NORWALK, CONN. (AUGUST 18, 2016)
for not-for-profit financial reporting, albeit with scaled back ambitions to keep the standards for nonprofit organizations aligned with standards for businesses.
The update aims to improve how a nonprofit organization classifies its net assets and provides information in its financial statements and notes about its financial performance, cash flow and liquidity.
“The major changes really revolve around the net asset classification,” FASB board member Larry Smith told Accounting Today. “We’ll be changing the three net asset classes that we have now, which are unrestricted, temporarily restricted and permanently restricted. We’ll just have two classifications: unrestricted and donor restricted. That will hopefully make things more evident and remove some of the confusion that exists today.”
The accounting standards update also changes how underwater donor-restricted endowment funds are treated. “To the extent that you have underwater endowment funds, now those are reflected in the unrestricted category,” said Smith. “The board decided to maintain those underwater amounts within the donor-restricted fund class. That’s a change that people need to be aware of.”
The new accounting standards update will also increase the information available about liquidity and the availability of resources, he noted. “The ASU requires a not-for-profit to provide certain qualitative information as to how it manages its liquidity, and then also requires some quantitative information, and that talks about the availability of a not-for-profit’s financial assets,” said Smith. “As to the balance sheet dates to meet cash needs for the next year, it requires a reconciliation that shows any limits that were imposed by the donors or by law, as well as any internal limits, such as those that have been designated by the governing board.”
The new standard also now requires financial statements for not-for-profits to provide expenses both by nature and function, as well as an analysis of those expenses by both nature and function, along with disclosure of the methods used to allocate those costs among the various functions, he noted.
“We’re also standardizing how organizations present investment returns and what expenses should be netted against those returns, which eliminates some of the flexibility that currently exists and the differences that currently exist,” said Smith. “Finally it allows a not-for-profit to elect the direct cash flow method without imposing on it the need to have a reconciliation that is currently required for those people that use the direct cash flow method. We hope the removal of that reconciliation will incent people to use the direct method of cash flows.”
The update requires not-for-profits and their accountants to improve their presentation and disclosures to provide more relevant information about their resources (and the changes in those resources) to their donors, grantors, creditors and other users. There are qualitative and quantitative requirements in a number of areas, including net asset classes, investment return, expenses, liquidity and availability of resources, and presentation of operating cash flows.
“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,” said FASB Chair Russell G. Golden in a statement. “The new guidance simplifies and improves the face of the financial statements and enhances the disclosures in the notes—which will enable not-for-profits to better communicate their financial performance and condition to their stakeholders while also reducing certain costs and complexities in preparing their financial statements.”
The project has been in the works since 2011 when FASB's Not-for-Profit Advisory Committee recommended it was time to re-evaluate the standards, and FASB added two projects to its agenda the following year. FASB met with various groups of stakeholders, receiving more than 260 comment letters on an exposure draft that it released in April 2015 of the proposed standards (see FASB Proposes Major Changes in Nonprofit Accounting
Big Changes Ahead
Lee Klumpp, director in BDO USA’s Nonprofit Institute for Excellence, believes the ASU will mark the “biggest change to nonprofit financial reporting in more than 20 years.” As a former member of the FASB Industry Fellowship Program, he was involved in helping draft the proposed standard and explaining it to groups around the country.
He advises nonprofits to get ready for the changes. “There’s often an initial resistance to change,” said Klumpp. “But this is an opportunity for nonprofits to be catalysts for progress, taking their financial statements to a higher level and making them a better resource for communicating accomplishments and outcomes to stakeholders instead of using financial statements as just a vehicle to report history.”
In last year's exposure draft, FASB chairman Golden and vice chairman James Kroeker expressed dissenting views on the proposed standard (see FASB Sees Dissent on Nonprofit Accounting Changes). FASB heard concerns during its outreach that the proposed changes for not-for-profits could be getting ahead of the accounting standard updates for for-profit businesses and decided to put off some of the more radical changes until a “phase 2.” For the final standard released Thursday, representing phase 1, only one FASB board member, Thomas Linsmeier, voted against the changes, though it was for a different reason.
“The only person that voted against it was Tom Linsmeier, and his vote against it had to do with the direct cash flow method,” said Smith. “He wanted the direct cash flow method to be required as opposed to just making it optional.”
Phase 2 will deal with some of the more controversial proposals. “I think the people that objected to it previously didn’t feel comfortable with what we were presenting in the operating measure, and that in fact has been deferred until phase 2 now, so we haven’t addressed that in this ASU,” said Smith. “In fact some of the people that commented on the exposure draft specifically pointed out that we have a research agenda project on financial performance reporting for business enterprises. Some people have commented that they think we should consider what we do for business enterprises in arriving at whatever we decide to do for an operating measure for not-for-profits.”
