In August of 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-14, “Presentation of Financial Statements of Not-for-Profit Entities (Topic 958)”. The issuance of this update represents the most significant change to not-for-profit financial statement reporting rules since 1993, when the FASB issued Financial Accounting Standard No. 117, which provided a complete overhaul of the accounting standards for not-for-profit organizations. The new ASU represents an improvement rather than an overhaul of the existing reporting standards, so while there will be additional costs to implement the new standard, such costs should not be as significant as the 1993 changes.
The goal of the new standard is to provide better information about a not-for-profit’s resources (and the changes in those resources) to donors, grantors, creditors and other users of financial statements. The standard also incorporates qualitative requirements in addition to quantitative requirements. Some of the significant changes are as follows:
Net asset classifications
- Existing classes of net assets (unrestricted, temporarily restricted and permanently restricted) are replaced with two new classes of net assets – net assets with donor restrictions and net assets without donor restrictions. If an organization feels that the users of its financial statements want to retain some aspects of the three previous categories, they can continue to show them on the face of the financial statements or in the notes, provided totals are shown for the two basic classes of net assets. Differences in the nature of donor restrictions will be disclosed in the notes.
- The net asset classification of underwater amounts of donor-restricted endowment funds is changed, and additional disclosures concerning underwater endowment funds are required. Endowments are said to be “underwater” when the fair value of the assets associated with an individual donor-restricted endowment fund falls below the value of the initial and subsequent donor gift amounts. Underwater endowment funds under the new standard are classified as a reduction to the category “With Donor Restrictions.”
- The over-time approach for the expiration of restrictions on capital gifts is eliminated in favor of the placed-in-service approach, in the absence of explicit donor stipulations.
Liquidity and Availability of Resources
Determining liquidity has long been a challenge for users of not-for-profit financial statements, as the existing standards do not mandate the use of a classified statement of financial position.
The new ASU requires qualitative information that communicates how a not-for-profit manages its liquid available resources to meet cash needs for general expenditures within one year of the balance sheet date. The ASU also requires quantitative information as to the availability of the resources at the balance sheet date to meet the cash needs of general expenditures within one year. The availability of resources (financial asset) may be affected by a) its nature, b) external limits imposed by donors, grantors, laws and contracts with others and c) internal limits (i.e. board designated funds) imposed by governing board decisions. This mandate should force not-for-profits to establish a more rigorous cash flow forecasting process.. Such liquidity information can be presented in a tabular format or in a management’s discussion and analysis section.
Under the new standard, all organizations will present investment return net of related external and direct internal expenses, and the current required disclosure of those netted expenses is eliminated.
The new standard requires all not-for-profits to provide an analysis of expenses by nature and function. 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 – supplemented by enhanced disclosures about the method used to allocate costs among functions. Most organizations already have this information, which is required for the federal form 990.
Presentation of Operating Cash Flows
Initially, the FASB contemplated mandating the use of the direct method for preparing the statement of cash flows, as the prevailing thought was that it provided more meaningful information than the indirect method, even though the indirect method is widely used in practice. In the end, the FASB decided to allow the use of either method, while no longer requiring a reconciliation to the indirect method should the organization elect to use the direct method.
There will be a Phase 2 of this project, during which time other areas will be deliberated. The new standard will take effect 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, and early adoption of the standard is permitted. For further information, contact Amish Mehta at email@example.com or a member of Friedman LLPs Not-for-Profit Team at www.friedmanllp.com.