In the for-profit world, we use the concept of equity: “owner’s equity” in a sole proprietorship, or “stockholders’ equity” in a corporation. In the nonprofit world, we use the term net assets. Mathematically, net assets is total assets minus total liabilities, and is reported on the Statement of Financial Position. We think of net assets as the net resources available to the organization at any given point in time with which it can accomplish its mission.
Net assets are classified into one of the following three categories depending on the absence (or presence and nature) of donor-imposed restrictions:
- Unrestricted Net Assets, which are not restricted either by donors or by law.
- Temporarily Restricted Net Assets, whose use have been limited by donor-imposed time restrictions or purpose restrictions.
- Permanently Restricted Net Assets, which have been restricted by donor or by law to be maintained by the organization in perpetuity.
Classification of net assets can be difficult at times. Here are some common confusions:
- Designations – Designations are voluntary or self-imposed, board-approved segregations of otherwise unrestricted net assets for specific purposes, projects, or investments. The governing board of the nonprofit may approve designations to aid in planning future expenditures, but designations are not expenses and should not be reported in the statement of activities. Since designations are voluntary and may be reversed by the governing board at any time, designated portions of net assets are not considered restricted; this includes board-designated endowments, which is one of the most commonly misclassified items.
- Contractual or other limitations – Nonprofits may have certain contractual or other limitations placed on the use of net assets other than those resulting from donor-imposed restrictions. If the limitations or restrictions on net assets do not relate to a donor stipulation, then corresponding net assets are not restricted. For example, certain government grants that qualify as exchange transactions may have restrictions limiting the nonprofit’s use of the funds. In such cases, the associated net assets are unrestricted because the restrictions are imposed by the other party to the exchange transaction, not by a donor.
- Donor-imposed restrictions on unrestricted net assets – In some instances, a nonprofit can create a restriction on previously unrestricted net assets. For example, a donor might give $100,000 to establish an endowment, but only if the nonprofit matches the contribution with $100,000 of unrestricted net assets. As a result, unrestricted net assets in the amount of $100,000 should be reclassified to permanently restricted net assets, since the nonprofit no longer has discretion.
Financial Statement Disclosure:
FASB ASC 958-210-45-1 states that amounts for each of the three classes of net assets and total net assets are required to be reported on the face of the statement of financial position. According to FASB ASC 958-210-4-9, additional information is required to be reported for temporarily restricted and permanently restricted net assets.
For more detailed information on net assets presentation, please refer to FASB ASC 958-210-45.
- PPC’s Guide to Preparing Nonprofit Financial Statements
- FASB ASC 958-225-45-13
As a general disclaimer, the information provided above is very general and broad in nature, is not represented as complete, and may not apply to taxpayers’ individual situations. We advise all taxpayers to consult a professional advisor regarding their own specific needs.