When auditors of not-for-profit organizations can provide the optimal level of assurance on an organization's financial statements, the report will say “the financial statements present fairly, in all material respects, the financial position of the organization and the changes in its net assets and cash flows.” The question naturally arises, then: what is meant by “material”? Auditing standards define materiality as something that could influence “the judgment of a reasonable person relying on the information.” Thus, materiality is not only quantitative but qualitative as well.
With that in mind, it is advisable to consider the many recent accounting changes and what material effect they will have on the users of financial statements.
Going concern issues
In August 2014, the Financial Accounting Standards Board (FASB) released Accounting Standards Update (ASU) 2014-15, revising the criteria for considering going concern basis for calendar years beginning in 2016. Prior to this, auditors had to consider whether an organization is likely to continue in operation for a year following the date of the financial statements—the statement of financial position or balance sheet date.
If an organization had a financial structure that made this difficult to attest to, such as a negative net assets balance, they could put off their audit until later in the year, shortening this period to a few months. The new ASU changes the date when the clock starts on the year of viability. Henceforth, auditors must consider whether an organization will continue in operation for a year following the issuance of financial statements—the auditor’s report date.
Because no auditing procedures can be performed after issuance, this change eliminates the delay strategy and forces auditors to address going concern in the auditors’ report. Bringing the issue up in the auditors’ report will inform all users and raise concerns among grantors and donors.
In January 2015, FASB released ASU 2015-01, eliminating the concept of extraordinary items. In it, the FASB concluded there is no clear way to define the concept of “unusual and infrequent” on a ubiquitous basis, so they agreed to end the practice altogether. Before ASU 2015-01,
events or transactions that met the then-current criteria for classification as an extraordinary item were required to be segregated from the results of ordinary operations and shown separately in the statement of activities, net of tax, after income from continuing operations. Beginning in 2016, if a nonprofit faces some unexpected calamity that would historically be classified as an extraordinary item, such as earthquake damage in Illinois, they would no longer be permitted to segregate this amount from operating expenses, although they may still report it as a separate line item within operating expenses. Still, this increase in total expenses may raise concerns among some users.
Debt financing costs
In April 2015, FASB released ASU 2015-03, changing the way debt financing is presented on the financial statements. Beginning in calendar year 2016, organizations must reclassify capitalized financing costs from the asset side of the statement of financial position and, instead, classify it as a subtraction from liabilities. Thus, total assets will be lower than in prior years for organizations that had previously recognized financing costs as an asset.
Investments using net assets value as a practical expedient
In May 2015, FASB released ASU 2015-07, eliminating the requirement to include investments valued at their net asset value in the fair value hierarchy disclosure, beginning in 2017. Instead, nonprofits will be required to provide a reconciliation between the fair value hierarchy disclosure total and the investments reported on the statement of financial position. This change will tend to draw these investments to the attention of users and distinguish them from other investments—a qualitative difference in reporting.
In May 2014, FASB released ASU 2014-09, clarifying the GAAP requirements for recognizing revenue from contracts with customers. Beginning in calendar year 2019, organizations must recognize revenue from contracts, such as research and development grants, based on the achievement of major milestones in the contracts rather than on the passage of time.
Because considerable effort may be required before a milestone can be said to have been achieved, this new reporting may tend to delay revenue recognition, depressing the bottom line of nonprofits’ and others’ statements of activity in the early years of multi-year contracts. The new revenue recognition requirements will be applied retroactively upon implementation, so nonprofits need to start identifying contracts and customers now.
Not-for-profit financial statement presentation
In August 2016, FASB released ASU 2016-14, making numerous changes in the presentation of nonprofit financial statements, beginning in calendar year 2018. This ASU establishes new requirements in the areas of net assets, investment return, functional expenses, and operating cash flows. Additionally, nonprofits will have to provide detailed information about liquidity and how they plan to use available cash to cover expenses for the year following the date of the financial statements. The information is required to be both narrative and tabular. Nonprofits that have borrowed from their restricted funds to cover general expenses will need to disclose this.
In February 2016, FASB released ASU 2016-02, a long anticipated attempt to align accounting principles in the United States with internationally recognized standards. This change in accounting may be the most impactful of the current batch of new standards.
When adopting this ASU, nonprofits and all other entities will be required, beginning in calendar year 2020, to recognize a liability for any leases under which they are obligated to make payments. Entities will also be required to recognize an asset valued at the same amount. Net assets won’t change (the asset and liability will offset each other). But, reporting and debt ratios (standard in most loan covenants)—such as debt-to-equity ratios—will change dramatically. The effect will be largest for new leases. Debt to equity ratios, as currently formulated, will increase significantly, placing many borrowers into default on their loan covenants.
Although it may seem that nothing has changed, financial institutions may perceive a difference in risk between nonprofits with large new leases and those without. The time for all entities to address this with their lenders is now, while they still have some leverage.
Changes to financial statements are here... and are coming. UHY LLP professionals are available to analyze your nonprofit’s existing financial reporting relationships and consider the effect of accounting changes, including providing pro forma drafts of how current financial statements would look when the changes have been implemented.