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Making sense of new accounting standard for nonprofits
Nov 08, 2018
By Jayme F. Moore, CPA
Accounting & Auditing Director
The new financial reporting standard for nonprofits, which takes effect this year for many organizations, is intended to increase the transparency and usefulness of financial reporting information presented by organizations. The Financial Accounting Standards Board (FASB) says that applying the standard also will:
- Reduce cost and complexity for nonprofits when classifying net assets,
- Provide more relevant information on how imposed limits on resources (for example, board designations) affect the availability of those resources,
- Make comparing expenses and investment returns between nonprofits easier, and
- Provide greater transparency about organizations’ service efforts and ability to continue providing services, too.
The FASB’s Accounting Standards Update (ASU) No. 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities, is the first update to the financial reporting rules for nonprofits since 1993.
Now is the time to get ready for the new standard, for organizations that have not yet prepared.
What are the new net asset classes?
The new standard consolidates the current net asset classes (unrestricted, temporarily restricted and permanently restricted) into net assets with donor restrictions and net assets without donor restrictions. It also requires additional disclosures related to board designations and donor-imposed restrictions, such as:
- Funds earmarked for a specific purpose,
- The passage of time (for example, when the funds may be used only after a specific number of years have passed),
- The funds included in board-designated operating reserves, or
- The occurrence of a specific event — for example, the attainment of a desired programmatic outcome.
The ASU changes the reporting of “underwater” endowments whose fair value is less than the original gift amount. It now requires the underwater portion to be classified as net assets with donor restrictions, and enhanced disclosures will be required.
The new standard also generally eliminates the over-time method for reporting the expiration of restrictions on capital gifts used to purchase or build long-lived assets such as buildings. Unless the gift includes additional donor restrictions, you must use the placed-in-service approach to reclassify these gifts as net assets without donor restrictions in the year the asset is placed in service, rather than spreading out the expiration of the restrictions over the asset’s useful life. This could affect debt service ratios and other loan covenants.
How has liquidity and available resources reporting changed?
Under ASU 2016-14, your financial statements must include certain qualitative and quantitative disclosures of information to help the financial statement user evaluate your organization’s liquidity. The quantitative information — which will show the availability of your financial assets to meet cash needs for general expenses within the year following the balance sheet date — is now required in a more specific format. The newly mandated qualitative information will show how you plan to manage liquid available resources to meet cash needs for general expenses within a year of the balance sheet date.
The qualitative disclosure requirements might prove among the most challenging to implement because they call for a high degree of judgment. The standard gives organizations flexibility in terms of what will be disclosed regarding their liquid available resources and plans for the upcoming year.
What about reporting your expenses and investment return?
The new standard requires you to classify expenses by both nature and function in one location (function was already required) and present an analysis of expenses by both nature and function. “Nature” refers to expense categories such as salaries and wages, rent and utilities. “Function” primarily means program services and supporting activities, such as management and general and fundraising. For many nonprofit organizations, this information also is required on IRS Form 990, “Return of Organization Exempt From Income Tax,” so you shouldn’t have trouble collecting it. Even if your organization currently classifies expenses by both nature and function for the financial statements or the IRS Form 990, now is the time to take another close, fresh look at how expenses are being allocated and presented.
You must present investment income net of all related external expenses (expenses paid to third parties such as investment managers) and direct internal expenses. The new standard also eliminates the current requirement to disclose the components of net investment income.
How to present operating cash flows?
The FASB had previously proposed requiring nonprofits to use the direct method to present the net amount of operating cash flows. But the new standard lets you opt for either the direct or indirect method. If you opt for the direct method, you won’t need to include an indirect method reconciliation, as is currently required.
What should you do next?
The FASB doesn’t expect ongoing compliance costs to be significant for most not-for-profits. Even your initial costs should be manageable, as changes to your financial reporting will require only a one-time reformatting. But it may take some time to familiarize stakeholders, such as the board of directors and management, with the requirements and changes to how information is presented. It would be a good practice to revise a recent set of financial statements according to the ASU and share them with your board and management teams. At a minimum, these changes should be discussed to help them understand the changes to come.
The new standard applies to annual financial statements issued for fiscal years beginning after December 15, 2017, and for interim periods within fiscal years beginning after December 15, 2018.
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