Last August, the Financial Accounting Standards Board (FASB) released its much anticipated Accounting Standards Update (ASU) 2016-14, which changes the way not-for-profits classify net assets and prepare nonprofit financial statements. The previous nonprofit financial statement reporting model had been in place for over 20 years. This refresh aims to improve its effectiveness and provide more useful information to the financial statement users, including donors and grantors.
Previously, financial statement users were confused by the three different types of net assets represented. The presentation of the nonprofit financial statements varied, making it difficult to determine the liquidity of the statement of financial position and the availability of cash to meet current obligations.
The goal of the ASU was to tweak standards and update the model to better define nonprofit reporting and provide more detailed information to stakeholders while enabling the nonprofit to better tell their story.
FASB Chairman Russell Golden said in a statement, “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…The new guidance simplifies and improves the face of the financial statements and enhances the disclosures in the notes.”
The major improvements FASB made include:
- Reducing complexity in net asset classification
- Clarifying information regarding liquidity and availability of cash
- Increasing transparency in reporting financial measures
- Providing consistency in reporting expenses by function and nature
- Simplifying the presentation of operating cash flows
Net Asset Classification
The most fundamental change to the way most nonprofits think about financial statements is in regards to net asset classifications. On the statement of financial position, the ASU replaces the current presentation of three classes of net assets (unrestricted, temporarily restricted, and permanently restricted) with two classes of net assets –with donor restrictions and without donor restrictions.
The new standards:
Eliminate confusion over what the term “unrestricted” meant.
Previously, though assets lacked external restrictions, there may still have been board designations or internal use restrictions that limit what can and cannot be done with those funds. The new classifications are relabeled to clearly communicate only donor restrictions.
Focus on information that is more meaningful to the nonprofit.
Required footnote disclosures emphasize how and when net assets can be used by outlining donor restrictions. New required disclosures include information on board designations, such as the nature and amounts of board-designated funds and board-restricted funds, as well as donor restrictions. Outlining assets restricted for a specific purpose or passage of time gives readers the ability to understand what’s happening in your organization.
Require nonprofits to create new policies and practices regarding board designation.
Start your written policy for board designations now. If your organization doesn’t have any board designations, you still need to have something in place to govern when and if you need to designate funds. If your board designations were set 15-20 years ago, now’s the time to revisit them and make sure they are appropriate for your organization’s operations today.
Provide more clarification on endowments and how they are to be utilized, including underwater endowments.
All funds related to endowments will now be classified as with donor restriction. Additional disclosures include your organization’s ability to spend from underwater funds and any actions taken concerning appropriation of underwater funds. For any endowment funds, you’ll need to include the fair value, the original gift amount, the level that needs to be maintained and the amount of deficiencies.
Liquidity and Availability of Funds
Another change that will affect most not-for-profit organizations and could have the most impact on the readers of the financial statements is the disclosing of a nonprofit’s available resources, along with its management of liquidity and liquidity risk.
To improve the ability of financial statement users to assess a nonprofit entity’s available financial resources, the requirements include:
- Qualitative information on how the nonprofit manages liquid resources available to meet cash needs for general expenses within one year of the reporting date.
- Quantitative information that communicates the availability of assets at the reporting date to meet cash needs for general expenses within one year.
This requirement can tie in with your board designation policies by developing a liquidity reserve for your organization. For example, you may have a year with an excess of funds and your organization has decided to designate 5% of excess funds for future liquidity reserve. This process documents current financial assets you can convert into cash within a one-year period less any imposed restrictions or endowment funds restricted for longer term investing, any reserves you may have and what’s left over.
Currently, nonprofits have the option of presenting financial statements on a classified, meaning current assets and liabilities are identified in order of liquidity, or a nonclassified basis. This makes it difficult for the reader to know what obligations the organization can meet in the current one-year period and what obligations it can’t meet. The standard hopes to change that by making comparability more apparent across financial statements.
The new standard recommends utilizing a classified financial statement for comparability and readability by the end user. However, if you currently have an unclassified balance sheet and want to continue with it, there will be additional disclosures required about what your financial assets are and what is available. For example, if you have contributions receivable, you must document when those contributions are to be received as well as any other short-term means of accessing funds, such as a line of credit.
