The Financial Accounting Standards Board is beginning to hear from not-for-profit organizations and their accountants about the far-reaching changes it has proposed in reporting by nonprofits, and finding there are some disagreements, even among FASB’s own leaders.

[IMGCAP(1)]In April, FASB issued a proposed accounting standards update outlining the proposed changes (see FASB Proposes Major Changes in Nonprofit Accounting and Big Changes on the Way for Nonprofit Accounting).

The proposals include changes in the current net asset classification requirements and information presented in financial statements and notes to financial statements about a not-for-profit organization’s liquidity, financial performance, and cash flows. To better reflect financial performance in the statement of activities, there would be two measures of operating performance—available amounts that have been generated by or directed at carrying out the mission of a not-for-profit in the current period, both before and after any governing board actions affecting that availability.

“From what I’ve been hearing, everybody believes that if improvements can be made to help the users better understand the not-for-profit’s financial statements, that would be a good thing,” said Lee Klumpp, National Assurance Technical Director in BDO’s Nonprofit & Education practice, who has been closely involved with the project as a FASB fellow, at his firm as well as in the Greater Washington Society of CPAs’ Accounting Policy Committee.

However, he pointed out there are some tension points in the comment letters he has seen. There were even dissents within the proposal document itself from FASB chairman Russell Golden and vice chairman James Kroeker. Toward the end of the document, an “Alternative Views” section says in several instances, “Messrs. Golden and Kroeker disagree with the publication of this proposed Update.”

The changes aim to simplify the existing net asset classification scheme along with enhanced note disclosures. In addition, the proposed changes would enhance information in the notes to help financial statement users better assess a not-for-profit’s liquidity and how it is being managed. FASB also wants to make information about expenses more comparable and useful by requiring that all operating expenses be reported by both function and nature and investment return be reported net of related expenses.

Klumpp believes the main disagreements come in areas that could create additional confusion or don’t have much usefulness, except perhaps in helping one group versus another. “Nobody is in favor of any kind of confusion in the presentation for the reader,” he said.

Liquidity Subject to Manipulation
There seems to be broad support for changes in the net assets area. Many of the commenters support more disclosure about liquidity, but some groups disagree with some of the specifics.

“The liquidity standard that they’re talking about creates a time horizon, and it could be different,” said Klumpp. “It could 30, 60, 90, 120, or 360 days, or it could be even longer. For instance, if you have a trade association that has an annual conference, and membership dues support a third of the activity, but two-thirds of their activity is supported by the annual conference, when you look at the financial statements that have a fiscal year-end, one year could be really healthy and the next year is not so healthy because of how the conference ran. But when I look at liquidity, I have to look at liquidity based on the cycle. I may actually have to look at a liquidity cycle that may be longer or shorter than my year-end, and that’s fine. What people are concerned about is that because you have a disclosure that’s built on a piece of data that has subjectivity to it, there might be room for manipulation. What happens to the not-for-profit that has a bad year and they change their time horizons so they don’t have such a liquidity problem? People are concerned about manipulation in that area.”

Klumpp would like the balance sheet to include a breakout of assets that are limited to use. “Let’s say you have a line item on the financial statements that says investments,” he said. “Within investments, you could have endowment that is donor restricted. You could have quasi-endowment, which is board designated. You could also have investments that are just sitting there as part of the organization’s excess cash flow.” FASB has elected not to do that, however.

Objections on Statement of Activities
Other commenters have objected to some other aspects of the proposal, including ones related to the statement of activities. The accounting standards update tries to make the statement of cash flows more understandable by presenting cash flows provided by operating activities using the direct method of reporting, rather than the indirect (reconciliation) method, and classifying cash flows in ways that are more consistent with classifications in the statement of activities.

