Governmental and nonprofit accounting versus commercial accounting

Accounting Fundamentals for Healthcare Management

This paper examines governmental and nonprofit accounting and discusses how it differs from commercial accounting. In the accounting field, there may not always be a clear distinction between the three types of organizations. The dividing line between business and nonbusiness organizations may depend on the incidence and relative importance of the nonbusiness characteristics found in an entity. The funds of such organizations are usually earmarked for specific purposes and must be used in accordance with laws, regulations, or contractual requirements.

One distinction of nonbusiness organizations is that they generally have no single indicator of performance, such as profit or net income. FASB:CS-4 provides two performance indicators for financial reporting for nonbusiness organizations:

They provide information about the nature and relationship between inflows and outflows of resources.

They provide information about service efforts and accomplishments.

FASB: CS-4 also sets forth the distinctive features of the nonbusiness organization:

Nonbusiness organizations receive significant amounts of resources from providers who have no expectation of receiving either repayment or economic benefits proportionate to resources provided.

Their primary operating purposes are other than providing goods or services at a profit or profit equivalent.

They have no defined ownership interests that can be sold, transferred, or redeemed, or that convey entitlement to a share of a residual distribution of resources in the event of the organization's liquidation.

The performance of nonbusiness organizations is usually not subject to direct competition in markets as is the performance of business enterprises. (Siegel & Shim, 2006).

The objectives that FASB: CS-4 identifies apply to general purpose financial statements issued by nonbusiness organizations. The objectives are intended to satisfy the needs of external users who generally cannot prescribe the information they want an organization to provide. Therefore, the objective of financial reporting is accountability to the public rather than investors. As a result, the accounting equation associated with nonprofit accounting is:

Assets = Accountability

Accounting systems for nonprofit organizations must provide financial data to internal management for use in planning and controlling operations and to external parties, such as taxpayers and contributors, for use in determining operational effectiveness. The systems should include mechanisms to ensure that management observes restrictions imposed upon it by law, charter, or bylaws. Systems should also provide for financial statements to taxpayers, members, donors, and contributors that such restrictions have been satisfied. For these reasons a nonbusiness organization typically applies the concept of fund accounting along with a budget and appropriations method; they also apply encumbrance accounting to account for the assets and revenues that the organization receives, and to ensure that expenditures are made only for authorized purposes.

Encumbrance accounting is used in most governmental funds in order to prevent over expenditure and to demonstrate compliance with legal requirements. Encumbrances are monies that have been set aside for specific future purposes. Encumbrances are unique to governmental operations and have no counterpart in commercial accounting.

Nonfund accounts

The modified accrual or full accrual basis of accounting is used. Governmental funds revenues and expenditures should be recognized on the modified accrual basis. The recognition criteria for revenues include the following:

Revenue is earned during or levied for the period.

Revenue is objectively measurable.

Revenue is collected in the period or soon enough thereafter, usually 60 days, to pay for liabilities incurred for expenditures of the period.

The following are recognition criteria for expenditures:

When operating or capital outlay liabilities are to be paid currently from governmental funds are incurred

When debt service (principal and interest) payments on long-term liabilities are due

The accounting equation of most governmental funds is:

Financial assets -- Related liabilities = Fund balance

In effect, governmental funds are essentially working capital funds, and their operations are measured in terms of sources and uses of working capital.

The accounting equation of proprietary funds is similar to that of a business corporation. It includes accounts for all related assets and liabilities, not just for current assets and current liabilities. Accounting measures net assets, changes in net assets, and cash flows. The accounting equation is:

The sum of Current assets + Capital assets minus the sum of Current + Long-term liabilities = Net assets

Proprietary fund operations are measured in terms of revenues earned, expenses incurred, and net income or loss. Revenue is recognized when it is earned and becomes measurable, while expenses are recognized in the period incurred.

Fiduciary revenues and expenses should be recognized on the accrual basis. Fiduciary funds are accounted for by specific fund type depending upon the nature of the fund. Fiduciary funds include:

Nonexpendable Trust Funds

Expendable Trust Funds

Pension Trust Funds

Agency Funds

Expendable trust funds are accounted for in the same way as governmental funds, while both Nonexpendable Trust Funds and Pension Trust Funds are accounted for in the same way as proprietary funds. Agency Funds are purely custodial (that is, assets equal liabilities); assets and liabilities should be accounted for on the modified accrual basis. Fiduciary fund revenues and expenditures should generally be recognized on the accrual basis.

Nonprofit Organizations

Accounting and reporting standards that are applicable to nonprofit organizations are similar to standards for governmental units, including frequent segregation of activities by fund. Two standards that are specific to nonprofit organizations include FASB 116 and 117. FASB 116 sets standards for accounting for contributions received and made. Under FASB 117, standards are provided to enhance the usefulness, comprehensiveness, and comparability of financial statements.

Examples of Healthcare Entity Types

The following entities are examples of nonprofit healthcare organizations:

Sisters of Charity Hospital

Haight Ashbury Free Clinic

American Red Cross Adult Dental Clinic

The following entities are examples of governmental healthcare organizations:

Veterans Administration Hospital

Palm Beach County Dental Health Clinics

St, Lawrence County Mental Health Clinic

The following entities are examples of for profit healthcare organizations:

Kaiser Permanente

Facey Medical Clinics

Smile Dental Group

Works Consulted

Horowitz, K.J. (2006, February 26). State and Local Government Accounting Principles. Retrieved on Aril 15, 2011 from Mercer County Community College website: http://www.mccc.edu/~horowitk/documents/Chapter02D.pdf

Ruppel, W. (2010). Governmental Accounting Made Easy. Hoboken, New Jersey: John Wiley & Sons, Inc.

Siegel, J.G., & Shim, J.K. (2006). Barron's Accounting Handbook (4th ed.). Hauppage, New York: Barron's Educational Series.