The accounting requirements for contingencies are contained primarily in FASB ASC 450. A contingency is an existing condition, situation, or set of circumstances involving uncertainty as to possible gain or loss to an enterprise that will ultimately be resolved when one or more future events occur or fail to occur. Resolution of the uncertainty may confirm the acquisition of an asset, the reduction of a liability, the loss or impairment of an asset, or the incurrence of a liability. (FASB ASC 450-10-05-5)
Not-for-profit organizations use the same rules for recording and disclosing contingencies as commercial entities. In addition to all of the contingencies that face commercial enterprises, not-for-profit organizations often provide programs under cost-reimbursable contracts or grants. Disallowance of costs claimed under these cost-reimbursable contracts or grants represents loss contingencies to not-for-profit organizations. An estimated loss from a loss contingency is accrued by a reduction of net assets and the recording of a liability if both of the following conditions are met: (FASB ASC 450-20-25-2)
Gains from gain contingencies should not be accrued since doing so might recognize revenue before it is realized. In some cases, gain contingencies will require disclosure.
FASB ASC 460-10 addresses the recording of the fair value of a guarantee as a liability of the guarantor, and is also addressed in this chapter. GAAP also provides disclosure requirements relative to guarantees.
In addition to the considerations of uncertainties, financial statement preparers also need to consider the requirements of FASB ASC 275-10 regarding disclosures of significant risks and uncertainties. These disclosure requirements are also discussed in this chapter.
The following is a discussion of accounting for contingencies. It should be noted that not all uncertainties will result in a contingency. Generally, only uncertainties about whether a liability has been incurred or reduced, or an asset acquired or impaired, will result in a contingency. For example, depreciation estimates do not result in a contingency although there is uncertainty as to the actual useful life of an asset. Similarly, the possibility of a change in the requirements, conditions, or funding level of grants in the future may be uncertainties, but would not be considered contingencies.
General rules for loss contingencies. An estimated loss from a contingency is accrued by recording a decrease in net assets and the recording of a liability if both of the following conditions are met:
If the loss contingency is probable but only a range of estimated values can be made, the minimum point of the range should be accrued and the maximum point should be disclosed.
If the loss contingency is at least reasonably possible, a liability should not be recorded but disclosure is required. If feasible, that disclosure should include an estimate of the loss or range of loss. If a reasonable estimate of the loss cannot be made, that fact should be disclosed. (FASB ASC 450-20-50-3)
Certain contingencies are remote, in which case disclosure in financial statements is not required unless a guarantee has been given (see discussion below). No disclosure is required for unasserted claims or assessments when no act by the potential claimant has transpired. In addition, general or unspecified business risks are neither accrued nor disclosed.
In addition, a loss contingency should be disclosed if it involves a guarantee, even if the likelihood of loss is remote.
In summary, the accounting requirements are as follows for loss contingencies:
In cases where loss contingencies may arise after the financial statement date but before the financial statements are issued, FASB ASC 450-20-50 states that disclosure may be needed to prevent the financial statements from being misleading.
Some not-for-profit organizations may employ the practice of classifying a portion of net assets as appropriated for loss contingencies. This practice is acceptable when the following criteria are met:
The following is a discussion for applying the accrual requirements to specific contingencies that are common to not-for-profit organizations.
Noncompliance with donor or grantor restrictions. This is one of the more common loss contingency areas that is somewhat unique to not-for-profit organizations. Donors occasionally impose restrictions on not-for-profit organizations. Noncompliance may cause the organization to lose future revenues or support from the donor, or require the not-for-profit organization to reimburse the donor for previous donations.
In addition, not-for-profit organizations frequently receive financial assistance from governmental entities. By accepting the assistance, the not-for-profit organization is generally subject to laws and regulations, noncompliance with which may have a direct and material effect on the determination of amounts in their financial statements. For example, such laws may direct the types of goods or services that the organization may provide; the eligibility of those to whom the organization can provide benefits; the amounts organizations must contribute from their own resources toward projects; and principles and standards for determining the direct and indirect costs that are allowable as charges to government financial assistance programs.
If it is probable that a restricted donation or financial assistance will have to be reimbursed to the donor or grantor, and the amount of the reimbursement can be reasonably estimated, a contingent liability should be accrued.
