Joseph B. Ryan, Assurance Principal with TD&T, provides some insight on how new accounting standards for nonprofit organizations can improve understanding and provide better information for stakeholders.
I’m sure Benjamin Franklin was not considering accounting standards when he made this quote, but this article will address its applicability. The Financial Accounting Standards Board (FASB) in August of 2016 issued a new accounting standard update for nonprofit organizations. The update addresses improvements to the financial statements of the nonprofit organizations related to net asset classification, liquidity and cash flows. Although the standard update becomes effective for years beginning after December 15, 2017, it allows early implementation. This article will address reasons why a nonprofit organization should consider implementing these changes earlier.
The New Standard Reduces Complexity
The current reporting framework complicates the process of properly classifying net assets between temporary restrictions and those with permanent restrictions. The update reduces the number of net asset classifications from three (unrestricted, temporarily restricted and permanently restricted) to two (without donor restrictions and with donor restrictions). With this simplification, you can save time when determining the proper net asset classification, especially on the statement of activities, increase understandability, and provide the users of the financial statements with useful information for identifying and assessing key trends. The update will also add enhanced disclosures in the notes to the financial statements regarding the nature, amounts and effects of the various types of donor-imposed restrictions.
Along with the reduction of net asset classification, the update also changed the classification of “underwater endowments,” those for which the fair value of the fund is less than the original gift amount. The FASB Staff Position (FSP) FAS 117-1 was issued in 2008 in order to determine the effect that the Uniform Prudent Management of Institutional Funds Act of 2006 would have on reporting donor-restricted endowment funds. The FSP required classifying underwater endowments as unrestricted net assets. This created a number of restatements in previously issued financial statements by reducing the amount of unrestricted net assets. The change confused donors, grantors and other users of the financial statements. The update will move the underwater portion of the endowment now to be reported as net assets with donor restrictions, thereby increasing the amount of net assets without donor restrictions by the amount of the underwater endowments. This could have a significant effect on nonprofit organizations that are at least partially evaluated based on the amount of net assets that are unrestricted or without donor restrictions.
Changes Should Make Not-for-Profit Statements Easier to Understand
Users of nonprofit financial statements have experienced difficulty in assessing an organization’s liquidity, in large part due to restrictions placed on net assets. Current generally accepted accounting principles (GAAP) do not require the use of a classified statement of financial position (SFP). Classified SFPs include a classification for current assets, cash and other assets as of the SFP date, expected to be converted to cash within a year, and current liabilities, obligation owed as of the SFP date that are to be paid from current assets. Users of the financial statements, such as financial institutions and other creditors, need to know whether an organization has adequate resources available to meet their debt obligations. Other users of the financial statements want to know what available resources an organization has to meet other current obligations. The update addresses the issue of reporting liquidity by requiring enhanced disclosures of qualitative and quantitative information either on the statement of financial position or in the notes to the financial statements.
Qualitative information will include how the nonprofit manages liquid resources available to meet cash needs for general expenditures within one year of the statement of financial position date. This could include defining the term “liquid assets,” and the policy for determining an adequate amount of financial resources to meet general expenditures, liabilities and other obligations. Organizations can include quantitative information on the face of the statement of financial position or in the notes. This will communicate the availability of the nonprofit’s financial assets at the date of the statement of financial position to meet cash needs for general expenditures within one year of the statement of financial position date. By including this information, it can increase the usefulness to stakeholders who are interested in the liquidity of the nonprofit. It may also reduce follow-up inquiries from the stakeholders regarding the same information they would normally request in addition to the financial statements.
Finally, the new standard will no longer require nonprofits that use the direct method in preparing the statement of cash flow to include the indirect reconciliation for operating cash flows. This will save time in preparing the cash flow statement, while allowing flexibility to determine the reporting method that best serves the information needs of their particular users.