Standards Update: 8/22/16
In November 2011, the Financial Accounting Standards Board (FASB) added a project to its agenda focusing on the financial reporting of nonprofit entities. The objectives of this project focused on improving net asset classification requirements and the information provided in the financial statements and notes about liquidity, financial performance and cash flows. In April 2015, the FASB issued a Proposed Accounting Standards Update (Exposure Draft) related to the project, which was open for public comment through August 2015. The project has since been split into two phases.
The first phase of this project has resulted in the issuance of Accounting Standards Update (ASU) No. 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities. The update strives to improve how a nonprofit organization classifies its net assets and provides information in its financial statements and notes about its financial performance, cash flows and liquidity.
The main areas of financial reporting impacted by the ASU are as follows:
Current guidance specifies three classes of net assets: unrestricted, temporarily restricted and permanently restricted. The FASB has modified the guidance to replace these classes with two classes of net assets: net assets with and without donor-imposed restrictions. This change removes the hardline distinction between temporary and permanent restrictions and focuses on how and when resources can be used. Additional disclosure requirements are included for board-designated net assets within the net assets without donor-imposed restrictions class, including the amounts and purposes of governing board designations. In addition, enhanced disclosures are required about the composition of net assets with donor restrictions at the end of the period and how the restrictions affect the use of resources.
Currently, nonprofits are required to report the deficit portion of donor-restricted endowments with deficits relative to the original gift amount (i.e., underwater endowments) as a reduction to unrestricted net assets. The ASU requires these deficits to be reported within the net assets with donor-imposed restrictions class of net assets. Nonprofits will also be required to disclose:
- The nonprofit’s governing body’s policy, and any actions taken during the period, on whether to reduce or not spend from such funds
- The original gift amount or level required otherwise by the donor or law to be maintained
- The amount of the underwater endowments in the aggregate
Current guidance allows for two options in the treatment of expiration of restrictions related to long-lived assets: a placed-in-service approach and an approach that releases the donor-imposed restriction over the asset’s useful life. The ASU requires that nonprofits utilize the placed-in-service approach, eliminating the alternative of recognizing the expiration of the donor restriction over time.
Currently, nonprofits may elect to utilize the direct or indirect method to prepare the statement of cash flows. The ASU continues to allow either the direct or indirect method. When choosing the direct method for the preparation of the statement of cash flows, nonprofits will no longer be required to reconcile the change in net assets to net cash flows from operating activities.
The ASU requires nonprofits to provide qualitative information about how the nonprofit manages its liquid resources and quantitative information related to the availability of the nonprofit’s financial assets to meet cash needs for general expenditures within one year. Availability of a financial asset may be affected by its nature, external limits imposed by donors, grantors, laws, and contracts with others, and internal limits imposed by governing board decisions. The final ASU includes examples illustrating how nonprofits may choose to include this information in their financial statements.
Currently, nonprofits may net investment expenses against investment returns or report them within the nonprofit’s expenses. If the netted presentation is used, the expenses are required to be disclosed. The ASU requires the net presentation option for investment expenses, including external and direct internal expenses. The FASB removed the requirement to disclose the amount of investment expenses net against investment returns, but NFPs are permitted to disclose this information.
The ASU also defines what activities constitute direct internal investing activities, including the salaries and related expenses of staff responsible for the development and execution of investment strategy and allocable costs associated with internal investment management and supervising, selecting, and monitoring of external investment management firms.
In addition, under the ASU, nonprofits will be permitted to present net investment return managed differently or derived from different sources in multiple, appropriately labeled line items within the statement of activities.
Finally, the ASU eliminates the requirement to display investment return components in the endowment net assets roll forward.
The ASU includes a requirement for all nonprofits to report expenses by their nature and retained the requirement to report expense by function. This analysis will need to be presented in one location, in either the statement of activities, a separate statement of expenses (similar to the statement of functional expenses), or a schedule in the notes.
The ASU also includes enhanced disclosure requirements about the methods used to allocate costs among program and support functions and amendments to the definition of management and general activities. Implementation guidance also includes illustrated cases to better depict the types of costs that may be allocated across functions and those that should not be allocated.
Effective Date and Transition
The amendments are effective for annual financial statements issued for fiscal years beginning after Dec. 15, 2017. They are also effective for interim periods within fiscal years beginning after Dec. 15, 2018. Application to interim financial statements is permitted – but not required – in the initial year of application. Early application of the amendments is permitted.
When adopted, the amendments will be required on a retrospective basis for all years presented – except that the analysis of expenses by function and natural classification, and disclosure around liquidity and availability of resources, may be omitted for any years presented before adoption.
The second phase of the FASB’s Not-for-Profit Financial Reporting Project will address portions of the proposed changes that were part of the related Proposed ASU issued in April 2015. The FASB has not provided an anticipated date for the final ASU covering the second phase.
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