The Financial Accounting Standards Board is expected to release a scaled-back set of changes in accounting standards for nonprofit organizations this summer, with more far-reaching changes planned for the future, probably depending on whether they can also apply to for-profit businesses.
“In terms of the project itself and the output, FASB has pretty much wrapped up all of its redeliberations on phase 1,” said Martha Garner, a managing director at PwC who has been monitoring the developments. “Based on the feedback that they received, they broke it into two phases. The first phase is more immediate improvements and the second phase is going to deal with certain bigger issues, including issues that may cross over and intersect with business reporting issues. They recently made the decision about the effective date and transition. And they expect to have the final standard out sometime this summer.”
The amendments would be effective for financial statements for fiscal years beginning after Dec. 15, 2017, and for interim periods within fiscal years beginning after Dec. 15, 2018, with early adoption permitted (see FASB Looks at Nonprofits).
Phase 1 consists of targeted changes to the existing model for nonprofit organizations, but FASB has decided to put off further changes until they can also be applied to for-profit businesses, in response to the feedback it received on the initial proposals (see FASB Sees Dissent on Nonprofit Accounting Changes). Some of FASB’s constituents worried that the changes in nonprofit accounting might get ahead of those for business reporting.
“Any more fundamental changes to, let’s say, the general U.S. financial reporting model that the not-for-profit model is based on, they would do all at the same time for business entities and nonprofits so that the two models can stay in sync,” Garner explained. “That was really a very important part of the feedback that they’ve heard from the comment letter process. The industry felt strongly that the two models needed to stay in sync.”
FASB received plenty of feedback in response to its initial proposals. “We were all surprised by the volume of comment letters that were submitted from nonprofits,” said Garner. “Typically nonprofits don’t often submit comment letters, and they got 250+ comment letters on this. There was a consistent theme through the majority of the letters, which was how important it was for the not-for- profit reporting model and the for-profit reporting model to stay in sync, and there are good reasons for that. If FASB wants to undertake more wholesale changes to the not-for-profit model, do it at the same time that they make similar changes to the for-profit model. It’s vital that these two models stay in sync.”
The project raised awareness that when FASB built the not-for-profit model over 20 years ago, it was built on the foundation of the business-reporting model. FASB’s Nonprofit Advisory Committee, or NAC, wanted to take a fresh look at the landscape for not-for-profit financial reporting and evaluate a host of ways it could be improved (see Big Changes on the Way for Nonprofit Accounting).
“They tailored it for things that were unique for nonprofits, but their viewpoint then was to take what is the general rules that apply to business entities and say those will also apply to nonprofits, with some tailoring that’s appropriate to their characteristics,” said Garner. “It really was a different approach completely in how information would be reported in financials. Rather than do that now, they will leave these models in sync because that helps to make the not-for-profit statements more understandable. Make targeted changes now to improve the underlying model, but then if you’re going to look at more fundamental changes, do it when and if you start to look at similar changes to the for-profit reporting model.”
Getting onto FASB’s Agenda
The problem is that FASB already has an extensive number of possible projects to tackle for for-profit businesses, and it has not yet definitely set its agenda for which projects will definitely be on the horizon. Those projects may include the ones that also involve nonprofits, or they might not.
“FASB has a couple of projects on its research agenda to look at these same issues for business entities,” said Garner. “When they do their agenda paper sometime later this year where they’re looking at basically candidates to move up onto their agenda to fill in for some of the bigger projects that they’ve just finished, there’s the possibility that those business-reporting projects would move onto the technical agenda.”
However, when the agenda paper goes out, FASB will be soliciting comments on that as well, so the upcoming agenda is not likely to be finalized this year. In any case, FASB’s agenda is always subject to change.
Different Nonprofit Types
FASB heard from its nonprofit constituents that it should take into account the different types of nonprofits, and the functions they perform.
“Another big message that came through the feedback was that it’s important for not-for-profits to have the flexibility in their model that allows a not-for-profit operating in a particular area to be able to report similar to its counterparts,” said Garner. “For example, health care should be able to report comparably to other health care entities regardless of whether they’re not-for-profit or for-profit. The direction that the proposal had gone was to say, ‘let’s take a look at trying to make all not-for-profits report uniformly.’”
On the other hand, nonprofits also told FASB it should preserve the flexibility it provides in how they report information.
