Watch Out for These Common Financial Statement Errors

Each year, Thomson Reuters editors and outside authors review dozens of sets of financial statements while updating our products. We look to ensure they comply with accounting principles generally accepted in the United States (GAAP). This article highlights some of the recurring errors we found.

Practical Consideration: Financial statement preparers should consider materiality when determining the need to make financial statement presentations or disclosures. Statement of Financial Accounting Concepts (SFAC) 8, chapter 3, indicates materiality includes both quantitative and qualitative considerations.

Statement of Financial Position

Here are reminders about some statement of financial position (SOFP) requirements based on errors we noted:

• When choosing to present a classified SOFP, an organization needs to report all items properly broken down between current and noncurrent. This includes items such as contributions receivable due over a period of more than one year, long-term debt with a due on demand clause or an uncured covenant violation, and right-of-use lease assets and liabilities. (FASB ASC 958-205-45-2; 470-10-45-10 through-12; 842-20-45-1)

Practical Consideration: Organizations don’t have to present a classified SOFP, but they do have to present information about liquidity or maturity of assets and liabilities, including restrictions on the use of particular items. (FASB ASC 958-210-45-4)

• If the fair value of a donor-restricted endowment fund is less than either its original gift amount or the amount the donor requires the organization to maintain in the endowment, that endowment fund is an underwater endowment fund. An organization should record investment losses on an underwater endowment fund in net assets with donor restrictions. (FASB ASC 958-220-45-8 and-13A)

Statement of Activities

Nonprofit organizations may have flexibility in how they present their activities, but the statement of activities (SOA) still has some requirements. The following are some items we noted that needed correction:

• If an organization chooses to differentiate between operating and nonoperating activities, the SOA should allocate such items appropriately. For example, FASB ASC 360-10-45-5 requires presenting the gain or loss on the sale of assets used in operating activities (as opposed to discontinued operations) as an operating activity.
• Difficulty in estimating the fair value of contributed services doesn’t create a practical expedient allowing an organization to not record contributed services. If contributed services meet the criteria at FASB ASC 958-605-25-16, the organization should record those services.
• An organization also should record contributions of nonfinancial assets that meet the criteria for recognition. Whether the organization would have purchased the item or not isn’t part of the criteria. However, FASB ASC 958-605-25-4 states that a major uncertainty about the value of an item may indicate that an organization shouldn’t recognize it.

Practical Consideration: Indicators that an item may not have value include (1) the organization can’t use the item in its programs or internally and (2) the organization can’t sell the item.

• Additionally, the SOA should present contributions of nonfinancial assets in a separate line from contributions of cash and other financial assets (FASB ASC 958-605-45-7A)
• An organization shouldn’t include non-GAAP amounts in the SOA or statement of functional expenses. For example, some grants require matching contributions that include volunteer services that don’t meet the criteria for recognition under GAAP, or require reporting expenditures for fixed assets as an expense rather than capitalized as an asset. The financial statements should reflect GAAP requirements and not grant requirements unless the financial statements are prepared on using a financial reporting framework other than GAAP.

Statement of Functional Expenses

FASB ASC 958-720-45-15 requires organizations to disclose the relationship between functional and natural classifications of all expenses in one location in the financial statements. (The exception to the rule is external and direct internal investment expense that the organization netted against investment return. The analysis specifically excludes those expenses.)

An organization may disclose the analysis of the relationship on the face of the SOA, in a separate statement of functional expenses (SOFE), or in the notes to the financial statements. Errors we noted included:

• The financial statements present expenses such as those representing the cost of direct benefits to donors as netted against special events revenue, or cost of goods sold as netted against sales in the SOA, resulting in those expenses being excluded from the analysis of functional expenses. GAAP specifically calls out that an organization should report these netted expenses in both their natural and functional categories in the functional expense analysis. (FASB ASC 958-205-45-6)
• The analysis presented program services classifications mixed in with natural expense classification. For example, hotel operations or a fundraising program or event aren’t natural expense classifications. Examples of natural categories are salaries, rent, utilities, insurance, or depreciation. FASB ASC 958-205-20 defines natural expense classification, functional expense classification, program services, and supporting activities.
• The analysis didn’t show expenses such as depreciation allocated to appropriate program services or supporting activities. An organization should allocate costs that benefit more than one function. (FASB ASC 958-720-45-2A)

Practical Consideration: We noted that organizations used all three of these methods of presenting the required analysis about expenses in the financial statements we reviewed.

