It still surprises me how regularly I look at audited financial statements and find significant unusual activity in the operating section as revenue.
While this is not prohibited, here’s why it matters.
The problem with one-time events
When you have a one-time release of funds coming from restricted to unrestricted because a donor changed intent, or you found something that should have been released years ago, that is not something that will occur year after year. By definition, that would generally be considered non-operating.
Another common example involves donations for buildings, equipment, or other capital projects. As we construct these buildings, the cash goes out the door over a one- to three-year period. But the source of funds, if it was related to donor gifts, gets moved all at once to unrestricted only once the building is placed into service. This creates a significant mismatch in the timing of your financial statements. The cost of construction never appeared on the income statement in the first place, so now you have a significant revenue appearing that, if shown as operating, would distort the results of that year.
What the accounting guidance says
The accounting guidance related to operating versus non-operating gives us flexibility. According to the American Institute of Certified Public Accountants’ (AICPA) Not-for-Profit Guide, which interprets FASB ASC 958-220-45:
…the statement of activities generally should report the gross amounts of revenues and expenses for an NFP’s ongoing major or central operations and activities; gains and losses may be reported as net amounts if they result from peripheral or incidental transactions or from other events and circumstances that may be largely beyond the control of the NFP and its management. The frequency of the events and the significance of the gross revenues and expenses distinguish major or central events from peripheral or incidental events.
Events are ongoing major and central activities if they are normally part of an NFP’s strategy and it normally carries on such activities or if the event’s gross revenues or expenses are significant in relation to the NFP’s annual budget.
The AICPA guide further notes that:
…if an intermediate measure of operations, such as an excess or deficit of operating revenues over expenses, is reported in a statement of activities, (a) a note to financial statements should describe the nature of the reported measure of operations or the items excluded from operations if the NFP’s use of the term operations is not apparent from the details provided on the face of the statement, and (b) it must be in a financial statement that, at a minimum, reports the change in net assets without donor restrictions for the period.
While there are examples of what should be considered non-operating, these types of transactions are not specifically listed as such—leaving it up to management to decide if they qualify as ongoing major and central activities. As long as the treatment is consistent from year to year, this is not prohibited.
The cost of inconsistency
The problem comes into play when leadership does not understand these dynamics and finds itself facing inconsistent year-end results, with wild swings between breaking even and running deficits.
If we stripped out these unusual items, it would show a clearer picture of what is actually happening. For many small institutions, it would reveal consistent deficits that are growing over time.
This treatment also contributes to deferred maintenance challenges because the timing of these cash flows goes unexamined.
The path forward
If this sounds familiar, it may be time to start discussing what your numbers would look like if these unusual activities were not included, allowing leadership and the board to understand the “real” operating dynamics of your institution, especially as we enter the decades of the demographic cliff.
Now, I understand that moving these into non-operating may hurt your debt service coverage ratio, so you may not be ready to change how you report these activities for now. But if you don’t focus on these dynamics internally, it will be harder to make informed decisions about your future.