Government and Other Non-for-profit entities Accounting (ACFN

431)
UNIT ONE
Financial Reporting Environment for
Governmental and Not-For-Profit(GNFP) Entities
1.1 Meaning and Importance of NFP
1.1.1 Meaning of NFP
In accounting literatures there is no consensus as to the exact definition of what a Not for profit
Entity (NFP) mean. In day-to-day language, however, the term means an entity whose principal
objective is not the generation of profit. In this sense the term NFP also includes various types of
Governments. This definition even though it is correct but it is probably too summarized. As a
result it becomes essential to search a better definition.
In the process of searching for better definitions it has to be noted also that different countries do
have various criteria so as to count one entity as a non-for profit or not. In Canada, for example, the
criteria of being an NFP include a lack of transferable ownership, and a lack of financial return from
the NFP entity by resource providers. In the U.S.A. criteria include contributions of significant
amounts of resources from resource providers who do not expect commensurate or proportionate
pecuniary return, operating purposes other than to provide goods or services at a profit, and absence
of ownership interests like those of business enterprises. In New Zealand, the criterion used is
simply listing the organizations included under it. The organizations included are charities,
philanthropic trusts, welfare agencies, churches and sports organizations.
Taking into account the above criteria then we could define a Not-for-profit entity as any entity in
respect of which there is an absence of defined ownership interests that can be sold, transferred,
or redeemed, or that convey entitlement to a share of a distribution of resources, including a
residual distribution on liquidation of the entity.
In summary, the term NFP could be understood as an entity that possesses the following
characteristics that distinguish it from a business enterprise: (a) contributions of significant
amounts of resources from resource providers who do not expect commensurate or proportionate
pecuniary return, (b) operating purposes other than to provide goods or services at a profit, and (c)
absence of ownership interests like those of business enterprises.
1.1.2 Importance of NFP
Have you asked yourself why you are studying this course? If you did, this section will provide
you
some answers. To answer the question it would be good if we see and appreciate then the role of the
sector and thereby also discover the important of studying governmental and non-for profit
accounting. Some of the reasons are listed below:

Page 1
 Government and Other Non-for-profit entities Accounting (ACFN
431)
I. To better understand Reports of government and non-for profit organizations: With the
accounting courses you have taken you are well equipped to understand reports of business
organizations but not not-for profit-entitles. Once you have completed successfully this course you
will be having the competency to understand the reports of non-for-profit sectors and thereby
observe how our taxes and charitable donations are used effectively and efficiently.
II. To increase the employability of yourself: Probably one of the reasons why you are
studying accounting is because you want to advance in your career. The study of this course for
sure will increase your employability by increasing employment opportunities in the not-for-
profit sector. The employment opportunities awaiting you include but not limited to being a public
accountant, being hired in CPA Firms, and/or as a private accountant, being employed in
government and non- for profit organizations.
III. To be aware of the impact of the sector: whether we like it or not it has become a fact of life
that NFPs and governments do affect our daily life. Therefore, we have to assess their impact. In
Ethiopia as well as around the globe rather than decreasing their impact is also becoming significant
and increasing. They are indeed becoming the major political, social and economic factors in an
economy to the extent of contributing 1/3 of expenditures in a national economy. This very fact
makes it evident that we have to study so as to appreciate their impact on our daily basis.
IV. Due to a need for sound financial management. Since the sector holds giant amount of
scared resources, the need for sound financial management for best use is as important as the private
sector. Besides the giant resources the sector holds, it also finances often more complex than
comparable size of private business. Accountings being one of the tools of sound financial
management studying become essential.
V. To succeed in accounting related professional exams. In response to an increased demand to
professionals in the sector, questions related to the government and NFPs sector are now
representing substantial portion of accounting related professional exams. And therefore it is
becoming that knowledge of the sector is becoming no more an option rather a must. For example,
in CPA Exam in Accounting and Financial Reporting Section significant amount of questions are
embodied.
1.2 Significance Differences and Similarities with Business organizations
1.2.1 Significance Differences with Business Organizations
While you were reading the module introduction, you have been told that accounting for NFPs and
governments are different from accounting for business organizations. The accounting differences
are due to the fact that NFPs do have characteristics that make them to be significantly different
when compared to the business organizations. The following are, though not an exhaustive lists,

