New Financial Reporting Standards for NonprofitsBy Sibi Thomas, CPA, CFE, CGMA | October 2, 2017
Late last summer, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) that simplified and improved how nonprofit organizations tell their stories through their financial statements. This has been achieved by redefining classifications and how organizations report net assets, as well as other financial information.
These new standards are designed to help nonprofits provide more relevant and useful information about their resources to key stakeholders – including donors, board members, grantors, creditors and tax authorities.
At the time of the ASU release, FASB Chair Russell G. Golden noted, “While the current not-for-profit financial reporting model held up well for more than 20 years, stakeholders expressed concerns about the complexity, insufficient transparency, and limited usefulness of certain aspects of the model.” He continued “The new guidance simplifies and improves the face of the financial statements and enhances the disclosures in the notes.”
The FASB identified the following stakeholder concerns the new standards were designed to address:
- Complexities associated with net asset classification.
- Inconsistencies in reporting of expenses and investment returns.
- Deficiencies of other information.
- Issues related to the statement of cash flows.
Throughout the project, the FASB conducted extensive outreach with a diverse group of stakeholders, and received more than 260 comment letters.
Here are the specific areas impacted by these new standards:
Net Asset Classifications
The current net asset classification of unrestricted assets has been renamed “Without Donor Restrictions.” Temporarily and permanently restricted net assets have been combined and renamed “With Donor Restrictions.” It is important to note that the new net asset classification focuses on the word “donor.”
The term “unrestricted” net assets was often confusing to people other than accountants due to the notion that such assets are truly “available for operations.” Oftentimes, this is not the case since there may be contractual restrictions on those funds by a governmental funding source or board designation for a specific project.
The new name, “Without Donor Restrictions”, provides more clarity. Combining temporarily and permanently restricted into one category of “With Donor Restrictions” makes it easier to understand.
Another improvement in the new standards is the requirement to disclose the amounts and purpose of board-designated funds. This also emphasizes the importance to the board of considering the accounting implications of setting up a board-designated fund. There is a misconception among some that a large investment portfolio can be equated to board-designated funds.
For example, an organization with $10 million in its investment portfolio may not be able to designate all $10 million as board-designated net assets. The board needs to look at the true available net assets within the category of “Without Donor Restrictions” to ensure there are sufficient funds that could be set aside as board-designated. This will also avoid situations where the board-designated funds are more than the total net assets available for operations after disaggregating components such as “investment in plant, property and equipment.”
From time to time, the fair value of the assets associated with individual donor-restricted endowment funds may fall below the value of the initial and subsequent donor gift amounts. This situation is referred to as being “underwater.” With the new standards, when “underwater” endowment funds exist, they are classified as a reduction to the category “With Donor Restrictions.” This is a major improvement to nonprofit financial reporting. Under the new standards, the note disclosures should reflect the amount required to be maintained for donor-restricted endowments and the fair value of the endowment as of the financial statement date to report the “underwater” portion. The disclosure should include the spending policy, which raises the question of whether the organization continues to spend or decides to reduce spending on those “underwater” endowments.
The Uniform Prudent Management of Institutional Funds Act permits the organization to use the funds even if they are “underwater.” Thus, it makes perfect sense for the “underwater” potion to be included within the donor-restricted net assets.
The new standards eliminate the option that is currently available (except for nonprofits within the healthcare sector) to apply time restrictions when there is no purpose restriction on the donated plant, property and equipment. Going forward with the new standards, time restrictions on donated property and equipment are not allowed, except as instructed by the donor. In the absence of explicit donor restrictions, the asset is classified as new assets Without Donor Restrictions.
Cash Flow Statements
Under the new FASB standards, organizations that choose to report by the “direct method” are no longer required to do a reconciliation under the “indirect method.” This should encourage organizations to report by the direct method more often. Oftentimes, readers of financial statements pay little attention to the cash flow statement, primarily due to the complexity of the reporting format. The direct method is more user-friendly, and easier to understand for the average user. Nonprofits should start thinking about what type of reporting will make the most sense for their organization.
