Understanding the New Reporting Requirements for Not-for-Profit Entities

The new accounting and reporting requirements are designed to improve reporting by NFPs.

ASU 2016-14 incorporates many of the proposals included in the previous exposure draft relating to liquidity. Indeed, a major thrust of the ASU is to enhance reporting about NFPs’ liquidity and their ability to meet obligations as they come due. Other changes address the inconsistency of how expenses are reported and confusion about the absence or presence of external restrictions and/or internal designations on contributions and resources.

While the new pronouncement institutes significant changes, primarily related to additional disclosures, it also omits some significant – and controversial – proposals contained in the exposure draft. Chief among them is the elimination of proposed requirements to prepare the statement of cash flows using the direct method and to separately delineate in the statement of activities operating and non-operating activities based on availability of funds and the NFP’s mission. However, it should be noted that the ASU represents Phase 1 of a two part project. In Phase 2, the FASB intends to review reporting of financial reporting performance by NFP entities.

Following is an explanation of the most significant changes instituted by the ASU categorized by primary areas:

• Reporting expenses
• Classification of net assets
• Presentation of the statement of cash flows
• Reporting investment returns
• Relieving restrictions on long-lived assets
• Reporting underwater endowment funds
• Liquidity and other expanded disclosure requirements

Each of the above primary areas contains a summary of the promulgated changes for those who are interested in obtaining a quick overview of the ASU. Each primary area also contains further explanation and analysis for those interested in delving into more of the details of the ASU.

Reporting Expenses

Further Explanation

Within the statement of activities an NFP may present expense information by natural classification, functional classification or both.

If the statement of activities does not present both functional and natural classification of expenses, that information must be presented together in one location either in a separate basic financial statement, akin to the current statement of functional expenses, or in the notes to the financial statements. Further, expenses must be presented such that the relationship between functional expense and natural classification of expense is evident. The current matrix presentation used for most statements of functional expenses is an appropriate format.

Those expenses that are not reported by natural classification in the statement of activities must be broken out and reported by their natural classification in the functional expense analysis. For example, costs that are included as part of cost of goods sold – such as salaries, benefits, rent, etc. – in the statement of activities would need to be reported by natural classification in the analysis of functional expenses. Likewise, facility rental costs of special events reported as direct benefits to donors would need to be reported by natural classification, rent, in the functional expenses analysis. Further, the financial statements will need to reconcile the amounts of expenses reported to the statement of activities, as necessary.

Investment expenses, both internal and external, that are netted against investment return are not included in the functional expense analysis. For example, an internal investment manager’s salary, and related benefits, that are offset against investment income would not appear in the functional expense analysis.

Items that are reported in other comprehensive income of for-profit entities, and typically included in gains and losses in NFP financial statements, are also excluded from the functional expense analysis. This would include the following items:

• Foreign currency translation adjustments
• Gains and losses on foreign currency transactions designated as hedges
• Gains and losses on derivatives designated as a cash flow hedge
• Unrealized holding gains/losses on available-for-sale securities
• Unrealized holding gains/losses resulting from a debt security being transferred into the AFS category from the HTM category
• Gains/losses associated with benefit schemes that are not recognized immediately in periodic benefit cost

Net Asset Classes

Information about the nature, amounts and effects of the various types of donor-imposed restrictions will be presented in the notes to the financial statements if it is not presented on the face of the financial statements – see below. Such disclosures would include information related to limits on the purposes for which contributions can be used and the time frame for their use.

Further Explanation

There has been no substantive change in the factors one considers to classify a particular donation between net assets without donor restriction, previously unrestricted net assets, and net assets with donor restrictions, previously temporarily and permanently restricted net assets).

The presentation of the two classes of net assets represents a minimum presentation requirement. Entities are free to further disaggregate each class of net assets. For example, net assets with donor restrictions could be further disaggregated into donor restrictions that are permanent and those that are temporary. Net assets without donor restrictions might be disaggregated into various amounts designated by the governing body, management or law for certain purposes.

Regardless of the level of disaggregation, NFPs must continue to report the total of each of the two classes of net assets and the total for all net assets.

The ASU requires expanded disclosures regarding the following:

• Amounts and purposes of governing board designations and appropriations resulting in self-imposed limits on the use of resources, known as board designated endowments or quasi-endowments.
• Composition of net assets with donor restrictions as of the date of the statement of financial position and how the restrictions affect the use of resources.

Statement of Cash Flows

Further Explanation

The ASU does make one significant change in the current SCF requirements. Those NFPs that choose to present the statement of cash flows using the direct method will no longer have to present the reconciliation of the change in net assets to operating cash.

Reporting Investment Returns

Further Explanation

The requirement to offset investment returns against investment expenses relates to total return investing and not programmatic investing. Programmatic investing consists of making loans or other investments that are directed at carrying out an NFP’s purpose for existence rather than investing in the general production of income or the appreciation of an asset. An example of programmatic investing would be where an NFP provides low interest loans to constituents for education.

