Improving Disclosure

VOL.4 NO.3

Spring
2003
and Transparency in
Nonprofit Accounting
B Y G E R A L D A R A N O F F, P H . D . , C PA

DISAGGREGATED FUNDS-BASED REPORTING IS AN ESSENTIAL SUPPLEMENT TO THE

FINANCIAL STATEMENTS OF NONPROFIT ORGANIZATIONS. A HYPOTHETICAL CASE

ANALYSIS ILLUSTRATES IMPROVEMENTS TO NONPROFITS’ FINANCIAL DISCLOSURES.

EXECUTIVE SUMMARY: Nonprofit organizations should be required to include supplemental financial statements
that would improve disclosure and transparency. Traditional disaggregated funds balance sheets and statements
of changes in fund balances should be included as a supplement in financial reporting. More descriptive termi-
nology should be used in the equity section of the FASB-format balance sheet. The term “transfers” should be
used to describe flows between funds in the FASB-format statement of activities. The direct rather than indirect
method should be used for the statement of cash flows. A comprehensive, hypothetical illustration of a nonprofit
hospital’s financial reporting and disclosure is offered in support of the proposed changes.

Nonprofit accounting is typically part of advanced
accounting in a three-part curriculum consisting of princi-
ples, intermediate, and advanced. It is a difficult subject
for students to master. Financial Accounting Standards
Board (FASB) accounting pronouncements force nonprof-
it entities to adopt the accounting model of profit enter-
prises. While this makes it easier for students to learn
nonprofit accounting, I question how well this approach
meets the needs of users of nonprofit accounting reports.
Accountants are widely debating the merits of the
FASB rules on nonprofit accounting, stating their case
in articles in accounting journals and in conferences
about nonprofit accounting. The text I use for my
course at Tel-Aviv University on nonprofit accounting
states:
FASB Statement [of Financial Accounting
Standards] No. 117 [“Financial Statements of
Not-for-Profit Organizations”] requires [nonprofit
organizations] to present financial statements
showing an aggregate view of the entity. This rev-
olutionary approach effectively moved not-for-
profit financial reporting away from the
disaggregated, traditional method of fund-based
reporting and more toward the commercial for-
profit model of financial reporting. Not all users
welcomed this change and the impacts of this