Statement of Cash Flows

An organization may prepare the statement of cash flows (SOCF) using either the direct or indirect method. The financial statements we reviewed most often used the indirect method. Financial statement preparers need to consider the following common errors we noted:

• An organization should present, either on the face of the SOCF or in the notes to the financial statements, the SOFP line items that comprise cash, cash equivalents, and restricted cash and cash equivalents as reflected in the SOCF. (FASB ASC 230-10-50-8)
• Contributions restricted for long-term purposes, such as capital expenditures or endowments, aren’t operating activities for purposes of the SOCF. Instead, the SOCF should reflect proceeds from capital campaigns as financing activities. (FASB ASC 230-10-45-14c)
• Financial statements should disclose how much the organization paid in interest expense during the period if the SOCF uses the indirect method. The notes to the financial statements may include the disclosure, but financial statements commonly include it as a supplemental disclosure on the SOCF. (FASB ASC 230-10-50-2)

Disclosures

Complying with GAAP involves more than the basic financial statements. Disclosures are another important component. The financial statements reviewed sometimes missed the following disclosures:

• If the organization prepares the financial statements in accordance with a special purpose financial reporting framework (i.e., cash, tax, contractual), the organization should properly title the financial statements, include a summary of significant accounting policies, and describe the differences between the special purpose framework and GAAP. (AU-C 800.16)
• If the organization divides the SOA between operating and nonoperating activities, the disclosures should include how the organization defines operations. (FASB ASC 958-220-45-9 through -12)
• How the organization expenses advertising expenses in the financial statements. (FASB ASC 720-35-25-1)
• Policy for recognizing donor-restricted contributions as an increase in net assets without donor restrictions if the restriction expires in the reporting period in which the organization recognizes the contribution. (FASB ASC 958-605-50-2)
• Policy for recognizing conditional contributions with donor-imposed restrictions for which the organization meets the donor restrictions substantially at the same time as the condition. (FASB ASC 958-605-45-4B)
• Information about which expenses the organization allocated because they aren’t attributable to a single program service or support activity. (FASB ASC 958-720-50-1)
• Information about contributed nonfinancial assets, such as whether the organization sold or used them, any donor-imposed restrictions, the organization’s policy about monetizing vs. utilizing those contributed assets, and valuation techniques used to determine the fair value of the contribution. (FASB ASC 958-605-50-1A)
• How the organization determines which items it considers to be cash equivalents. (FASB ASC 230-10-50-1)

Practical Consideration: Generally, only investments with original maturities of three months or less qualify as cash equivalents.

• Information about investments for which the organization uses net asset value per share (NAV) as a practical expedient for determining fair value. (FASB ASC 820-10-55-107)
• Information about the capitalization policy for depreciable assets. (FASB ASC 958-360-50-1)
• Information about conditional promises to give such as amounts promises and a description and amount for groups of promises having similar characteristics. (FASB ASC 958-50-4)
• Information about underwater endowment funds. (FASB ASC 958-205-50-2)
• Properly reflecting cross-references to other notes to the financial statements and properly referencing the actual titles used on the financial statements (for example, referring to the statement of financial position as the balance sheet).
• Although not technically incorrect, we also noted instances when organizations disclosed information about the adoption of new accounting standards long after the period of adoption. GAAP doesn’t require that information when the period of adoption is no longer presented. However, the organization should disclose any accounting policies adopted for ongoing transactions related to the new accounting standard.

Practical Consideration: One of the best ways to ensure compliance with financial statement disclosure requirements is to use a financial statement disclosure checklist such as the one included in PPC’s Guide to Preparing Nonprofit Financial Statements and PPC’s Guide to Nonprofit GAAP. These Guides are available in print at store.tax.thomsonreuters.com and on Checkpoint at checkpoint.riag.com.