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Friday, February 24, 2017

FASB Update Part 3: Accounting for Your Cash Flows


Part 3: Statement of Cash Flows

With Accounting Standards Update 2016-14, Presentation of Financial Statements of Not-for-Profit Entities, the Financial Accounting Standards Board (FASB) hopes to decrease the cost and complexity of financial statement preparation and clarify the financial picture for boards, donors and other financial statement users. In this installment of our four-part series on the new standard, we look at the changes to how your organization accounts for cash flows.

Statement of Cash Flows
While the new standard certainly brings significant changes that will impact accounting personnel and resources, the statement of cash flows is one area where the FASB has not made large adjustments. The exposure draft had a provision that would have required that organizations use the direct method, not the indirect method, to present cash flows from operations on the statement of cash flows. This proved to be very controversial, however, and in response to industry concerns, the FASB decided to continue to allow nonprofits to use either approach in the final standard.  

The new rules keep the flexibility of the old standard and make it easier for nonprofits to use the direct method to account for cash flows. In addition to the direct and indirect presentation options, the new standard also requires reclassification of items reported in the statement of cash flows for increased transparency and alignment as to the sources and uses of certain cash flows.

Direct vs. Indirect Method
The direct method requires a categorized listing of all inflows and outflows of cash for operating activities during the reporting period. This list includes cash collections from contributions, program services and pledges receivable, as well as cash payments for vendors, employees, taxes and interest.

One problem with the direct method, and the reason so many organizations choose the indirect method, is that accrual-based companies often do not record cash and credit transactions separately. Having to go back through the entire period’s revenue data and trace out the cash transactions can make the direct method quite onerous—perhaps too onerous for nonprofits that rely on external resources for financial statement preparation. On the flip side, a direct method cash flow statement presentation increases the understandability of information and its usefulness to creditors, donors and other users of nonprofit financial statements.

Another deterring factor under the old rules was that the direct method still required presentation or disclosure of the indirect, or reconciliation, method. The indirect method presents the adjustments necessary to convert net income from an accrual basis to a cash basis. It adjusts net income for changes in the starting and ending balances of current assets and current liabilities, as well as non-cash expenses like depreciation and amortization.

Most organizations choose to use the indirect method because the data required to prepare it is more readily available, and it is more cost effective since those adjustments must be presented either way. We believe that the indirect method of cash flow presentation will still be the method of choice amongst nonprofit organizations, as well as their constituents and users of their financial statements.

Reclassification of Certain Cash Flows
The reclassification of certain cash flow items is required to better align them with the notion that operating activities reported in the statement of activities should be based on whether resource inflows and outflows are from, or directed at, carrying out a nonprofit’s purpose for existence. Realigning how these activities are presented will also serve to increase understandability and help communicate financial performance. These reclassifications will affect cash flows from purchases of, contributions received to acquire and sales of long-lived assets; interest payments on borrowings; and receipt of interest on dividends and loans and investments, other than those for programmatic purposes.

Cash Flows Can Reveal Liquidity Issues
Sources of non-cash income can conceal liquidity problems, so the statement of cash flows is a critical tool that can be used to reveal those sources. The new standard takes further steps to strengthen transparency in regards to liquidity, which is the subject of our fourth and final post in this series.

Looking Ahead
The new standard takes effect for annual financial statements issued for fiscal years beginning after December 15, 2017, and for interim periods within fiscal years beginning after December 15, 2018. Early application is allowed. Contact Armanino’s nonprofit accounting team for guidance as you think through the impacts of the new accounting standard on your financial reporting model and consider the most appropriate method for reporting cash flows.

RELATED ARTICLES

• Article : FASB Update Part 1: Accounting Update Reshapes Nonprofit Reporting
• Article : FASB Update Part 2: Accounting for the Money You Spend

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