On Thursday, August 18, the Financial Accounting Standards Board (FASB) issued final guidance intended to improve financial statement presentation by not-for-profit (NFP) organizations—a model that has existed for more than 20 years. The new guidance will affect substantially all NFPs, including charities, foundations, private colleges and universities, non-governmental health care providers, cultural institutions, religious organizations, and trade associations, among others. The amendments require NFPs to improve their presentation and disclosures to provide more relevant information about their resources (and the changes in those resources) to their donors, grantors, creditors and other 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.
Net Asset Classification
In order to simplify the net asset classification scheme, the new guidance requires NFPs to present, on the face of the statement of financial position, the amount for each of two classes of net assets—net assets with donor restrictions and net assets without donor restrictions—as opposed to three. However, the guidance does retain current requirements to provide information about the nature and amounts of different types of donor-imposed restrictions, and also requires similar information about governing board designations. The disclosures will highlight the importance of information about how those restrictions and designations affect the use of resources, including their liquidity.
As part of the change to net asset classification, the amendments change how endowments that have a current fair value less than the original gift amount (or amount required to be retained by donor or by law), known as “underwater” endowments, are classified; those amounts will now be classified in net assets with donor restrictions, instead of the current classification in unrestricted net assets. The amendments also require disclosure of the aggregate amount by which the funds are underwater, the original gift amount (or amount required to be maintained by the donor or law), and any governing board policy or decisions to spend, or not spend, from such funds.
NFPs will also now be required to use the placed-in-service approach (without specific donor restrictions stating otherwise) to report expirations of restrictions on gifts of cash or other assets to be used to acquire or construct a long-lived asset; the option to imply a time restriction and release the restriction over an asset’s useful life (the “over-time” approach) will no longer be permitted. This change is intended to improve comparability and better reflect the economics of such transactions.
Information about Liquidity
In order to provide more transparency, the new guidance includes requirements aimed at improving the ability of financial statement users to assess an NFP’s available financial resources and liquidity. Specifically, the amendments require disclosure of both quantitative and qualitative information about the availability of and how the NFP manages its liquid available resources to meet cash needs for general expenditures within one year of the balance sheet date. In addition, NFPs will present a reconciliation that shows any limits that were imposed by the donors or by law, as well as any internal limits, such as those that have been designated by the governing board.
OBSERVATION: Presenting a classified balance sheet may an effective way for organizations to comply with many of the new liquidity disclosure requirements.
OBSERVATION: Availability of a financial asset may be affected by:
- Its nature
- External limits imposed by donors, grantors, laws, and contracts with others
- Internal limits imposed by governing board decisions
In order to make information about expenses more comparable and useful, the new guidance requires all NFPs (not just voluntary health and welfare organizations) to provide information about their operating expenses by both nature and function—on the face of the statement of activities, as a separate statement, or in the notes to the financial statements, supplemented with enhanced disclosures about the methods used to allocate costs among functions. In addition, a net presentation of investment expenses against investment return will be required on the face of the statement of activities; external and direct internal investment expenses will be netted against the investment return. A disclosure of the components of investment expense will no longer be required.
OBSERVATION: While a separate statement of functional expenses is not required, it may be the most effective presentation option for NFPs with more than one program.
Statement of Cash Flows
In a departure from the FASB’s original exposure draft, which would have required the direct method, the new guidance allows NFPs to continue to present either the direct or indirect method of reporting operating cash flows. However, the presentation or disclosure of the indirect method reconciliation is no longer required if the NFP uses the direct method. The FASB hopes that the removal of the reconciliation requirement will encourage more NFPs to use the direct method.
Effective Date and Transition
The amendments are 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.
OBSERVATION: Discuss the new guidance with your board. Boards count on financial statements and should be a part of the process for managing implementation.
While the changes seem numerous, implementing the majority of them should not be onerous. Most of the new requirements have previously been available as options and could be used without formally adopting the new guidance early, except for the following items:
- Combining the temporarily restricted and permanently restricted net asset classes into one net asset class
- Presenting a deficit situation in endowments in a restricted net asset class rather than in unrestricted net assets
- Eliminating the disclosure of investment expenses that are netted against investment returns
- Eliminating the indirect method reconciliation when using the direct method on the statement of cash flows
OBSERVATION: A future Phase 2 of the FASBs NFP project is slated to address additional issues, including:
- Operating measure:
- Whether to require intermediate measure(s) in the financial statements
- Whether and how to define such measure(s) and what items should be included
- Alignment of measures of operations in the statement of activities with measures of operations in the statement of cash flows.
There is currently no expected timeframe for the completion of the second phase.
Adoption of the new guidance will result in significant changes to financial reporting and disclosures for all NFPs. Elliott Davis Decosimo is ready to answer your questions and provide the resources and training that you need. Subscribe to our CPE Webcast list to receive upcoming announcements about webcasts and whitepapers, and check our event listing to register now for our next webcast. In the meantime, if you have questions, please contact your Elliott Davis Decosimo advisor.