The Financial Accounting Standards Board (FASB) has been working on refreshing the financial reporting model for nonprofit organizations for some time. The FASB first announced the nonprofit reporting project in November 2011. The FASB issued an exposure draft of the pending accounting standard update in April 2015, Not-for-Profit Entities (Topic 958) and Health Care Entities (Topic 954): Presentation of Financial Statements of Not-for-Profit Entities. Comments on the exposure draft of the standard were due back in August 2015. The FASB received hundreds of comment letters from practitioners and nonprofit organizations providing feedback and criticism on various aspects of the proposed standard.
Because of the responses received, the FASB decided to divide its redeliberations of the proposed standard into two work streams. The first work stream would be to finalize aspects of the standards that are not dependent on other projects and are improvements the FASB could finalize in the new term. The second work stream would be to reconsider changes that are likely to require more time to resolve because of the criticism and alternative suggestions made by stakeholders.
The FASB has completed their work on the first work stream and the final standard will be released to the public around the end of July or early August. The final standard will be effective for periods beginning after December 15, 2017, which would be for calendar years ending December 31, 2018 or for fiscal years ending in 2019.
Key Non-Profit Financial Standard Changes
The FASB has indicated the key changes from current GAAP to the new standard include:
- Allowing free choice between the direct method and indirect method in presenting cash flows
- Improving the presentation and disclosures for net asset classes
- Enhancing information about the liquidity and availability of financial resources
- Providing better information about expenses and expense allocation
- Improving reporting of investment return
The new standard will remove the requirement for entities to include the indirect reconciliation of changes in net assets to cash flows from operations when presenting the direct method of cash flows. They perceive this change as allowing the organization to have a choice between using the direct method and the indirect method of presenting cash flows. In the original exposure draft, the FASB had floated the idea of requiring the direct method, but a wave of stakeholder responses influenced the FASB to reconsider that requirement.
Net Asset reporting will change from the current three classes of Unrestricted, Temporarily Restricted, and Permanently Restricted, to two classes of With Donor Restrictions and Without Donor Restrictions. The hard line distinction between temporary and permanent restrictions would be removed. The focus would be on describing differences in the nature of the donor imposed restrictions and how and when those resources can be used. There will be additional requirements for the organization to disclose the amount, purpose, and type of board designations that will be categorized as Without Donor Restrictions. Organizations will want to include additional disclosures to report the nature and amount of donor restrictions in the notes to the financial statements. Organizations may find it useful to disaggregate the With Donor Restrictions on the face of the financial statements along the lines of certain broad groupings, perpetual in nature – such as endowments, purpose restricted, or time restricted.
Underwater endowment funds, which are donor-restricted, where investment losses and expenditures have resulted in endowment balances falling below historic cost, will now be required to be classified in nets assets with donor restrictions rather than unrestricted net assets under current GAAP. Enhanced disclosures on endowment funds will require describing the organization’s policy or decision on whether to reduce or not spend from underwater endowment funds, the original gift amounts of the underwater endowment funds in the aggregate and the fair value of underwater endowment funds in the aggregate.
The new standard aims to improve the reporting of the liquidity and availability of resources. Qualitative information will be required to inform on how the organization manages its liquid available resources and its liquidity risk. Quantitative information will be required to communicate the availability of the organization’s financial assets at the balance sheet date to meet cash needs for general expenditures within one year. The quantitative disclosures could be provided in a chart form in the footnotes that will start with all liquid financial assets available at year end and then reduce that total for claims on those resources including, amounts restricted by donors with time or purpose, amounts subject to appropriation, investments held in trust, and other claims, to arrive at the remaining financial assets available within one year to meet cash needs for general expenditures within one year.
The FASB is requiring that organizations report expenses by both their nature and function. Nature being salaries, benefits, depreciation, supplies, and travel; while function would be categorized into programs, administrative, and fundraising. Current GAAP requires only Health and Welfare organizations to provide a functional expense schedule. Organizations will be required to provide qualitative disclosures about their methods used to allocate costs among program and support functions. The new standard will provide enhanced guidance on allocations from management and general expenses.
The new standard will require net presentation of investment expenses against investment return on the face of the statement of activities. There is currently a divergence in practice among the nonprofit community in this area. Some organizations report investment income separate from investment expenses. The new standard is going to align investment reporting across the nonprofit sector.
Items that were segregated to the second work stream which has been delayed and may not ever be finalized include proposed changes to requiring an operating measures and realignment of certain cash flow items. Changes to the statement of activities regarding the operating measure surrounded on whether to require intermediate measure, whether and how to define such measurer, and what items should or should not be included in the measure. These changes seemed to result in more confusion and potential division in industry practice and have been postponed for the time being. Changes to the classification of certain cash flow line items between operating, investing, and financing activities could have resulted in significant differences between for-profit and not-for-profit financial reporting. There was considerable feedback given to the FASB on this issue which resulted in it being tabled for further deliberation.
Look for the new standard on financial reporting for nonprofits to be issued at the end of July or early August. This will be the first change to nonprofit reporting in more than twenty years. We will be providing more analysis and advice on the new standard in the months to come. Contact us if you have any questions or need guidance in managing these new requirements.