Not-for-profit accounting and financial reporting has remained relatively unchanged over the last 20 years. For the past three years, the Financial Accounting Standards Board (“FASB”) has worked closely with the Not-for-Profit Advisory Committee and other stakeholders to identify ways organizations could provide more useful information to the various users of their financial statements. On August 18, 2016, the FASB released Accounting Standards Update (“ASU”) No. 2016-14 – Not-For-Profit Entities (Topic 958): Presentation of Financial Statements of Not-For-Profits Entities, which will have a significant impact on not-for-profit financial statements.
The ASU makes several improvements to the current reporting requirements and address key problems such as:
- Complexities of net asset classification
- Lack of transparency and utility of information to assess an entity’s liquidity
- Inconsistencies in reporting of expenses
- Additional time and effort preparing cash flow statement if the direct method is chosen
Net Asset Classification
The classification of net assets is simplified to present only two classes of net assets – net assets without donor restrictions (currently unrestricted net assets) and net assets with donor restrictions (currently temporarily restricted and permanently restricted net assets). FASB’s goal with the change in classifications and terminology is to reduce complexity and avoid misunderstandings relating to the use of permanently restricted endowments. The notes to the financial statements will play a larger role in helping users understand the nature and types of donor-imposed restrictions or board designations as are result of the change. Enhanced disclosure requirements will help ensure the users of the financial statements understand all relevant information, including how externally and internally imposed limits affect the availability of resources.
Not-for-profit organizations with endowments that are less than the original gift or less than what is required by the donor or law (i.e. underwater) will be required to classify that shortfall within net assets with donor restrictions. Currently, the underwater amount is classified as a component of unrestricted net assets. The ASU will require organizations to disclose its policies for the appropriation of endowment, including its policy for appropriation of underwater endowment funds. In addition, the organization will be required to disclose: 1) the fair value of such funds, 2) the original endowment gift amount or level required to be maintained by donor stipulations or by law that extends donor restrictions, and 3) the amount of the deficiencies of such funds.
Reporting of Operating Expenses
Organizations are currently required to report their expenses by function and only voluntary health and welfare organizations are required to present a statement of functional expenses. FASB’s research noted that many users of the financial statements found the statement of functional expenses to be useful in assessing an organizations use of resources. The ASU requires all not-for-profits to report operating expenses by both function (i.e. program services and support services) and nature (i.e. salaries, utilities, depreciation, etc.) in one location. This information can be on the face of the statement of activities, in the notes to the financial statements, or as a separate financial statement.
Reporting of Investment Return
The ASU requires investment returns to be reported net of any external or direct internal investment expenses and no longer requires disclosure of those netted expenses. Currently, this presentation is an option, but not a requirement.
Statement of Cash Flows
Organizations currently have the option of using the direct method or indirect method when preparing the statement of cash flows. If the direct method is used, an indirect method reconciliation must presented on the face of the statements or in the notes to the financial statements. This ASU continues to give organizations these options, however, if the direct method is used, the indirect method reconciliation is no longer required.
When is it effective?
The ASU will be effective for annual financial statements issued for fiscal years beginning after December 15, 2017 and early adoption is permitted. In the period adopted, the amendments in this ASU should be applied on a retrospective basis. However, if presenting comparative financial statements, the organization has the option to omit the following for periods presented before the period of adoption:
- Analysis of expense by both natural and functional classification (separate presentation still required)
- Disclosures about liquidity and availability of resources
There are many users of not-for-profit financial statements, including management, governing bodies, donors, grantors, creditors, and governmental agencies. Meeting the needs of each of these can be a challenging task. One of the main goals of this ASU is to improve usefulness of not-for-profit financial statements to allow the users to make better informed decisions. While there are some costs associated with these changes, the benefits are expected to outweigh the additional costs that may occur.
The final ASU can be accessed on the FASB website .
The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.