Starting in 2018, a new accounting standard goes into effect for charities, public universities and colleges, and other types of cultural, religious and trade-related not-for-profits. Accounting Standards Update (ASU) No. 2016-14, Not-for Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities, makes the first significant changes to the accounting rules for such organizations’ financial statements since the early 1990s. Here are the details.
Need for Change
The last time the Financial Accounting Standards Board (FASB) changed the accounting rules for not-for-profits was in 1993. However, in recent years, donors, grantors, creditors and other financial statement users have raised concerns about such issues as:
- The complexity and “understandability” of net asset classification,
- Weaknesses in the information presented about a nonprofit’s liquidity and the availability of its resources,
- The lack of consistency in the type of information provided by different nonprofits about their expenses and investment returns, and
- The usefulness of the statement of cash flows.
The FASB responded by releasing an Exposure Draft, Presentation of Financial Statements of Not-for-Profit Entities, in 2015. The FASB approved several key changes in 2016. These changes take effect 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.
Two Net Asset Classes
ASU 2016-14 replaces the three current net asset classes (unrestricted, temporarily restricted and permanently restricted) with two new classes (net assets with donor restrictions and net assets without donor restrictions). The new classifications reflect changes in the law under which organizations can now tap a permanently restricted endowment despite the fact that its fair value has dipped below the original endowed gift amount.
Under the updated standard, these “underwater” endowments will be classified as net assets with donor restrictions. Under the existing guidance, they’re presented as unrestricted net assets. The new guidance also expands the required disclosures for underwater endowments.
In addition, the guidance removes the option of using the “over-time” method to report the expiration of restrictions on gifts used to purchase or build long-lived capital assets, such as buildings. Not-for-profits will be required to use the placed-in-service approach (in the absence of explicit donor stipulations to the contrary).
As a result, organizations must reclassify such capital gifts as net assets without donor restrictions when the asset is placed in service, instead of over the asset’s useful life. This change will prevent not-for-profits from matching the depreciation expense with the release of these restricted net assets unless the donor stipulates over-time treatment.
The new standard aims to help financial statement users assess how a not-for-profit manages its liquid-available resources and its liquidity risks. To that end, the standard requires organizations to provide:
- Qualitative information that conveys how they manage their liquid-available resources to meet cash needs for general expenses within one year of the balance sheet date, and
- Quantitative information that conveys the availability of their financial assets at the balance sheet date to meet cash needs for general expenses within one year.
The liquidity of a financial asset could be affected by its nature; external limits imposed by donors, grantors, laws and contracts with others; and internal limits imposed by governing board decisions. Disclosure is also required for board designations or other internal limits on the use of net assets without donor restriction.
Expenses and Investment Returns
The new standard requires not-for-profits to report expenses by both function (which is already required) and nature in one location. They also must present an analysis of expenses by both nature and function on a separate statement, on the statement of activities or in the footnotes. The information will be supplemented with enhanced disclosures about the specific methods the organization used to allocate costs among program and support functions.
This will help stakeholders better understand the degree to which expenses are fixed or discretionary, how the related resources are allocated, and the costs of the services provided.
As for investment-related expenses, not-for-profits must report investment return net of all external and direct internal investment expenses on the statement of activities. Financial statement users will be better able to compare investment returns among different not-for-profits, regardless of whether investments are managed externally (for example, by an outside investment manager who charges management fees) or internally (by staff).
Additionally, the new standard does away with the current required disclosure of the netted expenses. Why? Some not-for-profits have found it difficult to identify third-party management fees that have been embedded in investment returns, which caused inconsistencies in the reported amounts of investment expenses.
Not-for-profits must juggle implementing ASU 2016-14 with the new revenue recognition and lease guidance that will soon go into effect for not-for-profit entities. Contact your accountant for more information or for help preparing your systems and procedures for the updated guidance.
How to Differentiate Exchanges vs. Contributions
In May, the Financial Accounting Standards Board (FASB) approved an updated standard that addresses when and how foundations, charities, museums and other nonprofit organizations should account for grants and other funds from foundations and government bodies that often have strings attached to them. An updated standard is expected in June 2018, based on Proposed Accounting Standards Update (ASU) No. 2017-270, Not-for-Profit Entities (Topic 958) Clarifying the Scope and the Accounting Guidance for Contributions Received and Contributions Made.
Don’t expect the final guidance to provide black-and-white answers in all cases. Instead, the FASB is counting on not-for-profit organizations to continue using judgment.
The line between exchanges and contributions has been blurry for years. However, concerns about scant accounting guidance intensified after the FASB published its landmark revenue recognition standard in 2014 — ASU No. 2014-09, Revenue from Contracts with Customers — which erased the already limited guidance for restricted contributions.
The update is intended to clarify the evaluation of whether gifts to not-for-profit groups should be accounted for as:
- Contributions subject to FASB Accounting Standards Codification (ASC) Topic 958-605, Not-for-Profit Entities ― Revenue Recognition, or
- Exchanges that should be accounted for with other areas of U.S. Generally Accepted Accounting Principles (GAAP), such as the revenue recognition guidance in FASB ASC 606, Revenue from Contracts with Customers.
An example of a conditional contribution would be a grant to a nonprofit to provide career training to disabled veterans with a stipulation that the group help a minimum number of veterans each quarter or forfeit the money. In contrast, “exchange” transactions involve the receipt of funding in return for specific actions, such as research on the benefits of a longer school year. The clarified guidance is expected to lead to more transactions that are accounted for as contributions instead of exchanges.
While the draft guidance primarily would affect not-for-profit groups such as charities and foundations, it could also apply to for-profit enterprises that receive government grants. The effective date for this standard is generally the same as the effective date for the new revenue recognition standard.
However, the effective date for the revenue recognition standard was the first quarter of 2018 for public companies and certain not-for-profit groups that receive funds through state or local government bonds, known as conduit debt obligors. So, the FASB decided that public companies and conduit debt obligors will have to comply with the forthcoming amendments for annual periods beginning after June 15, 2018. The later effective date is expected to let organizations that had to apply the revenue recognition guidance in 2018 avoid issuing restatements.
If you have any questions, please contact a Briggs & Veselka representative at (713) 667-9147.