In addition, audits in progress or completed by grantors of these specific grants or contracts, as well as the results of Single Audits performed in accordance with Title 2 U.S. Code of Federal Regulations Part 200, Uniform Administrative Requirements, Cost Principles, and Audit Requirements for Federal Awards (commonly referred to as the Uniform Guidance) relating to expenditures under federal awards programs, should also be considered.
Noncompliance with restrictions imposed on an organization by a donor should be disclosed if there is a reasonable possibility that a material contingent liability has been incurred at the date of the financial statements or there is at least a reasonable possibility that the noncompliance could lead to a material loss of revenue or could cause an entity to continue as a going concern. For example, if the noncompliance resulted in the termination of an organization's most important contract with the grantor, the organization may have lost its largest source of revenue. This impact needs to be assessed.
Allowance for uncollectible receivables. An allowance for uncollectible receivables, including pledges and contributions receivable, should be recorded if both of the following conditions are met:
The purpose of the allowance is to properly measure the value of receivables as a whole. Accordingly, an allowance should be recorded even if specific uncollectible receivables cannot be identified.
An organization may be unable to reasonably estimate uncollectible receivables. This inability might preclude it from recording an allowance and may indicate that it should use the installment method, cost recovery method, or other method to recognize revenues.
Expropriation of assets. The threat that a government will expropriate an organization's assets is a contingency. A loss should be accrued if:
An expropriation's imminence may be indicated by a government's public or private declarations of intent or its actual expropriation of another organization's assets. (FASB ASC 450-20-55-9) Many not-for-profit organizations with worldwide missions often have operations and assets in countries outside of the United States. This contingency is often overlooked by not-for-profit organizations' financial statement preparers. This contingency could very conceivably result in a required (and useful) financial statement disclosure if the appropriate conditions are met. Obviously, a loss should be accrued if the two conditions above are present.
Claims-made insurance policies. The claims-made coverage insures only those claims that are reported to the insurance company during the policy period. Therefore, the organization has a liability for any losses incurred during the policy period that have not been reported to the insurance company.
An organization should record a liability for probable losses from claims incurred but not reported during the policy period if the losses are both probable and reasonably estimable. Losses that are reasonably possible or probable but cannot be reasonably estimated should be disclosed.
Litigation and claims. A loss due to pending or threatened litigation, or actual or possible claims and assessments, should be accrued if all of the following conditions are met: (FASB ASC 450-20-55)
The criteria for disclosing or accruing the contingency when a claim or assessment is unasserted are somewhat different. The organization must first determine whether it is probable that a suit will be filed or a claim or assessment asserted. Based on the assessment, the following is applicable:
Joint and several liability. The FASB issued ASU 2013-04 Liabilities (Topic 405) Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation is Fixed at the Reporting Date (ASU 2013-04) to provide guidance for the recognition, measurement, and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation is fixed at the reporting deadline, except for obligations addressed in existing GAAP guidance. Examples of obligations within its scope provided by ASU 2013-04 include debt arrangements, other contractual obligations, and settled litigation and judicial rulings. Obligations accounted for under other GAAP are specified in ASU 2013-04 as follows:
ASU 2013-04 points out that there is a diversity in current practice as to how these obligations are recorded. Some entities record the entire amount under joint and several liability arrangements, while other entities record less than the total amount of the obligation, using allocations or the portion of the amount the entity agrees to pay its co-obligors.
ASU 2013-04 provides that an entity should measure obligations resulting from joint and several liability arrangements for which the total amount of the obligation is within its scope and is fixed at the reporting date as the sum of:
In addition, the entity is required to disclose the following information about each obligation, or each group of obligations, resulting from joint and several liability arrangements within the scope of ASU 2013-04:
ASU 2013-04 is effective for fiscal years and interim periods within those years, beginning after December 15, 2013. For nonpublic entities, ASU 2013-04 is effective for fiscal years ending after December 15, 2014, and interim periods and annual periods thereafter.
