New standards for nonprofits present their own challenges
There are a number of significant standards that nonprofits will need to implement over the next two to three years.
The new standard for nonprofit financial statements
The new standard, ASU 2016-14, was issued in 2016 and is effective for fiscal years that began after Dec. 15, 2017. Some organizations have adopted the standard early, although many are waiting for the last moment so that they have the opportunity to see some examples from those early adopters.
Key provisions of the new standard
- Net asset classification: Current rules dictate classifying net assets between unrestricted, temporarily restricted and permanently restricted. Going forward, that classification will be between net assets with and without donor restrictions. This is intended to make the classification easier to understand and more closely aligned with the legal restrictions imposed by donors.
There is a requirement for more detailed disclosure about board designations and more detailed disclosure on donor restrictions. Many organizations already provide that disclosure, but for some this will be a significant change.
Underwater endowments under the current standards required nonprofits to reduce unrestricted net assets for any amount less than the originally permanently restricted portion of an endowment.
- Statement of financial position: Organizations now have new choices regarding how to present their net asset section. They can present it simply, just showing with and without donor restrictions, or present it more fully, with the type of designation and donor restrictions detailed on the face of the statement. If it's not on the face of the statement, then that detail does have to be presented in a note.
- Donations of long-lived assets: Under the current rules, organizations were able to imply a time restriction if they receive a gift of cash for the acquisition or construction of a long-live asset or a long-asset itself, or they chose to release the restrictions at the time that the building was placed in service. Going forward, the choice for an implied time restriction will no longer be available to nonprofits and they will be required to use the placed-in-service approach, with a time restriction only used if it is explicit by the donor. This is consistent with the standard used currently by health care nonprofits but not by others.
- Expense reporting: Under the old standard, voluntary health and welfare organizations—those whose revenue is coming primarily from contributions—were required to disclose expenses by both function and natural classification. Going forward, this information will be required to be presented for all organizations. This information, however, can be provided in the notes to the financial statements and should be readily available to all organizations, as it is similar to information presented in the form 990.
There is also a new requirement to give information on how costs are being allocated by an organization. There is not a single, correct way to do cost allocation, and each organization may describe the way that it allocates costs differently. Under a new, clarifying concept in the standard, determining which cost should appear in which function depends on whether the cost is related to direct conduct or to direct supervision of a function, or to management in general.
- Liquidity and availability of resources: This may be the biggest change and new information that will need to be disclosed in the financial statement. There is a requirement to provide information qualitatively, that is, in narrative form, in the notes of the financial statements about how the organization manages its liquid available resources and the risks related to them. On a quantitative basis, there's a requirement to provide information to show the amount of financial assets that are available to meet cash needs for general expenditures within one year.
The goal is to tell the story of the organization. Many organizations may not have thought of this as policy, and they may want to discuss it with their audit committee and board, and consider whether or not they need a formal policy in this area. Some organizations may find that they don't end up with a positive amount of financial assets available to meet cash needs over the next year. Those organizations will want to look carefully at how they qualitatively describe management of their cash flow needs. This is an opportunity for cash-strapped organizations to explain how they manage. It can also be a good fundraising tool, when nonprofits look to build some reserves, to limit risk in this area.
- Investment return: Comparing investment performance between organizations that invest in different mixes of assets can be quite difficult. The goal of the changes in the new standard is to simplify disclosure of net investment return, net of external and direct internal investment expenses. There's no requirement to disclose investment expenses, and no requirement to disclose the investment return component. Internal expenses to be deducted must involve direct conduct or direct supervision of strategic and tactical activities involved in generating investment return. So accounting for endowment pools, or investment accounting, will not count, whereas the activities of investment officers likely would qualify.
- Operating measure: If an organization uses an operating measure to show governing board designations, appropriations and similar actions, it must show these designations appropriately disaggregated so that a reader can understand what is and is not included within the organization’s operating measure. That information needs to be either on the face of the financial statements or in the notes.
Steps to take now
- Prepare a pro forma of financial statements meeting the new requirements
- Draft new/expanded disclosure requirements
- Identify what areas are going to be challenging to perform, in particular, for liquidity and availability of resources
- Determine the need for new board policies in areas such as:
Maintenance of liquid resources
Evaluating availability of funds
Delegation of authority for designation of net assets
Revenue recognition, grants and contracts
The revenue recognition standard (ASU 2014-09, revenue from contracts with customers, topic 606) came about due to a desire to be consistent with international standards, and to arrive at a model for revenue recognition that would be consistent across most industries.
For nonprofit organizations, it applies to most contracts with customers (except for contributions). Most revenue sources that were previously or are now accounted for as exchange transactions will be affected. It affects most revenue sources that are exchange transactions, in particular those with impact beyond reporting period, such as tuition and fees, membership dues, licenses and royalties. It does have a significant impact on the health care industry, including on health care revenues and continuing care retirement communities. But for most nonprofits, there may not be a major impact.
The revenue recognition standard has a five-step revenue model:
- Identify the contract with a customer
- Identify the performance obligations in the contract
- Determine the transaction price
- Allocate the transaction price across the various performance obligations
- Recognize revenue as each performance obligation is satisfied
For nonprofits, the AICPA established revenue recognition task forces to consider the most important areas to investigate, including the following:
- Tuition and housing revenue: For most schools in North America, their fiscal year ends June 30. On that date of any particular year, an institution may have received deposits. It may have already invoiced for tuition and housing revenue. But it usually will not yet have actually provided any of the services that are being paid for and, as a result, none of the revenue would be recorded. So any amount received would be on the balance sheet as what will be called a contract liability, which today we would call deferred revenue. Under current rules, if amounts are due, then it is possible to record the receivable, but many institutions will have netted the receivable with the deferred revenue because the earning process has not started. Under the new rules, a receivable would not be able to be recorded on the balance sheet until any free refund period has passed. So generally you will not see significant receivables at June 30 for educational institutions.
- Government grants and contributions: When is a grant or contract a contribution, and when is it a contract with a customer? This issue is confused by the fact that government and foundation grants are often described using different terminology by different organizations—sometimes they are referred to as contributions, sometimes as grants, sometimes as contracts—and there is confusion regarding to how to account for them. Two issues were addressed by FASB: reciprocal and nonreciprocal agreements, and conditional and unconditional agreements. Which grants and contracts should be subject to new revenue recognition rules? When is a grant or contract a contribution, and when is it a contract with a customer? (This has been clarified with a new ASU issued by FASB in June, 2018 – ASU 2018-08.)
Impact of the changes in ASU 2018-08
More grants will likely be considered conditional, and this will present challenges for granting entities that need to know when conditions are met. For most nonprofit grants received, the effective date is for periods beginning after Dec. 15, 2018; however, it is six months earlier for nonprofit organizations that have publicly held debt, either directly or as conduit bond obligors. The effective date for grants provided by an organization is for periods beginning after Dec. 15, 2019, except those entities with public debt for which the date is one year earlier.
For more details on the new standards for nonprofits—as well as information on accounting for leases and other matters—listen to the webcast.