Accounting Standards Update (ASU) 2016-14, Presentation of Financial Statements of Not-for-Profit Entities was established to clarify complexities regarding donor-imposed restrictions and to increase transparency by showing useful information related to liquidity. The update also removed inconsistencies related to functional expense and cash flow reporting.
“The new ASU gives nonprofit financials a facelift and provides more transparent and useful information. It’s something that all users need to understand at some level—not just the accountants,” says Anna Goldman, Senior Manager in Warren Averett’s Nonprofit Practice Group. “We’ve been working closely with our clients over the past year to ensure they are prepared for the changes.”
The ASU will be effective for annual financial statements for fiscal years beginning after December 15, 2017 and for interim periods with fiscal years beginning after December 15, 2018. Early implementation is permitted. The changes in the ASU will be applied on a retrospective basis, which means that all financial statements presented must reflect the changes and the effect must be disclosed for each period presented. If a nonprofit chooses to present comparative statements in the year of adoption they have the option to omit 1) the analysis of expenses and 2) the disclosures of qualitative and quantitative information on liquidity and cash availability for any period presented before adoption.
The ASU represents the most significant change to nonprofit financial statements in over 25 years. It is, therefore, important for nonprofits to understand and be informed about the changes so that their reporting complies with the new guidance. We’ve highlighted some important information regarding these technical changes to benefit your organization’s compliance efforts below.
Here are the seven major changes that your organization should know:
Net asset classification
The most significant aspect of the ASU is the change to the face of nonprofit financial statements, which now requires two net asset classes instead of three. Previously, nonprofit net assets were divided into three categories: unrestricted, temporarily restricted and permanently restricted, on the statement of financial position. The update has re-categorized the classification of net assets into two categories:
- Net Assets without Donor Restrictions (Previously unrestricted and board designated net assets)
- Net Assets with Donor Restrictions (Previously temporarily and permanently restricted net assets)
The reduction in the number of net assets is intended to reduce the complexity and increase the understandability of nonprofit financial statements. Net assets without donor restrictions will represent the portion of net assets that are available for general use as they are not subject to donor-imposed restrictions. This category also includes board-designated net assets. Net assets with donor restrictions, however, are subject to donor-imposed restrictions. It is important to point out that only a donor can impose restrictions. Consistent with current guidance, management or a governing body cannot designate a portion of net assets as having donor restrictions.
The two types of net assets are the minimum reporting that will be required. Entities may elect to disaggregate further, but the new standard requires that the total for each of the two net asset classes be reported on the statement of financial position. The ASU will allow some flexibility for reporting on the statement of activities as long as the requirements are met. For example, the information may be presented in single columns, multiples columns or even on two separate statements. In addition, disclosures including the various types of donor restrictions (e.g., those that are perpetual in nature or support a certain type of activity) will not be eliminated. The donor imposed restrictions can be presented as separate lines within the net assets with donor restrictions or in the notes to the financial statements.
2. Placed-in-service assets
The current guidance allows for two options when reporting on expirations of donor-imposed restrictions on gifts restricted for the construction or acquisition of long-lived assets. The first was to release the donor restrictions when the asset was placed in service. Alternatively, the donor restrictions could be released over the estimated useful life of the acquired asset. Absent explicit donor stipulations, organizations will now only use the placed-in-service approach for reporting expirations of donor-imposed restrictions on gifts of cash or other assets to be used to acquire or construct a long-lived asset. Under this method, once the related asset is placed in service, the net assets will be reclassified to net assets without donor restrictions. It is important to note that the nonprofit may have to reclassify amounts from net assets with donor restrictions to net assets without donor restrictions for any long-lived asset placed into service upon adopting the new guidance.
There is an exception to the placed in service requirement in the new guidance if a donor restriction extends past the point that an asset is placed in service. For example, if a donor specified a period of time that the asset must be used, the restriction would expire over that period of time.
Warren Averett note: Your organization may need to make a policy change if you used the useful lives approach.