Page 2
 Government and Other Non-for-profit entities Accounting (ACFN
431)
major difference of the sector in relation to the for profit sector. While reading it is helpful to ask
oneself in terms of what kind of implication does it have on financial reporting?
I. Difference in Operating purposes or Organizational objectives
Generally speaking NFP entities are not in business to make profit. They are rather operating for
purposes other than providing goods and services at a profit or profit equivalent. For these
organizations the profit motive is not inherent in their inception or operation. This is obviously
contrary to business organizations which do have a profit maximization motive and therefore seek
to increase wealth of owners and therefore basically focus on net income and earnings per share.
Behind commercial accounting and financial reporting model then there is an economic system
based upon the profit motive. Commercial accounting theory is based upon a matching relationship
between revenues and expenses, wherein the sale of a product or service gives rise to the
recognition of costs related to the sale. Accrual accounting, using accrual, deferral, and amortization
techniques, facilitates the determination of cost.
On contrary to businesses these organizations provide goods and services to a community or society
as a whole, often without reference to whether costs incurred are recouped through charges levied
on those receiving them and without regard to whether those receiving the goods and services are
those paying for them. There is no profit motive, there are no individual shareholders to whom
dividends are paid, and the success or failure of NFP entities usually cannot be evaluated in terms of
net income or earnings per share. This feature obviously demands then an accounting theory based
on the non-for profit motive.
II. Difference in source of financial resources
NFP entities receive significant amount of resources from individuals or organizations who or
which do not expect to receive either direct repayment or economic benefits proportionate to the
resources they provided. In simple term then non-economic reasons are commonly factors in
decisions to provide resources to particular non-business organizations. The consequence is then the
organizations receive of significant amounts of resources from resource providers, who do not
expect to receive either repayment or economic benefits proportionate to resources provided.
As a result, for governmental organizations, taxation is the major source of financial resources in
addition to grants, intergovernmental transfers and charges for goods and services. A not for profit's
also similarly secure financial resources mainly from grants and member contributions rather than
owners investment, which is in for profit enterprises. In case where user charges are collected, these

revenues from charges for goods and services provided are mainly intended to cover operating costs
rather than adding value to the firm. The financial sources are basically of voluntary or involuntary

Page 3
 Government and Other Non-for-profit entities Accounting (ACFN
431)
contributions based on governmental or non-governmental non-for profit entity.
III. Difference in ownership interest and stewardship for resources
These entities are usually owned collectively by their constituents rather than associated to
individual owners who can be referred too. There are no clearly defined ownership interests, like for
example a stock certificate, that can be sold, transferred, redeemed or convey entitlement to a share
of a residual distribution of resources in the event of liquidation of the entities. Lack of individual
ownership coupled with a substantial portion of the resources of the entities being from contribution
from the public, the organizations must account for the resources on a stewardship basis. The
stewardship requirement makes then the necessity of complying with various legal provisions. And
the two most important legal provisions affecting accounting are those relating to (1) budgeting and
(2) funds
IV. Difference Measurement of objectives or output
In business organizations the major goal of wealth is found to be creating wealth to owners. As a
result of such objective net income or earning per share can measure the performance of the
business. In NFP sector, however, measuring the objectives or outputs in either monetary terms or
any other quantitative terms is very much difficult. The success of the organizations hinges on the
facts that to what extent are they fulfilling the mission statement for which they are created.
V. Difference in whom they serve
The main purpose of the sector is to render goods and services to society as a whole. Here the word
society might range from a limited number of citizens in a community to almost the entire
population of a city. For example, a foundation which is designed to serve heart patients is limited
to people who do have heart sickness. You have to remember that NFPs are not mainly after
demand (people who could afford to pay) rather needs.
VI. Difference in internal accounting
In business, the revenue-expense matching relationship plays such an important role but this does
not exist in non-for profit entities. This is basically because in the first place, they are operating to
marshal resources from a variety of sources to provide services unrelated to the specific revenues
used to pay for the services. Secondly, it is highly unlikely that those who provide the resources (for
example, individual taxpayers) provide them in the same proportion as the value of the services they
consume. In short, mostly there are no sales to drive the recognition of related costs in general-
purpose governments.
Owing the above facts then internal accounting for the sector focuses on compliance with legal,
donor and other similar restrictions and ensuring spending does not exceed budget and is made on
and for predetermined goods and services only. In business organization, internal accounting mainly

