On August 18, 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-14, Presentation of Financial Statements of Not-for-Profit Entities, aimed at making financial reporting less complex for not-for-profits and more user-friendly for entities relying on this data, such as donors, grantors or creditors.
The issuance of this ASU completes Phase I of FASB’s project to look at the presentation of not-for-profit statements and comes in response to stakeholder feedback to FASB’s 2015 proposal to uncouple not-for-profits from the reporting model used by for-profit entities. It improves current requirements related to net asset classifications, liquidity assessment, expense reporting consistency and methods used to present cash flow from operations. Below, we take a more detailed look at how each of these areas will change from current practices.
Simplified Net Asset Reporting and Classification
Currently, not-for-profits must present amounts for three classes of net assets (unrestricted, temporarily restricted and permanently restricted) on the face of the statement of financial position. To reduce complexity, this ASU streamlines these three net asset categories into two (net assets with donor restrictions and net assets without donor restrictions) for which not-for-profits must report amounts on the face of their statements of financial position.
For net assets with donor restrictions, the new ASU requires disclosures in the notes to financial statements regarding their composition, as well as amounts and purposes of governing board designations. When donor stipulations are not available, the ASU requires the placed-in-service approach for reporting expirations of restrictions on gifts of assets to be used to acquire or construct a long-lived asset. This approach reclassifies any amounts from net assets with donor restrictions to net assets without restrictions for such long-lived assets that have been placed in service as of the ASU’s effective date, as discussed below. This change is intended to improve the comparability and usefulness of classes of net assets.
The ASU also mandates that underwater endowment funds be included among net assets with donor restrictions, the very notion of which may contradict Pennsylvania trust laws. It also requires not-for-profits to disclose their policies concerning appropriation from endowment funds, their fair value, the original gift amounts to be maintained, and the aggregate amount by which the funds are underwater.
More Context Around Liquidity
This ASU requires more qualitative information in notes to the financial statements related to how a not-for-profit manages its liquid financial resources available to meet general expenditure obligations within one year of the date of the statement of financial position. This disclosure must also explain how net asset restrictions affect the availability of financial assets at the date of the statement of financial position to meet short-term financial obligations. This additional information will be useful in understanding limits on how, and during what time frame, resources can be used.
Expense Reporting Consistency
In addition to reporting expenditures by functional classifications, as currently required (i.e. program and supporting activities), the ASU also requires reporting by natural classification. This information must be presented in one location in the financial statements and provide an analysis of how the nature of these expenditures relate to their functional classifications. In addition, the methods used to allocate costs among functional classifications must also be disclosed in the financial statements.
Another expense reporting change concerns investment returns. While investment returns will still be presented net of investment expense, the ASU limits allowable netted expenses to external and direct internal investment expenses and no longer requires their disclosure. This netted expense limitation provides a more comparable measure of returns across all not-for-profits, regardless of how their investment activities are managed.
Methods to Present Cash Flow Statements
The net amount for operating cash flows will still be presented on the face of the statement of cash flows under either the direct or indirect method. However, if using the direct method, a not-for-profit is no longer required under this ASU to present or disclose the indirect method (reconciliation).
When Do These Changes Take Effect?
This ASU is effective for financial statements issued for fiscal years beginning after December 15, 2017, and for interim periods within fiscal years beginning after December 15, 2018.
Early adoption is permitted; however, initial adoption of the ASU is only for an annual fiscal period or for the first interim period within the fiscal year of adoption. The nature of any reclassifications or restatements in the initial year of adoption and their effects on the change in the net asset classifications for each fiscal period presented should be disclosed in the financial statements in the initial year of adoption. The requirements of the ASU should be applied on a retrospective basis in the year of initial adoption.
Questions about how to prepare for these reporting changes? Contact Douglas L. Berman, Not-for-Profit Industry Group leader.
Contributed by Andrew D. Kehl, CPA, manager in RKL’s Audit Services Group. Andrew has accounting and auditing experience serving clients in a wide variety of industries including nonprofit, healthcare and government.