The Financial Accounting Standards Board ("FASB") issued an exposure draft on April 22, 2015 proposing sweeping changes to the not-for-profit financial reporting model encompassing liquidity, cash flows, operating results, expense reporting and other disclosures intended to enhance comparability between nonprofits. But changing a model that professionals, management, and other users have become accustomed to may shake up the not-for-profit reporting world for financial professionals.
Here's what you need to know about the recent not-for-profit financial reporting proposal so you can be prepared.
The most fundamental change impacts the existing three classes of net assets: unrestricted, temporarily restricted, and permanently restricted. The change compresses the three classes into two: net assets with donor restrictions and net assets without donor restrictions. This change may require a higher commitment of resources to adapt account coding and internal reporting frameworks to conform to the proposal.
The catalyst for the change to the net asset classes is partially rooted in the Uniform Prudent Management of Institutional Funds Act ("UPMIFA"), the effect of which has rendered the current model with its three net asset classes unclear.
Determining a net asset class has become more difficult as a result of the UPMIFA provision that eliminates the concept of "historic dollar value" and permits prudent spending from underwater endowment funds.
Disclosure of the types of restrictions within the net asset class "with donor restrictions" would include donor-restricted contributions such as time, purpose and endowments. Similarly, disclosure of the types of net assets classified as "without donor restrictions" would include board-designated restrictions.
The proposal also provides further simplification by reclassifying donated property and equipment, currently classified as restricted net assets, to net assets without donor restriction when placed in service.
Current generally accepted accounting principles ("GAAP") requires underwater restricted endowment funds to be bifurcated, reporting the deficiency as a reduction in unrestricted net assets and the value of the original gift as restricted net assets. The proposal requires that you report the entire amount as net assets "with donor restrictions", and provide enhanced disclosures including the original gift amount, current fair value and the spending policy related to the endowment.
Statement of Activities
To improve comparability between different organizations, the proposal requires intermediate operating measures on the statement of activities: operating and non-operating results, including transfers between operating and non-operating without donor restrictions. Current GAAP does not define or require reporting an operating measure.
Current GAAP captions identify the release of donor restrictions as "satisfaction of program restrictions"; the sample proposed statement of activities uses the caption "restricted support released". This caption relates strictly to net assets "with donor restrictions."
The proposal requires disclosure of transfers between non-operating and operating activities that reflect reclassifications related to net assets with board designations. Nonprofits will need to address current account coding and internal reporting frameworks to determine cost-effective policies and procedures for identifying and aggregating transfers between non-operating and operating activities.
The proposal includes a one statement approach that segregates activities without donor restrictions from activities with donor restrictions in a two-column format. Alternatively, a two statement approach would split off the "Statement of Operations" in a one column format to report operating activities separately from the "Statement of Changes in Net Assets," which reports the non-operating activities without donor restrictions and with donor restrictions in a two column format.
Under the current reporting framework, nonprofits are not required to present the details of expenses on a functional basis unless they are considered to be a "voluntary health and welfare" organization. Disclosure of expenses based upon natural expense categories on a functional basis is required by the proposal; however, functional expenses may be presented in a variety of formats: in the statement of activities, a separate statement or a schedule in the financial statement notes.
The FASB proposal no longer requires the disclosure of investment expenses except for internal salaries and benefits that have been netted against investment returns. Under current GAAP, investment expenses incurred are required to be disclosed; however, as a practical matter, embedded investment expenses such as fees charged directly to mutual funds are difficult if not impossible to ascertain.
Cash Flow Statement
Under current GAAP, there are two methods for reporting cash flows, direct and indirect. As a matter of practice, many nonprofits use the indirect method for reporting cash flows. The proposal eliminates the indirect method of reporting and requires the direct method.
The direct method requires income and expenses recorded on the accrual basis to be reported on the cash basis. Similar to the change to net asset classes, this change may require a higher commitment of resources to conform to the proposal. Under current GAAP, the direct method also requires a reconciliation of net income to cash flows from operations that is optional under the proposal.
In addition to the requirement to use the direct method, cash flows customarily reported as investing or financing are re-categorized as operating. For example, the purchase of property and equipment currently reported as an investing activity will be reported as an operating activity. Similarly, interest paid on long-term debt currently reported as an operating activity will be reported as an investing activity.
The ability or ease with which assets, particularly those with restrictions, can be converted into cash is unclear under the current reporting model. The proposal requires enhanced quantitative and qualitative disclosures with respect to restrictions and "self-imposed limits" (board-designated restrictions) that impact the liquidity of resources.
• Define the time horizon used by the organization to manage its liquidity
• Identify assets that are not available to meet liquidity needs due to external or internal limits
• Quantify total liabilities that are due within the defined time horizon
• Strategies for addressing risks that may affect liquidity, e.g., availability of line of credit
• Policy for establishing liquidity reserves
• Basis for determining the time horizon used as disclosed quantitatively
Similar to the change to net asset classes and the direct method of reporting cash flows, this change may require a higher commitment of resources to conform to the proposal.
The comment period for the proposal ends August 20, 2015, and the final standard could be issued in late 2016, with an effective date as early as 2017. Given the nature of these sweeping changes, the learning curve may be steep. Nonprofit management and boards are encouraged to get in front of these reporting changes and consult with their audit and accounting advisors to implement a strategy suitable for the size and complexity of the organization to assess the impact the proposal will have on policies, procedures, and staff.