Financial Reporting for Not-for-Profit Organizations
By Gregory Marazita, Partner, Assurance Services
The long-awaited effective date for the new guidance on financial reporting for not-for-profit organizations under ASU 2016-14, Not-for-Profit Entities (Topic 958) Presentation of Financial Statements of Not-for-Profit Entities, is upon us. The new reporting standards are effective for annual financial statements for fiscal years beginning after December 15, 2017. Effectively, calendar year 2018 entities will be required to report their financial statements in accordance with the new requirements.
Adoption of ASU 2016-14 will require modifications to the existing financial statement framework and will require new disclosures related to liquidity, availability of assets, and board-designated net assets. Further, it may require organizations to revise certain policies and procedures, update financial reporting practices, and make net asset accounting adjustments.
An overview of the main provisions under the new reporting requirements includes the following:
- Presentation on the face of the statement of financial position (balance sheet) two classes of net assets (net assets with donor restrictions and net assets without donor restrictions), rather than the current three classes.
- Presentation on the face of the statement of activities two subtotals of the operating activities associated with changes in net assets without donor restrictions:
- Operating revenues, support, expenses, gains, and losses that are without donor-imposed restrictions and before internal transfers.
- The effects of internal transfers resulting from governing board designations, appropriations, and similar actions that place (or remove) self-imposed limits on the use of resources that make them unavailable (or available) for current-period operating activities.
- The direct method of reporting cash flows for operating activities will be encouraged, but not required. Also, certain cash flows will be classified differently under the new ASU.
- Disclosure of quantitative and qualitative information useful in assessing liquidity, including a description of the time horizon used to manage liquidity and the financial assets available to meet near-term demands for cash.
- Enhanced functional expense disclosures, including the methods to allocate costs among program and support functions.
- Reporting investment income net of external and direct internal investment expenses.
In adopting the changes to the net asset presentation, combining the temporarily restricted and permanently restricted net assets will likely be accompanied by additional information in the note disclosures about the nature and amounts of the different types of donor-imposed restrictions. In addition, information regarding board designations of net assets will need to be addressed.
In considering changes to cash flows presentation, an entity should consider what will be most meaningful for readers of the financial statements. Although we anticipate that most entities will continue to report cash flows using the indirect method, the direct method of reporting cash flows, while considered more difficult to prepare, may be easier for readers to understand.
For the liquidity disclosures, qualitative information will be required in the notes to the financial statements, useful in assessing an entity’s liquidity and that communicates how a not-for-profit organization manages its liquid resources available to meet cash needs for general expenditures within one year of the date of the statement of financial position. In addition, information regarding the availability of a not-for-profit organization’s financial assets available to meet cash needs will be required. Availability of a financial asset may be affected by its nature, external limits imposed by donors, or internal limits imposed by the governing board. These enhanced disclosures related to liquidity should assist creditors, donors, and other users in assessing the near-term liquidity of cash.
Functional expense reporting under the provisions of ASU 2016-14 can be accomplished either on the face of the financial statements or in the notes, by function and natural classification, accompanied by qualitative disclosure information regarding the methods used to allocate costs among program and support functions.
For not-for-profit organizations with significant investment income, reporting will be net of external and direct internal expenses. For direct internal expenses, consideration will need to be given as to what internal expenses should be included (netted) with investment income for reporting purposes. These internal expenses could include an allocation of staff involved in managing or recording investment activity.
Other Implementation Considerations in Year of Adoption
- Presentation of comparative vs. single year financial statements. It is likely that most not-for-profit organizations will opt to present comparative financial statements in the year of adoption. Consideration should be given as to the expectations of the board and other users of the financial statements in making this determination.
- For comparative financial statements, certain practical expedients are available in the year of adoption relating to functional expense presentation and disclosures about liquidity and availability of resources.
- Will any restatements be required as a result of implementation?