Nonprofit Financial Statements: The Four Reports and What Each Must Show

FASB ASU 2016-14 became effective for fiscal years beginning after December 15, 2017 — meaning most nonprofits transitioned to the new presentation in fiscal year 2018 or 2019. Eight years later, board members who received training on the old three-class framework still ask why “temporarily restricted” no longer appears on the financial statements, and grant officers at foundations still send templates built around the pre-2018 terminology. Understanding what changed, and what the current statements must show, prevents the downstream confusion that creates errors in your funder reporting.

The Four Required Statements Under FASB ASC 958

FASB ASC 958 — the primary accounting standard governing nonprofit financial reporting — requires four financial statements. Each presents a different dimension of organizational financial health, and each serves a different reader: the board, the auditor, the funder, and the regulatory body.

The four statements are interconnected. Net asset balances flow from the Statement of Activities into the Statement of Financial Position. Cash activity in the Statement of Cash Flows must reconcile to changes in the cash line on the Statement of Financial Position. Functional expense totals on the Statement of Functional Expenses must match expense totals on the Statement of Activities. Discrepancies between statements are audit findings.

Statement of Financial Position

The Statement of Financial Position is the nonprofit balance sheet. It presents assets, liabilities, and net assets at a specific point in time — typically the last day of your fiscal year or a quarter-end date.

The critical nonprofit-specific feature is the net asset section. Under FASB ASU 2016-14, net assets are presented in exactly two classes: without donor restrictions and with donor restrictions. The former three-class presentation (unrestricted, temporarily restricted, permanently restricted) is no longer GAAP-compliant.

Net assets without donor restrictions represent resources the board can allocate at its discretion. Within this category, board-designated net assets — funds the board has set aside for specific purposes by internal resolution — must be disclosed separately but remain classified as without donor restrictions because the limitation is internal, not donor-imposed.

Net assets with donor restrictions include both purpose-restricted funds (donor requires the money be spent on a specific program) and time-restricted funds (donor has specified a future period for use). Permanently restricted endowments — where the donor has required the principal to be maintained in perpetuity — also fall in this class under the 2016-14 framework.

Auditors test the Statement of Financial Position for: completeness of restricted fund balances, proper classification of board-designated versus donor-restricted net assets, and consistency of restricted balances with the prior year’s Statement of Activities.

Statement of Activities

The Statement of Activities is the closest equivalent to an income statement, but its structure reflects nonprofit accounting principles that have no for-profit parallel.

Revenue is presented in two columns: without donor restrictions and with donor restrictions. This means a single grant receipt may appear entirely in the “with donor restrictions” column even though it was deposited in the operating bank account. Under FASB ASC 958-605, restricted revenue is recognized when the conditions of the grant are substantially met, not when the cash is received. A grant paid in advance is recorded as a deferred revenue liability, not as income, until the conditions trigger recognition.

When restricted funds are spent on their designated purpose and the restriction is satisfied, the Statement of Activities shows a line called “net assets released from restrictions” — a positive amount in the without donor restrictions column and a negative amount in the with donor restrictions column. This reclassification is not a revenue or expense event; it is a transfer between net asset classes.

Expenses appear only in the without donor restrictions column. Nonprofits do not record expenses as restricted. The act of spending restricted funds is the mechanism that releases the restriction — you spend the money on the approved purpose, then record the release.

Auditors test the Statement of Activities for: proper revenue recognition timing for restricted awards, accurate release-from-restriction entries with appropriate supporting documentation, and correct functional expense presentation.

Statement of Functional Expenses

The Statement of Functional Expenses presents expenses by both nature (what was purchased: salaries, rent, supplies, professional fees) and function (what organizational activity it served: program services, management and general, fundraising).

FASB ASC 958-720 requires all nonprofits to present this information. Voluntary health and welfare organizations must include it as a primary financial statement. Other nonprofits may present it in the notes or on the face of the Statement of Activities, but the underlying data must be available.

The allocation methodology — the basis on which shared costs are divided across functions — must be disclosed in the notes to comply with FASB ASC 958-720-45-2. Personnel costs are typically allocated based on time studies or time records that document what percentage of each employee’s time was spent on each function — the IRS Form 990 Part IX uses the same functional expense data and is publicly visible. Other shared costs (occupancy, depreciation, technology) are allocated based on documented methods such as headcount ratios, square footage percentages, or actual usage tracking.

