other Support) --> B{Evaluate Donor Restrictions}
	    B -- With Restrictions --> D(Net Assets \n With Donor Restrictions)
	    B -- Without Restrictions --> C(Net Assets \n Without Donor Restrictions)
	    D --> E(Statement of Activities\nGains, Losses, Net Asset Releases)
	    C --> E
	    E --> F(Expenses)
	    F --> G(Change in Net Assets)
	
	    style A fill:#cfc, stroke:#090, stroke-width:2px
	    style B fill:#ccf, stroke:#06c, stroke-width:2px
	    style C fill:#ffc, stroke:#990, stroke-width:2px
	    style D fill:#ffc, stroke:#990, stroke-width:2px
	    style E fill:#cff, stroke:#099, stroke-width:2px
	    style F fill:#fcc, stroke:#c00, stroke-width:2px
	    style G fill:#ccc, stroke:#666, stroke-width:2px

In this diagram, note how all inflows (contributions, grants, other support) filter through an assessment process to determine whether they possess donor-imposed restrictions. If so, they first increase “Net Assets With Donor Restrictions”. Over time, as the purpose or time restriction is met, the resources are reclassified (or released) to “Net Assets Without Donor Restrictions,” disclosed in the statement as “net assets released from restrictions.” Eventually, the resources are used for expenses that meet the organization’s mission. This cyclical flow continues each reporting period.

Classification of Revenues and Other Support

Not-for-profit entities may receive funding from various sources. Understanding how to classify and present these funds is essential for providing an accurate depiction of financial performance. The key classifications typically include:

• Contributions (including pledges)
• Grants and Contracts
• Program or Service Revenues (Exchange Transactions)
• Other Income (e.g., investment income, special events proceeds)

Let’s break down each category in detail.

Contributions

A contribution is defined as an unconditional transfer of cash or other assets (or a settlement or cancellation of liabilities) to a not-for-profit entity in a voluntary, nonreciprocal transaction. Examples include donations from individuals, corporations, or foundations. Contributions, which fall under FASB ASC 958-605, are reported as increases in either net assets with or without donor restrictions, depending on donor stipulations. Key considerations include:

• Donor-Imposed Restrictions: Contributions may contain restrictions on use, purpose, or time. If so, the funds should be recorded initially as increases in “Net Assets With Donor Restrictions.” Once the restriction is satisfied, a reclassification (net asset release) is recognized in the statement of activities, transferring the funds to “Net Assets Without Donor Restrictions.”
• Conditional Contributions: Gifts that include barriers or conditions (e.g., matching requirements or performance-related goals) are not recognized as revenue or support until the condition is substantially met.
• Unconditional Pledges: These are recognized in the period in which the pledge is made, at fair value. If collection is deferred, a discount to present value might be necessary.

For example, imagine a donor pledges $100,000 for the specific purpose of funding a new community program, with no further conditions. This inflow is recorded initially as an increase in Net Assets With Donor Restrictions. When the not-for-profit launches the program or meets the budget requirement to use those funds for that specified purpose, the $100,000 is released from restriction and recognized as an increase (or reduction of net assets with donor restrictions and an increase in net assets without donor restrictions).

Grants and Contracts

Many not-for-profits receive grants or contracts from governmental agencies or private foundations. The classification often depends on whether the transaction is deemed a “contribution” or an “exchange transaction.” Grants or contracts may be:

• Exchange Transactions: If the grantor or contracting entity receives commensurate value in return for the resources provided (e.g., a direct benefit of goods or services at a fair value), it is recorded as earned revenue.
• Nonexchange Transactions (i.e., contributions): If the resource provider does not receive commensurate value, then the transaction represents a contribution recorded similarly to donor gifts.

It is crucial to carefully evaluate the terms of the grant or contract: federal or state grants for providing specific services to the public can be either conditional contributions or exchange transactions. The classification determines whether you record the inflow immediately (in the case of unconditional contributions) or recognize income over time as performance obligations are satisfied (in the case of exchange transactions under ASC 606 or conditional contributions under ASC 958-605).

