Not-For-Profit Industry Update

Posted on 02.21.14

By: Doug K. Nickerson, CPA, CGFM, CRE, CIA, CCA | Business Assurance & Advisory Services Partner

The success of not-for-profit organizations depends greatly on their ability to raise funds, have a dependable source of revenue, and serve a committed group. When any of these factors falter, these organizations are forced to limit their expenses. The recent economic crisis has left many in need, and there are several industry trends and challenges leaving nonprofits worldwide in a state of rehabilitation.

One of these challenges is the fact that thousands of nonprofits in the United States receive late government payments on their contracts and grants each year. These late payments lead to internal problems causing the organizations decrease employee salaries, increase credit lines and draw down their overall reserves. There is also a considerable knowledge gap between nonprofits and foundations. In fact, the Center for Effective Philanthropy (CEP) reported in previous grant research that less than five percent of foundations conduct an official assessment when determining need assistance beyond official grants. A third challenge is the proposed limitation on tax deductions for charitable donations circulating in the Senate. Depending on how these limits and deductions are configured, it could mean a multi-billion dollar loss in revenue for nonprofit organizations as donors would search for more financially rewarding outlets to decrease their tax bills.

Another set of factors to consider when looking at nonprofit organizations are the industry issues and opportunities at hand. First, and foremost, is the nonprofit dependence on economic conditions. Regardless of size or  endowment, all nonprofits suffer in hostile economies because their income relies on the state of the market. These organizations also rely on a few major donors for a large portion of their revenue. The issue herein lies with the lack of a binding contract insuring these donations in the future. If donor assets drop, they cannot fulfill their prior financial promises. The sheer competition of the nonprofit market is another factor in their cyclical instability. The number of organizations grew by thirty-percent in the last decade causing competition for resources like experienced staff and industry donations. Organizations compete for their niche in the market by marketing codes of ethics and beliefs to the public, differentiating themselves from their competitors.

Taking these challenges and factors into account, there is opportunity for alternative nonprofit fundraising through the Internet and social networking. These methods are especially effective in times of down economies due to their low administrative cost, and broad outreach for recruiting staff, support lists, and potential donors. Those organizations turned off by the time commitment of social networking may see a new challenge arise in trying to overcome their competitors, who are more adaptive in their internal methods of restructuring.

On December 9, 2013, the FASB’s Not-for-Profit Advisory Committee (NAC) discussed the following matters related to FASB’s project on Not-for-Profit Financial Reporting: Financial Statements:

  1. The Board’s decisions reached for improving a statement of cash flows
  2. Reporting of expenses, including whether to require classification of expenses by both function and nature and require their presentation or disclosure in a basic statement, in notes or elsewhere
  3. Alternatives for improving information about liquidity and financial flexibility.

Statement of Cash Flows – The NAC discussed the recent Board decision to require the direct method of reporting cash flows and to remove the requirement to reconcile the change in net assets to net cash flows from operating activities (referred to as the indirect method). NAC members were asked whether they envision significant concerns from creditors, donors or others users by removing the requirement to reconcile the change in net assets to net cash flows from operating activities.   No significant  negative consequences were noted. However, a member suggested that significant noncash expenses (for example, depreciation and amortization) be separately presented on an activity statement or otherwise disclosed.

NAC members did not note any significant negative consequences for not-for-profit entities (NFPs) to provide direct method cash flows. The staff clarified that NFPs currently using the direct method of reporting are using mapping techniques to estimate the direct cash inflows and outflows, which did not require new accounting systems. The staff also noted that the Board anticipates that those techniques would continue. NAC members also discussed the Board decision to classify cash outflows for long-lived assets for operating purposes within operating cash flows so as to improve the alignment with the activity statement. Some members noted that many constituents view the acquisition of long-lived assets as a non-operating activity; thus, that potential change to current practice may require further educational efforts.

Reporting Expenses, including a Statement of Functional Expenses (SFE) - The NAC members were asked to discuss whether requiring natural classification of expenses for all NFPs would provide incremental benefits to NFP financial reporting that justify any added costs. The consensus from members is that the incremental benefits of the information would justify the insignificant costs to provide that information. Some members noted that although natural classification is not required many not-for-profit organizations, including healthcare entities and membership organizations, currently provide that information in their GAAP-based financial statements.

NAC members also discussed the usefulness of reporting expenses by both function and nature in a matrix format, either as a basic statement, as a schedule in notes, or elsewhere. NAC members generally agreed that the matrix format adds understandability, clarity and transparency that is useful to donors in assessing how a NFP   uses its resources. Some members noted that it is also useful to members of a NFP’s governing board. In general members agreed that the incremental benefits often justify the costs; however, some NAC members raised reservations about the degree of utility for reporting expenses by function for those NFPs that have a single mission/program (e.g., patient care) and little to no significant fund raising costs.   Some members also cautioned care in describing programs, particularly for entities like universities that have highly integrated activities (such as instruction and research) that could present cost allocation difficulties.

Liquidity and Financial Flexibility – NAC members discussed whether a NFPs notes to financial statements related to liquidity should discuss both (a) assets that are liquid and available and obligations that are required to be met in the immediate subsequent period and (b) the entity’s financial flexibility or ability to address reasonably possible circumstances that impose liquidity risks as of the date of the financial statements. Members generally noted that such information would be useful; however, members also suggested that financial flexibility and management plans are best left for   discussion outside of the audited financial statements.

The NAC’s next scheduled meeting is set for March 10-11, 2014.

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Posted by: Doug K. Nickerson, CPA, CGFM, CFE, CIA, CCA

Doug shares his real estate and construction accounting insights with his clients to help them achieve their financial goals. He is a member of Keiter’s Real Estate and Construction team. Doug has over 18 years of experience in corporate accounting and public accounting providing audit and consulting services. Read more of Doug’s insights on our blog.