Upcoming Changes to Not-for-Profit Accounting
In August of 2016, after receiving over 250 comment letters since its exposure draft from preparers, auditors and other users abroad, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update 2016-14 – Not-for-Profit Entities (Top 958): Presentation of Financial Statements of Not-for-Profit Entities (ASU 2016-14). The overall goal of the update was to enable Not-for-Profit’s (NFP’s) to better “tell their financial story”. While this update is not considered to be an overhaul of the current model, ASU 2016-14 will be the most significant update to NFP financial reporting in years.
The key provisions of ASU 2016-14 are as follows:
- Net Asset Classes
- Liquidity and Availability
- Expense Reporting
- Investment Return
- Statement of Cash Flows
Net Asset Classes
Under the current model, there are three types of net asset classes: unrestricted net assets, temporarily restricted net assets and permanently restricted net assets. These three classifications were confusing to many readers as the term “unrestricted net assets” was misunderstood. Therefore, the new presentation will combine net assets into two classes: net assets without donor restrictions and net assets with donor restrictions. Note that NFP’s will still be required to disclose donor/grantor-imposed restrictions, including how and when the resources may be used.
Liquidity and Availability
One of the more interesting provisions to ASU 2016-14 (interesting in the fact that it would be specific to NFP’s only) is the requirement to disclose qualitative and quantitative liquidity information. Specifically, information regarding how a NFP manages its available liquid resources and the availability of financial assets at the balance sheet date to meet upcoming cash needs (within 1 year).
A unique aspect of NFP financial reporting when compared to other types of industries is the requirement to show donor restrictions to its net assets. While this may be beneficial and informative, it can also mask the liquidity of an otherwise healthy balance sheet. For example, if an NFP were to have $25 million in cash, $50 million in PP&E, no debt and very few payables and accruals, this would indicate a very healthy balance sheet, right? However, what if that same NFP had a $20 million donor-imposed restriction on its cash and anticipated a $10 million loss in the next year? Would the NFP be able to meet its cash needs for general expenditures within 1 year? Probably not. These types of scenarios have occurred frequently and are the reason for the liquidity and availability disclosure as part of ASU 2016-14. To see an example of this disclosure click here.
The new requirements for expense reporting will require all NFP entities to present their expenses either on the face of the financial statements or in the disclosure notes by function and natural classification. Previously, this was only a requirement for voluntary health and welfare entities but now will affect all NFP’s (i.e. private foundations). The ASU also provides enhanced guidance on allocations from management and general expenses regarding activities that represent direct conduct or direct supervision.
Currently, NFP’s are required to disclose gross investment income and expense. Under ASU 2016-14, NFP’s are now permitted (but not required) to net investment expenses against investment return on the face of the statement of activities. This provision is the only update in ASU 2016-14 that was made in an effort to simplify NFP financial reporting. Note that this does not apply to programmatic investing activities (i.e. NFP’s that are in the business of making affordable loans to low-income families).
Statement of Cash Flows
The hottest topic under discussion from the FASB’s exposure draft was the potential measure to require NFP’s to present their statement of cash flows (SCF) using only the direct method. Those for the measure argued that the indirect method was confusing to readers whereas those against the measure argued that the SCF was not useful as part of the financial statements in general and that the direct method would be too cumbersome to produce. This was also evidenced at the AICPA’s most recent Governmental and Not-for-Profit Training Program in Las Vegas, where in a room full of 200+ CPA’s, when asked how many in the audience prepared the SCF using the direct method, two hands went up.
Fortunately, the FASB decided to leave this one alone (for the most part) and both the indirect and direct methods are still allowed under ASU-2016-14. The only change related to the SCF under ASU 2016-14 is for those few NFP’s that report the SFC using the direct method; they are no longer required to show the indirect reconciliation in the notes to the financial statements.
ASU 2016-14 is effective for fiscal years beginning after December 15, 2017 (calendar year 2018 and fiscal year 2018-2019) with early adoption permitted. Also, it is important to note that all of the amendments must be incorporated in the year of adoption. ASU 2016-14 is considered to be Phase I of a two part deliberations plan. Phase II is expected to be released for discussion soon and includes projects for further consideration including the statement of cash flows, expense reporting, and other various operating measures.
The full version of ASU 2016-14 can be accessed through the FASB website here.
If you have any questions regarding the FASB ASU 2016-14 update, please contact Chris Soderberg at ARM.