The Financial Accounting Standards Board (FASB) has issued the first update to U.S. Generally Accepted Accounting Principles (GAAP) for nonprofits’ financial statement presentation in more than two decades.
The main goal of Accounting Standards Update (ASU) No. 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities, is to increase transparency so users of nonprofits’ financial statements — whether the board of directors, lenders, grantors, donors or others — aren’t caught unaware of organizations’ means, as some were during the 2008 economic downturn. It contains several significant revisions of the initial exposure draft the FASB had released in April 2015.
Liquidity and availability of resources
The new requirements for the reporting of liquidity and available resources reflect this focus on transparency. ASU 2016-14 requires your organization to include certain qualitative and quantitative disclosures to help financial statement users better assess your nonprofit’s available financial resources.
The most difficult aspect of these disclosures may be the frank discussions the standard requires about liquidity to cover general expenses in the coming year. Disclosures will need to address cash on hand, cash forecasts, and reserves. For example, if your organization has little cash on hand and a lot of reimbursement contracts, you’ll need to think about how best to manage your day-to-day cash flows. You may determine that this is a good time to secure a line of credit that can act as a bridge in the event of late reimbursements. But you must include that line of credit in the disclosures.
Net asset classes
The new standard pares the net asset classes to two: net assets with donor restrictions and net assets without donor restrictions. And it requires additional disclosures related to board designations of net assets.
The ASU also changes the reporting of endowments that are underwater (meaning their fair value has fallen below the original endowed gift amount). It now requires the underwater portion to be classified as net assets with donor restrictions rather than unrestricted net assets and adds disclosures, including the aggregate of original gift amounts and fair value.
The new standard also generally mandates the use of the placed-in-service approach when you’re reporting the expiration of restrictions on capital gifts used to purchase or build long-lived assets such as buildings. In other words, nonprofits must reclassify these gifts as net assets without donor restrictions when the asset is placed in service. If you’ve been using the over-time approach (which spreads out the expiration of restrictions on gifts by recognizing them over the asset’s useful life), you should talk to your lenders about how this change could affect debt service ratios or liquidity covenants.
Expenses and investment return
Under the ASU, you’ll be required to classify expenses by both nature and function in one location (function was already required) and present an analysis of expenses by nature and function. “Nature” refers to expense categories such as salaries and wages, rent and utilities, and “function” primarily refers to program services and supporting activities. Your organization probably will be relatively unaffected by this new requirement, as you likely already collect and report the information.
You also must present any investment return net of all related external expenses (expenses paid to third parties such as investment managers) and direct internal expenses. This change will make it easier for financial statement users to make apples-to-apples comparisons of different nonprofits’ investment returns. The new standard eliminates the requirement to disclose the netted expenses, though.
Presentation of operating cash flows
In an earlier draft, the FASB proposed requiring nonprofits to use the direct method — which provides financial statement users with more information — to present the net amount of operating cash flows. The new standard lets you choose the direct or indirect method.
The new standard takes effect for annual financial statements issued for fiscal years starting after December 15, 2017, and for interim periods within fiscal years beginning after December 15, 2018. Early application is allowed. Please give us a call to help you determine the best time for your organization to adopt the standard.