New FASB Accounting Standards: What Do They Mean for Fundraisers?
By Seth Perlman
(Established in 1973, the Financial Accounting Standards Board (FASB) is an independent, nonprofit organization that establishes financial accounting and reporting standards for public and private companies and nonprofit organizations that follow Generally Accepted Accounting Principles (GAAP). So any changes they release are VERY important for charities and can affect fundraising in some instances. Seth Perlman, one of AFP’s government relations consultants and president of Perlman and Perlman in New York, discusses the latest changes in the standards).
The recent changes in the Financial Accounting Standards Board (FASB) new guidance for nonprofits are common sense but are nonetheless significant. The reporting of net asset classes, decisions on how expense categories are allocated and underwater endowments can have an impact on the ability of fundraiser to tell their story and acquire support from donors. Thus, these changes are important to the AFP membership.
In the event you have not seen it, below is a summary of the most recent FASB changes. Keep in mind: this is only phase one of the proposed changes.
Why Is FASB Issuing This Accounting Standards Update?
The FASB added a project to its agenda to improve the current net asset classification requirements and the information presented in financial statements and notes about a nonprofit entity’s (NFP’s) liquidity, financial performance, and cash flows. The FASB’s Not-for-Profit Advisory Committee (NAC) and other stakeholders indicated that existing standards for financial statements of NFPs are sound but could be improved to provide more useful information to donors, grantors, creditors, and other users of financial statements.
This update is the result of FASB’s efforts in the first of two phases of its project. The amendments in this update make certain improvements that address many, but not all, of the identified issues about the current financial reporting for NFPs. A second phase of the project is expected to address more protracted issues surrounding whether and how to define the term operations and align measures of operations (or financial performance) as presented in a statement of activities with measures of operations in a statement of cash flows. That will allow the Board to coordinate its Phase 2 considerations for nonprofits with related research activities on financial performance reporting by business entities.
This update makes several improvements to current reporting requirements that address, among others, the following problems:
- Complexities about the use of the currently required three classes of net assets that focus on the absence or presence of donor-imposed restrictions and whether those restrictions are temporary or permanent
- Deficiencies in the transparency and utility of information useful in assessing an entity’s liquidity caused by potential misunderstandings and confusion about the term unrestricted net assets and how restrictions or limits imposed by donors, grantors, laws, contracts, and governing boards affect an entity’s liquidity, classes of net assets, and financial performance
- Inconsistencies in the type of information provided about expenses of the period—for example, some, but not all, nonprofits provide information about expenses by both nature and function
- Impediment of preparing the indirect method reconciliation if a nonprofit chooses to use the direct method of presenting operating cash flows.
What Are the Main Provisions?
The main provisions of this update require a nonprofit to:
1. Present the statement of financial position amounts for two classes of net assets at the end of the period, rather than for the currently required three classes. That is, a nonprofit will report amounts for net assets with donor restrictions and net assets without donor restrictions, as well as the currently required amount for total net assets.
2. Present the statement of activities the amount of the change in each of the two classes of net assets (noted in item 1) rather than that of the currently required three classes. A nonprofit would continue to report the currently required amount of the change in total net assets for the period.
3. Continue to present the statement of cash flows of the net amount for operating cash flows using either the direct or indirect method of reporting, but no longer require the presentation or disclosure of the indirect method (reconciliation) if using the direct method.
4. Provide the following enhanced disclosures about:
a. Amounts and purposes of governing board designations, appropriations, and similar actions that result in self-imposed limits on the use of resources without donor-imposed restrictions as of the end of the period.
b. Composition of net assets with donor restrictions at the end of the period and how the restrictions affect the use of resources.
c. Qualitative information that communicates how a nonprofit manages its liquid resources available to meet cash needs for general expenditures within one year of the balance sheet date.
d. Quantitative information, either on the face of the balance sheet or in the notes, and additional qualitative information in the notes as necessary, that communicates the availability of a nonprofit’s financial assets at the balance sheet date to meet cash needs for general expenditures within one year of the balance sheet date. Availability of a financial asset may be affected by (1) its nature, (2) external limits imposed by donors, grantors, laws, and contracts with others, and (3) internal limits imposed by governing board decisions.
e. Amounts of expenses by both their natural classification and their functional classification. That analysis of expenses is to be provided in one location, which could be on the face of the statement of activities, as a separate statement, or in notes to financial statements.
f. Method(s) used to allocate costs among program and support functions.
g. Underwater endowment funds, which include required disclosures of (1) a nonprofit’s policy, and any actions taken during the period, concerning appropriation from underwater endowment funds, (2) the aggregate fair value of such funds, (3) the aggregate of the original gift amounts (or level required by donor or law) to be maintained, and (4) the aggregate amount by which funds are underwater (deficiencies), which are to be classified as part of net assets with donor restrictions.
5. Report investment return net of external and direct internal investment expenses and no longer require disclosure of those netted expenses.
6. Use, in the absence of explicit donor stipulations, the placed-in-service approach for reporting expirations of restrictions on gifts of cash or other assets to be used to acquire or construct a long-lived asset and reclassify any amounts from net assets with donor restrictions to net assets without donor restrictions for such long-lived assets that have been placed in service as of the beginning of the period of adoption (thus eliminating the current option to release the donor-imposed restriction over the estimated useful life of the acquired asset).
