New standards for nonprofits affect a number of major areas
INSIGHT ARTICLE |
Over the past few years, the Financial Accounting Standards Board has been busy developing a number of new accounting standards. The time has finally come for many of those standards to be implemented. Some organizations are implementing all the applicable standards at once, while others are implementing them in turn, based on effective date.
The new nonprofit financial statement format, ASU 2016-14, is currently being adopted by nonprofit organizations because the standard is generally effective for calendar 2018 and fiscal 2019 year-ends. There are a number of major areas affected by the new standard.
For organizations that have recently adopted the new standard, the new rules for reporting expenses by nature and function, as well as the new disclosures for liquidity, appear to be the most challenging. Even the condensing of net assets from three categories to two can be a challenge for some organizations
Many preparers of financial statements for nonprofits are confused on the concept of net assets, especially how endowments are to be reported when they fall under an enacted version of the Uniform Prudent Management of Institutional Funds Act. There should no longer be a bright line between the corpus and the related accumulated earnings, and the disclosures should reflect that.
The new standard requires all nonprofits to present expenses by natural and functional categories instead of just by functional category under the old standard. The old standard only required voluntary health and welfare organizations to present expenses by natural and functional (through a statement of functional expenses) categories. In addition, there are some optional changes to the cash flow statement, and investment returns must now be presented net of investment expenses.
Functional expense reporting
All nonprofits are required to disclose expenses by function and by natural classification in the notes or on the face of statements. There is also an enhanced requirement to disclose more details regarding the methods used to allocate those costs among programs and the support functions.
The new standard makes several changes to how certain expenses should be allocated:
- Employees who directly supervise program staff should have their time allocated to program services
- Information technology costs should be allocated across the functional categories, not just as a management and general expense
- Employees who work in multiple functions should allocate their time across those functions. For example, a chief executive officer who spends time fundraising and also in program service should have the time allocated to the respective function, and not just to management and general expense.
Organizations can present these allocations either within a statement of functional expenses (part of the core financial statements) or as a note disclosure. Under generally accepted accounting principles, major program services should be broken out or disaggregated, as appropriate, with the levels of supporting services (i.e., management and general, and fundraising) reflected as well.
Note that management and general expenses is a separate category from overhead. Overhead (occupancy costs, depreciation, etc.) should be allocated to the functions that benefit from the overhead costs using a rationale method such as square footage, head count or salaries, to name a few. Management and general expenses are reported at gross in order to meet the requirements.
Liquidity and availability of resources
The new standard will require new disclosures:
- The qualitative discolsure will describe how the organization manages its liquidity needs. The disclosure should report the financial assets available to meet general expenditures for the next 12 months. The term “general expenditures” is not defined so there may be some differences in application between organizations.
- The quantitative disclosure will use the format that best fits the organization's structure.
There are some challenges regarding the new liquidity disclosure. First, there is no set definition for “financial assets available for expenditures over the next 12 months” so variance in application between organization is likely to occur. Second, designation of net assets by the board and management may or may not affect the total amount to be disclosed for available liquidity. Formal board designations that create long-term funds will most likely be a reduction to available liquidity but similar designations by management may not affect liquidity unless the board has granted authority to management to create such long-term designations.
There are two new accounting standards that affect revenue recognition:
- ASU 2014-09 (also known as ASC 606) will affect how most exchange transactions are recognized.
- ASU 2018-08 will help distinguish exchange transactions from nonexchange transactions, and describe how nonexchange (i.e., grants and contributions) are to be recorded.
ASU 2018-08 introduces new revenue recognition models and decision trees that push nonprofit organizations to the correct method, depending on the type of revenue stream.
- Exchange transactions (unless exceptions are met) will be pushed to ASC 606 guidance. One of the main determining factors for a transaction to be an exchange transaction is if the resource provider directly benefits from the transaction (i.e., a quid pro quo).
- Nonexchange transactions will be pushed to the ASU 2018-08 contribution guidance. Consistent with the contribution rules, a nonexchange transaction must be determined to be unconditional in order to be recorded; conditional awards cannot be recorded until those conditions are met.
The standards also introduce new criteria for determining if a nonexchange transaction is conditional. A nonexchange transaction will be deemed conditional if it contains both a right of refund and a release of obligation as well as a barrier. Probability assessments on whether a right of refund or a barrier would be remote, possible or probable are no longer allowed/appropriate. If agreements contain both criteria, they will be deemed conditional.
The general effective date for both new revenue standards is for reporting years beginning after Dec. 15, 2018. However, organizations that have issued conduit public debt (i.e., bonds that are traded in the public) will adopt ASC 606 one year earlier than the general effective date and may have an earlier adoption of ASU 2018-08 depending on their particular year-end.
Organizations will be expected to produce memos and other analysis in their year of adoption outlining their revenue recognition methods for each revenue stream to comply with ASC 606, and should expect additional audit testing over revenue methods in the year of adoption.
The new standard for leases is going to have to be adopted over the next year or so by nonprofit organizations. The main provision of the new lease standard is that most leases will now be accounted for on the balance sheet as a right-of-use asset and a lease obligation. Leases with terms less than 12 months and immaterial leases will not be affected. The general effective date for the lease standards is for fiscal years beginning after Dec. 15, 2019. (Breaking news: a one-year deferral for certain entities, including nonprofit organizations, is being pursued by the FASB – stay tuned for further communications.) Organizations with pass-through public debt will adopt one year earlier.
For more details on implementation of the new FASB standards, listen to the webcast.