After more than three years of debate, comment, and revision, the Financial Accounting Standards Board’s (FASB) much-anticipated Accounting Standards Update (ASU) 2016-14, Presentation of Financial Statements for Not-for-Profit Entities, was released on August 18, 2016. FASB says the update is designed to improve nonprofit financial statements and provide more useful information to donors, grantors, creditors, and other financial statement users. The effective date is December 15, 2017, for fiscal year entities, or December 31, 2018, for calendar year entities. Early application is permitted.
Improvements to Nonprofit Financial Reporting
The amendments in ASU 2016-14 are the first half of a two-phase project intended to make short-term improvements that address:
Complexity in net asset classification requirements
Deficiencies in transparency and utility of information regarding liquidity
Deficiencies in reporting of financial performance measures
Inconsistencies of reporting expenses by function and nature
Misunderstandings in presentation of cash flows information
Two Net Asset Classifications Instead of Three
With the new ASU, the three existing classes of net assets will be condensed into two:
Unrestricted net assets will become net assets without donor restrictions.
Temporarily and permanently restricted net assets will collectively become net assets with donor restrictions.
Financial statement notes will need to include the timing and nature of the restrictions, as well as the composition of net assets with donor restrictions at the end of the period. In addition, underwater endowments will now be classified in net assets with donor restrictions, instead of the current classification in unrestricted net assets. Expanded notes will also be required to disclose amounts underwater and include plans for reducing or not spending from these funds. A nonprofit’s governing board may make designations or appropriations that result in self-imposed limits on the use of resources without donor restrictions; enhanced disclosure information will be required on the amounts and purposes of these designations. The placed-in-service approach will also be required for reporting the expiration of donor restrictions on resources used to acquire or construct long-lived assets, and the reclassification of amounts from net assets with donor restrictions to net assets without donor restrictions.
Transparency and Utility of Liquidity
New disclosures will be necessary for the management of liquidity and the financial assets available to meet near-term demands for cash. The disclosure will include both quantitative and qualitative information, including factors that may impact the financial availability, such as the nature, imposed external limits, or imposed internal limits. The time horizon for the quantitative disclosures is one year, and footnote disclosure is only required in circumstances where information is not apparent on the statement of financial position.
Reporting Financial Performance Measures
Nonprofits will continue to report the change in total net assets for the period, and will also need to report the amount of change in each of the two classes of net assets in the statement of activities. While presenting an intermediate measure of operations is still allowed, enhanced disclosures will be required. Investment income will now be reported after deducting external and direct internal investment expenses. The disclosure of investment expenses is permitted, but it will no longer be required, except for the disclosure of the amount of internal salaries and benefits that have been netted (if any) against investment return.
Expenses by Function and Nature
Reporting expenses by both function and natural classification will be required for all nonprofits on a separate statement, on the face of the statement of activities, or in the footnotes. While a separate statement of functional expenses is not required, it may be the most effective presentation option for nonprofits with more than one program. These reporting updates may require changes to internal procedures to ensure that this level of detail is tracked and that it complies with the requirement. Additional disclosures will also be required regarding methods used to allocate costs for program and support functions.
Presentation of Cash Flow Information
Under the new guidance, nonprofits may present operating cash flows using either the direct or indirect method, but organizations will no longer be required to present or disclose the indirect method reconciliation if the direct method is used. This is intended to provide greater flexibility and the freedom to choose the method that best serves each entity’s informational needs.
FASB has stated that the overall expected benefits of these improvements justify the perceived costs that they may impose. While the changes resulting from the ASU will impact all nonprofits, the effects on individual industries will vary. A future second phase of the project will address additional issues surrounding whether and how to define the operations and aligning 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.
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