In August 2016, the Financial Accounting Standards Board (“FASB”), the accounting standard setter in the US, issued accounting guidance specific to nonprofit organizations called Accounting Standards Update 2016-14 (“ASU 2016-14”). The main goals of ASU 2016-14 were to (1) improve the usefulness of information included in the financial statements of nonprofit organizations to its readers, and (2) to reduce unnecessary complexity. Below are some answers to some common (and more basic) questions about ASU 2016-14.
Q: What are the key provisions of the changes?
A: There are a number of different changes resulting from the issuance of ASU 2016-14:
- The statement of financial position will now have two classes of net assets instead of three. Today, organizations could have unrestricted, temporarily restricted and permanently restricted net assets. ASU 2016-14 will require only “net assets without donor restrictions”, and “net assets with donor restrictions”. Similarly, the statement of activities will only show the changes the two new classes instead of three (and in total, of course). Additional disclosures will be required about the nature of net assets with donor restrictions. More on that below.
- If you use the direct method of reporting operating cash flows in your statement of cash flows, there will no longer be a requirement to disclose operating cash flows using the indirect method. Most organizations use the indirect method, so this isn’t likely to be a change for many organizations.
- A requirement to disclose the amount of expenses by both their natural (salaries, rent, office supplies, etc.) and functional (Program services, management and general, etc.) classifications. That presentation of expenses must be in one place, which could be on the face of the statement of activities, in a separate financial statement, or in the notes to the financial statements.
- Several enhanced disclosures will be required:
- Amounts and purposes of governing board designations, appropriations, and similar internal actions that limit otherwise unrestricted as of the end of the period.
- Composition of net assets with donor restrictions at the end of the period and how the restrictions affect the use of resources.
- Qualitative information about how an NFP manages its liquid resources available to meet cash needs for general expenditures within one year of the date on the statement of financial position.
- Quantitative information, either on the face of the statement of financial position or in the notes, and additional qualitative information in the notes as necessary, that communicates the availability of an NFP’s financial assets at the balance sheet date to meet cash needs for general expenditures within one year of the balance sheet date. Availability of a financial asset may be affected by (1) its nature, (2) external limits imposed by donors, grantors, laws, and contracts with others, and (3) internal limits imposed by governing board decisions.
- Method(s) used to allocate costs among program and support functions.
- Additional disclosures related to underwater endowment funds.
- Report investment return net of external and direct internal investment expenses and no longer require disclosure of those netted expenses.
- Use, in the absence of explicit donor stipulations, the placed-in-service approach for reporting expirations of restrictions on gifts of cash or other assets to be used to acquire or construct a long-lived asset and reclassify any amounts from net assets with donor restrictions to net assets without donor restrictions for such long-lived assets that have been placed in service as of the beginning of the period of adoption (thus eliminating the current option to release the donor-imposed restriction over the estimated useful life of the acquired asset).
Q: What are the likely financial statement implications of these changes?
A: For many organizations, the changes will be mostly optical, that is, the format of the financial statements may change and there will be additional disclosures required, but there won’t be changes in total net assets at the end of the year or in changes in net assets during the year as compared to accounting guidance before ASU 2016-14 is effective. For organizations that have internal costs associated with their investments, such as the salary of a chief investment officer, there may be a change in where expenses are reported. In our chief investment officer example, salary costs that would have previously been reported as salaries would now be netted against investment income in the statement of activities. Other changes are unlikely to have a significant impact on most nonprofit organizations, particularly smaller ones.
Q: When do I have to be ready for all of this?
A: The effective date of ASU 2016-14 is for fiscal years beginning after December 15, 2017, so January 1, 2018 for calendar year organizations, July 1, 2018 for June 30 fiscal year organizations, etc. If your organization has interim period reporting requirements (most frequently quarterly), the effective date for those periods is for interim periods within annual periods beginning after December 15, 2018. So, if you’re a calendar year organization that follows US GAAP, your financial statements for the year ended December 31, 2018 will be the first set of financial statements subject to ASU 2016-14.
Q: Do I have to look backwards once these are effective, or do I just need to worry about transactions after the effective date?
A: The guidance has to be applied retrospectively, so if you present comparative financial statements then all years will have to apply the guidance in ASU 2016-14, though the analysis of expenses by both natural and functional classification and disclosures about liquidity and availability of resources aren’t required for comparative years (i.e. years before the current year). The separate presentation of expenses by functional classification and expenses by natural classification, however, is still required.
Q: Ugh. Where do I start?
A: Hopefully you’ve already started, but if you haven’t, you’ll need to make sure that you have systems in place to capture the information that is now required, particularly expenses by function. Some nonprofit organizations (501(c)(3) and 501(c)(4) organizations to be precise) are already required to report expenses by function in their form 990 so they may be in pretty good shape, but many aren’t and may not be tracking costs that way in their accounting system. It goes without saying that it is MUCH easier to categorize costs by function during the year than it would be to try to do it retroactively after the year is over. If you’re not currently tracking funds with internal restrictions on them, you’ll want your system set up to do that too. The rest of the changes should (hopefully) be simply the communication of systems or processes that are already in place or information that is already available.
If you need help with your implementation or have questions about the article, just contact us, we’d be happy to help.