Changes to Nonprofit Financial Reporting
By Jack Murray, HoganTaylor Lead Nonprofit Partner
As most of you know, the rumored changes to nonprofit financial reporting have arrived. Phase I of the project has been completed and FASB issued a new Accounting Standards Update. This update did not change any of the accounting standards for nonprofits, only freshened the financial reporting requirements.
On August 18, 2016, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) that simplifies and improves how a not-for-profit organization classifies its net assets, as well as the information it presents in financial statements and notes about its liquidity, financial performance, and cash flows.
“While the current not-for-profit financial reporting model held up well for more than 20 years, stakeholders expressed concerns about the complexity, insufficient transparency, and limited usefulness of certain aspects of the model,” said FASB Chair Russell G. Golden.
“The new guidance simplifies and improves the face of the financial statements and enhances the disclosures in the notes—which will enable not-for-profits to better communicate their financial performance and condition to their stakeholders while also reducing certain costs and complexities in preparing their financial statements,” Mr. Golden added.
The ASU requires improved presentation and disclosures to help nonprofits provide more relevant information about their resources (and the changes in those resources) to donors, grantors, creditors, and other users.
These include qualitative and quantitative requirements in the following areas:
- Net Asset Classes
- Investment Return
- Liquidity and Availability of Resources
- Presentation of Operating Cash Flows.
In addition, the ASU includes illustrative financial statements of nonprofit entities, which reflect changes made by the new standard.
Net asset classes
On the balance sheet, the ASU replaces the current presentation of three classes of net assets (unrestricted, temporarily restricted, and permanently restricted) with two classes of net assets – net assets with donor restrictions and net assets without donor restrictions. As such, entities will no longer distinguish between temporary and permanent restrictions on the face of the statements. In addition, the net asset classification of underwater amounts of donor-restricted endowment funds will be classified as part of net assets with donor restrictions. Additional disclosures related to these underwater endowment funds are required.
The new standard retains the current requirements to provide information about the nature and amounts of different types of donor-imposed restrictions and the need to highlight how these restrictions affect the use of the resources and their impact on liquidity.
The ASU eliminates the over-time approach for the expiration of restrictions on capital gifts and requires the use of the placed-in-service approach in the absence of donor explicit stipulations.
Nonprofits will present the amount of the change in each of the two net asset classes above on the statement of activities. In addition, the ASU requires investment return to be presented net of all related external and direct internal expenses. It eliminates the current requirement to disclose the amount of such netted expenses.
Under current standards, nonprofit entities must present expenses by function. The ASU introduces a requirement to present expenses by nature and function, as well as an analysis of these expenses in one location to help users assess how a nonprofit uses its resources. This analysis can be presented on the face of the statement of activities, as a separate statement, or in the notes to the financial statements. It should be supplemented with enhanced disclosures about the methods used to allocate costs among the functions.
Presentation of Operating Cash Flows
The ASU maintains the option for nonprofit organizations to present their statement of cash flows using either the direct or indirect method of reporting. If an organization chooses to use the direct method, the reconciliation of changes in net assets to cash provided (used in) operating activities is no longer required.
Liquidity and availability of resources
To improve the ability of financial statement users to assess a nonprofit entity’s available financial resources and the methods by which it manages liquidity and liquidity risk, the ASU requires specific disclosures including:
- Qualitative information that communicates how a nonprofit entity manages its liquid available resources to meet cash needs for general expenditures within one year of the balance sheet date.
- Quantitative information that communicates the availability of a nonprofit’s financial assets to meet cash needs for general expenditures within one year of the balance sheet date. Items that should be taken into consideration in this analysis are whether the availability of a financial asset is affected by its nature, external limits imposed by grantors, donors, laws and contracts with others, and internal limits imposed by governing board decisions.
Throughout the project, the FASB conducted extensive outreach with diverse groups of stakeholders, and received more than 260 comment letters on the 2015 Exposure Draft.
Outreach included three roundtables with more than 35 representatives including users, preparers, and auditors; 10 workshops and fieldwork meetings with preparers of various types and sizes; 12 meetings with the FASB’s Not-For-Profit Advisory Committee; 10 meetings with the FASB’s Not-For-Profit Project Resource Group comprising more than 20 users, preparers, auditors, and academics; 25 meetings with not-for-profit industry representative groups; and other meetings with more than 60 stakeholders.
Nonprofit organizations that will be affected include charities, foundations, colleges and universities, health care providers, religious organizations, trade associations, and cultural institutions, among others.
The amendments in the standard are effective for annual financial statements issued for fiscal years beginning after December 15, 2017, and for interim periods within fiscal years beginning after December 15, 2018. Application to interim financial statements is permitted but not required in the initial year of application. Early application of the amendments in this Update is permitted. Accordingly, these standards will impact most entities with their December 31, 2018 or June 30, 2019 financial statements.
The objective of Phase 2 of this project is to reexamine existing standards for financial statement presentation by nonprofit entities (NFP), focusing on:
- Whether to require a measure of operations.
- Whether and how to define a measure of operations.
- Realignment of certain items in the statement of cash flows to better align operating cash flows with an operating measure on the statement of activities.
- An alternative of segment reporting for NFP health care entities in lieu of the requirement to provide an analysis of expenses by both natural and functional classification (a requirement in Phase 1).
We will continue to provide articles in our newsletter discussing specific areas of the ASU in more detail. We also encourage you to access the FASB.org website and digest as much information as you can to understand the impact to your organization. HoganTaylor will assist nonprofits in implementing these changes to your financial reporting process.
Further information about the ASU—including a FASB in Focus overview, a FASB: Understanding Costs and Benefits document, and a video entitled Why a New Not-for-Profit Financial Reporting Standard? is available at www.fasb.org.