“They received some strong messaging from the industry that on reflection they really liked the flexibility that is inherent in the existing model that lets you decide what is the most informative way to report,” said Garner. “For example, under the proposed model that they brought out, that was going to tell you if you had a certain type of item or activity it will go here in your activities statement. It will go into the classification. If you were a private foundation that operates off of investments, and the grant making you do is based off of investment return, today investment return is the top line in those foundation financial statements. Under the model it would have dropped down to nonoperating revenue. The messaging was it’s important for a particular type of not-for-profit to be able to report within the boundaries of GAAP, but to be able to present information in a way that best tells their story.”
Definite Changes for Phase 1
Even though the changes in nonprofit accounting standards in phase 1 are not as extensive as originally envisioned, there will be a number of significant revisions, including the way not-for-profits report net assets.
“Right now they report their net assets in three classes: unrestricted, temporarily restricted and permanently restricted,” Garner explained. “They’re going to collapse those down into two categories. There will be basically a category that is with donor restrictions and a category without donor restrictions, which is the old unrestricted category. Then they’re doing some refinement on certain areas related to releases of restriction, again just very targeted changes to the basic rules around the reporting of those net asset classes.”
There will be also some tweaks in the reporting of investment returns, although those changes won’t be as widespread as originally proposed. “What they have decided to do is they have largely left the existing rules for reporting investing returns in place, but they’ve clarified certain aspects of it,” said Garner. “For example, you net the expenses associated with the investment income against the income itself, and they’ve clarified the types of expenses that are appropriate to net. They’ve also clarified a couple of other presentation aspects with respect to the investment return. That’s a really important area in particular for not-for-profits that have large endowments or that are otherwise very dependent on an investment return.”
Another area seeing changes is referred to as liquidity and availability. “A lot of this focuses on the balance sheet, helping to better tell the story about what financial resources the not-for-profit has that are spendable for obligations that are coming up,” said Garner. “They’re doing that through some disclosure as well as providing illustrations and ideas for ways that not-for-profits can make that clearer on the balance sheet itself. That has been a really important area of focus for them.”
Also expect to see changes in the rules for how nonprofits report expenses by function. “Right now there is a requirement for a not-for-profit to provide information in its financials about the expenses that are associated with particular programs,” said Garner. “For example, if an entity is doing research, education and other things, then there are requirements for them to report how much in expenses is assorted with research, and how much with the other areas. They’ve been building on that and are going to really expand the disclosures that are required in that area. There’s been a lot of discussion about that and whether that’s a good idea just for some nonprofits or all nonprofits. They have decided, at least in this phase, that it will be applicable to all nonprofits, but when they get into phase 2 of the project, then they might take a look at some other areas. For example, should not-for-profit health care—which is an industry that is driven by revenues as opposed to contributions—be doing something like segment reporting where they are showing revenues that they generate and the expenses that go with that, in a way that is similar to the way that business entities do. But that would be an issue to consider in phase 2. For right now, they’re staying with the idea of functional reporting and then expanding those disclosures a bit.”
In addition, FASB is making some modest improvements to the operating indicator that many nonprofits report in their financials. “The whole aspect of requiring nonprofits to report an operating measure and to prescribe how it would be reported was one of the most controversial areas of the proposal,” Garner noted. “Again they said, all right, we’ll take that back up in phase 2. For right now, if a nonprofit does report an operating/nonoperating distinction in its activities, if those activities include transfers of designated funds by the board—for example, if a board gets a large unrestricted contribution and decides to basically designate it for a long-term purpose—they might show that on the face of the statement of activities and the board requirement would just be that if you have those types of transactions and you report an operating measure that would be affected by that, then you should be very transparent to the reader of the financial statements so that they can see basically how those board decisions have affected the statement of activities. That would only be for a nonprofit that (a) voluntarily reports an operating measure today and then (b) on top of that also includes the board-designated transfers in the activity that they report on the statement. That’s not common to all nonprofits, but there are nonprofits that consider it an important area of reporting for them.”
Phase 1 will thus take the existing model for nonprofit reporting and make targeted changes to it. Phase 2 promises to have more pervasive and fundamental changes.
FASB has consulted with the Not-for-Profit Advisory Committee, or NAC, throughout the process, soliciting the NAC’s input on various proposals. “FASB has really seemed to gain a better understanding about its not-for-profit constituency,” said Garner. “They have really invested a lot of time and resources to gain an understanding about what are the needs of this constituency. They know a lot about their other two constituencies, the public business entities and the private companies, but they have really invested a lot of time and effort now into understanding at a pretty granular level about nonprofits, about who the users of the financials are, about what the areas of concerns are, and that has really been reflected in the redeliberations that have taken place. Not-for-profit reporting at times in the past has almost seemed to be an arcane area of financial reporting. A few people understand it, but it’s over there to the side. Now it’s really been much more mainstreamed into what FASB is doing and talking about.”