Originally posted on Accounting Today April 27, 2016
Wondering what’s happening with the Financial Accounting Standards Board’s Accounting Standards Update for Not-for-Profit Entities on the presentation of financial statements?
Below is a summary of the board’s tentative decisions reached as of the beginning of April 2016. Just remember, the board’s decisions become final only after a formal written ballot to issue final standards. I have also included an impact analysis on each of the items.
Net asset classification: The board decided to combine temporarily and permanently restricted net assets into one — “Net Assets with Donor Restrictions.” Unrestricted net assets will be called “Net Assets without Donor Restrictions.” In addition, NFPs will be required to disclose the amount and the purpose of board-designated net assets.
In addition, the aggregate amount by which endowment funds are underwater would be classified within the net assets with donor restrictions, rather than the unrestricted category as currently presented. The board also proposed enhanced disclosure on underwater endowment funds.
There is a significant change on the presentation of net assets used to purchase long-lived assets. In the absence of explicit donor instructions, NFPs would be required to reclassify net assets with donor restrictions that are for the acquisition or construction of long-lived assets as net assets without donor restrictions when the long-lived asset is placed in service, removing the alternative of recognizing the expiration of the donor restriction over time.
Impact analysis: Classification of net assets into two categories would align the accounting standards with the current legal requirements on maintaining donor-restricted endowment funds. We have to wait and see what the note disclosure requirements are on net assets with donor restrictions. At a minimum, the disclosure should identify those net assets that are permanently restricted. Combining the “underwater” endowments within the category of net assets with donor restrictions makes perfect sense. The change on classification of long-lived assets will have an impact on the so-called “matching” principle, because NFPs will no longer be allowed to match the depreciation expense with releases of restricted net assets unless explicitly instructed by the donor.
Operating measure: The board decided to enhance the current requirements of those not-for-profit entities that choose to present an operating measure in the statement of activities and present internal board designations or appropriations (for example, appropriation of investment earnings for operations). Such NFPs would be required to report these types of transfers disaggregated and described by type either on the face of the financial statements or in the notes to the financial statements.
Impact analysis: Many NFPs currently include the amount of investment earnings allocated for operations through a spending policy as operating activities in their statement of activities. In addition, generally NFPs disclose the spending formula used for such allocation. This is important especially for social service agencies that are funded by government contracts. As you may know, government contracts seldom cover the full cost of operating programs, resulting in nonprofit organizations depending on the investment earnings (if they are fortunate to have a large enough investment portfolio) to cover the shortfall. Currently, those nonprofits that present the statement of activities with a self-defined operating measure disclose the definition of operations versus non-operations in the notes to the financials. As a result of the update, such NFPs will be required to present enhanced disclosures.
Expenses by function and nature: The board affirmed the proposal to require all NFPs to disclose expenses by natural classification. It also approved retaining the current requirements for all NFPs to report expenses by function. In addition, NFPs would be required to enhance the disclosures on method(s) used to allocate costs among program and support functions.
Impact analysis: Most organizations currently have a generic disclosure on allocation of costs; the new requirement will need specifics on the cost allocation methodology — for example, square footage for rent or salary study for personnel costs, etc. NFPs that require external governmental reporting such as the New York State Consolidated Fiscal Report must ensure that the methodology described in the financial statements is consistent with NYS CFR reporting or other such similar external reporting requirements. In addition, developing a formal cost allocation methodology will assist in the disclosure requirements.
Those NFPs that currently don’t present a statement of functional expenses should start preparing for the change. Enhancements to the current chart of accounts or the accounting software will assist in generating a statement of functional expenses statement directly from the general ledger with minimal edits outside of the system.
Investment return: Nonprofit organizations would be required to present investment return net of external and internal direct investment expenses. In addition, NFPs are no longer required to disclose investment expenses and details of investment components in the endowment net assets roll-forward in the notes.
Impact analysis: Hooray! Like many of you, I was never a fan of the detailed disclosures of investment components in the endowment roll-forward. In addition, no more trying to figure out the investment expenses to disclose separately in the notes.
Assessing liquidity: The board decided that NFPs should provide quantitative and qualitative information in the financial statements on the liquidity of the organization for one year from the balance sheet date.
Impact analysis: Additional disclosures on liquidity will require analyzing the assets and liabilities on a classified approach — current versus non-current to develop the disclosure information. In addition, nonprofits would be required to identify any restrictions on the current or non-current items based on laws, limits by donor, governing body, or other contractual restrictions. Given the recent events of bankruptcies of nonprofit organizations, this will shed more light into their financial viability. An internal liquidity analysis as part of the audit by the auditors will be a strong case to assess the viability of the organization. It will be interesting to see what the board’s illustrations and examples look like.
Cash flow statement: NFPs will be allowed to use either the direct or indirect method. Those NFPs that choose to use the direct method will no longer be required to provide the indirect reconciliation.
Impact analysis: The removal of the reconciliation requirement may encourage more NFPs to choose the direct method.
Transition: The board decided that NFPs should apply the amendments on a retrospective basis for all years present. They also decided to permit early adoption.
Effective date: The board decided that the amendments will be effective for financial statements for fiscal years beginning after Dec. 15, 2017, and for interim financial statements for periods after that date — in other words, calendar 2018 and fiscal 2019 year ends.
Sibi Thomas, CPA, CFE, CGMA, is a partner at the Nonprofit & Government Group of Marks Paneth LLP. He is also an adjunct faculty at New York University. Reach him at email@example.com and follow him on Twitter at @SibiThomas_.