Page 4
 Government and Other Non-for-profit entities Accounting (ACFN
431)
focuses on ensuring that spending is generating required income. The internal accounting is mainly
driven by the question of having sufficient resources to discharge its objective.
VII. Difference in use of budget
Budget is the most widely used method for control resources of non-for profit entities. It helps the
entities to identify sources and uses of financial resources. Because of its unique feature in
controlling financial resources, preparation of an annual or otherwise budget is mandatory in most
of the entities. The driving force behind most of the activities of non-for profit sectors is the budget.
In terms of public administration, in governmental entities, the budget and the related appropriation
acts represent an important expression of the separation of powers as between the executive and the
legislative branches. Prepared by the executive branch, the budget is at once an economic, social,
and political document; a statement of spending priorities; a plan of action; and a legal instrument.
Since the amounts appropriated by the legislature represent legal limitations on spending for
particular programs, activities, or objects, the budget is perhaps the most fundamental internal
control in government.
VIII. Difference in regulation and control
Business organizations choose on the type and quantity of goods and services they provide to the
public, based on the invisible hand principle. And also does have the right to decide on the amount
resources they may spend for different activities they perform to achieve their profit objectives. The
not for profit entities, on the other hand, may be required by law and/or contractual agreements to
provide certain goods and services irrespective of the fact that they choose it or not. Besides,
spending is usually governed by legal budget and/or contractual restrictions as to amount and
purpose of spending.
IX. Difficulty in evaluating operating performance and the need for stringency in
control
From the characteristics of NFPs we have discussed so far probably you have noticed that
evaluating the performance and operating results of most NFP entities is extremely difficult for
several reasons. The reasons are many but the most important ones are:
 There is no open market supply and demand test of the value of the goods and services
they provide.
 The relationship, if any, between the resource providers and the receipts of the goods
and services is remote and indirect.
 Such entities are not profit-oriented in the usual sense and are not expected to
operate profitably. As a result, the profit test is neither a valid performance indicator
nor an automatic regulating device.

Page 5
 Government and Other Non-for-profit entities Accounting (ACFN
431)
 when it comes to government, it can force resource contributions through taxation.

X. The Need for Stringent control

As a result, other operating results measures and controls must be employed to ensure that NFP
entity resources are used appropriately and to prevent uneconomical or ineffective NFP entities
from continuing to operate in that manner indefinitely. NFP entities, particularly GOs are therefore
subject to more stringent legal, regulatory and other controls than are private profit-seeking entities.
Such regulatory and control measures may be internally imposed ones such as charter, bylaw and
ordinances or externally imposed ones such as governmental statute, trust agreement, donor
stipulations and contracts. Furthermore, the need to ensure compliance with such extensive legal
and contractual requirements often results in more stringent operational and administrative controls
than in private profit-seeking enterprises. This involves substitution of statutory, fund and budgetary
controls for the supply and demand and profit regulator/control devices inherent in profit-seeking
organizations.
Aspects of NFP entity operations that may be regulated or otherwise controlled include:
Organization structure- form; composition of its governing board; the number and duties of its
personnel; lines of authority and responsibility; which officials or employees are to be elected,
appointed, or hired from among applicants.
Personnel policies and procedures- who will appoint or hire personnel; tenure of personnel;
policies and procedures upon termination; extent of minority group or women representation on the
staff; compensation levels; promotion policies; and permissible types and amounts of compensation
increments.

