Hopefully by now, everyone is aware of Accounting Standards Update (ASU) 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities. The ASU is effective for annual financial statements issued for fiscal years beginning after December 31, 2017, which means that organizations with December 31, 2018 calendar year ends have completed (or are in the process) of implementing the ASU. During the course of assisting our clients with implementation of this ASU, a number of decisions and considerations were made that were unique to each client. Organizations that have not yet implemented the ASU should take advantage of the additional time afforded them by discussing these upcoming decisions and coming to conclusions before the annual audit starts.
Net Asset Classification –
Although the change in net asset classification is relatively simple on the surface, there are several considerations that should be made by each organization.
- Many organizations will likely show the totals of each net asset class on the face of the financial statements, and then disaggregate the categories in the footnotes. However, some organizations may want to disclose the amount of perpetual and time/purpose restrictions on the face of the financial statements. Many financial statement users are used to seeing the presentation of net asset categories on the face of the financial statements, and your organization may wish to continue to present that information to prevent confusion.
- For those organizations that have endowments, the endowment footnote has historically shown the categories of endowment by unrestricted, temporarily restricted, and permanently restricted. Although the temporarily and permanently restricted categories are now combined into one category called with donor restrictions, organizations may want to keep three categories in the endowment footnote (unrestricted, net assets with restrictions for time/purpose, and net assets with perpetual restrictions). This additional information may provide value to the readers of an organization’s financial statements.
Reporting of Expenses –
Many organizations have historically shown expenses broken out by both function and nature within the financial statements. However, for those organizations that have only shown one or the other, some significant decisions need to be made on how this information will be presented going forward.
- Organizations need to decide where to present the information. One option is to present the information on the statement of activities and change in net assets. For organizations that have a simple presentation, this may be the best choice. Other organizations may wish to add an additional statement to the face of the financial statements, which shows expenses disaggregated into functional and natural categories. The final option is to present the information in the footnotes. Each option is acceptable, and organizations should consider which will fit best into their financial statement presentation and provide the most useful information to the readers of the financial statements. Note that some organizations have historically presented functional information as an exhibit to the financial statements – that presentation is no longer acceptable to meet the requirements of the new ASU.
- While not a requirement under the new ASU, some organizations are adding additional information within the footnotes to define the different functional categories of expenses.
- Allocation methodologies must also be disclosed in the footnotes to the financial statements for expenses that are not directly charged to program or supporting services.
Liquidity Disclosures –
This is perhaps the biggest change to the financial statements for many organizations, as the required disclosures contain information that is completely new to the financial statements. Organizations will need to ensure that the liquidity disclosures are clear and contain all the relevant information that a reader will need.
- There are a number of ways to present the quantitative information. One option is to simply disclose the financial assets available at the end of the year. This option removes financial assets that are unavailable “behind the scenes”, rather than showing them as a reduction from total financial assets within the footnote. This may be the best choice for relatively simple financial statements. For more complex financial statements, organizations may want to start with total financial assets and then subtract out unavailable financial assets. If desired, the total financial assets can also be broken out in detail. Whatever option your organization chooses, be cognizant of how this disclosure relates to the rest of your financial statements. It may be desirable to show a breakout of total financial assets that is able to be agreed back to the balance sheet. Additionally, you may wish to ensure that the non-financial assets that are removed are broken into categories that agree to your net assets with donor restrictions and endowment footnotes. Taking this approach will allow a user of the financial statements to readily cross reference the liquidity disclosures to the rest of the financial statements, and may prevent confusion and misunderstandings.
- Keep in mind that many users of the financial statements may not be educated on the new disclosures, and organizations should not assume that these users will have the accounting background to understand the quantitative disclosures without robust qualitative disclosures to explain the numbers presented. Organizations should ensure that the qualitative disclosures are robust and “tell the story”, particularly if the quantitative disclosures do not present the financial health of your organization in a positive light.
Investment Expenses –
One provision of the new ASU requires that direct internal investment expenses be netted against investment return, rather than shown as an operating expense.
- Some organizations have taken this to mean that an allocation of expense should be made for time spent by the finance department on accounting related activities for the investment portfolio. This is incorrect – only direct internal investment expenses that are associated with generating investment return should be netted against investment return. For example, organizations that have a Chief Investment Officer that actively manages the portfolio would net the related salary against investment return. Expense related to time spent on accounting, unitization of an endowment, reporting to donors, etc. should not be netted against investment return.
The above are some of the major considerations that we have encountered thus far in our implementation of the ASU. However, each organization is different and you may find that you come across additional challenges while implementing the new ASU. We recommend that you work with your accounting advisors now to work through these challenges and make decisions on how your financial statements will be presented. You may also want to have upfront discussions with your Audit Committee so that there are no surprises at your year-end meeting.