Net investment returns can be reported as a single amount or they may be disaggregated by source or other criteria at the option of the NFP.

Direct internal investment expenses involve the direct conduct and supervision of the strategic and tactical activities involved in generating investment return. They do not included items not associated with the generation of investment return such as unitization and other costs associated with endowment management.

Relieving Restrictions on Long-lived Assets

Further Explanation

A donor stipulation that limits the use of a donated long-lived assets, or cash restricted for the purchase of long-lived assets, for a period of time or for a particular purpose would require the NFP to recognize the release of those restrictions over the required time frame or the period over which the specific purpose is satisfied. A similar rule applies to the donation of works of art and historical treasures.

For example, if a donor contributes $1,000,000 to purchase or construct a building to be used for the general purposes of the NFP, the NFP would initially recognize the contribution as an addition to net assets with donor restrictions. The restriction would expire when the building was placed in service, whether it was purchased or constructed. At that time, the NFP would transfer $1,000,000 from net assets with donor restrictions to net assets without donor restrictions.

On the other hand, assume a donor contributes land and building to an NFP to be used for a substance abuse counseling center for the useful life of the building. In this instance, the NFP would record the original contribution as a net asset with donor restrictions; subsequently the NFP would relieve the restriction on some basis, say straight-line, over the useful life of the donated building.

Depreciation of donated assets is based on the estimated useful life of the asset itself. The depreciable life of an asset may not be equivalent to the period of time over which restrictions are relieved – which is based on the specific stipulation of the donor. For example, if a donor contributes property with a useful life of 10 years and stipulates that the asset is to be used for Program X for a period of 6 years, the depreciation expense would be based on the useful life of 10 years and the restriction would be relieved over the stipulated 6 year period. If the donor did not specify a time period of use, the restriction would be relieved when the asset was placed in service; however, depreciation would continue over the useful life of 10 years, which assumes that the asset has an alternative use for the succeeding 4 years.

Underwater Endowment Funds

Further Explanation

NFPs are required to disclose their interpretation of their ability to spend from underwater endowment funds. Furthermore, they need to disclose their policy with respect to spending from underwater endowment funds as well as any actions taken during the reporting period concerning appropriations from such funds. Sample disclosures are provided in the ASU.

The following disclosures are required, in the aggregate, for all underwater funds:

1. The fair value of the underwater funds
2. The original endowment gift amount or level required to be maintained by donor stipulations or by law that extends donor stipulations (UPMIFA)
3. The amount of the deficiencies of the underwater endowment funds (determined by subtracting b from a)

Liquidity and Other Expanded Disclosure Requirements

Further Explanation

Qualitative information is to: 1) be useful in assessing the entity’s liquidity and 2) disclose how an NFP manages its liquid resources. Liquidity information can be disclosed in both the basic financial statements and the notes to the financial statements through the use of one or more of the following:

1. Sequencing assets according to their nearness of conversion to cash and sequencing liabilities according to the nearness of their use of cash.
2. Presenting a classified balance sheet – classifying assets and liabilities as current and noncurrent. A classified balance sheet is required for NFP business orientated healthcare entities.
3. Additional relevant note disclosures regarding the liquidity or maturity of assets and liabilities including restrictions on the use of assets.

In conjunction with the qualitative information, an entity is to present quantitative information about the availability of an NFP’s financial assets at the statement of financial position date to satisfy the NFP’s cash requirements for general expenditures for the next year. Such information can be accomplished by presenting a table indicating total financial assets as of the date of the statement of financial position followed by disclosures of the financial assets which are not available for general expenditures resulting in the reporting of the net financial assets available for general operations for the next year. The ASU provides sample disclosures.

Effective Date

Implementation

The amendments in the ASU are to be applied on a retrospective basis in the first year that the ASU is adopted. If comparative financial statements are presented, an NFP can elect to omit the following information for all periods presented except the period of adoption:

1. Analysis of expenses by both natural classification and functionalclassification – the separate presentation of expenses by functionalclassification and expenses by natural classification is still required.NFPs that previously were required to present a statement of functionalexpenses do not have the option to omit this analysis; however, they maypresent the comparative period information in any of the formats permitted in this update, consistent with the presentation in the period ofadoption.
2. Disclosures about liquidity and availability of resources.

The amendments in the ASU will not result in a cumulative adjustment to net assets. However, they may result in significant reclassifications of amounts previously reported when comparative financial statements are presented. For example, the old reporting of temporarily and permanently restricted net assets will now be combined into the net assets with donor restrictions category in both the statement of financial position and the statement of activities.

Retrospective application means that if an NFP adopts the standard for is fiscal year ending June 30, 2019, the first period a June 30 reporting entity would be required to adopt, and the NFP also presents prior year comparative financial statements, it would need to apply all of the new disclosure requirements to its June 30, 2018 financial statements with the exceptions noted above.

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The information contained herein is not necessarily all inclusive, does not constitute legal or any other advice, and should not be relied upon without first consulting with appropriate qualified professionals for your individual facts and circumstances.