The Financial Accounting Standards Board (FASB) recently issued the first major accounting changes for the not-for-profit sector in more than two decades.

Just about every not-for-profit organization — including charities, universities, foundations and others – will be affected by the much-anticipated Accounting Standards Update (ASU) No. 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities). The aim of the update is to help such groups provide more useful information to donors, grantors and other stakeholders on how they spend and manage their resources.

The rules take effect for fiscal years beginning after December 15, 2017, and for interim periods within fiscal years beginning after December 15, 2018. Organizations can choose to apply the changes to interim financial statements in the first year of adoption, but doing so isn’t required (they also can apply the standards earlier).

Background Information

The independent FASB sets financial accounting and reporting standards for companies and not-for-profit organizations that follow Generally Accepted Accounting Principles (GAAP). Currently, organizations prepare their financial statements using standards that were set in 1993.

The recent changes are a response to recommendations by the FASB’s Not-for-Profit Advisory Committee (NAC) and as part of an overall focus on GAAP. The project was split into two phases. The first phase produced the new ASU. The second will focus on even more challenging issues, such as presenting measures of operations between the statements of activities and cash flows.

Notably, the new rules address the following areas:

  • Complexity and “understandability” of net asset classification,
  • Deficiencies in information about an organization’s liquidity and the availability of its resources,
  • Inconsistencies in the type of information provided by different organizations about expenses and investment returns, and
  • Misunderstandings about and opportunities to enhance the usefulness of the statement of cash flows.

“The new guidance simplifies and improves the face of the financial statements and enhances the disclosures in the notes, which will enable not-for-profits to better communicate their financial performance and condition to their stakeholders, while also reducing certain costs and complexities in preparing their financial statements,” said FASB Chairman Russell Golden.

Changes Under the New Standards

Major changes were made in the following areas:

Net asset classes. The three existing classes of assets — unrestricted, temporarily restricted and permanently restricted assets — are replaced by two classes: net assets with donor restrictions and net assets without donor restrictions. This is expected to reduce complexity and increase understanding of financial statements.

In addition, organizations can now access funds from a permanently restricted endowment, even if its value has dropped below its initial amount. These “underwater” endowments will be classified as net assets with donor restrictions instead of as unrestricted net assets. Additional disclosures regarding underwater endowments are required.

The rules also eliminate the over-time approach for the expiration of restrictions on capital gifts in favor of the placed-in-service method — unless there is a specific donor request.

Liquidity and availability of resources. The standards include additional disclosures that will help make it easier to assess a nonprofit’s available financial resources. Organizations now must provide:

  1. Qualitative information indicating how they manage their liquid available resources to meet cash needs for general expenses within one year of the balance sheet date, and
  2. Quantitative information indicating the availability at the balance sheet date of their financial assets to meet cash needs for general expenses within one year of the balance sheet date.

The ASU also requires disclosure of internal limits for use of net assets without donor restrictions.

This change is expected to increase transparency about the nature and extent of both internal and external limits on available resources and help assess an organization’s financial flexibility.

Expenses. These will have to be analyzed by both function and nature. Doing so is expected to boost understanding by donors, grantors, creditors and others about how a not-for-profit uses its resources. For example, users may be able to assess:

  • The extent to which expenses are fixed or fluctuating,
  • How expenses are allocated, and
  • The costs of services provided.

Although a separate statement of functional expenses isn’t required, the FASB says it may be the most effective presentation option when a not-for-profit has more than one program. Investment expenses that have been netted against investment returns aren’t permitted to be included in that analysis.

Investment returns. The standard requires the reporting of investment returns net of related expenses, which will paint a clearer picture of returns regardless of whether investments are managed by outsiders or internal staff. In addition, it eliminates the need to disclose the amount of netted expenses, removing the difficulties and related costs of identifying embedded management fees.

Presentation of operating cash flows. The standard let organizations continue to use either the direct or indirect method to present operating cash flows. The two methods provide the same results, but the direct method is easier to work with and understand. To encourage its adoption, entities using it will no longer need to include an indirect method reconciliation.

Brave New World

There may be additional expenses associated with the new rules, such as costs for implementing new systems, collecting data and notifying stakeholders. But the FASB expects that any ongoing costs will be minimal. In any event, the long-term benefits should outweigh the short-term costs.

In the end, it’ll be a brave new world for not-for-profits once the changes are made. Although there’s still plenty of time to comply, organizations are encouraged to “get ahead of the curve” and begin developing new systems and processes as soon as possible. Rely on your financial accounting advisors for assistance.