3. Underwater endowments
When the original gift amount of an endowment or the amount required to be maintained by the donor (or by law) is more than the current fair value at the reporting date, it is considered an “underwater endowment.” The new ASU expands the guidance on the reporting of endowment funds and makes changes to the presentation of underwater donor-restricted endowments.
Current guidance requires accumulated losses or the underwater portion of endowments to be shown as a reduction of unrestricted net assets and to present the endowment at the amount required by the donor (or by law). The new guidance, however, will change this presentation and require that the accumulated losses, if any, be included with the related fund in net assets with donor restrictions.
In addition, for each underwater endowment that your organization has, the following information must be disclosed:
- The governing board’s interpretation of the state UPMIFA law as to its ability to spend from underwater endowments;
- The organization’s policy on the appropriation of underwater endowment funds;
- Aggregate amounts for the fair value of underwater endowment funds;
- Aggregate original endowment funds; and
- The amount by which the funds are underwater.
Warren Averett note: If your organization does not have a written policy regarding spending from underwater endowments, now is a good time to develop and implement one.
4. Transparency and utility of liquidity
New and expansive disclosures will now be required relating to the liquidity and availability of resources of your organization. More specifically, this relates to how your organization will meet its cash requirements for the next full year of operations, both qualitatively and quantitatively. The new disclosures are intended to provide more useful information.
Nonprofits are required to disclose information that is useful in evaluating the liquidity of resources or the maturity of assets and liabilities, including how they manage liquid resources to meet the cash needs for general expenditures within one year of the date of the statement of financial position.
The new ASU will also require that a nonprofit discloses the availability of financial assets as of the date of the statement of financial position to meet cash needs for general expenditures within one year. This may be disclosed in the notes or on the face of the financial statements with additional information in the notes as needed. The nature of the assets as well as any internal or external limits should be considered when determining the availability of financial assets.
Warren Averett note: Entities have the opportunity to include or exclude amounts based on what they are trying to tell the user. Nonprofits should utilize this freedom to provide explanatory information for amounts that are included or excluded from their calculations.
5. Expenses classified by function and nature
Under existing guidance, the analysis of expenses by function and nature is only required for voluntary health and welfare organizations. Under the new standard, all nonprofits will be required to report expenses by both natural and functional classification in one location in the financial statements either on the face of the statement of activities, either as a separate financial statement or in the notes to the statements. This analysis cannot be presented as supplemental information. Additional disclosures about the methods used to allocate expenses between program and support are required.
Expenses should be disaggregated by functional expense category, for example, major classes of program services and supporting activities (management and general fund raising). Expenses will be further disaggregated by natural classification such as salaries, rent, professional services and supplies.
Warren Averett note: Most organizations are expected to provide the expense analysis through a statement of functional expenses.
6. Investment returns
The new ASU will require nonprofits to present investment returns net of the related expenses, both direct internal and external. This change is intended to make the reporting of investment returns more comparable across all nonprofits, no matter whether their investment activities are managed internally or by outside investment managers. The net presentation means expenses will be included in the net asset category in which investments are reported. Disclosure of the netted expenses will no longer be required.
Warren Averett note: Nonprofits should be cautious when allocating costs to investment expenses. Direct internal investment expenses should only include those that directly contribute to generating investment returns.
7. Statement of cash flows
Nonprofits still can prepare the statement of cash flows using the direct or indirect method. When reporting cash flows on the direct method, however, the indirect reconciliation is no longer required under the new guidance.
Warren Averett note: Although nonprofits are not required to use the direct method under the new guidance, the Board is considering a project to improve the guidance for the cash flow statement across all industries.
Warren Averett can help your organization prepare for these reporting changes. Whether you’re a community-based nonprofit or a regional nonprofit, Warren Averett has the experience and expertise to help aid your organization in meeting its needs and goals. If you have questions regarding any of these technical aspects, please contact your Warren Averett advisor.