Nonprofits’ Financial Statements Will Look Different Under New Accounting Standards

Over the next couple of years, nonprofits must face an array of accounting standard modifications. Not only must they take more universal requirements into account, like the new revenue recognition requirements and the new leasing standards, they must also consider nonprofit-specific pronouncements. One of the most impactful regulatory pronouncements for nonprofits is Accounting Standards Update (ASU) 2016-14, Presentation of Financial Statements of Not-for-Profit Entities. ASU 2016-14 was released in 2016 but went into effect for nonprofits this year. The changes should be fully adopted on the annual reports for fiscal years beginning after December 15, 2017, and for interim periods within fiscal years that begin after December 15, 2018. While this standard does not require a complete overhaul of the financials, it does institute some significant changes.

Expense Classifications

ASU 2016-14 requires nonprofits to classify their expenses in an entirely different manner. Going forward, they must report expenses both by natural classification and functional classification. Grouping by natural classification (expense type) is what most nonprofits have been doing all along. This is when all interest expenses are grouped together, or all contributions are grouped together. Grouping by functional classification is a bit different. Functional classifications look to the expense’s purpose rather than its type. An expense’s purpose must be either categorized as “program expenses” (those that support the entity’s main programs) or “support services” (administrative or indirect expenses). Allocations between these two functions can be by square footage, by head count or by any other method that is most accurate.

Net Asset Classifications

Under prior guidelines, net assets were grouped into three categories:

1. Unrestricted
2. Temporarily Restricted
3. Permanently Restricted

Going forward, net assets should be lumped into one of just two categories: net assets without donor restrictions, or net assets with donor restrictions. In effect, the last two categories – temporarily and permanently restricted – were combined into one. Amounts that are temporarily restricted will eventually cycle out of the “net assets with donor restrictions” section and into the “net assets without donor restrictions” section.

Liquidity Disclosures

To help increase transparency, nonprofits are now required to disclose more information about their liquidity risk, restrictions and overall availability of assets. We discussed this change in more detail in this article.

Statement of Cash Flows

The Statement of Cash Flows will look similar; it can still be presented using either the direct or indirect method. However, ASU 2016-14 lessens some of the reporting burden for those using the direct method. Nonprofits who use the direct method are no longer required to reconcile cash used in operating activities to the change in net assets. The Financial Accounting Standards Board (FASB), the standard-setting body that created ASU 2016-14, expects more nonprofits to elect into the direct method now that this reporting burden has been lifted.

Underwater Endowment Funds

Occasionally, the fair value of a donor-restricted endowment will fall below the value of the original gift before it can be utilized. The reporting for these “underwater endowment funds” will be changing in a few ways.

• Instead of the reduction in value being reported separately from the endowment, ASU 2016-14 allows the accumulated losses to be effectively combined with the endowment, resulting in a simpler and truer asset value at first glance.
• The reports must divide the underwater fund into the original gift amount, the fair value of the fund, and the deficiency.
• The nonprofit must disclose its policy for using underwater endowment funds.
• The nonprofit must also disclose any actions it has taken to appropriate these underwater endowment funds during the year.

Contact Us

When viewing these changes all at once, they may seem onerous. However, if you can look at them individually, you will see how well-equipped you are to implement them. No matter what, one step at a time will get you there. Your annual reports for this year must include these changes, so if there are one or two provisions that are challenging, call us at 770-476-1004 or click here to contact us. We look forward to speaking with you soon.