Raffie’s Kids, a nonprofit organization that provides aid to victims of domestic violence, low-income families, and special-needs children, has a 30-year, 5% mortgage on the existing building. The mortgage requires monthly payments of $3,000. Raffie’s bookkeeper is preparing financial statements for the board and, in doing so, lists the mortgage balance of $287,000 under current liabilities because the board hopes to be able to pay the mortgage off in full next year. Of the mortgage principal, $20,000 will be paid next year if Raffie’s pays according to the mortgage agreement. The board members call you, their trusted CPA, to advise the on how Raffie’s Kids should report the mortgage on its balance sheet. What is the ethical issue? Provide your recommendation and discuss the reason for your recommendation.
student 1 (Richard):
Raffie’s Kids balance sheet is a snapshot of the organizations financial position as it is at the specified time and is usually at the end of a trading period. As a Non-Profit Organization, Raffie’s Kids have to be aware of all the financial reporting requirements. Sponsors, individual donors, state, foundations provide financial and other resources to Non-profit organizations and at the same time they expect fulfillment of public goals by the activities of non-profit organization. Raffie’s Kids just like other Non-profit organization cannot function without the this type of management(Hajduova,& Husakova, 2014).Therefore, Raffie’s Kids is obligated to maintain a balance sheet that outlays true and fair position of its financial position.
Raffie’s Kids should treat and report its current mortgage balance amount of $287,000 as its principle mortgage. The mortgage is planned to be cleared within a year, therefore it should be reported as a current asset. In addition, Raffie’s Kids should report all the interest that it has accrued since the last payment as interest payable under current liabilities. The organization pays an installment of $3000 from which an interest payable of 5% is charged ($3000 x 5%) per month which is equal $150. The annual interest payable for the organization is approximately ($150 x 12) or $1800. However, the General Accepted Accounting Standards does not require non-profitable organizations to report future anticipated interest, as a result the $20,000 mortgage principle should not be reported on the balance sheet.
The ethical issue of reporting this mortgage on the balance sheet consists of pressure from the management requiring the accountant to ensure the report is positive to the investors. I would recommend the organization to do away with mortgage as a source of financing and rather opt for donations and simple loans. This is because despite a mortgage charging low interest in the short run, it’s the most expensive source of fund with borrower paying a total cash almost double the initial value of the principle.
Hajduova, Z., & Husakova, N. (2014). Financial management of non-profit organization providing specific services. Applied Mechanics and Materials, 708, 210-215. doi:10.4028/www.scientific.net/AMM.708.210.
Mortgages payable are long-term debts that are backed with security interest in a specific property. Like long-term notes payable, the mortgage payable has a specific amount due in each year, which is determined by an Amortization Schedule. (Nobles, Mattison, & Matsumura, 2014). On the balance sheet, the mortgage payable for the current year (in the amount of $20,000 according to the mortgage agreement) should be recorded as a current liability, because current liabilities would only cover the amount of the mortgage due within that current year. This amount would be detailed in the amortization schedule. The remaining balance of the principle amount, $267,000, should be recorded as a long-term liability because it is not due within that current year.
The purpose of a balance sheet is to “report on assets, liabilities, and owner’s equity of the business as of a specific date” (Nobles, Mattison, & Matsumura, 2014). If the Raffie’s Kids organization were to record the entire principle amount of the mortgage as a current liability, then current liabilities would be overstated, while long-term liabilities would be understated, resulting in the misrepresentation of the nonprofit’s current financial situation. Sponsors and other donors often depend on a company’s truthful financial representation when making decisions about donations, and Raffie’s Kids owe it to them to be honest on all financial statements.
If Raffie’s Kids wishes to pay off the total principle amount of the mortgage, it should adjust the amortization schedule to reflect that desire. In changing the schedule to reflect that the entire principle will be paid in the current year, then Raffie’s could truthful list the mortgage payable as a current liability with no ethical issues to trip over.
Nobles, T., Mattison, B., & Matsumura, E. M. (2014). Horngren’s Accounting, 10th Edition. Pearson Education, Inc.