“There’s a new presentation concept that’s being introduced and it allows for the policies of the board around the bringing in for use or excluding from use in operations certain resources,” said Klumpp. “For instance, if the board policy says all bequests received are going to go straight into the quasi-endowment, that means I’m taking an unrestricted contribution through a board designation and putting it into an investing activity. Boards have been doing this for years, but it’s never been reflected in the statement of activities. It’s just been reflected in the balance sheet, so you see the investment on the balance sheet side. You see the contribution coming in as just a regular contribution unrestricted on the statement of activities. You don’t see those decisions by the board to set aside resources to fund scholarships or to fund other programmatic activities in the future.”

FASB has been hearing requests for more information about the use of resources by nonprofits. “What most people want to know is what resources were received during the period, what resources were made available during the period, and how did you use all those resources,” said Klumpp. “Those three things are the key. So if by policy they make resources unavailable for a particular reason, people would like to know that. On the flip side of that, if all of a sudden those excess earnings that are sitting over in nonprofits’ version of retained earnings, which are currently ‘unrestricted’ or in the future will be known as ‘without donor restriction,’ the board decides to bring them in to expend them to expand on a current program or to develop a new program or to build a building, the user wants to know that.

“Bringing those funds back in is a good thing and you bring them back in through the transfer line,” he added. “So you have a gross operating measure, which is all your resources that came in, all your contributions and other resources, general revenue that came in and what was made available over a period, less your expenses, comes to a gross intermediate operating measure. Then you have your transfers that come in through the net. What it does is it introduces the pulling out or bringing in of resources. So the decisions that are being made at a policy level by the board are now reflected in the statement of activities because people want to know how resources are being used. I would say there are a lot of people who are supportive of that, and there are a lot of people who are not so supportive.”

For example, some confusion could arise over how to treat capital transactions. “If you have a gift by a donor of a building, or a gift by a donor of cash to acquire or construct a building, those are restricted because they’re being used for a building,” said Klumpp. “When you take occupancy or you turn around and meet those requirements, or even if someone gives you a building and you monetize it so you sell it right away, currently that stuff flows through in big chunks on the statement of activities. It comes in as a contribution and it gets released from restrictions as this big blip that shows up on the statement of activities. Now what they want to do is they’re still going to show it as coming into the total revenue and support, but then they’re going to pull it back out through transfers and put it down in non-operating. Some people believe that is creating a new heightened level of confusion on the face of the statements because you’ve got it coming in and you’ve got it going back out.”

Why not just take the amount straight to the non-operating category? “There are some reasons for that because theoretically that asset was legally available, so it’s meeting that requirement,” Klumpp explained. “It’s mission related so it comes in and it goes back out again without donor restrictions because originally it was restricted. And also the purpose of that is to try to articulate the statement of activities with the statement of cash flows. Some don’t necessarily believe that all this complexity is worth the benefit of what you’re going to get for articulation. I believe articulation between the two statements is very meaningful, but I can see where other people are coming from with the confusion.”

Another aspect involves the interest expense. “It’s believed that’s non-operating, so therefore it wouldn’t be up in the expenses,” said Klumpp. “That creates articulation with the statement of activities. There are people who have differences of opinion on that.”

The statement of cash flows has also caused some controversy. “Most people would agree that the statement of cash flows doesn’t provide very much useful information currently for the readers,” said Klumpp. “Keep in mind, those are mostly board members, funding organizations or donors, and credit-rating agencies or creditors. Those are the key users. We call them the nonprofit constituents. Some believe that by going to the direct method, it’s going to make the statement more useful. There are a lot of people who are not happy and there’s a tension point that’s been developed around some of the reclassifications of that.”

In the future interest expense would be a financing activity, while interest and dividends would be an investing activity. Previously they were both operating activities. Klumpp pointed out that the same two items were also tension points in the 1980s when FASB issued FAS 95 for the statement of cash flows.