If you run a lean organization or are breaking even most years, disclosing your ability to meet future obligations may be challenging. You may need to start thinking about what other options you have, such a board designation of funds to have a pool of money available or a line of credit in the event of an emergency, and document where that is going to come from.
On the other hand, these disclosures can highlight the financial health of the organization. Be sure to consider whether this could make you look too healthy from a donor standpoint.
Of all of the pieces of the standard, this one will dramatically alter the landscape of financial reporting. You’ll want to take some time early on to think about the story and the message this is going to tell the readers of your financial statements.
Going forward, the new standard will require all nonprofits to present expenses by both their natural and functional classification in a single location in the financial statements or, for certain entities, as supplementary information to the financial statements. Information about functional categories includes programmatic services, management and general, fundraising and membership development costs.
Programmatic services are the result of the good or service being distributed to a third party beneficiary, customer or member in fulfillment of the organization’s mission. These activities, and the supervision of these activities, are at the core of what you do as an organization. Documenting this allows you to allocate the time, effort and energies helping you fulfill your mission.
Support services that relate to management and general may be a bit different than what has been reported in the past. Support services may not directly relate to the execution of your mission but help to support those activities. These services may include:
- Business management
- General recordkeeping and payroll
- Soliciting funds other than contributions and membership dues
- Disseminating information to inform the public of the NFP’s stewardship
- Administering contracts
- Employee benefits management and oversight
Meeting this new requirement will take some time and effort because you’ll need to start documenting when costs are applicable to more than one program and allocate those costs among the different programs within your organization. However, this is really just bringing some of the information you already have to include in your informational return 990 into your basic financial statements and creating a more user-friendly document for the readers.
The new guidance requires nonprofits to present investment return net of related external and direct internal investment expenses. It also eliminates the current requirement to disclose the amount of netted expenses.
Direct internal investment expenses pertain to the direct conduct or supervision of strategic and tactical activities that generate return. If you have a portion of your internal team who manages investments and endowments, part of that time, effort and energy is now going to be allocated to investment return. If you have an external manager, such as a fund manager, who charges your fees, include that in your investment return disclosure as well.
Statement of Cash Flows
Nonprofits will continue to have the option to present cash flows using either the direct or indirect method. Organizations that elect the direct method are no longer required to present or disclose the supplemental indirect method reconciliation for your operating cash flow
Effective Date and Transition
The new standards will be in effect for fiscal years beginning after December 15, 2017. For calendar year organizations, that will be calendar 2018. For fiscal year organizations, which typically end on June 30th, it will be the fiscal year beginning July 1, 2018. Early adoption is allowed, but you must implement everything.
If you are a calendar year-end organization, you’re going to have a limited window for implementation and documentation of some of these policies as information becomes more readily available throughout the course of 2017. If you plan to present comparative financial statements for 2018, you’re going to need to have those policies in place by the end of this year to help govern you for year-end close in 2017. Although there is limited information available from the FASB on implementation, your organization needs to start strategizing in order to have those policies before the fiscal year of implementation and presentation change actually takes place.
Here are some key takeaways for the transition period:
- You must adopt all provisions in the year of adoption. If you’re going to early adopt, be sure to adopt everything.
- If you’re doing comparative year financial statements, you must apply provisions to both years so it’s important to start thinking about those now. There is a little bit of wiggle room with comparative financial statements in that, for the comparative year, you don’t have to present the functional expense and liquidity disclosure.
- In the year of adoption, you are going to have to disclose nature of classifications, restatements and effects on net assets.
- There is the possibility for emphasis of matter paragraph in the opinion section.
- New liquidity and availability disclosures will require robust information that may not currently be tracked by your organization.
- You may need to re-visit policies and practices around internal designations of net assets.
- The reporting of investment expenses will change.
If you have any questions or if your organization needs help implementing these changes, please reach out to our nonprofit team here. To download a copy of sample financial statements under the new model, click here.
Meet the Author
Bobby LaCour, CPA
Aldrich CPAs + Advisors
Bobby joined Aldrich in 2005 and has over ten years of experience in public accounting. He specializes in providing attest and accounting services to nonprofit, manufacturing and other private middle-market entities. He also has extensive experience with internal control and operations analysis. Balboa Park Online Collaborative audit committee member American Society of Certified Public Accountants member…
- Nonprofit organizations
- Public sector
- Government entities
- Foundations and associations
- Certified Public Accountant