Debt In addition to the accounts payable and accrued expense liabilities described above, not-for-profit organizations generally have a liability for at least some form of debt which they have incurred. Debt is known by several different names, usually based on how long the debt has before it becomes due, or matures. For example, a short-term loan is generally evidenced by some type of legal instrument, commonly referred to as a note. These types of loans are usually recorded in the financial statements as notes payable, and generally mature in five years or less. There are a wide variety of transactions that may give rise to notes payable, some of which are very common. For example, a not-for-profit organization may purchase new office equipment and desire to pay off the purchase price over a three-year period. The equipment seller would usually have the organization sign a promissory note for the purchase price, providing a legal basis for their future right to collect the purchase price, including interest, from the not-for-profit organization. Another common form of short-term debt incurred by not-forprofit organizations is that of short-term cash advances received from lines of credit. Often, not-for-profit organizations receive donations on a cyclical basis. December is a popular time for donations, as the holiday season puts many donors in the spirit to give and donors rush to make contributions before the end of the calendar year for tax purposes. However, since a not-for-profit organization’s cash needs may be quite different from its pattern of cash receipts, many organizations obtain a credit line from a bank to help them through any cash-short times. It is important to note that a liability is not recorded at the time that the not-forprofit organization obtains the line of credit, but rather when it draws down on the credit line. For example, assume that the organization negotiates with a bank and obtains a credit line of $10,000. No money is borrowed, but similar to a consumer home equity credit line, the $10,000 is available at will by the not-forprofit organization. No liability is recorded at this time, although the existence of the credit line must be disclosed in the notes to the financial statements. Let us say that during the year the notforprofit organization draws $8,000 against the line, and at the end of the fiscal year the $8,000 is still outstanding. The statement of financial position would show a liability o $8,000 (in addition to any amount of accrued interest expense that should be recorded), reflecting the actual amount owed under the credit line. Longer-term debt incurred by a not-for-profit organization is usually associated with the construction of a facility or other major capital improvement. Long-term debt may take the form of bonds or a mortgage or other long-term financing from a financial institution. Larger not-for-profit organizations sometimes issue bonds to finance construction or purchase of significant facilities. The specific mechanics of these types of transactions are beyond the scope of this book. Suffice it to say that the unpaid principal of the bonds will be recorded as a liability on the statement of financial position of the not-for-profit organization. Since bonds can be sold at either a discount (e.g., a $1,000 face value bond can only be initially sold for $980) or a premium (e.g., a $1,000 face value bond is initially sold for $1,020), the liability recorded on the financial statements would represent the face amount of the bonds (also called their par value), decreased by discounts and increased on premiums on the initial sales of the bonds. Note that the total of the discounts or premiums is amortized (written off) gradually over the life of the bond. This amortization results in either a decrease in interest expense (in the case of a discount) or an increase in interest expense (in the case of a premium). Other long-term financing obtained by a not-for-profit organization often takes the form of bank loans secured by mortgages against the specific facilities constructed. The outstanding 26 Understanding the Basics of Not-for-Profit Accounting balances of these loans are reported as liabilities on the statement of financial position of the not-for-profit organization. All types of debt incurred by not-for-profit organizations will give rise to interest expense. Interest expense follows similar concepts for accruing other types of expenses. Interest expense is recognized as an expense when it is earned by the holder of the not-for-profit organization’s debt, regardless of when the interest is actually paid, as explained in this example:
Practical Example A not-for-profit organization with a September 30 year-end makes semiannual interest payments—on January 1 and July 1 each year—on bonds that it has sold. Interest is paid in arrears, which means that it is paid after it has been earned by the bond holder. In other words, the January 1 interest payment is for interest earned by the bond holder from July 1 to December 31. Accordingly, the January 1 interest payment includes interest relating to the period of July 1 through September 30. Interest related to this period must be accrued as interest expense by the not-for-profit organization in its September 30 financial statements. Accruing interest results in the recording of an accrued interest liability (another type of accrued expense liability as previously discussed), with a corresponding amount recorded as interest expense. When the actual payment is made on January 1, the accrued interest liability is reduced to zero, with the balance of the interest payment recognized as interest expense in the year that the payment is made.
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