M A N A G E M E N T A C C O U N T I N G Q U A R T E R LY 15 SPRING 2003, VOL.4, NO.3

 controversial change will take several years to be
assessed.1
Robert N. Anthony, professor emeritus at Harvard
University and the most prominent critic of FASB pro-
nouncements regarding nonprofit accounting, writes:
In June 1993, 15 years after it accepted respon-
sibility for nonprofit accounting, the Financial
Accounting Standards Board (FASB) issued its
major standards for financial accounting in non-
profit organizations. In this article, I argue that
these standards are incredibly poor, and, if imple-
mented, nonprofit accounting will take a giant
step backwards…
A major difference between nonprofit organiza-
tions and business enterprises is the source of
their equity capital. Business enterprises obtain
equity capital from shareholders, whereas non-
profit organizations obtain equity capital from
contributors in the form of endowment, buildings,
works of art, and similar long-lived assets. This
difference means that business organizations have
transactions not found in nonprofit organizations
and vice versa. For example, businesses pay divi-
dends and nonprofit organizations do not.2
Anthony is sharply critical of SFAS No. 117. He
writes, for example:
SFAS No. 117 challenges the accountant to
find a sensible way of preparing an operating
statement for nonprofit organizations that have
contributed endowment, plant, or museum
objects. The statement mixes operating transac-
tions with nonoperating transactions and leads to
what many believe to be a useless bottom line.
Many nonprofit organizations and their accoun-
tants feel the disclosure requirements of SFAS
No. 117, “Financial Statements of Not-for-Profit
Organizations,” may distort the results of their
operations. However, the statement provides a
great deal of flexibility in presenting results.3
I seek to improve disclosure and transparency in non-
profit accounting. My aim is that both internal man-
agers and external financial-statement users have
M A N A G E M E N T A C C O U N T I N G Q U A R T E R LY
improved accounting information to better understand
the nonprofit entity’s long-term and short-term financial
position and changes in financial position. My proposals
will enable better performance evaluation, particularly
regarding the revenues and costs of programs or func-
tions in a nonprofit entity.
P R O P O S E D S U P P L E M E N TA L F U N D S - B A S E D
REPORTING
FASB permits nonprofit entities to present disaggregat-
ed data classified by fund groups as long as the aggre-
gated net-asset statements are also presented. I
recommend that nonprofit entities exercise this option
to improve disclosure and transparency. Nonprofit enti-
ties that have special-purpose funds should, as a supple-
ment, present balance sheets of each fund and
statements of changes in all fund balances. This would
enable readers to distinguish better between resource
flows that relate to current operations and resource
flows that relate to expansions and plant moderniza-
tions. This is an important theme in FASB Concepts
Statement No. 4, “Objectives of Financial Reporting by
Nonbusiness Organizations,” that Robert Anthony
writes about.4 Paragraph 49 of Concepts No. 4 and
Anthony both stress that “financial accounting must
distinguish between resource flows that are related to
operations and those that are not.”
PROPOSED NEW TERMINOLOGY FOR FAS B
F O R M AT
A person looking at financial statements for a nonprofit
entity is struck by several anomalies. The equity sec-
tion in the nonprofit entity’s balance sheet is replaced
by a section with a new name: “net assets.” This equity
section with a new name is divided into three cate-
gories, also with new terminology: “unrestricted,” “tem-
porarily restricted,” and “permanently restricted.”
I recommend the term “equity” instead of net assets
(see Tables 1 and 6). Students have enough trouble
comprehending the equity section of a balance sheet
and understanding equity transactions of a nonprofit
organization without radical new terminology. The term
“net assets” suggests things of value. Things of value to
an entity belong under assets—not in the equity
section! Students are familiar with the fundamental
16 SPRING 2003, VOL. 4, NO. 3
 Table 1:Balance Sheets, FASB Format reserves,” “special-purpose reserves,” and “perpetual-
endowment reserves.” Students are familiar with the
with Proposed Terminology, for account name “reserves” as belonging to equity
“Tel-Aviv Hospital” accounts. In the asset section of the balance sheets,
As of December 31, 2001 and 2002
however, nonprofit entities can use whatever terms
2001 2002 they feel most clearly describe the nature of the assets,
ASSETS such as plant-replacement fund or perpetual-
Cash and cash equivalents $220,000 $259,000 endowment fund. They can make the terms shorter:
Receivables 37,000 277,000 plant fund or endowment fund.
Allowance for bad debts -7,000 -11,000 My terminology puts a positive twist on the nature of
Inventory 14,000 37,000 these equity accounts. A corporate stock certificate with
Total current assets 264,000 562,000 the word “restricted” in large letters on its face suggests
Plant fund 125,000 99,800 that the value to the holder may be sharply lower than
Endowment fund 266,000 266,000 otherwise. My proposed terms—”general reserves,”
Land 400,000 400,000 “special-purpose reserves,” and “perpetual-endowment
Buildings 1,750,000 1,750,000 reserves”—are clear. General reserves are the equity in
Accumulated depreciation: bldgs. -430,000 -474,000 the nonprofit entity that the governing board can use
Equipment 680,000 682,000 for any legal purpose. Special-purpose reserves are the
Accumulated depreciation: equip. -134,000 -185,400 equity in the nonprofit entity that the governing board
Total noncurrent assets 2,657,000 2,538,400 can use only for particular purposes designated by
Total assets $ 2,921,000 $ 3,100,400 donor restrictions, such as for a new plant or equipment.
Perpetual-endowment reserves are the equity in the
LIABILITIES AND EQUITY LIABILITIES nonprofit entity that must be maintained in perpetuity,
Payables $216,000 $422,000 also typically imposed by donor restrictions. The finan-
Accrued liabilities 6,000 6,100 cial statement footnotes should explain the details of
Total current liabilities 222,000 428,100 donor restrictions, such as how the governing board may
Mortgage payable 350,000 432,000 use investment income from donated funds.
Total liabilities 572,000 860,100 In the statement of activities (Table 6), which
replaces the income statement for nonprofit entities,
EQUITY there is a confusing item: “net assets released from
General reserves 1,958,000 1,874,500 restrictions.” This term suggests a court order releasing
Special-purpose reserves 125,000 99,800 a frozen bank account. I suggest a simpler term: “trans-
Perpetual-endowment reserves 266,000 266,000 fers from”—plus the name of the restricted-asset
Total equity 2,349,000 2,240,300 account, such as “transfer from plant fund.” A transfer
Total liabilities and equity $2,921,000 $3,100,400 from the plant fund to the general fund, for example, is
simply an increase in the general reserves and a
decrease in special-purpose reserves. This item is mere-
ly a reclassification in the equity section of the balance
accounting equation: assets = liabilities + equity. Equity sheet that arises typically because the governing board
in the sense of residual value still exists for nonprofits complied with a donor-designated wish, such as buying
though there are no defined ownership interests that can new equipment.
be sold or transferred.
Instead of the terms “unrestricted,” “temporarily DIRECT METHOD FOR CASH-FLOW
restricted,” and “permanently restricted” in the equity S TAT E M E N T
section of the balance sheet, I recommend “general Disclosure and transparency would be greatly improved