“It’s funny that some things still haven’t changed,” he said. “But the other thing you’ve got is currently if I give a gift, say, to my alma mater to build a building, currently that contribution would actually go into financing activity. If I turn around and I’m giving cash to do that, that goes into the financing. If I get a gift of a building, that’s on the statement of activities, but it’s not reflected in the cash flow because it’s not a cash transaction. But if I monetize that gift and buy it, whatever the purpose is, it’s going to come in as investing activity. What does that really mean? There are some people who have different ideas about the articulation between the statement of cash flows and the reclassification items.”

Impact on For-Profit Businesses
Klumpp pointed out the original mandate on the nonprofit project from former FASB chair Leslie Seidman was not to worry about any impact the changes might have on the standards for for-profit businesses.

“Part of the direction that came from the board at the time was not to hold back on making sure that what you were trying to do in this standard was equal to what was being done on the for-profit side, because there were enough differences between not-for-profits and for-profits that it didn’t necessarily need to have the same presentation requirements,” he recalled. “The staff followed those directions.”

However, in their “Alternative Views” in the proposed accounting standards update, current FASB chairman Russ Golden and vice chairman Jim Kroeker dissented for the opposite reason.

“On the statement of cash flows, they think the board is getting ahead of for-profits,” said Klumpp.

He pointed out that in the document, it says, “However, Messrs. Golden and Kroeker disagree with the publication of this proposed Update because a number of significant issues being addressed are not specific to or more uniquely encountered by NFPs. The following are examples of issues not unique to NFPs: a. Inconsistencies in the reporting (or lack of reporting) of intermediate measures of operations; b. Proposed requirement to present operating cash flows using the direct method in order to reduce asserted misunderstandings and improve the utility of the statement of cash flows; c. The fact that there are (or can be) differences between the reporting of operating performance and the reporting of operating cash flows.”

In terms of the proposals that could establish differences between not-for-profits and business entities, the document says, “Messrs. Golden and Kroeker do not support an approach of developing comprehensive presentation guidance related to establishing the required reporting of two intermediate measures of operating performance for NFPs while exploring essentially the same accounting issue for business enterprises (both public and private). Given the active and ongoing project on the Board’s research agenda to potentially address the same issues for business enterprises, they believe that the approach being taken to address a similar issue in a separate project that more narrowly considers only NFPs has a much higher likelihood of establishing different conclusions when evidence may suggest that an aligned approach is warranted. Messrs. Golden and Kroeker believe an important objective of the Board is to eliminate, rather than create, accounting and reporting differences that are not justified by differences in underlying facts and circumstances. Thus, they believe that this piecemeal approach to addressing the issue has a much greater potential to introduce unnecessary complexity to both preparers and auditors, as well as costs to users, in understanding differences that may be mandated by addressing the NFP reporting model separately.”

PwC Partner View
[IMGCAP(2)]Beth Paul, a partner in the National Professional Services Group at PricewaterhouseCoopers LLP, believes for-profit businesses should weigh in on the proposals because they might see an impact on standards for their companies. In a recent LinkedIn article, she encouraged for-profit entities to weigh in before the August 20 deadline for comments.

“One of the things I was trying to encourage is for business entities to consider commenting,” she told Accounting Today. “Some of the underlying concepts they’re proposing on coming up with operating measures—what’s known as the statement of activities for not-for-profits, but would be an income statement for business entities, and then linking that to the cash flow from operations amounts—might be something they would consider down the road for business entities. I’m speculating a little bit there, but there are projects on the FASB’s agenda for business entities on both financial performance reporting, such as the income statement, and on the cash flow statement. I was trying to encourage business entities to comment if they had observations so the FASB would have all the information when they move forward on the not-for-profit project, rather than moving forward with one and then doing a business entity project and hearing from business entities at that time. I thought that would be a better process and more effective, and maybe helpful to the FASB to get all perspectives at once.”

