Not-for-Profit Insights Financial Statement
Usefulness
Change is on the way. Are you ready? FASB updates accounting standard for Not-for-Profits to improve financial statement usefulness ACCOUNTING STANDARDS UPDATE (ASU) 2016-14 – Presentation of Financial Statements of Not-for-Profit Entities – significantly changes generally accepted accounting principles (GAAP) that has guided Notfor-Profit entities (Topic 958) for decades. Prior to the release of this ASU, financial reporting practices for Not-for-Profit entities has been guided by FASB 116 and 117. So why the change? For years, the current accounting requirements for Not-for-Profits have been said to be overly complex with insufficient transparency and not enough useful information to help those who relied on the statements to make educated informed decisions about organizations. The ASU’s goal is to provide more transparent information regarding a Not-for-Profit organization’s overall financial statements by reducing complexities, reporting inconsistencies and misunderstandings, and provide more relevant information about the organization to donors, grantors and board members. The new ASU is designed to more accurately help Not-forProfits tell their story through their financial statements. The FASB’s ASU incorporates the following characteristics into GAAP to attain that greater transparency and achieve those supporting objectives:
Changes to Net Asset Classification Replacement of Three Net Asset Classes with Two Net Asset Classes CURRENT NOT-FOR-PROFIT STANDARDS DEFINE three classes of net assets – unrestricted (UR), temporarily restricted (TR) and permanently restricted (PR) net assets. Not-for-Profits are guided by donor restrictions to place the assets into one of those three categories. Over the years, organizations and users of the financial statements questioned if the three categories were useful. The disclosures for Not-for-Profits have increased significantly over the past five years and have blurred the usefulness of the three categories. In addition to donor restricted issues, there has been some confusion on board designated net assets (quasi-endowments) and whether such assets are restricted. The ASU eliminates the temporary and permanent restriction net asset classes and replaces them with just one new net asset class called “net assets with donor restrictions.” The current unrestricted group will be renamed to “net assets without donor restrictions.” All assets will now be grouped into one of these two categories. There are many benefits to moving to this type of reporting model.
Not-for-Profit Insights: Financial Statement Usefulness Exhibit 1. Proposed Changes to Net Asset Classification
• The new model removes the confusion of whether an asset should be accounted for as permanently or temporarily restricted. The goal is to now focus on the nature of donor restrictions, for example, how and when the assets can be used. • In the statement of activities single statement format, the presentation will move from four columns (UR, TR, PR, and total) to three columns (without restrictions, with restrictions and total). Column reduction itself reduces financial statement complexity and makes the statements easier to read. The new format will focus more on disclosing the components of net assets based on donor restrictions and internal board designations. New Disclosures: Enhanced disclosures would then be used to explain the nature of a donor restriction, thereby focusing attention on how and when net assets can be used. The enhanced disclosures would provide explanation for such restrictions and changes in designation from a net asset with restrictions. The statement of activities would likewise reflect those changes in net asset classes. Organizations will also be required to disclose amounts and purposes of all board designated net asset restrictions, which in the current guidance is optional. This will include all board designated and appropriations of designated net assets. The principal, or corpus, amounts of endowment funds will be identified in the footnotes as perpetual amounts but will be a subset of net assets with restrictions and will no longer be classified as permanently restricted net assets.
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Changes to Underwater Endowments UNDER CURRENT REPORTING RULES for underwater endowments (funds whose net asset value is below the original gift amount or amount required to be maintained) that follow the Uniform Prudent Management of Institutional Funds Act, the unrealized gains and losses are recorded separate from the original gift. The original gift is placed in PR net assets while the unrealized gains and losses are recorded in TR net assets. That is until the balance in TR hits $0, at which time the loss on the net assets are then reported in UR. The reporting of underwater amounts has led to confusion as to how to properly record the related net asset, and how to describe this to the readers of the financial statements. With underwater endowments impacting all three net asset classes, it is easy to see why this is confusing for some. Under the new ASU, underwater endowment funds and all earnings on the funds would be classified under assets with donor restrictions, thereby moving the amounts by which endowments are underwater from net assets without donor restrictions to net assets with donor restrictions, requiring expanded disclosure. New Disclosures: Under the ASU, a Not-for-Profit would still be required to disclose the amount of the underwater investments, but now the organization will also be required to disclose any policies related to the use of underwater funds, the aggregated fair value of the funds, and the original gift amounts to be maintained. Such disclosure may also provide insight into the appropriateness of investment decisions regarding those endowment funds.
