Major Changes (or Improvements?) Proposed for Not-for-Profit Financial Statements
Posted on 05.21.15
By Richard W. Lewis, CPA, CFE | Partner | Not-for-Profit Industry Team
Over the past several years, the Financial Accounting Standards Board (“FASB”) has been receiving input from the Not-for-Profit Advisory Committee (“NAC”) on ways to improve and enhance the financial statements and disclosures of not-for-profit organizations. Many of us that have a keen interest in the not-for-profit community have been following the NAC to gain insight into what the proposed changes might look like and anxiously waiting for a proposed Accounting Standards Update (“ASU”) to be published. On April 22, 2015, the wait finally ended with the FASB making available to the public its first major proposed changes to not-for-profit accounting and financial reporting in over 20 years.
Proposed ASU No. 2015-230, Not-for-Profit Entities (Topic 958) and Health Care Entities (Topic 954): Presentation of Financial Statements of Not-for-Profit Entities includes several proposed changes that are significant and are likely to generate some objections during the comment period, which ends on August 20, 2015. Even so, I do not anticipate that the final ASU will change significantly from what is currently being proposed. The significant proposed changes include the following:
Net Asset Classification
The classification of net assets will be 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). This change will impact both the statement of financial position and the statement of activities as both statements currently are required to include information regarding all three net asset classes. Enhanced disclosures on net assets with donor restrictions will be required in order to allow users of the financial statements to gain important information on net assets available at the end of a reporting period that are either temporarily and permanently restricted.
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 statement of activities will be required to include a measure of a not-for-profit organization’s operating performance that is based on mission and availability. Mission considers whether resources result from or are directed at carrying out the purposes or mission for which the not-for-profit organization exists. Availability considers whether resources are available for current period activities, based on the presence or absence of donor or board restrictions. Essentially, there will be a new subtotal that includes operating revenues, gains, other support, expenses, and losses that are without donor restrictions and before any internally imposed restrictions (i.e. board designations, appropriations, etc.). Following that subtotal will be a second subtotal that reflects changes resulting from the internally imposed restrictions. All other activities (contributions with external imposed restrictions, non-operating revenues, expenses, etc.) will follow the second subtotal in arriving at a not-for-profit organization’s total change in net assets. This new definition and requirement to present operating performance is very different than the flexibility currently afforded to not-for-profit organizations in reporting operating results.
Reporting of Operating Expenses
All not-for-profit organizations will be required 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. As is currently required for not-for-profit organizations that meet the definition of a voluntarily health and welfare organization, the statement of functional expenses will not be a required statement for any not-for-profit organization any longer; although this might be the easiest way to present expenses by natural classification.
Reporting of Investment Expenses
Investment income will be required to be reported net of any investment expenses. Currently, this presentation is an option, but not a requirement.
Statement of Cash Flows
The statement of cash flows will be prepared using the direct method and inflows/outflows of cash will be more closely aligned with presentation of the statement of activities. Common examples of the realignment include classifying cash outflows to purchase property and equipment as an operating activity and classifying interest/dividends earned from an endowment as an investing activity.
Enhanced disclosures in the notes to the financial statements will be required and include the following:
- Both quantitative and qualitative information useful in accessing a not-for-profit organization’s liquidity position,
- Composition of net assets with donor restrictions, which will include net assets with purpose and time restrictions as well as net assets with permanent restrictions available at the end of each reporting period presented,
- Method(s) used to allocate expenses among functions (i.e. program services and support services), and
- Additional information on endowment funds that are less than the original gift or the amount required to be maintained by the donor or law. The proposed new disclosure will include primarily any board policies or decisions to spend from such endowments while they are underwater. Currently, the disclosure requirement is limited to the aggregate amount by which these endowments are underwater.
Financial statements of a not-for-profit organization are available to the public and have more users than any other entity type. Users, or stakeholders, of not-for-profit financial statements can include all of the following: management, governing bodies, donors, grantors, creditors, and governmental agencies. Developing a format and structure that meets the needs of all these stakeholders is a difficult task. Through these proposed changes, the FASB has made a number of improvements that should allow for easier decision making and better governance, which will ultimately drive greater impact to the community.
Questions on how these changes may impact your not-for-profit organization? Contact our Not-for-Profit Industry team. firstname.lastname@example.org | 804.747.0000