She pointed out that for a long time the financial reporting model for not-for-profits was based on the model for business entities and was only modified for unique not-for-profit transactions and characteristics. “Not-for-profits have contribution revenues as a revenue source, which business entities don’t, so there is specific guidance,” said Paul. “To me that’s a good model for all stakeholders.”
She believes that having a core common framework helps accountants and other stakeholders understand the financial statements, while FASB can make tweaks as appropriate to the standards for nonprofits.  “It’s easier for preparers who oftentimes are going to take people that went for a traditional accounting degree or worked at both public and private companies, so having one fundamental model with tweaks is a better way for preparers to understand it.”

“They are looking at the balance sheet and looking to simplify it for not-for-profits and reduce the number of captions from three to two,” she added. “I think something like that is very specific to not-for-profits and probably makes sense to focus on.”

For some not-for-profits, the changes may be easier to swallow than for others.

“Each not-for-profit has to look at its own facts and circumstances and systems, but the proposal is a sweeping reform,” said Paul. “It is changing the lines that are required on the income statement, or the statement of activities as it’s called, and it’s proposing to change the statement of cash flow from an indirect method to a direct method, which would require either new systems or new processes to gather the information that way from how they’re doing it today. I think it will require some time to prepare and put in whatever processes and control systems to be able to present the information in this new way.”

Mission Creep
Some of the objections to the standards are coming from those who believe the not-for-profit standards should align with those for for-profit businesses.

“What people are having a problem with is the reclassifications because that is getting out in front of the for-profits,” said Klumpp. “And if I’m a business owner and I’m used to reading financial statements in a for-profit, and I have to understand a different cash flow methodology, and I don’t even understand the one we use now, that’s going to become an issue.”

Some observers in the financial industry worry that FASB is using the standard as a springboard for changes in the future for for-profits, but Klumpp believes that is far from the truth.

While there are some disagreements over the proposed changes in the cash flow statement and the statement of activities, there appears to be more agreement on the changes in the statement of functional expenses.

“That doesn’t seem to be such a tension point,” said Klumpp. “Some believe the netting of interest income and interest expense together on the face of the statements would probably be a good thing in creating comparability. There are others, however, who believe that no longer requiring disclosure of the components of investment income and what total investment expense is takes information away. Now they’re no longer requiring it, but they’re not prohibiting you from doing it. There are a lot of things in the statements that people put in there because they find it useful.”

Roundtables Planned
To gauge additional reactions to the nonprofit accounting proposals, FASB plans to hold public roundtables at its Norwalk, Conn., headquarters on Sept. 21, 2015 and at the University of Southern California in Los Angeles on Oct. 6, 2015.

“The groups they really want to hear from are the preparers and users of the financial statements,” said Klumpp. “For the preparers, have we projected the cost benefit correctly? Is this going to put any undue burden on anybody? No one believes it will at this point, but you’ve got to listen. And then from the users: is this really helping you? For instance, the liquidity information, is that helping funders and creditors understand the liquidity of a not-for-profit because that’s what that information is trying to convey, so you can understand their ability to be able to continue to sustain themselves as well as meet their mission requirements.”

FASB is also gauging feedback in other ways, with project leaders and board members traveling all over the country speaking about the proposals and hearing back from attendees at venues such as recent conferences of the National Association of College and University Business Officers and the American Institute of CPAs.

“There is definitely an interest in the project,” said Klumpp. “Now that people have the exposure draft and hear more about it, they’re formulating more opinions. And as they formulate those opinions, the board and the staff are trying to get them to comment so they can take that information and use it for redeliberations.”

FASB staff will be analyzing all the comments and come up with a redeliberation plan. “That redeliberation plan will be highly guided by the comment letters and also comments that the board members and staff members have been hearing,” said Klumpp. “Depending on what they hear depends on how extensive the redeliberation plan will be. And all of that will be provided to the public. They’ll have a board meeting that will be a public meeting where they will discuss the redeliberation plan. Some people may be happy and some people not so happy, and hopefully what we end up with in the long run is an improvement. I think it will be.”

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