M A N A G E M E N T A C C O U N T I N G Q U A R T E R LY 17 SPRING 2003, VOL. 4, NO. 3

if nonprofit entities made the following further change
permitted by current rules. I recommend that nonprofit Table 2: Balance Sheets, Funds
entities use the direct method for their statement of Format As of December 31, 2001 and 2002
cash flows (see Table 5). Especially with confusing
resource flows involving donor funds, the direct method 2001 2002
is much easier than the indirect method for understand- GENERAL FUNDS
ing the details of net cash provided by operating activi- Assets
ties. The direct method simply lists the cash inflows Cash and cash equivalents $220,000 $259,000
and outflows. It is perfectly clear. The indirect method Receivables 37,000 277,000
relies on a complicated reconciliation between change Allowance for bad debts -7,000 -11,000
in net assets and net cash provided by operating Inventory 14,000 37,000
activities. Total current assets 264,000 562,000
Land 400,000 400,000
T E L- A V I V H O S P I TA L Buildings 1,750,000 1,750,000
To prove the advantages of my recommendations for a Accumulated depreciation: bldgs. -430,000 -474,000
hypothetical nonprofit private hospital, “Tel-Aviv Hos- Equipment 680,000 682,000
pital,” I show transactions in Table 3 and financial state- Accumulated depreciation: equip. -134,000 -185,400
ments in Tables 1 and 2 and 4, 5, and 6. I present the Total noncurrent assets 2,266,000 2,172,600
FASB format with my proposed terminology in Tables Total assets $2,530,000 $2,734,600
1, 5, and 6, and I show the fund-based statements in Liabilities and Fund Balance Liabilities
Tables 2 and 4. I argue that the fund-based statements Payables $216,000 $422,000
are essential supplements for adequate disclosure and Accrued liabilities 6,000 6,100
transparency. Total current liabilities 222,000 428,100
Tel-Aviv Hospital maintains three funds: a general Payable to plant fund 200,000 280,000
fund, a plant-replacement fund, and a perpetual- Mortgage payable 350,000 432,000
endowment fund. Each fund is a fiscal and accounting Total liabilities 772,000 1,140,100
entity. Each has a separate, self-balancing set of Fund balance 1,758,000 1,594,500
accounts for recording cash and other financial resources Total liabilities and fund balance $2,530,000 $2,734,600
together with all related liabilities and residual balances
and changes therein. PLANT FUND
The board of directors governs the hospital. The Assets
board uses the general fund to account for all financial Cash and cash equivalents $53,800 $28,600
resources except those that must be accounted for in Investments 71,200 71,200
another fund. The board uses the plant-replacement Receivable from general fund 200,000 280,000
fund to account for cash and investments that have been Total assets 325,000 379,800
donated to the hospital specifically for plant replace- Fund balance $325,000 $379,800
ment or expansion. The board uses the perpetual-
endowment fund to account for cash and investments ENDOWMENT FUND
whose principal must be maintained in perpetuity and Assets
whose income the board can use as they see fit. Cash and cash equivalents $6,000 $6,000
Table 1 shows comparative balance sheets in an FASB Investments 260,000 260,000
format for years ending 2001 and 2002. Total assets rose Total assets 266,000 266,000
moderately, while total equity declined slightly. The hos- Fund balance $266,000 $266,000
pital appears not to be in immediate danger of bankrupt-
cy, judging by the margin of current assets over current