The functional expense allocation is where auditors probe hardest, particularly for organizations with significant management and general expenses. A disproportionately high percentage of expenses classified as “program” relative to industry benchmarks will draw scrutiny. The IRS Form 990 Part IX uses functional expense data directly, and the percentages reported there are visible to the public through GuideStar/Candid.

Statement of Cash Flows

The Statement of Cash Flows presents the sources and uses of cash during the reporting period, classified into operating activities, investing activities, and financing activities.

For nonprofits, the direct method of presentation (showing actual cash receipts and payments) is encouraged by FASB but the indirect method (starting from change in net assets and adjusting for non-cash items) is permitted. Most nonprofits use the indirect method because it requires less detailed cash tracking.

The financing activities section includes restricted contributions received for long-term purposes — endowment gifts and capital campaign receipts — which are classified as financing rather than operating cash flows under FASB ASC 958. This is a nonprofit-specific presentation rule that has no for-profit equivalent.

Auditors test the Statement of Cash Flows for: reconciliation to beginning and ending cash on the Statement of Financial Position, and correct classification of restricted versus unrestricted cash receipts.

How Restricted Funds Appear Across All Four Statements

A single restricted grant moves through all four statements in a predictable sequence.

When the grant is awarded and payment is received in advance: cash increases on the Statement of Cash Flows (operating activities, or financing if it meets the long-term purpose criteria), deferred revenue increases on the Statement of Financial Position, and nothing appears on the Statement of Activities because the condition for revenue recognition has not been met.

When conditions are met and revenue is recognized: restricted revenue appears in the “with donor restrictions” column on the Statement of Activities, and the deferred revenue liability on the Statement of Financial Position is reduced.

When the grant is spent on approved purposes: expenses appear in the without donor restrictions column of the Statement of Activities (expenses are always presented as unrestricted), and a “net assets released from restrictions” entry reclassifies dollars from the with donor restrictions column to the without donor restrictions column.

At year-end: the cumulative effect of all these entries is reflected in the net asset balances on the Statement of Financial Position, which must agree to the prior year plus the current year’s change in net assets as shown on the Statement of Activities.

If your year-end Statement of Financial Position shows a restricted net asset balance for a grant that has been fully spent, one of three errors has occurred: the release from restriction was not recorded, expenses were recorded against the wrong fund, or the original revenue recognition entry was wrong. Any of these is an audit finding.

What Auditors Check on Each Statement

Your auditor’s PBC list will include requests tied to each statement. The patterns are predictable.

On the Statement of Financial Position: auditors confirm restricted fund balances with grantor letters and donor gift agreements, test that board-designated reserves have supporting board resolutions, and verify that endowment balances match investment statements.

On the Statement of Activities: auditors test a sample of restricted revenue receipts for proper recognition timing, review all releases from restriction for supporting documentation showing conditions were met, and agree functional expense totals to the Statement of Functional Expenses.

On the Statement of Functional Expenses: auditors examine the allocation methodology for personnel costs, looking specifically for time records or time studies that support the percentages used. Undocumented functional allocations — applying a percentage to personnel costs without supporting time records — are a management letter comment in virtually every audit where they appear.

On the Statement of Cash Flows: auditors confirm the beginning and ending cash balances tie to bank statements and Statement of Financial Position, and verify that restricted cash receipts are correctly classified between operating and financing activities.

For a foundational overview of how restricted funds are accounted for, see Restricted Fund Accounting Basics. For a guide to FASB ASC 958’s full reporting framework, see FASB ASC 958 Nonprofit Reporting. For a checklist approach to fiscal year-end close, see Nonprofit Fiscal Year-End Close Checklist.

DEFINITION

Statement of Financial Position

The nonprofit equivalent of a balance sheet, showing assets, liabilities, and net assets at a point in time. Net assets are classified as with donor restrictions and without donor restrictions under FASB ASU 2016-14.

DEFINITION

Net assets with donor restrictions

Resources whose use is limited by donor stipulations — either for a specific purpose or for a future time period. Includes funds that were previously classified as temporarily restricted or permanently restricted under the pre-2018 framework.

DEFINITION

Functional expense allocation

The process of distributing expenses across program services, management and general, and fundraising functions, typically based on time studies for personnel costs and direct identification or allocation methods for other costs. Required to be disclosed under FASB ASC 958-720.