Nonprofit Accounting Basics

New Financial Reporting Standards for Nonprofits

The Financial Accounting Standards Board (FASB) has issued Accounting Standard Update (ASU) 2016-14.  This ASU is intended to update, not overhaul, the current financial statement model to improve information presented in the financial statements and notes about financial performance, cash flows and liquidity.

Net Asset Classes

The new standard reduces the number of net asset classes from three to two.  Unrestricted net assets, including board designations, will be presented as Without Donor Restriction. Temporarily Restricted and Permanently Restricted net assets will be combined and presented as With Donor Restrictions.

Disclosure requirements include explaining the composition of net assets with donor/grantor restrictions, emphasizing how and when resources can be used, i.e., the specified purpose and time restrictions.  Regarding board-designated net assets, the organization must disclose the nature and amounts of board-designations, and summarize the organization’s policies and/or practices surrounding board designations. 

Underwater Endowments

For any underwater endowment, the organization must disclose the current value of the fund, the original gift amount, and the net loss.  The entire balance of the endowment must be reported within the With Donor Restrictions class of net assets.  This is a change from current practice under which the original amount is reported as permanently restricted while the underwater amount is included as unrestricted. In addition, disclosures must include the organization’s interpretation of the ability to spend from the underwater endowment, and the organization’s policies and actions taken during the period concerning appropriation from underwater funds.

Donations of Property and Equipment

Regarding donations of property and equipment, or contributions restricted for their purchase, the option to release the donor-imposed restriction over the estimated useful life of the asset has been eliminated. The placed-in-service approach, whereby the amounts are reclassified from With Donor Restriction to Without Donor Restrictions when long-lived assets are placed in service, must be followed.

Disclosures about Liquidity

In addition to the disclosures discussed above, there are new disclosures required to provide qualitative and quantitative information about liquidity.  Qualitative information addresses how the organization manages its liquid resources available to meet cash needs for general expenditures within one year of the balance sheet date.  Quantitative information communicates the availability of financial assets at the balance sheet date to meet cash needs for general expenditures within one year of the balance sheet date given factors such as the nature of the assets, external limits imposed by donors, laws and contracts, and internal limits imposed by board decisions.

Disclosures about Expenses

Under current accounting standards, voluntary health and welfare organizations must provide a statement of functional expenses which is a disaggregation of functional expense classifications (programs and support services) by their natural expenses (payroll, rent, depreciation, etc.). Such information will now be required for all non-profit organizations in either the notes, in the statement of activities, or as a separate statement.  (Some organizations currently provide this information in a separate supplemental schedule, but that will not meet the new requirement that the information be provided as part of the basic financial statements.)  In addition, there is a requirement that the accounting policy or other note include a clear description of the method used to allocate costs among programs and support functions.

The new ASU removes the requirement to disclose gross investment income and expense, and allows a net presentation.  However, disclosure of the gross amounts is permitted.  Further, the ASU allows both external and direct internal expenses as defined in the ASU to be reported as investment expenses.

Statement of Cash Flows

Another change is to the statement of cash flows.  Organizations currently have the option to use either the direct method (which shows the cash received from donors/customers, cash paid for expenses, cash from other activities) or indirect method (which start with a reconciliation of net income to cash from operations). Although the direct method is preferred by the FASB, the reporting entity must include the indirect reconciliation if the direct method is used.  The new ASU eliminates the requirement to show indirect reconciliation.

Effective Date and Transition Guidance

ASU 2016-14 becomes effective for fiscal years beginning after December 15, 2017 (i.e., calendar year 2018 or fiscal year 2018/2019. Early adoption is permitted. In the year of adoption, all provisions must be applied retrospectively. However, for comparative years presented, the organization can elect to not present the analysis of expenses by nature and function, and/or the disclosures about liquidity and availability of resources.

Organizations can make many of the changes in the ASU without formally adopting the ASU.  The only changes that cannot be made without formally adopting the ASU are:  presenting the two classes of net asset rather than the currently required three classes; underwater endowment accounting; eliminating disclosures of investment return components and netted expenses; and eliminating the requirement to provide the indirect reconciliation if using the direct method for operating cash flows.

The ASU includes several examples of the disclosures and presentations discussed above.  These can be of significant help in the transition to the new reporting standards.