Program and Service Revenues

Program or service revenues stem from exchange transactions in which the not-for-profit entity provides goods or services to beneficiaries or customers who pay directly for them. Common examples include:

• Tuition and fees at educational institutions.
• Patient service revenue in healthcare.
• Membership fees with direct benefits.
• Tickets to cultural events or museum admissions (if the transaction is deemed an exchange).

Revenues from these activities typically increase “Net Assets Without Donor Restrictions,” because they do not involve donor-imposed restrictions. If a not-for-profit charges a fee for a program that is partially subsidized by grants, the fee portion should be recognized as program revenue earned, while the grant portion may be considered a contribution (potentially restricted or unrestricted).

Special Events and Auxiliary Activities

Not-for-profit entities frequently host fundraising events such as galas, auctions, or charity runs. Revenue generated from such special events can be categorized into:

• Contribution Component: If attendees pay an amount above the fair value of any direct benefit received (e.g., the ticket price exceeding the approximate value of the meal), the excess is recorded as contribution revenue.
• Exchange Component: The portion equivalent to the fair value of what donors receive (e.g., dinner, entertainment) is recorded as exchange revenue.

Allocating proceeds between these two components is crucial for clear financial reporting.

Classification of Expenses

For not-for-profits, expenses should be reported as decreases in net assets without donor restrictions (unless specifically allowed to be offset against a restricted net asset class, which is rare). Expenses generally fall into two main categories: program services and supporting services. However, FASB requires reporting of both functional and natural classifications. Typically, not-for-profits present natural expenses in the notes or a supplementary statement (Statement of Functional Expenses), while the Statement of Activities displays the functional expense categories and net changes in net assets.

Functional Classifications

• Program Services: These are expenses directly associated with carrying out the primary mission, programs, and services for the beneficiaries. For instance, a healthcare charity’s clinical outreach, an art museum’s exhibition costs, or a homeless shelter’s food and housing programs.
• Supporting Services: These include:
– Management and General: Administrative functions necessary for organizational oversight, budgeting, recordkeeping, and compliance.
– Fundraising: Activities undertaken to raise resources, such as direct mail campaigns, donor solicitations, marketing for financial support, and special event fundraising expenses.

Natural Classifications

On the other hand, expenses must also be broken down by their natural classification (the type of expense). Common natural classifications include:
• Salaries and Wages
• Rent and Occupancy
• Utilities
• Depreciation and Amortization
• Professional Fees
• Supplies
• Travel and Entertainment
• Interest Expense

These expenses should be allocated to the function (program vs. management and general vs. fundraising) based on how they benefit each area. Not-for-profit entities must apply reasonable allocation methodologies to ensure accurate representation of program costs versus supporting services.

To illustrate, an organization that pays $20,000 in rent might allocate $15,000 to programs, $3,500 to management, and $1,500 to fundraising, reflecting the space usage by each function.

Presentation of Revenues, Expenses, and Support

Below is a simplified example of a Statement of Activities for a not-for-profit entity with both net assets without donor restrictions and with donor restrictions:

Statement of Activities (Simplified Example)
For the Year Ended December 31, 20XX

(Amounts in thousands)

                     Without Donor    With Donor      Total  
                     Restrictions     Restrictions       

Revenues & Support Contributions $ 500 $ 300 $ 800
Grants & Contracts 400 200 600
Program Fees 250 – 250
Investment Income 50 20 70

Total Revenues & Support 1,200 520 1,720

Net Assets Released from Restrictions 350 (350) –

Total Revenues, Support, and Releases 1,550 170 1,720

Expenses Program Services 1,100 – 1,100
Management & General 200 – 200
Fundraising 100 – 100

Total Expenses 1,400 – 1,400

Change in Net Assets 150 170 320
Beginning Net Assets 700 250 950

Ending Net Assets $850 $420 $1,270

In this example:
• Contributions of $800,000 are divided between $500,000 without donor restrictions and $300,000 with donor restrictions.
• Net assets with donor restrictions release $350,000 once conditions or purposes are fulfilled, resulting in an equivalent reduction in Net Assets With Donor Restrictions and an increase to Net Assets Without Donor Restrictions.
• Expenses are only shown in the column for net assets without donor restrictions, which underscores that expenses use resources from the unrestricted pool (or effectively released restricted funds).

