By Michael Lipschultz, Managing Director
Michael Hoyt assisted in the preparation of this article.
Not-for-profit (NFP) accounting and reporting has historically been challenging for many accountants and users of NFP financial statements. NFP organizations operate differently, and thus report differently from their for-profit counterparts, requiring special attention and specific industry knowledge to ensure transparent
and meaningful financial information. However, many accountants and users find that certain areas of the current NFP financial reporting framework are often difficult to navigate and interpret. This becomes especially apparent in the board room and at management meetings where financial statement literacy may not always be a core skillset for all members. In an effort to address some of these concerns among users, on August 18, 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-14, Not for Profit Entities (Topic 958): Presentation of Financial Statements of Not-For-Profit Entities.
The current guidance for NFP accounting and reporting dates back to 1993 when the FASB issued statement number 116 (SFAS 116), Accounting for Contributions Received and Contributions Made, and statement number 117 (SFAS 117), Financial Statements of Not-for-Profit Organizations, which at the time represented significant change for NFPs. The intent of these standards was to enhance the relevance, usefulness and comparability of NFP financial statements. Since NFP financial statements are primarily used by donors, members, creditors, and others who provide resources to NFP entities, the goal of the standards was to allow these users to make better assessments concerning how well an organization can continue to provide services, the overall results of operations of the NFP, and the extent to which management discharged their stewardship. One of the key provisions of SFAS 117 introduced the concept of permanently, temporarily and unrestricted net assets in a NFP’s financials statement rather than the traditional classification by funding source or group (formerly known as fund accounting).
The new standard is overarching and meant to simplify, and clarify the accounting for NFP entities, as well as increase the transparency of the financial statements for NFP entities. ASU 2016-14 focuses on a few primary areas, including net asset classification and liquidity disclosures. As an exposure draft, the proposed standard had also focused on operating performance measures; however, after the comment period, it was decided that the operating measures will be addressed in Phase 2 of the project. The standard as released will affect substantially all NFPs, as well as creditors, donors, grantors, and others that use their financial statements. NFPs will need to implement the new financial reporting model for fiscal years beginning after December 15, 2017.
Net Asset Classification
Under the SFAS 117, NFP entities were required to report three classes of net assets the face of their statement of financial position based upon the type of donor restriction placed upon a net assets, be it permanent, temporary or unrestricted. These classifications proved to be confusing to some users of NFP financial statements and many times difficult to apply in practice, especially in light of significant changes to endowment laws in recent years.
In an effort to simplify, under the proposed new guidance, these three classifications will be replaced with two: net assets with donor restrictions, and net assets without donor restrictions. Further, in response to changes in certain endowment laws which allow for prudent spending of “underwater funds,” (i.e.: permanently restricted gifts for which the value has decreased below the amount of the original gift or amount established by law), the “underwater” amount will be now classified as restricted and included with Net assets with donor restrictions, and additional disclosures will be required. Under the current rules, underwater funds are classified as unrestricted. The goal of these changes is to help users make a clearer distinction between those net assets that are available for the institutions operations and those that are not.
Statement of Cash Flows
The exposure draft originally required that all NFPs present its statement of cash flows using the direct method; however, that requirement was later retracted such that organizations may now continue to use either the direct or indirect method as set forth under previous guidance. However, to incentivize NFPs to utilize the direct method, the standard eliminates the need to provide a reconciliation of the direct method to the indirect method statement of cash flows when the direct method is presented.
Liquidity and Available Resources
The new ASU focuses on information about an organizations’ available resources to enable user to better understand liquidity risk. NFPs will be required to disclose certain qualitative information about how it evaluates its liquidity position and how the entity plans to utilize its available liquid resources to meet cash needs for general expenditures within a year of the date of the statement of financial position. Further, the ASU requires quantitative disclosures of its available liquid resources that are available to meet cash needs for general expenditures within one year of the date of the statement of financial position.
The new ASU requires other changes related to the statement of activities that include reporting information about operating expenses by both natural and functional classifications. These may be reported in one of three places, as a separate statement, on the face of the statement of activities, or as a note in the statement of activities. Certain qualitative information discussing the methods used to allocate expenses among program and support functions is also required. Finally, NFP entities will be required to include in the statement of activities, any returns on investments net of direct internal and related external expenses, as defined in the standard.
Phase 2 – Operating Measures, Alignment of Certain Cash Flow Items and Segment Reporting for Healthcare Entities
The proposed ASU exposure draft included amendments to assist users in understanding how an organization’s operations are performing. While these amendments are not included in ASU 2016-14 as released, the FASB has decided to address these amendments separately in Phase 2 of the not-for-profit reporting project.
ASU 2016-14 is effective for annual financial statements for fiscal years beginning after December 15, 2017, and for interim periods within fiscal years beginning after December 15, 2018, with early adoption permitted. NFPs presenting comparative financial statements must apply the requirements of this ASU retrospectively, although omission of certain of the amendments is permitted for periods prior to adoption.
Although these changes will require significant effort on the part of NFPs, the FASB’s goal is to improve the financial reporting of NFP entities to ensure that users of their financial statement received the most accurate picture of how the NFP is doing fiscally. These new requirements are intended to benefit not only the NFP entity but the users including donors, creditors, and others that otherwise engage in business activities with NFP entities.
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