As not-for-profit organizations prepare to adopt the new financial reporting requirements of Financial Accounting Standards Board (FASB) Accounting Standards Update 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities (ASU 2016-14), Board members should take an active role in overseeing the implementation of this standard since one of the key fiduciary responsibilities of those charged with governance is to oversee the financial reporting process. ASU 2016-14 is designed to provide more transparency into the financial reporting process of an organization and does so by addressing updates to several areas, including net asset classifications, investment reporting, expenses and the presentation of statement of cash flows information. However, two key areas of change are specifically designed to improve the Board's understanding of and effective governance over the financial assets of an organization, including the new disclosure requirements illuminating restrictions on the availability of liquid assets and the accounting and disclosure of endowment funds.
It's important for the Board to understand how the changes required by ASU 2016-14 will affect the financial statements prior to reviewing an audited version of the financial statements. Understanding the changes and how the new measures may affect other areas of operations, such as fundraising and strategic planning over new and existing program initiatives, is critical for effective governance and oversight. Not-for-profits will want to begin those conversations soon; ASU 2016-14 takes effect for reporting periods beginning after Dec. 31, 2017.
The Liquidity Discussion
One of the reasons the FASB decided to update the not-for-profit financial reporting model came from conversations with Board members who served for not-for-profit organizations, which ultimately failed. These conversations revealed that Board members misjudged the severity of an organization's liquidity position and cash flow problems because they did not understand the nature of limitations on financial resources. Some organizations had seemingly healthy amounts of liquid assets, but those funds were not available to support operations.
To clarify the issue around whether liquid assets are available to support the cash flow needs of operations, ASU 2016-14 will require enhanced disclosures, both qualitative and quantitative, regarding an organization's liquidity and availability of resources. Qualitative disclosures will include a description of how the organization manages its liquid assets to meet the cash flow needs for general expenditures within one year of the balance sheet date. Quantitative disclosures will include a reconciliation of total financial assets reduced by limitations, both internal and external, to amounts available to meet current year needs.
Not-for-profit organizations should prepare sample disclosures of their liquidity and availability of resources now so they can educate their Board members on what the new disclosures will look like and what it might say about the organization. A deeper dive into unrestricted net assets could reveal that the not-for-profit organization is not as financially healthy as it appeared at first glance and that it does not have the liquid resources it needs to meet a year's worth of general expenditures.
The sooner the Board can understand if liquidity disclosures are going to be a problem, the sooner the Board can consider any needed actions, such as changes to existing Board designations which may improve the organization's liquidity position. Donors, grantors and creditors will evaluate whether the organization has sufficient resources to meet its financial obligations in the future. Board members should assess how best to utilize the organization's liquidity disclosures to respond to these concerns and perhaps more importantly, incorporate the need for improved liquidity in its fundraising appeals.
Endowment Funds and Net Asset Classes
Another significant change required by ASU 2016-14 involves net asset classification. Under current U.S. Generally Accepted Accounting Principles (GAAP), net assets are classified into three categories: permanently restricted, temporarily restricted, and unrestricted net assets. Under the new ASU, net asset reporting will be streamlined into two categories: net assets without restrictions and net assets with restrictions.
In a change from current practice, the classification of a shortfall in an endowment fund (an underwater endowment) will be classified as a component of net assets with donor restrictions. Under current GAAP, the shortfall is classified as a reduction of unrestricted net assets. Organizations will continue to make disclosures about their underwater endowments, with enhanced disclosures about the not-for-profit's spending policy as it relates to underwater endowments, the aggregate fair value of underwater endowment funds, the aggregate amount that the donor requires to be maintained, and the aggregate amount by which the funds are underwater. Another change from current practice will be the elimination of the option to imply time restrictions on contributions restricted for the acquisition of property and equipment absent explicit donor restrictions on the use of the acquired assets. Under the new ASU, the organization must use the placed in service approach to classify net assets restricted for the capital acquisitions. In the year of adoption, the organization will disclose the nature of these reclassifications resulting from adoption of the ASU.
The key to understanding the limitations placed on net assets will be through enhanced footnote disclosures with an emphasis on how and when restricted resources can be used. Footnotes will also disclose all Board designations and similar self-imposed limits on net assets without donor restrictions. As such, the Board should review any existing designations as part of the implementation process.
Meet With Your Board Before the Standard Takes Effect
Management should be sure to meet with their Board frequently as they work through implementation issues and other changes required by ASU 2016-14. Financial statements provide the Board with vital information about the organization's operations and its ability to fulfill its mission. The Board should have a clear understanding of what's changing in the financial statements as a result of ASU 2016-14 so its members can continue to fulfill their fiduciary responsibilities and effectively govern during the implementation of this key accounting standard.
For More Information
If you have any comments, questions, or concerns about the not-for-profit financial statement changes, please contact us.
Published on May 18, 2018