Major changes are ahead for the presentation of nonprofit financial statements, thanks to Accounting Standards Update (ASU) No. 2016-14, Presentation of Financial Statements of Not-for-Profit Entities. Unveiled in August 2016 by the Financial Accounting Standards Board (FASB), ASU 2016-14 streamlines and simplifies requirements related to several aspects of financial reporting to improve consistency among not-for-profit organizations. This update takes effect for fiscal years beginning after December 15, 2017.
In order to help nonprofit leaders digest this significant update and prepare for the changes, we have been breaking out components for closer examination. Earlier this year, we outlined changes related to investment returns and expense reporting. Now, we turn our focus to another area of this ASU: net asset classification.
Simplified net asset classifications
One of the most significant changes from this ASU is reducing the number of net asset classifications. Currently, nonprofits must present net assets in one of these three classes: Unrestricted Net Assets, Temporarily Restricted Net Assets or Permanently Restricted Net Assets.
The current classification structure presents a number of challenges for nonprofits and related third parties (like donors, partner organizations, federal regulators, etc.), including misunderstanding of terminology, confusion around the classes, deficiencies in transparency and more. There is also a lack of information regarding how restrictions imposed by donors, laws and governing boards affect an NFP’s liquidity and classes of net assets.
For these reasons and more, ASU 2016-14 set out to simplify the presentation of net assets, reducing the classes from three to two and changing the basis of classification to address restrictions imposed by donors. This change will reduce complexity and improve understanding of financial statements. The two classes of net assets under the new standard are Without Donor Restrictions and With Donor Restrictions.
Reporting requirements for net assets
Under the new classification structure, the donor-imposed restriction category includes what was previously reported as Permanently Restricted and Temporarily Restricted. Net assets without donor-imposed restrictions, including those that are designated by the board, are those previously reported as Unrestricted. See additional information below related to board-designated net assets.
The change in classification to net assets With Donor Restrictions does not eliminate current requirements to disclose the nature and amounts of different types of donor-imposed restrictions. Additionally, separate line items may be reported within net assets with donor restrictions or in notes to financial statements to distinguish between various types of donor-imposed restrictions, such as those expected to be maintained in perpetuity and those expected to be spent over time or for a particular purpose. This information must be disclosed on the year-end balance of net assets with donor restrictions.
Revised definition and disclosure for board-designated net assets
As mentioned above, net assets that are without donor-imposed restrictions may still be designated by the board. Under current standards, board-designated net assets may be earmarked for future programs, investment or other uses. This remains true with the implementation of ASU 2016-14. Additionally, this ASU allows governing boards to delegate designation decisions to internal management, with those designations also included in board-designated net assets.
Although board-designated net assets exist under current standards, the new ASU adds a requirement to disclose information about the amounts, purpose and type of any board designations included in net assets without donor restrictions.
Underwater Endowment Funds
More minor in scope than the net asset changes, ASU 2016-14 also adds a new entry to the FASB master glossary for “underwater endowment funds,” which it defines as “donor-restricted endowment funds for which the fair value of the fund at the reporting date is less than either the original gift amount required to be maintained by the donor or by law that extends donor restrictions.”
The new underwater endowment fund definition brings with it new disclosure requirements. Nonprofits must now report the entire balance of endowment fund within the With Donor Restrictions class of net assets and, for each period a statement of financial position is presented, outline the information below in the aggregate for all underwater endowment funds:
- Fair values of the underwater endowment funds
- Original endowment gift amount or level required to be maintained by donor stipulations or by law that extends donor restrictions
- Amount of the deficiencies of the underwater endowment funds.
In addition to reporting the financial characteristics of the fund as described above, nonprofits must also disclose the following:
- An interpretation of the nonprofit’s ability to spend from underwater endowment funds.
- A description of policy, and any actions taken during the period, concerning appropriation from underwater endowment funds.
It is important to note, however, that this ASU does not contemplate the effects of Pennsylvania’s Act 141 for endowments. It is up to organizations to consider the effect on their financial statements and disclosures, if any.
While the above changes and others contained in ASU 2016-14 will streamline and improve financial reporting for nonprofits, it will be a significant departure from current practice that will require preparation and adjustment. Nonprofit leaders and their finance teams should familiarize themselves with these impending changes prior to the fiscal year the ASU takes effect and work internally or with external practitioners to plan for adoption.
RKL’s team of professionals focused on the nonprofit sector are available to help organizations better understand and prepare for these changes. Contact Douglas L. Berman, CPA, Not-for-Profit Industry Group Leader, with any questions or for more information.
Contributed by Michelle J. Frye, CPA, Manager in RKL’s Audit Services Group. Michelle has over 14 years of experience in public accounting and serves the assurance needs of a wide range of not-for-profit organizations.