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By Jack Murray, CPA, HoganTaylor Lead Nonprofit Partner

Accounting Standards Update 2016-14, Presentation of Financial Statements of Not-for-Profit Entities, represents the first significant change in nonprofit financial reporting since the 1990’s.  We have previously discussed the highlights of this standards update in summary form.  We will be discussing specific aspects of the changes in more detail in the next few newsletters.

Today we will spotlight the changes to expense reporting.  Previously, all nonprofits had to report their expenses on the Statement of Activities by function.  Functional expense categories were program, management and general and fund-raising.  These categories were required to give a reader a picture of how efficient a nonprofit was in managing its resources by comparing management and general and fund-raising to total expenses.  Program expenses, in total or broken down by multiple programs, allowed a reader to determine where a nonprofit was expending their resources towards fulfillment of their mission.

Only voluntary health and welfare organizations were required to present a statement of functional expenses under the previous standard.  This statement spread natural categories of expenses over their functional categories.  Natural categories are represented by salaries and benefits, rent, insurance and professional fees among others.  If an organization was not a voluntary health and welfare organization, they were not required to present the statement of functional expenses.  Accordingly, a reader would not be able to discern from the financial statements, for example, the magnitude of salaries and benefits represented in total expenses or by functional category.

Program services are the activities that result in goods and services being distributed to beneficiaries, customers or members that fulfill the purposes or mission for which the nonprofit exists.  Those services are the major purpose for and the major output of the nonprofit and often relate to several major programs.  For example, a large university may have programs for student instruction, research and patient care, among others.  Similarly, a health and welfare entity may have programs for health or family services, research, disaster relief and public education, among others.

Supporting activities are all activities of a nonprofit other than program services.  Generally, supporting activities include management and general activities, fundraising activities and membership development activities. Management and general activities include oversight, business management, general recordkeeping, advertising, billing and collection efforts, disseminating information to inform the public of the nonprofit’s stewardship of funds, human resource activities, and producing the annuals report, among other activities.  The costs of oversight and management usually include the salaries and costs of the governing board, the chief executive officer and the supporting staff.  If such staff spends a portion of their time directly conducting or supervising program services or other supporting services, however, their salaries and expenses can be allocated to those other functions. Other allocations are allowed, as in the case of occupancy expenses.  Costs of occupying facilities can be allocated either by square footage utilized by program and supporting functions or another rational method, consistently applied.

The new standard requires all nonprofits to report expenses by nature as well as function, including an analysis of expenses showing the relationship between functional and natural classification for all expenses.  All nonprofits will report information about all expenses in one location on the face of the statement of activities, as a schedule in the notes to financial statements, or in a separate financial statement as discussed in ASC 958-205-45-6.  The relationship between functional classification and natural classification for all expenses must be presented in an analysis that disaggregates functional expense classifications, such as major classes of program services and supporting activities by their natural expense classifications, such as salaries, electricity, depreciation, etc.  As mentioned, each organization has a choice in where and how to present this analysis within the financial statements.  Accordingly, similar organizations may choose to present this information in different schedules or footnotes within the financial statements.  One organization may decide that the natural classification on the statement of activities best represents their organization while another may decide that the traditional functional expense presentation will be continued.  But all organizations will be required to present both functional and natural classifications and this analysis will be available to all readers.

Reporting expenses by nature and function is useful in associating expenses with service efforts and accomplishments of nonprofits.  Users of nonprofit financial statements had questioned the comparability of various organizations service efforts when the previous standard allowed varying degrees of expense reporting, often increasing the difficulty of comparing similar organizations in this regard.

The new standard is intended to simplify and improve how a nonprofit classifies its net assets, as well as information it presents in its financial statements and notes about its liquidity, financial performance and cash flow and is effective for annual financial statements issued for fiscal years beginning after December 15, 2017.  HoganTaylor’s Nonprofit Practice Industry Group can assist you as you determine how to modify your organization’s financial reporting to comply with the new standard.

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