Not-for-Profit Insights: Financial Statement Usefulness Changes to Reporting Expenses Enhanced Disclosure Pertaining to Expenses by Nature and Function NATURAL EXPENSE CATEGORIES INCLUDE categories such as salaries, payroll taxes, professional fees and office supplies. Functional categories include programs, general and administrative, and fundraising. For now, all Notfor-Profit organizations are required to present expenses by functional classification, but only voluntary health and welfare organizations are required to report expenditures by both natural and functional classification. The updated ASU will require every Not-for-Profit organization to disclose an analysis of both the natural and functional classification for all expenses for the period presented. Not-for-Profit organizations would need to report expenses by both natural and functional classifications in one of three ways:
For organizations that have not been aggregating information based on natural classification, this may represent a significant change in how expenditures are aggregated and analyzed. New Disclosures: The new standard provides new guidance on allocation of expenses. Enhanced disclosures regarding the methods used to allocate costs among program and support functions are crucial for evaluating a Not-for-Profit’s performance. Such costs include general administrative expenses, some salaries, various forms of insurance, and other costs attributed to overall organizational operations. The new disclosures will need to include the methods used to allocate costs among the functional categories. These required disclosures give financial statement users an understanding of the methodology used to allocate expenses as they relate to various program and support functions.
1. Within the statement of activities 2. As part of a separate statement 3. Within the footnotes to the financial statements
Exhibit 2. Expense Reporting by Nature and Function in F/S
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Not-for-Profit Insights: Financial Statement Usefulness Assets Placed-in-Service ANOTHER AREA OF ACCOUNTING that differed among Not-for-Profits was in the treatment of donorrestricted funds used to purchase long-lived assets, which created another trouble spot in Not-for-Profit reporting. Organizations currently have the option to release the donor restriction over the useful life of a long-lived asset or to report the release of restriction once the asset is placed in service. Having this option makes it harder for Not-forProfits to be comparable to each other. The ASU will require in the absence of explicit donor restrictions, that donor-imposed restrictions associated with providing funding for long-lived assets expire as soon as those assets are placed in service. This update eliminates the current option to use the asset over time and moves to a placed in service approach.
This provision is designed to make it easier to compare investment returns among Not-for-Profit entities, regardless of whether their investment activities are managed by internal staff, outside investment managers, volunteers, or a combination for which management fees are embedded in the investment return of the vehicle. The statement of activities changes illustrate how the FASB is trying to make Not-for-Profit reporting the same for all entities and trying to make the financial statements more comparable among similar organizations. Exhibit 3. Reporting Investment Expenses
The ASU provides for uniform recognition practices among all Not-for-Profit entities and reduces complexity for both compiling and evaluating a Notfor-Profit entity’s financial statement.
Reporting Investment Income ANOTHER COMMON AREA OF DIFFERENCE between organizations is in the way they report their investment returns in the financial statements, specifically in reporting investment income net of external and direct internal investment expenses. An endowment fund or other means of investment income may be managed in various ways. Some Not-for-Profits rely upon internal staff or volunteers while others may utilize the services of an external investment manager. Investment holdings vary as well and might include mutual funds, hedge funds, or other vehicles. Those various investment practices may include embedded management fees, fees separately assessed by an investment professional, or fees associated with the purchases or sales of investments. The variety in the types of investments made comparing investment activities between organizations complicated. The new ASU will require all Not-for-Profits to present net investment return (investment return less investment expenses) net of related external and direct internal expenses within their statement of activities.
