Back to the future: FASB projects focused on not-for-profits
In the first decade of my career, the first not-for-profit (NFP) standards, known as FAS 116 and 117, were issued. At the time, they were welcomed as a significant step in responding to the specialized reporting needs of NFP organizations. Now, in the third decade of my career, the FASB’s Not-for-Profit Advisory Committee (NAC) is studying and working on recommendations to improve the financial reporting of NFP organizations. It is a project whose time has come. While the Form 990 and websites have become the primary tools NFPs use to tell their story, FASB has recognized that NFP financial statements need to reflect the needs of financial statement users, which include better understanding of an organization’s mission fulfillment, sustainability, stewardship and liquidity. This is an exciting time to be serving NFPs, as we help them envision and prepare for a "brave new world" in financial accountability.
The NAC was established in October 2009, as a FASB resource group whose work would be focused on four distinct areas:
- Net asset classifications and how to reframe them to better reflect liquidity, operations and cash flows
- Improving the presentation and linkage between the statement of activities and the statement of cash flows to better communicate financial performance
- Creating a framework, similar to a public company’s "management discussion and analysis" (MD&A), as a tool to improving communication around mission, financial performance and sustainability
- Improving existing financial disclosure requirements, with a goal of streamlining and increasing understandability
While much of the NAC’s work is focused on existing standards, it is expected they may present entirely new ideas and concepts.
While NFP financial statements have long presented three classes of net assets (unrestricted, temporarily restricted and permanently restricted), outside of auditors, credit analysts and experienced industry professionals, there continues to be much confusion around these categories. Since these categories are used by analysts, lenders and others to assess an organization’s liquidity and related risks, reframing them to expand understanding beyond a limited circle of financial statement users is imperative. In addition, improving the linkage between net asset classes and current and future cash flows provides insights into an organization’s stewardship and sustainability.
One common challenge for many NFP boards is bridging the understanding gap from their typically for-profit (FP) financial reporting backgrounds to an NFP reporting format. Due to the required statement of activities format, especially for organizations with significant activity in each net asset class, it is difficult to discern financial performance. With all of the transfers between categories and presentation differences for items that would be above or below the operating indicator in an FP entity, not to mention those items that would be in other comprehensive income in an FP, assessing financial outcome can be a challenge. Couple the operating statement presentation with a statement of cash flows, whose categories and requirements, applied to an NFP, result in a confusing presentation that makes understanding current financial performance and assessing future cash flows an elusive and frustrating endeavor. While the NAC is currently focusing on a format that makes distinctions between “operating" and “nonoperating" activities, based on the decisions at the May 29, 2013 meeting, more work may need to done.
At that meeting, the FASB tentatively decided on focusing on an intermediate operating measure with two "dimensions." The first dimension would be mission-focused (activity resulting from or expended on achievement of the NFP’s mission). The second is an “availability dimension" that would focus on whether resources are currently available, based on external limitations or limitations imposed by the governing board. It is too early for there to be examples of this format developed for review. The presentation goals are focused on financial statement user needs; it will be interesting to see how these practical, yet at the same time lofty, goals are achieved.
Current financial statement format and the related existing disclosure requirements provide an incomplete picture of mission and mission fulfillment. Donors, grantors and other supporters of NFP organizations are compelled to provide continuing support when there is a clear connection between their support and the attainment of desired goals and impact. The addition of a communication, similar to the MD&A provided in a public company’s financial report, allows an organization to better tell their story. This MD&A would link mission with past financial performance, and how that impacts, or leads to, continued mission fulfillment. Others discussion areas would include: economic, industry or other risks factors, overall financial health and (no surprise here) executive compensation. For more complex NFP organizations, communications around segments are also being considered. Combining this communication with improvements in financial reporting and net asset class presentation results in the ability to powerfully communicate how past and current financial performance leads to sustainable operations and impact.
Another area of continuing debate is the definition of a public entity. With the release of the current exposure draft on Aug. 7, 2013, you may think conclusions have been reached in this area. Not true. While the exposure draft continues the focus on conduit debt obligors as a delineator for NFP, the NAC has concluded that most organizations have a certain extent of public accountability due to multiple tax-exempt privileges (federal and state, property taxes, tax-exempt debt, etc.) and the tax deductibility of contributions for donors. The NAC believes that the current definition creates an "ineffective bright line"; as a result, this conversation will continue for NFP organizations.
Some existing standards that apply to NFP organizations will also be considered be the NAC. Those include requirements that may be reduced or eliminated and those that may be expanded. Those that may be reduced include:
- Gifts in kind and fair value considerations, specifically the concept of an exit price. For certain items, and in international organizations, determining an exit price is difficult, and results in differing values for similar products, impacting comparability between NFP organizations.
- Continued application issues with transfers of assets between organizations, otherwise known as agent versus principal (formerly known as FAS 136). While many NFP organizations are handling these transactions appropriately, there continues to be instances where multiple NFPs are recording contribution revenue for a single gift that passes through multiple NFPs.
- Disclosures that are complex without providing commensurate value, including:
- Pension and OPEB disclosure requirements
- Fair value measurement disclosures around Level 1, 2 and 3 inputs
- Fair value disclosures for debt
- Uncertain tax positions
Disclosures that may be expanded include: related party transactions, consolidation practices, international activities and information on governance and risks.
The current technical plan is to issue a discussion paper in the first half of 2014, as a means of assessing next steps and educating stakeholders about the project. The discussion paper will request input and feedback from NFP stakeholders. It is early in the process and the effective date will most likely not be earlier than 2017; outcomes are sufficiently unknown for there to be much discussion around the important (and costly) topics of potential process, systems and applications impact.
The last time significant changes were made to NFP reporting standards was more than 20 years ago. It is exciting that the profession is responding to the need for more and better information. It’s a “brave new world!" Follow and embrace the changes; use them to help your constituents better understand, and therefore, more willingly support, your organization.
For further information, please contact Susan Davis, Partner, RSM US LLP at 515.281.9275.