It’s Not too Early to Begin Adopting New Non-Profit Financial Reporting Standards by Megan Cavasini, CPA
On August 18, 2016, the Financial Accounting Standards Board (FASB) issued its latest update relating to how not-for-profits (NFPs) communicate their financial stories. While the new standards will not go into effect until after December 15, 2017, nonprofit charities, foundations, associations, museums, universities and religious organizations should take the time now to become familiar with Phase 1 of the update and begin taking steps to adopt the initial changes before the release of Phase 2 standards in the near future.
Financial statements are critical to help not-for-profit organizations inform key stakeholders about their fiscal health. Donors, grantors, lenders and creditors rely on the information contained in these documents to understand how and where a NFP will spend its financial contributions, which ultimately support the NFP’s mission and fund the programs and services it provides to help those in need. However, the FASB identified concerns about the “complexity, insufficient transparency and limited usefulness” of the current model of NFP financial reporting that has been in place for more than two decades. After six-years of planning, the FASB issued proposed regulations to simplify the way in which NFPs quantify and qualify their financial performance, their liquidity and cash flows, and their classification of net assets. The latest update aims to achieve this goal.
Two-Class System for Reporting Net Assets
Under Phase 1 of the new accounting standards for nonprofits, the existing three-class system of classifying net asset as unrestricted, temporarily unrestricted and permanently restricted, will be replaced with a simpler two-class structure. Going forward, NFPs will differentiate net assets solely between those net assets with donor restriction and net assets without donor restrictions. With this change, NFPs will still be required to disclose, on the face of financial statements, the nature and amounts of donor-imposed restrictions. However, this information will be supported with enhanced footnote disclosures detailing the limitations that governing boards and donors place on net assets and how the NFPs will ultimately allocate those assets in the future.
Another change intended to improve how stakeholders read and understand NFPs’ financial statements is the required disclosure of underwater endowment funds. When the fair market value of a donor-restricted endowment is less than the original gift amount or the amount the NFP is required to maintain by the donor or by law, NFPs will be required to also report the amount of the deficiency and their governing boards’ policies or decisions to reduce or spend from these funds.
Reporting on Expenses and Investment Returns
The new accounting standards require non-profit entities to report on either the face of financial statement or in disclosure notes not just the function of their expenses (as presently required by generally accepted accounting principles) but also the nature of those expenses. In addition, financial statement notes will need to include an analysis of how the NFP’s apply this information to allocate costs among their programs. This will provide readers of financial statements with more accurate detail about whether an NFP’s expenses are fixed or discretionary, how the expenses relate to the NFP’s mission and how the NFP allocates resources to pay those expenditures.
With regard to investment return, NFPs will no longer be required to disclose investment expenses. Rather, investment return should be presented net of all related external and direct internal investment expenses. This is expected to provide a more comparable measure of investment reporting across all not-for-profits, regardless of their investment activities. Moreover, this new method for presenting investment return will eliminate the difficulties and related costs that NFPs have faced in the past when identifying embedded fees and reporting this information.
Reporting on Liquidity and Availability of Resources
Understanding how a nonprofit manages its liquidity and liquidity risk is an important indication of how it makes use of the resources available to it and how well it maintains adequate cash flow to continue its operations. To make this information more transparent to readers of financial statements, the accounting standards update will require NFPs to disclose in financial statement notes quantitative information regarding how they will manage available liquid resources to meet cash needs for general expenses for the year following the balance sheet date. In addition, NFPs will be required to provide on the face of financial statements or in disclosure notes detailed quantitative information regarding their availability of financial assets at the balance sheet date to meet cash needs for the next year.
Reporting of Operating Cash Flows
Not-for-profits may continue to present the statement of cash flows using either the direct or indirect method of reporting. However, under the new reporting standard, NFPs employing the direct method to report cash flow will no longer be required to take the extra step of reconciling net income to the cash amounts presented under the indirect method.
While the effective date of the new accounting standards for nonprofits will not begin until fiscal years after December 15, 2017, and for interim periods with fiscal years beginning after December 15, 2018, it behooves NFPs to begin adopting Phase 1 of the new model early. Non-profits will be facing quite a few accounting changes in the coming years, including Phase 2 of the NFP reporting model as well as new standards for accounting for leases and recognizing revenue, both of which will also impact private businesses. This confluence of change will require NFPs to reassess and update their current processes and legacy accounting systems, including engaging in more in-depth and detailed analysis of their net assets and availability of resources, their expenses and their liquidity risk. According to the FASB, the new guidance, once adopted, will ultimately improve a not-for-profit’s ability to communicate its true financial health with its stakeholders and save the NFP additional costs and complexities when preparing their financial statements in the future. Not-for-profit entities should meet with their tax and audit professionals now to begin the process of adopting the new changes.
Berkowitz Pollack Brant has deep experience working with many Florida-based not-for-profit entities, including tax-exempt social and civic organizations, private foundations, hospitals, religious organizations and education institutions. The firm’s advisors and accountants provide tax compliance, audit and attest, and business-advisory services to help these organizations better manage risks, improve efficiency and operate with the highest levels of fiscal responsibility.
About the Author: Megan Cavasini, CPA, is an associate director with Berkowitz Pollack Brant’s Audit and Attest practice, where she works with non-profit organizations and real estate businesses. She can be reached at the CPA firm’s Ft. Lauderdale office at (954) 712-7000 or via email at firstname.lastname@example.org.