How Do the Main Provisions Differ from Current Generally Accepted Accounting Principles (GAAP) and Why Are They an Improvement?
As discussed below, the main provisions of this update change current GAAP in different ways. Some amendments in this update will:
- improve the usefulness of information provided to donors, grantors, creditors, and other users of an NFP’s financial statements,
- reduce complexities or costs for preparers or users of financial statements, or
- both improve usefulness and reduce complexities or costs.
Some amendments make more significant improvements than others, and the Board believes that collectively the overall expected benefits of the improvements justify the expected costs that they may impose. Eliminating the distinction between resources with permanent restrictions and those with temporary restrictions from the face of financial statements will reduce complexity. Enhanced disclosure in notes to financial statements will provide useful information about the nature, amounts, and effects of the various types of donor-imposed restrictions, which often include limits on the purposes for which the resources can be used as well as the time frame for their use.
Simplifying the face of financial statements together with enhancing disclosures in notes will enable nonprofits to continue to provide relevant and perhaps alternative breakouts that provide more useful information about an entity’s resources and changes in those resources that will be helpful to donors, grantors, creditors, and others in assessing a nonprofit’s:
- Availability of resources to meet cash needs for general expenditures within one year of the date of the statement of financial position
- Liquidity and financial flexibility
- Financial performance during the period
- Service efforts and ability to continue providing services
- Execution of its stewardship responsibilities and other aspects of its management’s performance.
The currently required distinction between permanent restrictions and temporary restrictions has become blurred by changes in state laws that diminished its relevance and rendered that distinction less useful on the face of financial statements. Reducing the number of classes of net assets that must be reported on the face of financial statements, especially the statement of activities, also helps to reduce complexity, increase understandability, and enable greater use of multi-period comparative financial statements that can provide donors, grantors, creditors, and other stakeholders with information useful in identifying and assessing key trends.
Continuing to allow nonprofits to present operating cash flows using either the direct method or the indirect method retains the current flexibility and freedom to choose the reporting method that best serves the informational needs of their particular types of users—creditors, donors, grantors, and others—in a way that strikes the right balance in improving the relevance and understandability of information without imposing undue costs.
Moreover, no longer requiring a nonprofit to present or disclose those cash flows using the indirect (reconciliation) method if the direct method is chosen eliminates the costs to provide and explain information in two different ways. Requiring enhanced disclosures of information (see item 4 of the main provisions) improves the decision usefulness of information helpful in assessing the following:
- The effects, if any, of the limits on the use of resources imposed by a nonprofit’s governing board, donors, grantors, laws, and contracts on a nonprofits’ liquidity, financial flexibility, and allocation of resources
- How a nonprofit manages its liquidity to meet short-term demands for cash
- The types of resources used and how they are allocated in carrying out a nonprofit’s activities
- The effects, if any, of methods used for allocating costs among a nonprofit’s program and supporting activities
- The effects, if any, of underwater endowment funds on a nonprofit’s spending policies and its financial flexibility.
Requiring a nonprofit to report its investment return net of external and direct internal investment expenses provides a more comparable measure of investment returns across all nonprofits, regardless of whether their investment activities (1) are managed by internal staff, outside investment managers, volunteers, or a combination or (2) employ the use of mutual funds, hedge funds, or other vehicles for which management fees are embedded in the investment return of the vehicle.
No longer requiring the disclosure of those netted expenses also eliminates the difficulties and related costs in identifying embedded fees and the resultant inconsistencies in the reported amounts of investment expenses.
Requiring a nonprofit to use the placed-in-service approach, absent specific donor restrictions stating otherwise, for reporting expirations of restrictions on gifts of cash or other assets to be used to acquire or construct a long-lived asset (that is, eliminating the option to release the donor-imposed restriction over the estimated useful life of the acquired asset) improves comparability. Therefore, it also improves the usefulness of both the required measures for changes in the classes of net assets with and without donor restrictions, and the required amounts for those classes of net assets at the end of the period.
When Will the Amendments Be Effective?
The amendments in this update are effective for annual financial statements issued for fiscal years beginning after December 15, 2017, and for interim periods within fiscal years beginning after December 15, 2018.
Application to interim financial statements is permitted but not required in the initial year of application.
Early application of the amendments in this update is permitted. The amendments in this update should be initially adopted only for an annual fiscal period or for the first interim period within the fiscal year of adoption.
The amendments in this update should be applied on a retrospective basis in the year that the Update is first applied. However, if presenting comparative financial statements, a nonprofit has the option to omit the following information for any periods presented before the period of adoption:
- Analysis of expenses by both natural classification and functional classification (the separate presentation of expenses by functional classification and expenses by natural classification is still required). NFPs that previously were required to present a statement of functional expenses do not have the option to omit this analysis; however, they may present the comparative period information in any of the formats permitted in this Update, consistent with the presentation in the period of adoption.
- Disclosures about liquidity and availability of resources.
In the period that the amendments are first applied, a nonprofit should disclose the nature of any reclassifications or restatements and their effects, if any, on changes in the net asset classes for each period presented.
How Do the Provisions Compare with International Financial Reporting Standards (IFRS)?
There are no specific nonprofit accounting and reporting standards in IFRS. Therefore, the proposed amendments are not expected to create or eliminate any differences between GAAP and IFRS.