Gearing Up for the Nonprofit Reporting Standard

Gearing Up for the Nonprofit Reporting Standard

Article posted in Exempt Organizations Update on 20 January 2016| comments
audience: National Publication, Dennis Walsh, CPA | last updated: 20 January 2016
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Summary

Dennis Walsh brings us up to date on the status of proposed reporting and accounting requirements for non profits. A must read for all and a call to action to help shape the future of the sector.

By Dennis Walsh, CPA

In April 2015 the Financial Accounting Standards Board (FASB) released a proposed accounting standards update, “Presentation of Financial Statements of Not-for-Profit Entities.”  When implemented, the new standard will require significant changes in the way information is presented in the financial statements of nonprofit organizations.  

Not since the 1993 release of FASB Statement No. 117, Financial Statements of Not-for-Profit Organizations, has there been anything comparable in terms of scope and implications for financial reporting in the nonprofit sector.  

This update should serve as a gateway to help boards, management, donors, creditors, advisors, and other stakeholders get more acquainted with the principal features and benefits of the revised reporting model, discern specific issues relevant to the organizations they serve, and to get a better sense of potential costs and challenges in implementing the new standard.  

Those not yet introduced to the standard can view a short video, concise summary of proposed changes, and the complete exposure draft at the FASB project website.

Not-for-Profit?

The phrase “not-for-profit” has been adopted for financial accounting use in order to describe entities existing for the accomplishment of public, non-private purposes.  This stands In contrast to the more familiar term “nonprofit,” rooted in state corporation laws, and the federal tax law term “exempt organization.”

While these terms are often used interchangeably, all three are misnomers in that such entities routinely engage in commerce for the production of income in carrying out their public purposes.  And exempt organizations are free from tax only on net income from activities directly related to their exempt functions.

The principal prohibition is not the realization of net income, as in a strict accounting sense, but rather the inurement of any amount of income to insiders, or substantial private benefit derived through the resources or activities of these entities.

Since this article is set in the context of accounting standards, organizations subject to the proposed standard will be described as not-for-profit, Or NFP.  And the term “Board” as used herein refers to the Financial Accounting Standards Board, The standard setting body for accounting principles in the United States.

Organizations affected

As stated by the Board, the proposed standard would affect substantially all NFPs as well as creditors, donors, grantors, and others that use their financial statements.  Such NFPs typically include charities, foundations, private colleges and universities, nongovernmental health care providers, cultural institutions, religious organizations, and trade associations, among others.

Whenever financial statements are prepared for such entities under generally accepted accounting principles (GAAP), as promulgated by the Board, the proposed standard would be applicable.  This includes financial statements audited, reviewed, or compiled by an independent CPA.

Project objective

According to the Board, the objective of the accounting standards update (ASU) project is to reexamine existing standards for financial statement presentation by NFP entities, focusing on improving:

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

As further explained by the Board, the proposed requirements that are most likely to provide significant improvements to financial reporting are from:

  • Simplifying net asset classifications and improving related terminology and disclosures – In particular, the enactment of the Uniform Prudent Management of Institutional Funds Act (UPMIFA) by 49 states has largely obfuscated the distinction between the temporarily and permanently restricted net asset classes
  • Requiring qualitative and quantitative information useful in assessing liquidity - i.e. cash and other near-cash assets available to meet short-term operating needs
  • Requiring more standardized intermediate measures of operations – Some NFPs, large organizations primarily, have adopted performance indicators similar to those used by for-profit entities (e.g. “income from continuing operations”), while others have not, resulting in less comparability among organizations across the NFP sector
  • Improving the understandability about an NFP’s cash flows, particularly cash flows from operations – Reclassification of certain items within the statement of cash flows will improve comparability with operating items reported in the statement of activities and improve the financial measurement of mission activities

Implementation

While subject to change, the following points summarize the Board’s current plan for implementation of the standard:                    

  • The effective date, and whether it should be the same for all NFPs, as well as whether early adoption will be permitted, will be determined at a future time (see recent developments below)
  • The Board decided that the standard will be applied on a retrospective basis, requiring restatement of financial statements of earlier years presented in comparative form along with the current year financial statements
  • Application to interim financial statements would not be required in the initial year of application
  • Information for interim periods would be restated if reported with annual financial statements for the year of implementation
  • For the year that the final Update is first applied, an NFP would disclose the nature of any reclassifications or restatements and their effects, if any, on changes in the net asset classes for each year presented

Recent developments

In the months following release of the ASU exposure draft, the Board conducted a public comment period that ended in August, and since that time has held two public roundtable events.  This provided opportunities for stakeholders to voice their concerns and suggestions, in order to help the Board shape deliberations and work plans.