Uninsured risks. Losses from uninsured risks that relate to future periods should not be accrued in the current period because they should be recognized in the period that a loss occurs. In addition, they generally do not need to be disclosed unless: (FASB ASC 450-20-55-7)
Guarantees. FASB ASC 460-10 clarifies the disclosure requirements to be made by a guarantor in its financial statements about its obligations under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of the guarantee, a liability for the fair value of the obligation undertaken in issuing a guarantee. This recognition is an “interpretation” of GAAP contingency requirements as to the initial recording of a liability for the fair value of an obligation resulting from a guarantee. However, GAAP does not provide an approach for the subsequent measuring of the recognized liability over the term of the related guarantee.
The following are the types of guarantee contracts to which the provisions of FIN 45 (FASB ASC 460-10) apply:
FASB ASC 460-10 does not apply to every type of guarantee. For example, it lists the following as outside of its scope:
In addition, the following types of guarantees are not subject to the initial liability recognition requirements of GAAP, but are subject to its disclosure requirements:
There are generally two obligations of a guarantor:
GAAP requires that the noncontingent liability (first bullet) above be recognized at fair value in the statement of financial position. If a liability for the contingent obligation (second bullet) above is required to be recognized under FASB ASC 450 because it meets the probable and estimable criteria, the liability for the guarantee as a whole should be the greater of the liability for the noncontingent liability and the contingent liability components of the guarantee.
In terms of measuring the initial liability for a guarantee, GAAP provides the following guidance:
GAAP also addresses the situation where a guarantee is issued as a contribution to an unrelated party. The liability should be recognized at the inception of the guarantee and be measured at its fair value as contributions are measured at fair value. It also provides an example of a community foundation providing a loan guarantee program to assist a not-for-profit in obtaining bank financing at a reasonable cost. Under this type of program, the community foundation may issue a guarantee of a not-for-profit organization's bank debt. Upon the issuance of the guarantee, the community foundation would recognize a liability for the fair value of the guarantee. The issuance of the guarantee would not be considered merely a conditional promise to give because upon issuance of the guarantee, the not-for-profit organization will have received the gift of the community foundation's credit support, which enables the not-for-profit organization to obtain a lower interest rate for its financing.
While this example is directed to the guarantor, it can be interpreted from the example that the not-for-profit organizations benefiting from the loan guarantee would also record a contribution for the fair value of the guarantee. GAAP does not provide specific guidance as to how to value the guarantee, but without any evidence of premiums paid to the guarantor, the difference in the interest rate obtained with the guarantee compared with the interest rate that would have been obtained without the guarantee and discounted the cash flow differences between the two interest rates seems like a fairly logical and objective method of estimation.
Gain contingencies should be disclosed in the notes to the financial statements; however, the disclosure should indicate that this gain is not certain to be obtained. Contingencies that result in gains should not be accrued because future events still need to occur before this revenue is “earned.”
FASB ASC 740-10 provides guidance for consideration when there is uncertainty about:
However, FASB ASC 740-10 will only infrequently need to be considered, as the applicability and computation of this tax (including deferred amounts) are in most cases not likely to be uncertain. Further, since the tax rate is only 2% (1% in some cases), any uncertain tax amounts are not likely to be material to a foundation's financial statements.
Two exceptions to the above could be when:
The fundamental question is whether the organization has over $1,000 of net income, as defined in IRC Sec. 512(a), from an unrelated trade or business, as defined in Sec. 513(a). Since there is allowed a specific deduction of that amount, lesser amounts of net income will not result in any tax payable. (There is a $1,000 gross income threshold for filing Form 990-T, but if no tax is due, there will be no penalty for failure to file this form.)
The following aspects of this may give rise to uncertain tax positions:
When disclosures about loss contingencies are required, the following information should be presented:
In certain cases where a contingency would be very significant to the financial statements, contingencies arising after the financial statement date may be best disclosed by supplementing the financial statements with pro forma information that reports the loss as if it occurred at the financial statement date.
An audit of the organization's expenditures under a grant received from the Benevolent Foundation has reported questioned costs of $100,000 relating to costs that were charged to this grant. The organization is currently disputing this finding. At this time, the outcome is uncertain and the amount the organization may have to reimburse the Benevolent Foundation cannot be reasonably estimated.
Certain significant risks and uncertainties. FASB ASC 275-10 requires an organization to disclose risk and uncertainties that may significantly affect items reported in the financial statements in the near term. Disclosures required relate to the nature of the organization's operations, use of significant estimates, and the current vulnerability caused by certain categories of concentrations. While designed primarily for commercial enterprises, the disclosure requirements are applicable to not-for-profit organizations.