Sources of financial resources- the types and maximum amounts of taxes, licenses, fines or fees a
government may levy; the procedure for setting user charges; tuition rates; debt limits; the purposes
for which debt may be incurred; the allowable methods for soliciting charitable contributions.
Use of financial resources- the purpose for which resources may be used, including earmarking of
certain resources for use only for specific purposes; purchasing procedures to be followed;
budgeting methods, forms, or procedures to be used.
Accounting- any or all phases of the accounting system; for example, chart of accounts, bases of
accounting, forms and procedures.
Financial reporting- type and frequency of financial reports; reports format and content; report
recipients.
Auditing- frequency of audit; who is to perform the audit; the scope and type of audit; the time and
place for filing the audit report; who is to receive or have access to the audit report; the wording of
the auditor’s report.

Page 6
 Government and Other Non-for-profit entities Accounting (ACFN
431)
Thus, managers of NFP entities may have limited discretion compared with managers of business
enterprises.
1.2.2 NFPs Similarity with Business Organizations
In the above section you have studied the major differences that make NFPs unique from business.
In this section you will realize that even if non-for profits do have differences, which make them
unique from business, they have also similarities they share. The following are partial lists of the
overlaps:
 Both NFPs and business do acquire resources to provide goods or
services
 Both are integral part of the same economic system. As a result, they
operate and compete for same resources in financial, capital, and human
markets.
 In some instances both NFPs and business do provide goods and
services, many of which may be similar. Examples are transportation
systems (transit, airports, and roads), Sanitation services, and utilities.
 Both NFPs and business do use of accounting & other information
systems for informed decision making.
 Both NFPs and business do use financial management processes
 Both NFPs and business do use Cost analyses, control and evaluation
techniques
1.3 How Do Governmental Entities Differ From Not-For-Profit Organizations?
In the above discussions the term not-for- profit organization has been used as a broader term
including both various levels of governments and private not-for profits. In a restricted sense of the
term, however, Non-for-Profit is usually is used to connote only private not-for-profits.
Governments, however, do have also unique characteristic that makes them to be different from
private not-for-profits entitles. These characteristics are:
1. Power ultimately rests in the hands of the people: the controlling majority of members of
governing board of state or local governments are either voted or appointed
2. Government NFPs are created by and accountable to a higher-level government: The higher level
government usually does have a potential for unilateral dissolution by a government with net
assets reverting to government.
3. Government NFPs do have power to enact and enforce a tax levy to raise revenue for covering
their expenditures.
4. Governmental NFPs do have the ability to issue tax-exempt debt

Page 7
 Government and Other Non-for-profit entities Accounting (ACFN
431)
1.4 Users and Uses of Financial Reporting
As any other accounting reports government financial reporting is derived from a need to satisfy the
information needs of a variety of users. Based on a review of accounting literature and authoritative
pronouncements on financial reporting by governments, the principal users of government financial
reporting are:
I. Legislative and other governing bodies: Legislative and governing bodies grant authority to
governments and to their units to administer public financial affairs and resources, and subsequently
hold them accountable. They are primary users of government financial reports. They look to
financial reports to provide information to help them asses the government's stewardship of
resources, compliance with legislation -and other authorities, state of finances and performance.
II. The public: Legislatures and governing bodies of units are accountable to the public who
provide the revenues and resources necessary for government operations, who receive government
services and who are the beneficial owners of the public money and property. The public Includes
taxpayers, electors, voters, special interest groups and recipients of goods, services or benefits
provided by the government. These various groups often rely heavily on reports in the media. The
public and media seek information on how well governments have managed their financial affairs
and resources" and or the overall economic impact of government activities.
III. Investors and creditors: Investors in government securities and enterprises and other
creditors provide financial resources to governments. Governments have an interest in providing
investors and creditors with information that Is useful in evaluating the government's or a particular
unit's ability to finance Its activities and to meet its 'liabilities and commitments. Sometimes,
investors and creditors seek specific information ill addition to the general-purpose financial
reports.
IV. Other governments. International agencies and other resource providers: Similar to investors
and, creditors, other governments, international agencies and other resource providers are interested
in a government's or units' state of finances. In addition, they are also 'interested in its plans and
priorities.
V. Economic and financial analysts: Economic and financial analysts, including the financial
media, review, analyze and disseminate information to other users, legislators, the, public, other
governments, resource providers. They use the information provided to: analyze and evaluate
financial and economic issues.
1.5 Objectives of Financial Reporting
As a general principle, financial reports should communicate Information that is relevant to the
decision-making and accountability needs of users. In fact, accountability and decision-making