Resource Liquidity & Availability
Under the new standards, organizations need to provide qualitative and quantitative information on the liquidity and availability of their resources. Qualitative information should be used to report on how an organization manages its liquid available resources and provide for any liquidity risk. For example, how does an organization make sure it has enough liquidity? The answer could be maintaining a line of credit or bank account balances to cover a certain number of weeks’ expenses.
Quantitative information should communicate the availability of resources on the balance sheet to meet the cash needs for general expenditures within one year. The word “general expenditure” is important, because funds restricted by donors, contractual agreements or other types of internal designations may not be considered available for general expenditures.
For example, an organization can have liquid assets, thus providing liquidity. However, such liquid assets may not be available for general expenditures. The new standards provide more information and transparency that will be useful to the average reader about the financial viability and overall health of an organization.
One of the questions that organizations will want to consider is how they will treat board-designated funds in the liquidity and availability disclosure. Board-designated funds could be liquid, however they may not be “available” for general expenditures within one year. If the board-designated funds are liquid and available for general expenditures within one year, such funds could be included as available in the quantitative disclosures.
There is a greater level of flexibility with how organizations report their liquidity and availability information. It could be presented in a tabular format or management discussion and analysis format that can provide both qualitative and quantitative information. It’s important for organizations to start thinking about this now, evaluate their financial position and look at the balance sheet on a “classified” basis as well as consider the “availability” factor.
Investment expenses will be presented net of investment income in the face of the statement of activities. Netting is limited to external and direct internal expenses. It is no longer required to disclose investment expenses, and the new standards also remove the requirement of reporting various components of investment returns.
The new standards require expenses to be reported by function and nature. The old standards only required reporting expenses by function. Most organizations are already doing this either in the financial statements, in notes or on the IRS Form 990.
The new reporting requirements by function and nature can be either in the basic financial statements or in the notes. In addition, organizations are required to disclose how expenses are allocated by function. There is no set guidance in the accounting standards on what is an acceptable allocation methodology. However, the allocation methodology could be driven by government funding source regulations and requirements for social service agencies.
The keyword is “direct” function: If the CEO of the organization is directly involved in fundraising, their compensation should be allocated to fundraising. The new standards could be more challenging for nonprofits that currently do not present a statement of functional expense.
It’s clear that there are many “moving parts” to the FASB Not-for-Profit Entities Accounting Standards Update from last year. Even the most well-intentioned NFP organizations may find it challenging to meet all the requirements of this update. At the very least, it is helpful to engage an expert third-party for assistance reviewing the changes required in your own nonprofit financial statement preparation and associated disclosures.
Please note that per FASB, the amendments in this update are effective for annual financial statements issued for calendar year 2018 or fiscal year 2019. We advise that you allow adequate time and resources to make the necessary changes to your financial statements for your next reporting period.
Marks Paneth serves over 150 charities in and around the metro NYC area. For more information on our nonprofit accounting capabilities, please contact:
Sibi Thomas - Partner Nonprofit, Government & Healthcare Group | Marks Paneth
Phone: (212) 201-3004 | SThomas@markspaneth.com
This material has been prepared for general informational and educational purposes only and is not intended, and should not be relied upon, as accounting, tax or other professional advice.
Please refer to your advisors for specific advice.
About Sibi B. Thomas
Sibi Thomas is a Partner in the Nonprofit, Government & Healthcare Group at Marks Paneth LLP. He has more than 13 years of accounting, auditing, tax and consulting experience in the nonprofit industry. Mr. Thomas serves on the AICPA’s Not-for-Profit Entities Expert Panel and has been recognized by the CPA Practice Advisor as a 40 under 40 honoree for his leadership in the accounting profession. Mr. Thomas plans, coordinates and conducts audits of nonprofit organizations including: large... READ MORE +
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