Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) 2016-14, Presentation of Financial Statements for Not-for-Profit Entities, was released on August 18, 2016. The ASU’s scope includes all not-for-profits (such as charities, foundations, private colleges and universities, nongovernmental healthcare providers, cultural institutions, and trade associations) that apply ASC 958, Not-for-Profit Entities, or the not-for-profit provisions of ASC 954, Health Care Entities. Mutual entities, cooperatives, and similar organizations organized as not-for-profit corporations are not in the scope of the ASU. ASU 2016-14 is effective for annual financial statements issued for fiscal years beginning after December 15, 2017, and for interim periods within fiscal years beginning after December 15, 2018. Application to interim financial statements is permitted but not required in the initial year of application. Early application is permitted.
The FASB does not intend ASU 2016-14 to be a complete overhaul of the current financial reporting model for not-for-profits contained in GAAP, and the current financial reporting model in GAAP is still applicable. The goal of ASU 2016-14 is to improve the way not-for-profits communicate their financial performance and condition, while also reducing certain complexities in preparing financial statements. The amendments in this ASU are intended to improve financial statement presentation by not-for-profit organizations, provide donors, grantors, creditors, and other financial statement users with statements that are clearer and more transparent, and provide increased consistency of information. The ASU significantly changes how not-for-profits present net assets on the face of the financial statements and requires additional disclosures to provide more relevant information about not-for-profits’ resources (and the changes in those resources) to financial statement 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. The key changes proposed in the ASU are summarized below.
Net asset classifications
Under prior reporting requirements, there were three net asset classes: unrestricted, temporarily restricted, and permanently restricted. There are now two classes: net assets without donor restrictions and net assets with donor restrictions. The latter includes what was formerly separated into the temporarily restricted and permanently restricted net asset categories. In addition, organizations are now required to disclose additional information regarding net assets with donor restrictions, including liquidity and availability of funds, as well as when and how funds can be used. Year-end balances and purposes of board-designated funds must also be disclosed along with policies for managing those funds.
ASU 2016-14 also eliminates the “over time” approach of releasing long-lived assets to net assets without donor restrictions. Instead, a placed-in-service approach must be used, absent explicit donor restrictions. This means the full gift amount will be reclassified from “with donor restrictions” to “without donor restrictions” when the acquired or constructed asset is placed in service.
For endowments with losses (i.e., underwater endowments), organizations are now required to report the current fair value of the fund, original gift amount, and amount of the deficiency. Donor-funded endowments must be reported as net assets with donor restrictions on the statement of financial position. Quasi-endowment funds, which are designated by the organization’s governing board, should be reported as net assets without donor restrictions.
Expenses classified by function and nature
Functional expenses grouped by program or support must now be reported by their natural expense category (e.g. payroll, rent, etc.). This information must be presented on the face of the statement of activities, in a disclosure, or in a separate financial statement. Also, organizations are now required to disclose the method used to allocate costs between programs and support functions.
Investment income reporting
Organizations must now report investment returns net of external and direct internal investment expenses, whereas under current GAAP, this presentation is optional. The change will allow a better comparison of investment returns among all nonprofit organizations, regardless of whether their investments are managed internally or externally or if the organization uses mutual funds or other investment vehicles in which fees are embedded. Most organizations will not have direct internal expenses, which are generally incurred if you have a dedicated internal investment manager. In addition, disclosure of investment expenses and the components of investment return (investment income and realized/unrealized) are no longer required.
Liquidity and availability of resources
New disclosures will be required that describe the liquidity and availability of funds—specifically, how organizations will meet cash requirements for the next year. This is a detailed disclosure that will encompass the nature of assets, donor limits, laws, contracts, and board limits. Organizations will be required to disclose qualitative and quantitative information surrounding their liquidity to give financial statement users a better understanding of how an organization manages its risks. Such information includes how a not-for-profit manages (qualitative) its liquid available resources to meet cash needs for general expenditures within one year, as well as the availability (quantitative) of financial assets at the balance sheet date to meet those same expenditures.
Presentation of the statement of cash flows
This ASU eliminates the requirement to show indirect reconciliation from the change in net assets when the direct method of reporting is used. However, the new guidance continues to allow organizations to use either the direct method or indirect method to prepare their statement of cash flows.
Impact to your organization
Given the significant reporting and disclosure changes involved, all not-for-profit organizations that are impacted by this new reporting requirement should start preparing for these changes now. Some of the new disclosures, such as those regarding liquidity and availability, may necessitate an education process for managers, board members, lenders, and others who rely on financial statements for decision making. Other disclosures, such as the required disclosure of board designations on net assets, may require not-for-profits to adopt new policies and practices.
Nonprofits should evaluate whether to implement internally or hire a consulting firm to help implement. Organizations interested in internal implementation should make sure they have the bandwidth and time to implement on their own. The clock is ticking on the effective date for implementing the ASU 2016-14, and nonprofits should make it a priority to ensure smooth transition to this new financial reporting requirements before auditors are onsite.