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Disclosure Change: The new ASU will no longer require the disclosure of those netted expenses to be disclosed. This eliminates the difficulties and related costs in identifying embedded fees and the resultant inconsistencies in the reported amounts of investment expenses.
Not-for-Profit Insights: Financial Statement Usefulness Liquidity and Availability of Resources New Disclosures: THE ASU ALSO INCLUDES new disclosure requirements for a Not-for-Profit’s liquidity position. In keeping with the aim of making Not-for-Profits’ financial statements more comparable, the FASB is requiring organizations to disclose their liquidity positions and how liquidity is managed. Organizations will need to disclose both quantitative and qualitative information used for expressing liquidity and availability in their financial statements. These new disclosures will help the readers of the financial statements understand the organization’s exposure to risk, how the organization manages its liquidity risks, and directly tell the reader what assets are available to meet current cash needs. Quantitative information includes the amount of financial assets at the end of the reporting period. Organizations could also disclose the amount of financial assets not available to meet current cash needs in the near term due to restrictions or limitations on their use from either external donors
or internal Board designations, as well as the amount of financial liabilities that require cash in the near term. The quantitative information can be presented either on the face of the statement of financial position or in the footnotes. Exhibit 4. Liquidity
Required qualitative disclosures would also enhance a user’s understanding of the Not-for-Profit’s strategy for addressing entity-wide risks that may affect its liquidity, including its access to lines of credit, its policy for establishing liquidity reserves and its basis for determining the time horizon used for managing its liquidity.
Exhibit 5. Liquidity Disclosures
Quantitative Elements » »
Liquidity »
Timeframe (30/60/90 day horizon)
Qualitative Elements »
How short-term liquidity is managed
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Total financial assets Amounts not available due to limitations/ restrictions Total financial liabilities due within identified timeframe
Additional Information
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Not-for-Profit Insights: Financial Statement Usefulness New Disclosures: A Not-for-Profit organization’s governing board may make designations, appropriations or other transfers, resulting in the addition of removal of self-imposed limits on how unrestricted net assets are used. Enhanced disclosure for such activities give individuals a greater understanding of how a Not-for-Profit’s leaders allocate assets and set priorities. Enhanced disclosure pertaining to the composition of net assets with donor restrictions provide understanding as to what activities a Not-for-Profit can undertake based on donor-imposed restrictions. Such a disclosure may reveal that while a Not-for-Profit’s overall total net assets may deem it financially sound, the entity may be rather limited as to how it can use those net assets. Another enhanced disclosure – for management of liquidity and quantitative information about financial assets available to meet near-term demands for cash – provides understanding as to what net assets are available within a particular time, what liabilities are anticipated during that same timespan, and how the Not-for-Profit maintains sufficient liquidity to meet both expected and unexpected expenses.
Cash Flows UNDER CURRENT GUIDANCE organizations have the option to use the direct or indirect method of reporting their cash flow statement. The ASU will continue to allow organizations to choose between the direct method and indirect method for presenting operating cash flow. The ASU eliminates the requirement for those who use the direct method to perform a reconciliation with the indirect method.
An Overall Emphasis on Providing Uniform, Useful Information WITH THE UPDATED STANDARD for Not-for-Profit entities, the FASB seeks to provide financial statement users with information that can be more easily understood and used to evaluate a Notfor-Profit’s performance, and to compare a Not-for-Profit entity’s performance to the performance of similar Not-for-Profits. Specific aims include more useful information regarding: • A Not-for-Profit’s financial flexibility and liquidity • A Not-for-Profit’s financial performance during a reporting period • A Not-for-Profit’s service efforts and ability to continue providing service • A Not-for-Profit’s stewardship execution and other aspects of management’s performance Not-for-Profit organization leaders and the accounting professionals who counsel them need to be aware of the updated FASB provisions and recognize not only the changes they contain, but also the additional value they can offer to all stakeholders.
