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Wednesday, April 6, 2016

Accounting Update May Change the Face of Your Financials


For the first time in more than 20 years, nonprofit financial statements are getting a face-lift. The nip and tuck comes in the form of proposed Accounting Standards Update (ASU), Presentation of Financial Statements of Not-for-Profit Entities.

The stated goal, according to the Financial Accounting Standards Board (FASB), is to create more comparable financial reporting among nonprofits, and to provide donors and lenders with the liquidity information they need to better assess the financial health of the organizations they are funding. Specifically, the new accounting standard focuses on improving:

  • net asset classification requirements
  • information provided in financial statements and notes about liquidity, financial performance and cash flows

In particular, the proposed changes would cover these key areas of nonprofit financial reporting:

Asset Restrictions: The three current classifications of net assets—permanently restricted, temporarily restricted and unrestricted—would be replaced by two new classifications. Assets would be categorized either as “with donor restrictions” or “without donor restrictions,” essentially combining the previous categories of temporarily or permanently restricted net assets

When treating the expiration of restrictions related to long-lived assets, nonprofits will be required to utilize the “placed-in-service” approach, thus eliminating the option to release the donor-imposed restriction over an asset’s estimated useful life.

Expenses: Expenses will be reported by both their nature and function as in a statement of functional expenses. Currently, only voluntary health and welfare organizations are required to allocate expenses this way. Nonprofits would have the flexibility to present expenses on their Statement of Activities, as a separate statement or within notes to the financial statement.

Cash Flows: The proposal would also require two fundamental changes designed to increase the understandability and usefulness of the statement of cash flows:

  1. Cash flows must be presented by operating activities using the direct method of reporting, rather than the indirect (reconciliation) method
  2. Cash flows must be classified in ways that are more consistent with classifications in the Statement of Activities

Endowment Funds: The amount of any endowment funds that are underwater would be reported under the new “with donor restrictions” category of net assets. Financial statements would be required to provide additional disclosures about the original gift amount, current fair value and organizational spending policies.

Investment Expenses: The accounting change would also require the netting of external and direct internal investment expenses against investment return. Nonprofits would not be required to disclose internal salaries and benefits that are netted against investment return.

Operating Measures: Nonprofits would be required to present two intermediate operating measures of operating activities:

  1. A measure of operating activities based on whether resources are from or directed at carrying out a nonprofit’s mission/exempt purpose, including operating revenues, support, expenses, and unrestricted gains and losses before internal transfers
  2. A measure based on whether resources are available for current-period activities, including any external limitations and internal actions of the governing board such as internal transfers resulting from governing board designations, appropriations, and similar self-imposed actions

Liquidity: Financial statements would be required to provide quantitative and qualitative information that a statement user could use to assess a nonprofit organization’s liquidity and how it is being managed -- including a description of the amount of financial liabilities that require cash in the near term and the time horizon used to manage liquidity.

When Will It Happen?
The ASU has proceeded through both the exposure draft and public comment period, with some 260 affected entities issuing comment letters. FASB continued its deliberations at a meeting on March 2, 2016. Note that any decisions to date are tentative and do not change current accounting standards.

The current prediction is that FASB might complete deliberations and issue Phase 1 updates this summer, with Phase 2 to come at a later time. The ASU would then be effective for audits of financial statements for periods ending on or after December 15, 2016.

Our Thoughts
The proposed accounting update represents a conceptually different approach to how information is presented in financial statements. Those who prepare the financial reporting for their organizations will certainly be impacted. Yet, with adequate prior planning, we believe these changes will also enable nonprofits to better tell their financial story.

Our experienced professionals are a good resource for navigating the proposed accounting updates. For a better understanding of the proposal and its impact on your nonprofit, please contact your local nonprofit expert.

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