Are You Ready for the New Not-for-Profit Reporting Standard?
Starting in 2018, a new accounting standard goes into effect for charities, public universities and colleges, and other types of cultural, religious and trade-related not for profits. Accounting Standards Update (ASU) No. 2016-14, Not-for Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities, makes the first significant changes to the accounting rules for such organizations’ financial statements since the early 1990s. Here are the details.
Need for change
The last time the Financial Accounting Standards Board (FASB) changed the accounting rules for not for profits was in 1993. However, in recent years, donors, grantors, creditors and other financial statement users have raised concerns about such issues as:
- The complexity and “understandability” of net asset classification
- Weaknesses in the information presented about a nonprofit’s liquidity and the availability of its resources
- The lack of consistency in the type of information provided by different nonprofits about their expenses and investment returns
- The usefulness of the statement of cash flows
The FASB responded by releasing an Exposure Draft, Presentation of Financial Statements of Not-for-Profit Entities, in 2015. The FASB approved several key changes in 2016. These changes 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.
Two net asset classes
ASU 2016-14 replaces the three current net asset classes (unrestricted, temporarily restricted and permanently restricted) with two new classes (net assets with donor restrictions and net assets without donor restrictions). The new classifications reflect changes in the law under which organizations can now tap a permanently restricted endowment despite the fact that its fair value has dipped below the original endowed gift amount.
Under the updated standard, these “underwater” endowments will be classified as net assets with donor restrictions. Under the existing guidance, they’re presented as unrestricted net assets. The new guidance also expands the required disclosures for underwater endowments.
In addition, the guidance removes the option of using the “over-time” method to report the expiration of restrictions on gifts used to purchase or build long-lived capital assets, such as buildings. Not for profits will be required to use the placed-in-service approach (in the absence of explicit donor stipulations to the contrary).
As a result, organizations must reclassify such capital gifts as net assets without donor restrictions when the asset is placed in service, instead of over the asset’s useful life. This change will prevent not for profits from matching the depreciation expense with the release of these restricted net assets unless the donor stipulates over-time treatment.
The new standard aims to help financial statement users assess how a not for profit manages its liquid-available resources and its liquidity risks. To that end, the standard requires organizations to provide:
- Qualitative information that conveys how they manage their liquid-available resources to meet cash needs for general expenses within one year of the balance sheet date, and
- Quantitative information that conveys the availability of their financial assets at the balance sheet date to meet cash needs for general expenses within one year.
The liquidity of a financial asset could be affected by its nature; external limits imposed by donors, grantors, laws and contracts with others; and internal limits imposed by governing board decisions. Disclosure is also required for board designations or other internal limits on the use of net assets without donor restriction.
Expenses and investment returns
The new standard requires not for profits to report expenses by both function (which is already required) and nature in one location. They also must present an analysis of expenses by both nature and function on a separate statement, on the statement of activities or in the footnotes. The information will be supplemented with enhanced disclosures about the specific methods the organization used to allocate costs among program and support functions.
This will help stakeholders better understand the degree to which expenses are fixed or discretionary, how the related resources are allocated, and the costs of the services provided.
As for investment-related expenses, not for profits must report investment return net of all external and direct internal investment expenses on the statement of activities. Financial statement users will be better able to compare investment returns among different not for profits, regardless of whether investments are managed externally (for example, by an outside investment manager who charges management fees) or internally (by staff).
Additionally, the new standard does away with the current required disclosure of the netted expenses. Why? Some not for profits have found it difficult to identify third-party management fees that have been embedded in investment returns, which caused inconsistencies in the reported amounts of investment expenses.
Not for profits must juggle implementing ASU 2016-14 with the new revenue recognition and lease guidance that will soon go into effect for not-for-profit entities. Contact us for more information or for help preparing your systems and procedures for the updated guidance.