M A N A G E M E N T A C C O U N T I N G Q U A R T E R LY 18 SPRING 2003, VOL. 4, NO. 3

 Table 3: General Journal Entries for Year 2002 in a Fund Accounting System
GENERAL FUNDS DEBITS CREDITS

1 Receivables $1,086,000
Patient service revenues $1,086,000
Gross charges for hospital services, all charged to accounts and notes receivables.

2 Contractual adjustments 30,000

Receivables 30,000
Provision for bad debts 15,000
Allowance for bad debts 15,000
Additional information relating to 2002 receivables and revenues.

3 Mortgage payable 18,000

Cash and cash equivalents 18,000
The general funds paid $18,000 to retire mortgage payable.

4 Cash and cash equivalents 56,500

Contributions 50,000
Income from endowment 6,500
During the year, the general funds received $50,000 from contributions and $6,500 income from endowment-fund investments.

5 Equipment 26,000
Transfer from plant fund 26,000
Cash and cash equivalents 500
Loss on disposal of equipment 1,900
Accumulated depreciation: equipment 21,600
Equipment 24,000
General funds received new equipment for which the plant fund paid $26,000.
General funds sold old equipment for $500 that cost $24,000 and accumulated depreciation of $21,600.

6 Administrative expense 215,000

General expense 225,000
Nursing services expense 520,000
Other professional services expense 165,000
Inventory 60,000
Accrued liabilities 6,000
Payables 1,191,000
During 2002, general funds recorded as payables: administrative expense, $215,000; general expense, $225,000; nursing services expense,
$520,000; other professional services expense, $165,000; supplies added to inventory, $60,000; and beginning balance accrued liabilities, $6,000.

7 Payables 985,000
Cash and cash equivalents 985,000
Payments on approved vouchers payable were $985,000.

8 Cash and cash equivalents 805,000

Allowance for bad debts 11,000
Receivables 816,000
Collections for receivables were $805,000 and write-offs, $11,000.

9 Nursing services expense 37,000

Inventory 37,000
Inventory was issued to nursing services for $37,000.

10 Depreciation expense 117,000

Accumulated depreciation: buildings 44,000
Accumulated depreciation: equipment 73,000
Depreciation on buildings was $44,000 and on equipment, $73,000.

Table 3 continues on next page

M A N A G E M E N T A C C O U N T I N G Q U A R T E R LY 19 SPRING 2003, VOL. 4, NO. 3

 11 Cash and cash equivalents 100,000
Mortgage payable 100,000
During the year, general funds borrowed $100,000, increasing the mortgage by $100,000.

12 Cash and cash equivalents 80,000

Payable to plant fund 80,000
During the year, general funds borrowed $80,000 from the plant fund.

13 Interest expense 6,100

Accrued liabilities 6,100
The year-end accrual for interest on the mortgage was $6,100.

PLANT FUND
1 Transfer to general fund 26,000
Cash and cash equivalents 26,000
The plant fund paid $26,000 for new equipment.

2 Cash and cash equivalents 80,000

Contributions 80,000
During the year, the plant fund received $80,000 contributions.

3 Receivable from general fund 80,000

Cash and cash equivalents 80,000
The plant fund transferred $80,000 to the general fund as a loan.

4 Cash and cash equivalents 800

Income from plant fund investments 800
Year-end accrued interest income on plant fund investments was $800.

