FASB’s New Financial Reporting Rules for Nonprofit Organizations | What You Need to Know

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On August 18, 2016, the Financial Accounting Standards Board (FASB) issued new rules for nonprofits: “Accounting Standards Update 2016-14 “Not-for-Profit Entities (Topic 958), Presentation of Financial Statements of Not-for-Profit Entities.” This is the first major set of changes to nonprofit financial statement presentation standards since 1993.  The new rules take effect for fiscal years starting after December 2017.

What are the goals of the new rules?

Guest author: Edward Mulherin CPA, Esq. – Founder and CEO of eCratchit Nonprofit

The FASB’s goals for the new rules are to provide better information to donors, grantmakers, creditors, and others who read nonprofit financial statements. The new rules will improve how a nonprofit organization can tell its story through its financial statements.  FASB hopes the changes will improve the usefulness of nonprofit financial statements and/or reduce complexities and costs of financial reporting. 

What organizations are affected by the new guidance? 

The new rules affect substantially all nonprofit organizations, including charities, foundations, private colleges and universities, health care providers, cultural institutions, religious organizations, and trade associations, among others.  Chances are, if your nonprofit has audited financial statements, these rules will apply to the presentation of your nonprofit’s financial statements. If your organization doesn’t require an audit, the rules would still apply to a Review engagement and any financial statements that are required to be prepared in accordance with Generally Accepted Accounting Principles (GAAP).  (If you are not sure whether the law requires your nonprofit to have an independent audit, then visiting the Council of Nonprofits’ free online 50-state map with links to state regulations may be useful.)

What do the new rules do?

The new rules address the following issues:

1. Simplify and clarify

The new rules simplify the treatment of net assets in financial statements by focusing on the existence or absence of donor imposed restrictions, as opposed to the types of restrictions (i.e., temporarily restricted vs. permanently restricted). The classification of temporarily restricted versus unrestricted assets has long been an area of confusion. Under the new rules the Statement of Financial Position will only have two classes of “Net Assets” – net assets with donor restrictions, and net assets without donor restrictions. The footnotes will also be changed to explain these classifications.

The new rules also replace the current three required classes of net assets (unrestricted, temporarily restricted, and permanently restricted) with two new classes (those with donor restrictions and those without donor restrictions).  The goal of this change is to simplify keeping track of donor imposed restrictions. Other advantages of this change are that the financial statements will now also provide more useful information about the nature, amounts, and types of donor restrictions.  Nonprofits will still have to track net assets and follow any restrictions imposed by donors; however, there is no longer a requirement to distinguish between temporarily and permanently restricted net assets.  Instead, new disclosure requirements will allow nonprofits to provide more useful information about limits placed on net assets by both boards and donors. Time will tell whether the guidelines actually accomplish the goal of simplification and clarity. 

2. Clarify cash on hand/available assets

The new rules require quantitative and qualitative information to explain how an organization manages its liquid resources available to meet cash needs for general expenditures within one year of the balance sheet date.  The requirement for qualitative information will be satisfied by “classified” presentation on the statement of financial position (i.e., a breakdown of current and non-current assets and liabilities). The requirement for quantitative information will be satisfied by  disclosure of whether or not a financial asset’s availability is limited by a.) its nature, b.) external limits imposed by donors, grantors, laws or contracts, or c.) internal limits imposed by governing boards.  The idea here is to inform the reader of the financial statements about any limitations on the use of liquid assets (typically cash and investments) by the nonprofit. Nonprofit managers should be ready to discuss these restrictions with their CPA performing the audit or review engagement.

3. Ensure consistency in the reporting of investment expenses and investment returns

The new rules require investment income to be reported net of related internal and external investment expenses (this is currently optional), but also eliminate the related requirement to disclose the amount of those netted investment expenses.  The result of this change is not only a consistent presentation across nonprofit entities, but also it gets rid of the difficulty and costs associated with identifying embedded investment fees in the investment returns used by some nonprofits, such as mutual funds and hedge funds.  Despite this change, nonprofit leaders should continue to make sure they are aware of the amount paid by the nonprofit for investment management fees.

4. Correct misunderstandings about the statement of cash flows and related presentation options

The new rules continue to allow nonprofits the freedom to choose to present operating cash flows using either the direct or indirect method (whichever method best serves the informational needs of those reading the nonprofit’s financial statements).  However, the new rules eliminate the requirement to present or disclose the indirect method in the notes if the direct method is presented on the statement of cash flows. The result is anticipated to be a more useful statement of cash flows and a reduction in costs to prepare the financial statements.  (Many organizations have avoided the use of the direct method because it essentially increased the cost of preparing and auditing the financial statements.)   

Why do these changes matter?

These changes will not materially affect how nonprofit finance teams handle underlying transactions; but staff will need to be ready to explain the difference in the look of the financial statements they present to the board and grantmakers. Also board members will need some training on the new rules as they pertain to their particular organization’s financial statements. Consider asking your nonprofit’s auditor to explain the impact of the new rules to your board of directors.

When are the new FASB standards effective?

There is still plenty of time before the new rules go into effect. Talk to your auditor about the potential impact on audited financial statements. The new standards apply to annual financial statements issued for fiscal years beginning after December 15, 2017.  Early application is permitted. Note: There is a “phase two” planned when FASB will address a variety of other issues affecting nonprofits, but new guidance is not expected for quite some time.

By Edward Mulherin CPA, Esq. – Founder and CEO of eCratchit Nonprofit. His firm provides outsourced accounting and CFO consulting to hundreds of nonprofit organizations nationwide, including to the National Council of Nonprofits. www.ecratchitnonprofit.com

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