With this feedback in hand, the Board decided at its October meeting to divide redeliberations of the standard into two work streams.  The first will reconsider the following issues that are not dependent on other FASB projects and are improvements the Board might finalize in the near term.  These include:

  1. Net asset classification scheme, including:
    1. Disclosure of board-designated funds
    2. Underwater endowments
    3. Placed-in-service option for expirations of capital restrictions
  2. Expenses, including:
    1. Expenses by nature and an analysis of expenses by function and nature
    2. Netting of external and direct internal investment expenses against investment return
    3. Disclosure of netted investment expenses
    4. Enhanced disclosures about cost allocations
  3. Operating measures: improving disclosures by those not-for-profit entities that choose to present such a measure
  4. Improving disclosures of information useful in assessing liquidity
  5. Statement of cash flows:  Methods of presenting operating cash flows

The second work stream will involve reconsideration of other proposed changes that are likely to require more time to resolve because they involve evaluation of alternatives suggested by stakeholders the Board did not previously consider or are related to similar issues being addressed in other projects.  Those proposals include:

  1. Operating measures:  all other elements of the proposal, including:
    1. Whether to require intermediate measure(s)
    2. Whether and how to define such measure(s) and what items should or should not be included in the measure(s)
    3. Alternative disaggregation approaches suggested by stakeholders
  2. Statement of cash flows: realignment of certain line items

It is anticipated that the Board’s priority will be to issue a final Update in the near-term that addresses the initial work stream issues and that the second work stream will require further research and consideration of the remaining issues over a longer term.

According to Supervising Project Manager Richard Cole, the Board expects to complete the first work stream in the second quarter of 2016.  At its December meeting, the Board affirmed several decisions regarding work stream one, which Cole said adds support for completing the initial phase in this time frame.  However, there has been no indication of an effective date for a resulting update.

Action items

Interested persons should monitor the ASU project website for continuing developments and consider the timing of these suggested actions:

  • Communicate with management, internal accounting staff, and independent accountants as necessary regarding process for implementation of the new standard
  • Review existing loan covenants and grant/donation agreements to identify any provisions that link compliance by reference to operating performance indicators or financial statement ratios that may be affected by the proposed standard
  • Review agreements, board minutes, and other documents to verify the presence and status of any express or implied restrictions on unexpended gifts and grants, in order to assure proper classification and to meet new disclosure requirements for endowments
  • Review board minutes, resolutions,  and other documents regarding the existence and status of any board-designated reserves or quasi-endowments that will be subject to disclosure under the standard
  • Identify and document cash management practices, including time horizon for which the organization manages liquidity through rolling cash flow projections or other methodologies, to help meet new disclosure requirements
  • Identify, review, and document existing practices for the allocation of functional expenses and internal investment expenses in order to satisfy new disclosure requirements
  • Plan for modifications to the chart of accounts to facilitate net asset reclassifications and reordering of revenue and expense accounts consistent with a revised statement of activities
  • Plan for advance communication with donors, creditors, and other users of the financial statements summarizing how the forthcoming changes will affect the organization and how reporting is expected to improve as a result
  • Assign specific responsibility for such items

While the costs and challenges of implementing the final standard will vary based on organization type and accounting resources available, these actions can serve a dual-benefit for all NFPs.  In addition to getting ready for the new standard, all organizations can benefit from an internal review leading to improvements in governance and financial management policies relating to such items. 

And when implementation is complete, an organization should be in a better position to tell its story – an underlying objective of the ASU project.

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