ENDOWMENT FUND
1 Cash and cash equivalents 6,500
Cash and cash equivalents 6,500
During 2002, the endowment fund received $6,500 income from investments and transferred it to the general fund.

liabilities. Its long-term liability—mortgage payable—
seems proper in view of its equity balances and its values
of land, buildings, and equipment. One can argue that
the growing receivables balance is a bad sign. Perhaps
collections patterns are declining. One would have to see
if this is in line with trends in the general economy. A
reader of these comparative balance sheets would want
to ask about the decline in the plant fund and the
increase in the mortgage.
Table 2, an addition I propose, allowed as a supple-
ment by the FASB, shows comparative balance sheets
for years ending 2001 and 2002 using a funds format.
The big difference between the FASB format and a
funds format is the payable to plant fund and the
receivable from general fund in the plant-fund balance
sheets. Apparently, Tel-Aviv Hospital has a practice of
borrowing from its plant fund for current needs.
This is a common problem. A hospital may be under
financial pressure. Possibly to pay nurses’ salaries at the
end of the month, the hospital board of directors is
forced to use funds earmarked for plant expansion.
Surely this is stressful to a hospital governing board.
The board calls it “borrowing from the plant fund,” but
the likelihood of repaying may be slim.
The funds format improves disclosure and trans-
parency because we see the payables and receivables
between funds, whereas the FASB format nets out
these payables and receivables. Thus, the FASB format
conceals—to an extent—the financial pressure and
stress on the hospital.
Table 3 illustrates 2002 general journal entries with
explanations in a fund accounting system for the gener-
al fund, plant fund, and the endowment fund. Table
4—an addition I propose, which the FASB allows as a
supplement—shows changes in fund balances for the
three funds. Table 5 shows cash flows using my recom-

M A N A G E M E N T A C C O U N T I N G Q U A R T E R LY 20 SPRING 2003, VOL. 4, NO. 3

 Statements of Changes in
Table 4: Statement of Cash Flows for
Table 5:

Fund Balances for Year Ending Year Ending December 31, 2002
(Using the Direct Method)
December 31, 2002

GENERAL FUNDS
Additions: Cash flows from operating activities:
Patient service revenues $1,086,000 Receipts from patients $805,000
Contributions 50,000 Contributions to general funds 50,000
Income from endowment 6,500 Income from endowment 6,500
Transfer from plant fund 26,000 Payments for operating expenses -985,000
Total additions 1,168,500 Cash provided by operating activities -123,500

Subtractions: Cash flows from investing activities:

Administrative expense 215,000 Receipts from disposal of equipment 500
General expense 225,000 Cash provided by investing activities 500
Nursing services expense 557,000
Other professional services expense 165,000 Cash flows from financing activities:
Contractual adjustments 30,000 Payment of mortgage -18,000
Provision for bad debts 15,000 Addition to mortgage 100,000
Depreciation 117,000 Borrowings from plant fund 80,000
Loss on disposal of equipment 1,900 Cash provided from financing activities 162,000
Interest expense 6,100
Total subtractions 1,332,000 Noncash investing activities:
Change in fund balance -163,500 Purchase of equipment -26,000
Fund balance, beginning 1,758,000 Use of plant fund 26,000
Fund balance, ending $1,594,500 Net increase in cash $39,000

PLANT FUND
Contributions
Transfer to general fund
Income from plant fund investment
Change in fund balance
Fund balance, beginning
Fund balance, ending
ENDOWMENT FUND
Change in fund balance
Fund balance, beginning
Fund balance, ending
$80,000
-26,000 mendation of the direct method, which the FASB
800 allows.
54,800 Tel-Aviv Hospital is under severe financial pressure
325,000 and stress because the general fund operates under a
$379,800 big deficit of $163,500. How does the hospital manage
to pay its bills with subtractions from the general fund
exceeding additions by so much? The Statement of
Cash Flows shows that the hospital dips into the plant
- fund and increases its mortgage on its property for cur-
266,000 rent needs.
$ 266,000 Table 6 shows an accounting of activities for 2002.
This is the nonprofit-accounting version of an income
statement. The columns of the three equity accounts
and their total follow the FASB format but use my pro-