Special Topic: Transfers Between Net Asset Classes

When a donor restriction is satisfied—e.g., the not-for-profit completes a program funded by a restricted grant—the entity “releases” these net assets to the without donor restrictions column. The Statement of Activities typically shows this activity under “Net Assets Released from Restrictions.” The total net effect on the organization’s net assets might remain the same, but it alters the composition between restricted and unrestricted resources.

Additionally, if a donor changes the restriction or if board designations reclassify certain amounts (a board-imposed designation is not the same as a donor restriction, but the board can set aside funds for a specific reserve), these flows should be clearly disclosed. Transparency around such transfers is crucial to convey whether the restrictions are donor-imposed or internally designated.

Functional Expense Reporting

Not-for-profit organizations are also required to present a statement of functional expenses or to include a matrix of natural and functional expenses in the notes. This requirement fosters transparency, allowing donors, regulators, and other users to see where money is spent in terms of both type and purpose. The matrix typically has columns for program services, management, and fundraising, and rows for natural classifications such as salaries, benefits, rent, etc.

By requiring both functional and natural expense reporting, standard-setters seek to highlight the extent to which the not-for-profit carries out its mission relative to the administrative and fundraising costs. This provides an essential measure of the efficiency and stewardship of the entity.

Common Pitfalls and Best Practices

1. Misclassification of Restriction vs. Unrestricted Funds: Errors occur when staff incorrectly record restricted gifts in the without donor restriction column. This compromises the financial portrayal of resources available for general use.
2. Failing to Recognize Conditional Contributions: Some not-for-profits prematurely recognize conditional contributions as revenue. In reality, no revenue should be recorded until the condition is substantially met.
3. Overlooking Matching Components in Grants and Contracts: The not-for-profit must carefully read the grant or contract documents to determine if the funds are conditional or if they represent exchange transactions under ASC 606.
4. Improper Allocation of Expenses: Organizations occasionally allocate too much overhead cost to programs (to demonstrate a high “program services ratio”) or fail to apply a consistent allocation methodology.
5. Inadequate Disclosure of Net Asset Releases: Transparent documentation and note disclosures about how restrictions have been met is a best practice.

Best Practices

• Maintain thorough documentation on donor intent, including purpose, time, and condition stipulations.
• Establish robust policies for identifying and releasing restrictions, ensuring timely updates to the accounting system and board oversight.
• Use a clear and justifiable allocation methodology for expenses based on time, square footage, or other reasonable measures.
• Provide plain-language disclosures that outline the nature of restrictions and how resources were used.
• Review FASB ASC 958 guidance regularly to keep up with evolving standards and best practices.

Real-World Example

Consider a local community health center that provides discounted or free medical services to low-income residents. The center receives the following support:

• A $200,000 annual grant from a healthcare foundation that requires the center to provide a minimum of 2,000 free patient screenings each year. The grant is conditional if the free screenings are not performed. Initially, the health center does not recognize the full $200,000. Each month, as the center completes a portion of the screenings, it recognizes that portion of the grant revenue and records it in the Statement of Activities (Net Assets Without Donor Restrictions).
• Individual donor contributions totaling $100,000, half of which is restricted to purchasing medical equipment. The half that is restricted remains with donor restrictions until the center actually purchases equipment.
• Program service revenue of $150,000 from patients who can pay. This is recognized as exchange revenue under ASC 606 because the center provides healthcare services in exchange for the fees.
• Fundraising event proceeds of $50,000. Fair value of the dinner provided is $10,000, so $40,000 is classified as contribution revenue, and $10,000 is recognized as exchange revenue.

At year-end, the center will present a Statement of Activities reflecting these inflows by net asset category, releasing the restricted net assets when the program’s or funder’s conditions are met.

Putting It All Together

The Statement of Activities for a not-for-profit entity is far more than a simple income statement. It reflects the interplay of donor-intended resources, operational expenditures, and mission-centric activities. By clearly classifying and presenting contributions, grants, program revenues, and related expenses, not-for-profit organizations can enhance transparency, strengthen donor confidence, and maintain compliance with U.S. GAAP.

A robust understanding of these nuances—supported by practical examples and thoroughly documented policies—empowers not-for-profit management, board members, and stakeholders to fulfill their missions responsibly and effectively.

Master the Statement of Activities: NFP Revenue and Expense Quiz

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