The New Financial Reporting Standard for Non-profit Entities is Now in Effect – What changed

May 17, 2019

Issued by the Financial Accounting Standards Board (FASB) in August 2016, Accounting Standards Update (ASU) 2016-14 Presentation of Financial Statements for Not-for-profit Entities has significantly changed the way non-profit organizations present their financial statements. The FASB’s stated purpose was to improve financial reporting for NFPs and this ASU is arguably the most significant change in almost 25 years. Financial statement users should ensure they are aware of the changes that were made. Among other provisions, ASU 2016-14 reduces the number of classes of net assets from three to two, requires the presentation of expenses in both natural and functional classifications, and eliminates the requirement to prepare a reconciliation in the statement of cash flows when applying the direct method. All NFP entities are affected. The new standard became effective for fiscal years beginning after December 15, 2017 and calendar year NFPs have now begun to issue their annual financial statements for the year ended December 31, 2018 under the new reporting standard. So what changed? The discussion below outlines the key changes under the new standard.

Will the numbers be different?

ASU 2016-14 is essentially a disclosure standard. However, there are two provisions that could give rise to adjustments:

1. Classification of the underwater portion of endowment funds – the underwater component, if any, will now be classified as donor-restricted net assets.

2. Requirement to use the placed-in-service approach for long-lived assets – if an entity has long-lived assets that have been placed in service classified as donor-restricted net assets, they should be reclassified as without donor restriction.

Net Asset Classifications

Non-profit entities issuing financial statements in accordance with generally accepted accounting principles (GAAP) are now required to present two classifications of net assets, replacing the three that have been presented for almost 25 years. Net assets will be classified as one of two categories: without donor restrictions or with donor restrictions. This change essentially merges “temporarily restricted” and “permanently restricted” into one net asset class. NFPs are also required to provide information about any additional limitations that have been placed on net assets without donor restrictions, for example, board-designated funds.

Placed-in-service Approach for Long-lived Assets

Although not the most common accounting treatment, existing GAAP allowed entities to continue to carry long-lived assets or gifts to purchase long-lived assets as temporarily restricted (now part of “with donor restrictions”) even after the assets were placed in service. Amounts equal to the depreciation on the asset were released from restriction each period. This election is no longer available with the implementation of ASU 2016-14. An adjustment will be required where the election was previously used to release the remaining net asset balance of long-lived assets (or cash to purchase them) placed in service to net assets without donor restriction.

Endowment Funds

Certain non-profit entities with underwater endowment funds have, to date, classified the portion of the loss that causes the individual endowment to fall below the original gift in the unrestricted net asset class (now “without donor restrictions”). When implemented, entities with underwater endowment funds will reclassify the underwater portion of the endowment fund from “without donor restrictions” to “with donor restrictions”.

The new standard also now requires certain other disclosures for any underwater endowment funds, while eliminating the requirement under the old standard to present the components of investment returns separately.

Statement of Cash Flows

Non-profit entities that use the direct method will no longer have to present the reconciliation of cash provided/used in operating activities. Those that use the indirect method for preparing the statement of cash flows may continue to do so.

Investment Returns

The new standard requires entities to now include both external and direct internal investment expenses in the amount netted from investment return. Direct internal expenses include personnel costs that develop, execute and monitor the investment strategy. Direct internal expenses do not include accounting expense including making endowment fund allocations. This should improve comparability because some NFPs manage investments in-house while others outsource this function.

Liquidity and Availability

NFPs will be required to provide qualitative as well as quantitative information on the way they manage their liquidity and availability of funds. Required disclosures include quantitative information about the availability of financial assets to meet general expenditures within one year of the financial statement date. Those assets that are unavailable due to donor restrictions or other limitations should not presented as liquid financial assets.

Functional and Natural Expense Classification

Previous GAAP required all NFPs to present information by function. ASU 2016-14 requires that all NFPs present expense information by both natural and functional classification. This information may be presented in a statement, a note disclosure or on the face of the Statement of Activities. All investments, with the exception of investment expenses, must be shown in one place. This means that entities that presently include the direct donor benefits for special events in the revenue section will now need to include the amounts related to direct donor benefits in the functional expense presentation, even if it results in a reconciliation to the statement of activities. NFPs are also now required to disclose their allocation methodologies in some detail.

The new standard is likely to have a significant impact on the financial statements of many non-profit entities. As such, preparers, users and other stakeholders may want to make use of the various resources that are available through the FASB and AICPA to aid in implementation. The ASC provides examples of disclosures. The AICPA has also provided sample financial statements. The AICPA has also written white papers that cover functional expenses, investment return and liquidity presentation, which can all be found on the AICPA website. Additionally, there is a publicly available document from the AICPA covering Frequently Missed Disclosures. This is yet another great tool for NFPs to assess their financial statement presentation. Non-profit entities who rely on funding from parties who may review their financial statements should ensure they partner with an accounting firm that is well versed in the changes now in effect under the new standard.

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DISCLAIMER – This article is not intended to provide tax or legal advice. This information is provided for general information and educational purposes and may change at any time. Please contact RS Miller & Associates LLC for additional information.

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