M A N A G E M E N T A C C O U N T I N G Q U A R T E R LY 21 SPRING 2003, VOL. 4, NO. 3

 Table 6: Statement of Activities for Year Ending December 31, 2002
FASB Format with Proposed Terminology
General Special-Purpose Perpetual-Endowment Total
Reserves Reserves Reserves Equity
REVENUES
Patient service revenues $1,086,000 $1,086,000
Contributions 50,000 80,000 130,000
Income from endowment 6,500 6,500
Income from plant fund 800 800
Transfer from plant fund 26,000 -26,000 -
Borrowing from plant fund 80,000 -80,000 -
Total revenues 1,248,500 -25,200 - 1,223,300
EXPENSES
Administrative expense 215,000 215,000
General expense 225,000 225,000
Nursing services expense 557,000 557,000
Other professional services exp. 165,000 165,000
Contractual adjustments 30,000 30,000
Provision for bad debts 15,000 15,000
Depreciation 117,000 117,000
Loss on disposal of equipment 1,900 1,900
Interest expense 6,100 6,100
Total Expenses 1,332,000 - - 1,332,000
Change in equity -83,500 -25,200 - -108,700
Equity, beginning 1,958,000 125,000 266,000 2,349,000
Equity, ending $1,874,500 $99,800 $266,000 $2,240,300

posed terminology. I argue that one can understand this
statement much better after looking at Table 4. The
deficit of $163,500 in Table 4 is probably a better mea-
sure of the bottom line for the hospital than the smaller
deficit numbers of the change in equity in Table 6.
A bad sign is that the hospital is lagging in fulfilling
donor wishes for new plant and equipment. In Table 4,
one sees that the hospital received donations earmarked
for new plant and equipment of $80,000 in the current
year but spent only $26,000. The backlog of earmarked
donations over expenditures for earmarked purposes is
$379,800. The amounts of cash and cash equivalents and
investment held by the plant fund in 2002 is only
$99,800, shown in Table 2. One wonders how a bank
could justify increasing the mortgage to a hospital with
these financial statements. In sum, the fund-based reports
of Tables 2 and 4 are essential to reveal clearly the finan-
cial stress and possible mismanagement of the hospital.
I M P R OV E D N O N P R O F I T AC CO U N T I N G
Overall, I am proposing that nonprofit accounting
should: (1) show a funds-format balance sheet and a
statement of changes in fund balances as supplemental
information; (2) use the term “equity” in the balance
sheet because it is simple, clear, and familiar; (3) use
the term “transfer” in describing transfers between
funds because it, too, is simple, clear, and familiar;
(4) use the terms “general reserves,” “special-purpose
reserves,” and “endowment reserves” in the equity sec-
tion of the balance sheet; and (5) use the direct method

M A N A G E M E N T A C C O U N T I N G Q U A R T E R LY 22 SPRING 2003, VOL. 4, NO. 3

for the statements of cash flows because it is simpler
and clearer than the indirect method.
These changes will make nonprofit accounting clear-
er and easier to learn, and, more important, will
improve disclosure and transparency. ■

Gerald Aranoff, Ph.D., CPA, is a professor of accounting at

The Academic College of Yehuda & Shomron in Ariel, Israel.
He is a member of the Israel Institute of Certified Public
Accountants. You can reach Prof. Aranoff at
011-972-3-674-0789 or garanoff@netvision.net.il.

1 Earl R. Wilson, Susan C. Kattelus, and Leon E. Hay, Accounting

for Governmental and Nonprofit Entities, McGraw-Hill/Irwin, New
York, N.Y, 12th edition, 2001, pp. 653-654.
2 Robert N. Anthony, “The Nonprofit Accounting Mess,”
Accounting Horizons, June 1995, p. 44.
3 Robert N. Anthony, “Coping with Nonprofit Accounting
Rules,” The CPA Journal, August 1996, abstract.
4 Robert N. Anthony, “The Nonprofit Accounting Mess,”
Accounting Horizons, June 1995, p. 46.

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