The new Financial Accounting Standards Board standards for nonprofits that were released in August represent the most significant changes in the not-for-profit reporting rules since 1993.
The new standards are not an “overhaul” of the existing standards, but an improvement. They improve the net asset classification and provide enhanced performance and liquidity information to the users of the financial statements. Here are the areas impacted by the new standards:
NET ASSET CLASSIFICATIONS
The current net asset classification of unrestricted net assets is renamed to “Without Donor Restrictions” and temporarily and permanently restricted net assets are combined and renamed to “With Donor Restrictions.” It is important to note that the new net asset classification focuses on the word “donor.” The term “unrestricted” net assets was often confusing to non-accountants, with a notion that such net assets are truly “available for operations.” Oftentimes this is not the case, since there could be contractual restrictions on those funds by a governmental funding source or board designations for a specific project. The new name, Without Donor Restrictions, provides more clarity. Combining the temporarily and permanently restricted into one category of With Donor Restrictions makes it easier to understand.
If an organization feels that the users of its financial statements want to see more detail, they can disaggregate the two minimum categories into more details either on the face of the financial statements or in the notes. If an organization decides to disaggregate the two minimum categories into more lines on the face of the financials, they still need to present totals for the two minimum categories.
The biggest improvement in the new standards is the requirement to disclose the amounts and purpose of board-designated funds. This also emphasizes the importance of the board of directors considering the accounting implications before they set up a board-designated fund. There is a misconception among some that a large investment portfolio can be equated to board-designated funds. For example, an organization with $10 million in its investment portfolio may not be able to designate all $10 million as board-designated net assets. The board needs to look at the true available net assets within the category of Without Donor Restrictions to ensure there are sufficient funds that could be set aside as board-designated. This will also avoid situations where the board-designated funds are more than the total net assets available for operations after disaggregating components such as “investment in plant, property and equipment.”
From time to time, the fair value of the assets associated with individual donor-restricted endowment funds may fall below the value of the initial and subsequent donor gift amounts. This is referred to as “underwater.” With the new standards, when “underwater” endowment funds exist, they are classified as a reduction to the category With Donor Restrictions. This is a major improvement. Under the new standards the note disclosures should reflect the amount required to be maintained for donor-restricted endowments and the fair value of the endowment as of the financial statement date to report the “underwater” portion. The disclosure should include the spending policy, which raises the question as to whether the organization continues to spend or reduce spending on those “underwater” endowments.
The Uniform Prudent Management of Institutional Funds Act permits the organization to keep on spending even if the funds are “underwater.” Thus it makes perfect sense for the “underwater” portion to be included within the donor-restricted net assets. Remember, the calculation is exactly the same under the new and current standards, which is on a fund-by-fund basis.
The new standards eliminate the option that is currently available (except for not-for-profits within the health care field) to apply time restrictions when there is no purpose restriction on donated plant, property and equipment. Going forward with the new standards, time restrictions on donated property and equipment are not allowed, except as instructed by the donor. In the absence of explicit donor restrictions, the asset is classified as net assets Without Donor Restrictions.
Organizations should start to look at their existing net asset classification and see what funds are rolled up into each net asset category. A detailed mapping exercise like this, and a cross walk from the various funds to the current net asset category, will serve as a guide on how such funds will be rolled up under the new format. This will also start the discussion on what level of disaggregation is best. For example, should funds set aside for bond sinking fund requirements be disaggregated (if material)? How about disaggregating the impact of defined-benefit pension plans?
Organizations can also be more creative in how they name each line if they choose to disaggregate further. One other option is to add more columns in the statement of activities that will roll up into the disaggregated lines on the face of the financial statements.
CASH FLOW STATEMENTS
Under the new standards, organizations that choose to report by the “direct method” are no longer required to do a reconciliation under the “indirect method.” This should encourage organizations to report by the direct method more often. Oftentimes, readers of the financial statements pay little attention to the cash flow statement, primarily due to the complexity of the reporting. The direct method is more user-friendly and understandable to an average user. Organizations should start thinking about what type of reporting will make sense for their organization.
RESOURCE LIQUIDITY & AVAILABILITY
Under the new standards, organizations need to provide qualitative and quantitative information on the liquidity and availability of their resources. Qualitative information should be used to report how an organization manages its liquid available resources and provide any liquidity risk. For example, how does an organization make sure it has enough liquidity? The answer could be maintaining a line of credit or bank account balances to cover a certain number of weeks’ expenses.
Quantitative information should communicate the availability of the resources at the balance sheet date to meet the cash needs for general expenditures within one year. The word “general expenditures” is important, because funds restricted by donors or contractual agreements or certain types of internal designations are not considered to be available for general expenditures. For example, an organization can have liquid assets, thus providing liquidity. However, such liquid assets may not be available for general expenditures. The new standards provide more information and transparency that will be useful to an average reader about the financial viability of an organization.
One of the questions that organizations will want to consider is how they would treat board-designated funds in the liquidity and availability disclosure. Board-designated funds could be liquid, however they may not be “available” for general expenditures within one year. If the board-designated funds are liquid and available for general expenditures within one year, such funds could be included as available in the quantitative disclosures.
There is a greater level of flexibility as to how organizations report their liquidity and availability information. It could be presented in a tabular format or a management discussion and analysis format that can provide both qualitative and quantitative information. It’s important for organizations to start thinking about this now, and to evaluate their financial position and look at the balance sheet on a “classified” basis and also considering the “availability” factor.
INVESTMENT ACTIVITIES
Investment expenses will be presented net of investment income in the face of the statement of activities. Netting is limited to external and direct internal expenses. It is no longer required to disclose investment expenses, and the new standards also remove the requirement of reporting various components of investment return.
EXPENSE REPORTING
The new standards require expenses to be reported by function and nature. Current standards only require reporting expenses by function. Most organizations are already doing this either in the financial statements or in notes or in the IRS Form 990.
The new reporting requirement by function and nature can be either in the basic financial statements or in the notes. In addition, organizations are required to disclose how expenses are allocated by function. There is no set guidance in the accounting standards on what is an acceptable allocation methodology. However, for social service agencies the allocation methodology could be driven by the governmental funding source regulations and requirements. The key word is “direct” function: If the CEO of the organization is directly involved in fundraising, their compensation should be allocated to fundraising. The new standards could be more challenging for nonprofits that currently do not present a statement of functional expenses.
Sibi Thomas, CPA, CFE, CGMA, is a partner in the Nonprofit & Government Group of Top 100 Firm Marks Paneth LLP. Reach him at sthomas@markspaneth.com and follow him on twitter at @sibithomas_.
