By Julleen Snyder, CPA, CGMA
*Note: This newsletter is from an article that Julleen wrote for the Washington Society of Certified Public Accountants
In June 1993, the FASB issued Statement #117 Financial Statements of Not-for-Profit Organizations. This standard introduced us to the concept of donor-restricted net assets, both temporarily restricted and permanently restricted, and we have been reporting under this standard ever since. Fast forward to August 2016. The financial accounting standards are now codified and FASB issued Accounting Standards Update No. 2016-14 Not-for-Profit Entities, the first major change to financial reporting for not-for-profits since 1993. Time for old and young dogs to learn a few new tricks. Are you ready?
The effective date of the new standard is for fiscal years beginning after December 15, 2017, so it must be implemented for calendar years ending December 31, 2018 or fiscal years ending June 30, 2019. Early implementation is permitted, however, the standard may not be implemented piecemeal; all relevant requirements must be implemented in the same year.
There are eight main impacts of the new standard:
1. Change in presentation of net assets from three classes to two classes
First, and most significant, is the change from three classes of net assets (unrestricted, temporarily restricted and permanently restricted) to two classes (net assets with donor restrictions and net assets without donor restrictions). Although those restriction terms are not new, they continue to be the source of significant confusion to financial statement users. This was exacerbated by the adoption of the Uniform Prudent Investment of Institutional Funds Act (UPMIFA), which blurs the lines between the net asset classes included within endowment funds. Therefore, the revised standard calls for net assets and change in net assets to be shown as either Net Assets without Donor Restriction or Net Assets with Donor Restriction, further emphasizing that only donor restrictions are contemplated in the restricted net asset class.
But wait. Before you start reducing the level of tracking you currently maintain for your restricted net assets, be aware that there are enhanced disclosure requirements with respect to the nature and availability of donor restricted funds. This will likely mean you will continue tracking restrictions in much the same way you do now:
- Disclose board designated or quasi-endowment funds (net assets without donor restriction) separately from donor-restricted endowment funds (net assets with donor restriction).
- Disclose the fair value of the underwater endowment funds, the amount of the original endowment gift and the amount of the deficiencies of the underwater funds (Although you no longer have to remove underwater endowments from net assets with donor restrictions).
- Track the original gift balance separately from the accumulated investment earnings, even though the break-out only needs to be disclosed if the fund goes underwater.
2. Enhanced disclosure relating to both classes of net assets
There are additional disclosure requirements with respect to any governing board designations, appropriations, or similar actions that result in self-imposed limits on the use of resources without donor restrictions. While many not-for-profits have voluntarily disclosed this type of information in the past, it will now be a requirement. As such, it is important that the actions of the governing board with respect to such activities are clearly documented, preferably in the minutes to the meetings of the governing board.
3. Additional disclosure regarding qualitative and quantitative aspects of liquidity
The qualitative portion of this disclosure focuses on how the not-for-profit manages its liquidity to meet short-term demands for cash. This could include operating reserve policies, cash management practices and/or availability of credit (line of credit). The quantitative portion of the disclosure calculates a measure of the availability of the not-for-profit’s financial assets to meet cash needs for general expenditures within one year of the balance sheet date. It can be affected by the nature of the financial assets; external limits imposed by donors, grantors, laws, and contracts with others; or internal limits imposed by governing board decisions. I suggest that all not-for-profits start calculating the available financial asset measure now so that if any changes are needed, action can be taken prior to implementation of the new standard.
4. Option to eliminate indirect cash flow reconciliation when direct method cash flow is presented
For-profit entities are not required to use the direct method, but is the preferred method for non-profits as it is generally easier for non-accountants to understand. Under the new standard, if the direct method is presented, the presentation of the indirect reconciliation becomes optional.
5. Required presentation of both natural and functional classification of expenses and enhanced disclosure of expense allocation methodologies
The goal of the remaining aspects of the standard is to improve comparability across not-for-profit financial statements by addressing certain variance in practice. The impact of these changes, if any, on your organization’s financial statements will depend on your current practice.
6. The nature and function of expenses must be shown in the same location
The statement of functional expenses, which shows both the natural and functional categories of expenses, has long been a required statement for voluntary health and welfare organizations. The new standard requires that the nature and function of expenses be shown in the same location, either on the face of the statement of activities, as a separate statement, or in notes. As the traditional statement of functional expenses is an easy way to accomplish this requirement, I anticipate that many not-for-profits will opt to include this statement.
7. Investment returns must be reported net of both external and direct internal investment expenses
Under the new standard, all organizations will report investment returns net of both external and direct internal investment expense and will no longer be required to disclose the amount of the investment expenses. Requiring all not-for-profits to report their investment returns net of direct investment expenses will provide a more comparable measure of investment returns across all not-for-profits, regardless of whether they manage their investments using internal staff, outside managers, volunteers or a combination. It will also address the issue of embedded fees included in mutual funds, hedge funds, and other similar investment vehicles. It is often difficult to accurately identify all embedded fees. Eliminating the requirement to disclose total investment expenses will eliminate the difficulties and related costs in identifying embedded fees and the resulting inconsistencies in the reported amounts of investment expenses.
8. Restrictions on gifts of cash or other assets must be released when the long-lived asset is placed in service
Currently, in the absence of explicit donor stipulations, not-for-profits have the option of releasing the restriction on gifts of cash or other assets to be used to acquire or construct a long-lived asset, either when the asset is placed in service or over the estimated useful life of the asset. Under the new standard, such restrictions must be released when the long-lived asset is placed in service. While the practice of releasing restrictions when the asset is placed in service is the more commonly selected method, those organizations who have chosen to release over time will see a significant change to their net asset classifications upon implementation of the new standard, as all remaining unreleased balances relating to long-lived assets will be reclassified to net assets without donor restriction.
I am excited to assist my clients in implementing the various provisions of this new standard and I do believe it will improve the understandability and comparability of not-for-profit financial statements. The standard continues to allow for diversity in presentation style that gives not-for-profit entities some choice as to how best to present their financial picture, while tightening up in areas that resulted in the most confusion among financial statement users.
Julleen Snyder, CPA, CGMA, is a partner with Jacobson Jarvis & Co. You can contact her at email@example.com.