Last summer, the Financial Accounting Standards Board (FASB) issued Accounting Standard Update (ASU) No. 2016-14, Presentation of Financial Statements of Not-for-Profit Entities, which significantly alters the financial statements of nonprofits. As part of FASB’s comprehensive review of not-for-profit statement presentation, ASU 2016-14 is intended to increase reporting consistency by adjusting current requirements across a number of categories.
With an effective date of fiscal years beginning after December 15, 2017, now is the time for not-for-profits to familiarize themselves with each category of changes and what they mean for their organizations. In this post, we take a look at one of the components of this ASU: improved consistency related to investment returns and expense reporting.
Comparable measurement of investment returns
ASU 2016-14 requires that returns from investments (other than programmatic investments) be reported net of external and direct internal investment expenses. Not-for-profits are permitted, but no longer required, to disclose these netted expenses in the financial statement notes.
Programmatic investments are those directed at carrying out the not-for-profit’s mission, as opposed to investments in the general production of income or appreciation of an asset. An example of a programmatic investment is a loan made to lower-income individuals to promote home ownership.
Direct internal investment expenses are defined as costs of the direct conduct or supervision of strategic and tactical activities involved in generating investment returns. Examples include, but are not limited to, costs associated with the staff responsible for developing and executing investment strategy (salary, travel, etc.) and allocable costs associated with internal investment management or the supervision, selection and monitoring of an external investment management firm. These expenses do not include costs that are not associated with generating investment return, such as unitization and other such aspects of endowment management.
By requiring returns from investments to be reported net of external and direct internal investment expenses, ASU 2016-14 aims to provide a more comparable measure of investment returns across all not-for-profit entities, regardless of how investment activities are managed.
Additional expense allocation disclosure
Previously, only voluntary health and welfare entities were required to present a statement of expenses by both functional and natural classifications. ASU 2016-14 has removed that requirement for those organizations and now requires disclosure of an expense analysis by function and nature for all not-for-profit entities to be presented in one location, either on the face of the statement of activities, as a separate statement or in the notes to the financial statements. In addition to this analysis, all not-for-profits will be required to disclose the methods used to allocate expenses to the functional categories.
Expenses should be allocated to one of two functional categories: program services and supporting activities. Program services are those activities that result in goods or services being distributed to beneficiaries, customers or members that fulfill the organization’s purpose or mission. Supporting activities represent all activities outside these program services, such as management and general activities, fundraising activities and membership development activities.
Requiring additional disclosures related to the allocation of expenses improves the usefulness of information for users of the financial statements, helping them better understand the methods used for allocating costs among functional categories and the types of resources used in carrying out an organization’s activities.
Effective dates and next steps
ASU 2016-14 is effective for annual financial statements issued for fiscal years beginning after December 15, 2017, and for interim periods within fiscal years beginning after December 15, 2018. The amendments in this ASU should be applied on a retrospective basis; however, if presenting comparative financial statements, a not-for-profit has the option to omit the analysis of expenses by both natural and functional classifications (the separate presentation of expenses by functional classification and expenses by natural classification is still required). Organizations that have previously been required to present a statement of functional expenses do not have the option to omit this analysis and may present the comparative period information in any of the formats permitted in the ASU.
These are significant changes with considerable impact to the financial reporting practices of not-for-profits. Prior to the fiscal year in which ASU 2016-14 takes effect, organizations should review and digest these changes fully with their internal finance teams and external practitioners and develop a basis, or multiple bases, for the expense allocation and investment return changes.
For more information and questions on how to prepare for these reporting changes, please contact Douglas L. Berman, CPA, RKL’s 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.