United States: Footnotes Tell a Story: What Constituents Can Glean from Your Financial Statements

When reviewing financial statements, not-for-profit board members and managers sometimes make the mistake of focusing solely on bottom-line figures. But financial statements also may include a wealth of information in their disclosures.

Savvy constituents and potential supporters know this and will examine the notes to your financial statements to gain a sense of how well your organization is pursuing its mission. This means that you, too, need to be familiar with the common types of disclosures and the information they make available for scrutiny.

What's in Your Accounting Policies?

The summary comprises two sections: a brief description of your not-for-profit (including its chief purpose and sources of revenue) and a list of the main accounting policies that have been applied in preparing your financial statements (with a subsection for each specific policy). A policy is generally considered significant if it could materially affect the determination of financial position, cash flows or changes in net assets.

The summary outlines specific policies such as:

  • The accounting method used in the financial statements (accrual, cash basis or modified cash basis);
  • Classification of cash equivalents;
  • Fixed asset capitalization and depreciation;
  • Investments;
  • Uncertain tax positions;
  • Recognition of contributions and grants as revenue; and
  • Recognition of in-kind contributions.

The disclosure of accounting policies should describe accounting principles and methods that have been selected from acceptable alternatives, and explain industry peculiarities or unusual or innovative applications of Generally Accepted Accounting Principles (GAAP).

How are Your Investments Performing?

Not-for-profit organizations must disclose in the notes a variety of information related to investments, beginning with the types of investments, such as equities, U.S. Treasury securities and real estate. Among other information, the notes must disclose the carrying amounts for each major type of investment, current year income, realized and unrealized gains and losses, and information about how fair value is determined.

Have You Had Related Party Transactions?

Constituents may look to the related party transaction disclosure to determine if the not-for-profit is susceptible to conflicts of interest. The note describes transactions entered into with related parties such as board members, senior management and major donors. The description should include the nature of the relationship between the parties, the dollar amount of the transaction and any amounts owed to or by the related party as of the date of the financial statements, and the terms and manner of settlement. Guarantees between related parties also must be disclosed.

What About Contingencies?

The not-for-profit must disclose any reasonably possible loss contingencies. Contingencies are existing conditions that could create an obligation in the future but arise from past transactions or events. Constituents may find loss contingencies of particular interest because of their potential effect on financial position and net assets. The financial statement notes must disclose the nature of the contingency and provide an estimate of the loss (or state that an estimate cannot be made). In certain circumstances, gain contingencies also may need to be disclosed.

Examples of nonprofits' contingencies include:

  • Pending, threatened or unasserted litigation, claims and assessments;
  • Claims for costs or expenditures that could be disallowed under a government grant;
  • Current IRS examinations related to tax-exempt status, unrelated business income; excise or other taxes; and
  • Arrangements with financial institutions, such as guarantees and endorsements.

Contingencies related to noncompliance with donor restrictions also should be included in the disclosures.

What Were Your Fundraising Costs?

Contributors, funding sources and regulators tend to be more interested in total expenses by function, such as fundraising costs, than expenses for line items like professional fees, postage and supplies. Not-for-profit financial statements should disclose information that allows users to compare the total amount of fundraising costs with the related proceeds and total program costs. If a ratio of fundraising expenses to funds raised is disclosed, the organization also should describe the method used to compute it.

What's Behind the Numbers?

Bottom-line numbers do not always tell the whole story of an organization's financial health. Board members and management need to follow the lead of their savvier constituents and take the time to read the disclosures so they know the facts behind the figures and can plan for their organization accordingly.

Sidebar: A Form 990 Disclosure Gets Renewed Attention

Financial statements are not the only place where not-for-profits make critical disclosures. Last fall, the Washington Post published a blockbuster article that drew public attention to what it dubbed "the most intriguing check box" on the Form 990.

The Post was referring to line 5 in Part VI, which asked, "Did the organization become aware during the year of a significant diversion of the organization's assets?" A diversion is "significant" if it exceeds $250,000 or 5% of the organization's receipts or assets.

The writer found that more than 1,000 not-for-profits had checked the "yes" box from 2008 to 2012, disclosing losses attributed to theft, investment fraud, embezzlement and other unauthorized uses of funds. Such "financial skullduggery" drained "hundreds of millions of dollars from institutions that are underwritten by public donations and government funds."

The Post has now established a public, searchable database of nonprofits that have disclosed diversions. Nonprofits would be wise to expect their constituents to check the database and possibly request further information.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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