Page 8
 Government and Other Non-for-profit entities Accounting (ACFN
431)
may be viewed as the overriding objectives from which all of the other objectives flow. Based on
the user information needs, identified, and taking into consideration the limitations of financial
reporting and the governmental environment, the following three objectives of general-purpose
financial reports of non for profits organizations are deduced.
1.5.1 Objectives of Accounting and Financial Reporting for the Federal government

The Federal Accounting Standards Advisory Board (FASAB) was established to recommend
accounting and financial reporting standards to the "principals," the U.S. Office of Management and
Budget, the U.S. Department of the Treasury, and the U.S. General Accounting Office. The FASAB
has passed three Statements of Federal Financial Accounting Concepts (SFFACs). These concepts
apply to financial reporting for the federal government as a whole and for individual reporting
agencies.
SFFAC I, Objectives of Federal Financial Reporting, outlined four objectives that should be
followed in federal financial reporting. The first, budgetary integrity indicates that financial
reporting should demonstrate accountability with regard to the raising and expending of moneys in
accord with the budgetary process and laws and regulations. The second, operating performance,
suggests that financial reporting should enable evaluation of the service efforts, costs, and
accomplishments of the reporting entity. The third, stewardship reflects the concept that
financial reporting should enable an assessment of the impact on the nation of the government's
operations and investments. Finally, the fourth, systems and controls, indicates that financial
reporting should reveal whether financial systems and controls are adequate. ,

1.5.2 Objectives of Financial Reporting by Not-for-Profit Entities

In its Statement of Financial Accounting Concepts No.6, the FASB emphasized that its concern is
with financial reporting to users who lack the authority to prescribe the information they want and
who must rely on the information management communicates to them to make economic decisions.
Therefore, the FASB stresses that the objective of financial reporting by not-for-profit organizations
is to provide information to "present and potential resource providers and others in making rational
decisions about allocating resources to not-for-profit organizations.''
1.5.3 Objectives of Accounting and Financial Reporting for State and Local Governmental
Units
The Governmental Accounting Standards Board was established in 1984 as the successor to the
National Council on Governmental Accounting (NCGA). In 1987 the GASB issued its Concepts
Statement No.1, Objectives of Financial Reporting, for state and local governments. In that
statement the Board noted the following:

Page 9
 Government and Other Non-for-profit entities Accounting (ACFN
431)
Accountability requires governments to answer to the citizenry-to justify the raising of public
resources and the purposes for which they are used. Governmental accountability is based on the
belief that the citizenry has a right to know, a right to receive openly declared facts that may lead to
public debate by the citizens and their elected representatives. Financial reporting plays a major role
in fulfilling government's duty to be publicly accountable in a democratic society.
Financial reports of state and local governments, according to the Governmental Accounting
Standards Board, are used primarily to:
(1) Compare actual financial results with the legally adopted budget;
(2) Assess financial condition and results of operations;
(3) Assist in determining compliance with finance-related laws, rules, and regulations; and
(4) Assist in evaluating efficiency and effectiveness.
In 1994 the GASB issued its Concepts Statement No.2, Service Efforts and Accomplishments
Reporting, to encourage state and local governments to experiment with reporting more complete
information about a governmental entity's performance than can be displayed in traditional financial
statements. Indicators of service efforts include inputs of nonmonetary resources as well as inputs of
dollars. Indicators of service accomplishments include both outputs and outcomes.

Page 10