Zak Organization is a not- for- profit organization set up for famine relief. Zak has been operating for 25 years and has a December 31 year- end. Zak’s policy with respect to capital assets is to capitalize and amortize the capital assets over their expected useful lives. On June 30, 20X3, Zak received three donations from a former director:
• $ 30,000 cash for famine relief.
• $ 50,000 to be used solely for construction of the new administrative building. Of the $ 50,000, 70% was received in cash, with the remainder promised in February 20X4. (Note: construction is expected to commence in October 20X4.)
• $ 600,000 cash, which was invested on July 1, 20X3, in long- term Government of Canada bonds, with 10% interest to be paid semi- annually on December 31 and June 30. The $ 600,000 donation was given with the stipulation that it be invested in interest- bearing securities with the principal maintained by Zak, although interest earned on the securities is not restricted.
1. Briefly explain (do not provide journal entries) how each of the three donations should be accounted for using the deferral method of accounting. In particular, should each of the donations be recognized as revenue for the year ended December 31, 20X3?
2. Despite the recent donations from its former director, Zak is increasingly faced with severe budgetary constraints. Zak is considering implementing encumbrance accounting in the coming year.
a) Briefly describe the process of encumbrance accounting.
b) Briefly describe how encumbrance accounting might serve as a device to help control spending when it is used in conjunction with a formal budgeting system.