The FASB’s not-for-profit accounting standard is the first major update to not-for-profit reporting in more than two decades. Because it goes into effect in 2018, not-for-profit organizations can expect to undergo significant changes to their financial reporting practices in the coming months.
Charities, foundations, and museums are in for major financial reporting changes in 2018.
Not-for-profit organizations with fiscal years that end on December 31, 2017, need to be ready to overhaul how they prepare their financial statements because of the changes in the FASB’s August 2016 Accounting Standards Update (ASU) No. 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities. The update is the first significant change to not-for-profit accounting in more than two decades.
“For calendar-year, not-for-profit organizations, implementation is literally right around the corner,” said FASB Technical Director Jeffrey Mechanick during a December 19 webcast about the new standard. “For those not-for-profits with fiscal year ends other than December 31, it’s not far behind.”
A central part of the new standard requires new, enhanced information about an organization’s finances, starting with its liquidity, or access to cash.
“What it’s really saying is, ‘What do I need to do to make sure I have money to pay the bills? What are my policies? Do I have cash reserve balances? Do I have lines of credit?” said FASB supervising project manager Rick Cole. “What do I do to make sure I’m going to be able to pay the bills as they come through?”
Not-for-profits must also offer information about endowments that have dropped below their initial value or the value set by law or a contract. In addition to stating by how much the endowment value has dropped, they have to say what they are doing to make up the shortfall, such as whether they will stop or reduce spending from accounts that are running a deficit.
U.S. GAAP has required organizations to disclose only the amount of the shortfall, but in ASU No. 2016-14, the FASB asked for more context in the footnotes, including the endowment’s original value. Depending on the original value, a donor or other reader of a financial statement can assess how big of a problem the organization has, Cole said.
“These enhanced disclosures, I think, become very helpful for financial statement users because now they get a bigger picture of what the underwater amount means for the organization,” he said.
ASU No. 2016-14 also attempts to convey more information about an organization’s assets. It changes the categorization of a group’s assets into those with donor restrictions and those without, versus current practice’s three categories — unrestricted, temporarily restricted, and permanently restricted. Few people outside not-for-profit accounting circles knew what “unrestricted” assets meant, the FASB said, and they may have thought the term applied to funds that are free for any use designated by the not-for-profit organization’s management. In reality, unrestricted assets can mean there may not be strings attached to them by donors, but they could be tied up by requirements set by trustees or for legal reasons. The new categories attempt to make the distinctions more transparent.
Andrew Prather, a shareholder of Clark Nuber P.S., an accounting and consulting firm in Bellevue, Washington, and a member of the FASB’s Not-for-Profit Advisory Committee, said he has fielded questions about the requirements to label funds “with donor restrictions” and “without donor restrictions.” He said there was some flexibility.
“The answer is no, those specific phrases aren’t mandated, although they’ll be commonly used in practice,” he said. “If you have some other labels or titles that would convey the same meaning, that would be allowable. However I would really caution you to avoid using the term ‘unrestricted’ or ‘temporarily’ or ‘permanently’ restricted.”
The update also requires all organizations to break down many new details about their expenses via an expense analysis. The analysis, which could take the form of a table, would include information about things like an organization’s salaries and the portion of them earmarked for programs versus fundraising or communications.
Currently, only voluntary health and welfare organizations are required to present an expense analysis. The new requirement aims to give watchdogs, donors, and others better insight to where an organization’s money goes.
ASU No. 2016-14 also lets not-for-profit organizations choose whether to present the statement of cash flows using either the direct or indirect method. The guidance that is being phased out says that an organization that uses the direct method must reconcile its cash flows with the more commonly used indirect method. The reconciliation requirement is phased out with the new standard.
“That will no longer be required, so it’s really a free choice. This change will only apply to not-for-profits,” Prather said.
The direct method requires separate reporting of cash receipts and payments tied to operating activities. The indirect method starts with net income, adjusts for all noncash transactions, and then makes a second adjustment for cash-based transactions. Both methods get to the same results. But most accountants are familiar with the indirect method, even though many of them say it is more complex. The majority of businesses report cash with the indirect method.
As it drafted ASU No. 2016-14, the FASB originally called for making the direct method a requirement, but many organizations balked, saying it would make their financial statements veer too far from the financial reporting methods employed in the for-profit sector.