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Not-for-Profit Insights: Financial Statement Usefulness When is the New Standard Effective? THE STANDARD IS EFFECTIVE for annual financial statements issued for fiscal years beginning after December 15, 2017. Therefore, if you are a calendar year end it will be effective December 31, 2018. If you are a fiscal year end then it will be on the fiscal year ended in year 2019. So, for example, June 30 year ends will be effective as of June 30, 2019. Not-For-Profit entities will be required to adopt the ASU changes retrospectively, and you can early adopt the changes in the provision. Please note that if the organizations financial statements are comparative, the organization has the option to omit the following information from the prior period: • Analysis of expenses by both natural and functional classification • Disclosures about liquidity and available resources The ASU includes guidance for the year of transition when the new standard is adopted, including specific disclosures that should be made.
Get Started Today 2018 WILL BE HERE before we know it, so don’t let this sit on your desk for a year before you start thinking about it. The organization should start thinking about the ASU today and start making an implementation plan. Management will need to review all their net assets to determine which assets will be impacted by the changes to the ASU. It is recommended to communicate to everyone that reads your organization’s financial statements about the changes, as they are significant.
Management will need to assess the necessary data needed to disclose the liquidity disclosures. This should be agreed to by the board. Management will also need to look into not only the costs but the time required to update the financial reporting process and controls needed for these new processes. Other disclosures, such as the required disclosures of board designations on new assets, may require organizations to adopt new policies and procedures.
More to Come – Phase Two of the Not-forProfit Project THE FASB DEFERRED a few of the original items in the exposure draft until a later time. The biggest item that was in the original exposure draft that was not in the final ASU but will be included in phase two of the project is the use of an operating measure in the financial statements. In the past, the FASB has not defined an operating measure for not-for-profits. Phase two would define what should be included in operations, based on liquidity and availability. Under current guidance not-for-profits are not required to have a measure of operations, but the FASB is thinking about requiring all not-for-profits to present two operating measures as subtotals in net assets without donor restrictions. There is no estimated timeframe for the completion of Phase II at this time. Stay tuned….
It is also recommended that the organization does a mock up draft of the financial statements, including footnotes, to show what the new statements will look like along with the new disclosures. Have the mock up reviewed by your auditors, board members and any other major stakeholder’s of the organization to make sure everyone is on the same page. Get this completed well before the year-end close and before the financial statement audit process begins.
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Not-for-Profit Insights: Financial Statement Usefulness
CONTACT US Sara Dempsey Partner-in-Charge, Government Services 972.448.6958 | sara.dempsey@weaver.com Running a Not-for-Profit organization is about more than the bottom line. You have more at stake than operating budgets and compliance issues. Our Not-for-Profit practice group applies advanced understanding of Not-for-Profit funding, financial models, reporting and guidelines to your needs, and we work closely with you to build your confidence in your financial operations. We also champion your mission as our own. We’ll share resources and connections that can help you expand your network and realize your vision. We provide assurance, tax and advisory services for Not-for-Profit organizations that are varied in scope and include: • Elderly care services • Foundations and trusts • Higher education • Museums and performing arts groups • Religious organizations • Primary and secondary education • Social and human services • Social work and counseling • Theological seminaries • Trade and professional associations Weaver currently serves the needs of hundreds of Not-for-Profit organizations. We can help you implement this new standard with minimal disruption to your staff or ongoing operations, and ensure your organization’s compliance now and in the future. Please contact us to discuss your questions today.
Disclaimer: This content is general in nature and is not intended to serve as accounting, legal or other professional services advice. Weaver assumes no responsibility for the reader’s reliance on this information. Before implementing any of the ideas contained in this publication, readers should consult with a professional advisor to determine whether the ideas apply to their unique circumstances. © Copyright 2020, Weaver and Tidwell, L.L.P.
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