To improve the transparency and consistency of NFP financial reporting, the Financial Accounting Standards Board (FASB) recently issued Accounting Standards Update 2016-14 (ASU 2016-14), Presentation of Financial Statements of Not-for-Profit Entities.
ASU 2016-14 significantly amends the accounting standards for the presentation and accompanying disclosures of financial statements for NFP organizations. These changes will affect substantially all NFP organizations, including charities, foundations, trade associations, labor unions, private colleges and universities, among others.
The significant changes of ASU 2016-14 are summarized below:
Net Asset Classification
The new guidance will require two classes of net assets rather than the previous three classes of net assets. The two new net asset classes are as follows:
- net assets with donor restrictions
- net assets without donor restrictions
The previous classes of temporarily, permanently restricted, and unrestricted net assets are no longer required.
Benefits: This presentation change reduces the complexity in financial reporting and increases the understandability of the information provided.
Board-Designated Net Assets
Enhanced disclosures will be required on the amounts and purposes of self-imposed limits on the use of resources.
Benefits: To provide information about the limits placed on net assets by governing boards, which can be useful in evaluating a NFP organization’s available resources.
To increase transparency in reporting of financial performance, a net presentation of investment expenses against the investment return will be required on the financial statements.
Benefits: This change will provide a more comparable measure of investment return across all not-for-profits, regardless of whether their investment activities are managed internally or externally.
Reporting of Operating Expenses by Nature and Function
All NFPs will be required to provide information about their operating expenses by both nature and function. Reporting by “natural” classification refers to the type of expense, for example, Salaries, Supplies, Travel, Depreciation, etc. Reporting by “functional” classification refers to how the NFP uses its resources, for example, expenses relating to the primary objective of the organization (program services) and expenses relating to supporting activities (Management & General activities, or Fundraising activities).
Benefits: To provide more useful information on how your organization uses its resources. Such information is valuable in assessing the costs of programs and other activities of your organization.
Information Regarding Liquidity and Availability of Resources
NFPs will be required to disclose information about the availability of financial assets, and how your NFP manages its liquid available resources to meet cash needs for general expenditures within one year of the balance sheet date. The goal of this change is to improve the ability of financial statement users to assess the NFP’s available financial resources and the liquidity of those resources.
Benefits: These changes will provide more transparent information that will enable financial statement users to have a better understanding of how a not-for-profit entity manages its liquid available resources and its liquidity risks.
Statement of Cash Flows
NFPs can continue to use either the direct or indirect method of presenting cash flows. However, ASU 2016-14 eliminates the previous requirement to include a reconciliation using the indirect method if the direct method is presented.
Benefits: This change will allow all not-for-profit entities to retain the current flexibility and freedom in financial reporting, while reducing the costs to entities that present the statement of cash flows using the direct method.
As part of the change to classification of net assets, endowments that have a current fair value that is less than the original gift amount (or amount required to be retained by donor or by law), known as underwater endowments, will now be classified in net assets with donor restrictions, instead of the previous classification in unrestricted net assets. Expanded disclosures will also be required to include the following information:
- The original amount of the endowment
- The NFP’s policy relating to spending from these funds
- Whether that policy was followed
Benefits: This change will more accurately report the classification of underwater endowments, and enhanced disclosures will provide more useful information to users of the financial statements.
ASU 2016-14 is effective for annual financial statements ending on or after December 31, 2018.
The overall goal of ASU 2016-14 is to improve transparency and consistency of NFP financial reporting. These changes will provide more relevant and useful information about an NFP organization’s resources and the changes in those resources to donors, grantors, creditors, and other financial statement users. The above is a brief summary of the key changes that will affect not-for-profit organizations. Lindquist partners and managers will be discussing these changes with our not-for-profit clients soon. If you are not a current client, we are available to assist your organization with implementing these changes. Please contact us at (925) 277-9100 for more information.