Along with deciding whether to require an operating measure for not-for-profits and how to define it specifically, in phase 2 FASB will revisit its earlier proposals for realigning some of the cash flow line items with what had been proposed as an operating measure. Another possibility for phase 2 is consideration of whether a not-for-profit should present segment information instead an analysis of expenses by both function and nature. “That’s something that has been discussed at board meetings but hasn’t specifically been decided on or voted on, but it has been discussed,” said Smith.
Some of the proposed changes for phase 2 may only apply to nonprofits that appear to operate like businesses, such as health care not-for-profits.
The standard released Thursday will affect a wide range of not-for-profit organizations, including charities, foundations, colleges and universities, health care providers, religious organizations, trade associations, cultural institutions and others.
“It will affect any not-for-profit that currently has temporarily restricted, permanently restricted and unrestricted funds,” said Smith. “It will also impact all of them from the standpoint of the liquidity disclosures. While many companies currently present the analysis of expenses by function and nature in their Form 990, this brings forth that requirement into the GAAP financial statements, so this will impact basically the body of not-for-profits.”
Get Ready Early
The changes in the standard are effective for annual financial statements issued for fiscal years beginning after Dec. 15, 2017, and for interim periods within fiscal years beginning after Dec. 15, 2018. FASB is allowing application of the amendments to interim financial statements but they are not required in the first year of applying the new standard. Early application of the amendments in the accounting standards update is also allowed.
Klumpp believes it's a good idea to adopt the changes early. “Organizations should strongly consider acting early on the new guidance,” said Klumpp. “The upcoming revenue recognition, lease accounting and financial reporting standard update deadlines could make for a challenging trifecta of accounting changes for nonprofits.”
Smith advises accountants to work closely with their clients to prepare them for the upcoming changes. “I think they are going to need to work with their clients to make sure they have good methodologies for the allocation of expenses by function,” he said. “That will be a key area. I also think they will need to work with their clients in terms of evaluating how an entity needs to structure its liquidity disclosures and what type of information it needs to have available for assessing the availability of cash flows and the types of limits that might be imposed by either donors, laws or their own governing body. In terms of going from the three classes to the two classes, I don’t think that’s anything that should be particularly difficult to accomplish.”
The new standards promise to provide better transparency for donors and members of nonprofit boards of trustees to help them understand the financial statements better.
“I truly believe this is a marked improvement in terms of how the net assets are presented,” said Smith. “It’s more understandable, more intuitive, and the liquidity disclosures and the availability of resources over the next 12 months are a major improvement in the disclosures over what is currently required, which is not a heck of a lot of information. I think it’s a dramatic improvement in what’s being displayed, and quite frankly I don’t think it’s an improvement that’s costing a heck of a lot. I think while there are some costs, particularly perhaps in the first year, I don’t think the costs are all that insurmountable. Therefore, I think it’s a good improvement in financial reporting for not-for-profits.”
Communicating the Changes
Nonprofits will need to make sure they tell their main constituents about the changes to their financial statements. “Organizations’ ability to effectively communicate these changes to their key stakeholders will be key during adoption,” said Klumpp. “While the ASU provides nonprofits with more options for presenting their results, it may prove to be a test of how well they can educate readers of their financial statements on what has changed and why.”
He believes the changes will give organizations more choices. “These changes offer nonprofits more options for presenting and reporting important financial information,” said Klumpp. “However, each organization will need to determine which options best fit their specific needs and the needs of their stakeholders.”
In addition to the accounting standards update, FASB has posted a “FASB in Focus” overview of the new standard, a “FASB: Understanding Costs and Benefits” document, and a video entitled "Why a New Not-For-Profit Financial Reporting Standard?” on its website www.fasb.org.
“We’d advise that nonprofits quickly do three things,” said Klumpp. “First, read and digest the guidance, then consider speaking with advisors about your options. The third step is to discuss it with your board. Boards count on financial statements and absolutely need to be a part of the process for managing implementation.”
FASB also plans to host a webcast entitled “In Focus: FASB Accounting Standards Update on Not-for-Profit Financial Statements,” on Sept. 13, 2016, from 1:00 to 2:15 p.m. EDT. The webcast will feature Smith discussing the ASU with FASB staff and answering questions submitted by viewers. Live broadcast viewers will be eligible for up to 1.5 hours of continuing professional education credit. For more information or to register for the event, click here.