The above disclosures are specifically not applicable to the following:
Nature of operations. The disclosure should include a description of the organization's principal or major services or programs, as well as where these services are performed, and the major classes of funding or revenue sources. These disclosures should include both a discussion of support received from donors as well as fee-for-service activities.
Estimates/certain significant estimates. The use of estimates should be disclosed when both of the following criteria are met:
If both conditions are met, then the required disclosure would include a description of the nature of the estimate and would indicate that “it is at least reasonably possible that a change in the estimate will occur in the near term.”
Current vulnerability caused by certain concentrations. Several categories of concentrations exist, including the following:
Many not-for-profit organizations are highly dependent on a limited number of programs or contracts for a majority of their revenue. This concentration of risk is very common and these disclosure requirements should be carefully considered.
The not-for-profit organization would disclose the risks associated with the above mentioned concentrations if all of the following are met:
In addition, the following specific disclosures are required for two types of concentration risks:
The Metropolitan Museum is supported primarily by individual contributions and exhibit fees. Twenty percent of its operating revenue was derived from one art exhibit which ended during the fiscal year.
The Metropolitan Museum is supported primarily by individual contributions and exhibit fees. One major contributor provided 25% of the support of the organization during the fiscal year.
The City Day Care Center currently has a contract to provide day care services on behalf of the City of Example. Currently, this contract accounts for approximately 80% of the organization's revenues.
Going concern contingencies. If there is substantial doubt about an organization's ability to continue as a going concern for a period of time of one year beyond the statement of financial position date, the following information should be disclosed:
NOTE: In August 2014, the FASB issued ASU 2014-15 Presentation of Financial Statements—Going Concern (Subtopic 205-40) Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern to provide guidance about management's responsibility to evaluate whether there is substantial doubt about an entity's ability to continue as a going concern and to provided related footnote disclosures. Previously, these considerations were only contained in the auditing standards. ASU 2014-15 will make the considerations part of GAAP relative to the preparation of financial statements.
ASU 2014-15 provides that in preparing financial statements each year, an entity's management should evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity's ability to continue as a going concern within one year after the date that the financial statements are issued or are available to be issued.
ASU 2014-15 also provides that management's evaluation should be based on relevant conditions and events that are known and reasonably knowable at the date that the financial statements are issued or are available to be issued. Substantial doubt about an entity's ability to continue as a going concern exists when relevant conditions and events, considered in the aggregate, indicate that it is probable (using the same definition discussed in this chapter for contingencies) that the entity will be unable to meet its obligations as they become due within one year after the date that the financial statements are issued or available to be issued.
When management identifies conditions or events that raise substantial doubt about an entity's ability to continue as a going concern, ASU 2014-15 provides that management should consider whether its plans that are intended to mitigate those relevant conditions or events will alleviate the substantial doubt. The mitigating effect of management's plans should be considered only to the extent that (1) it is probable that the plans will be effectively implemented, and, if so, (2) it is probable that the plans will mitigate the conditions or events that raise substantial doubt about the entity's ability to continue as a going concern. If conditions or events raise substantial doubt about an entity's ability to continue as a going concern, but the substantial doubt is alleviated as a result of consideration of management's plans, the entity should disclose information that enables users of the financial statements to understand all of the following (or refer to similar information disclosed elsewhere in the footnotes):
If conditions or events raise substantial doubt about an entity's ability to continue as a going concern, and substantial doubt is not alleviated after consideration of management's plans, ASU 2014-15 provides that an entity should include a statement in the footnotes indicating that there is substantial doubt about the entity's ability to continue as a going concern within one year after the date that the financial statements are issued or available to be issued. In addition, ASU 2014-15 provides that the entity should disclose information that enables users of the financial statements to understand all of the following:
ASU 2014-15 is effective for annual periods ending after December 15, 2016, with early application permitted.
Guarantees. A guarantor should disclose the following information about each guarantee, or each group of similar guarantees, even if the likelihood of the guarantor's having to make any payments under the guarantee is remote:
For guarantees involving related parties, these disclosures are in addition to related party disclosures contained in FASB ASC 850-10.