In 2016, the Auditing Standards Board (ASU) issued ASU No. 2016-14 which will substantially affect the financial reporting requirements of all non-profits and health care entities. ASU No. 2016-14 is effective for fiscal years beginning after December 15, 2017. The new standard will be effective for financial statements for the December 31, 2018 (for non-profits with December year ends) and June 30, 2019 (for non-profits with June year ends) reporting periods.
To be compliant, non-profits must now:
1. Apply all provisions of the new ASU.
2. Apply all provisions for comparative presentation except the analysis of expenses by nature and function (except for Voluntary Health and Welfare Entities that are already required to present a Statement of Functional Expenses) and disclosures around liquidity and availability of resources.
3. Disclose the nature of any re-classifications or restatements and their effects, if any, on the changes in the net asset classes for each period presented.
There are five key areas of impact for ASU 2016-14:
1. Reporting of net assets by non-profits
2. The liquidity information provided by non-profits
3. The statement of cash flows
4. The operating measure information provided
5. The reporting of expenses
1. Reporting of Net Assets
The new standard affects the reporting of net assets in several areas:
Reducing and Renaming the Classifications of Net Assets
- Unrestricted net assets become Net Assets without Donor Restriction (includes board designated).
- Temporarily and permanently restricted net assets are combined to become Net Assets with Donor Restriction.
- There are new disclosure requirements for net assets including the composition of net assets with donor restrictions, with an emphasis on how/when resources can be used with regard to purpose, time, and if they are to be used in perpetuity.
- Expanded disclosures are now required in the following areas:
-Amounts and purposes of board designations
-Similar actions resulting in self-imposed limits on the use of resources without donor-imposed restrictions
-Documented policies and procedures on the establishment of board designations, amounts, and how such board designated net assets may be released from designation
Reporting Expirations of Restrictions on Gifts Related to Long-Lived Assets
GAAP previously allowed
recognition when the asset is acquired and placed in service or in ratable
amounts over the asset’s estimated useful life. Going forward, under ASU
2016-14, non-profits are no longer allowed to choose and a placed-in-service
approach is required, in the absence of explicit donor stipulation. The impact
of this change is that the reclassification of net assets will be reported to
reflect the decrease in net assets with donor restrictions and will increase
net assets without donor restrictions.
Reporting Amounts Related to Underwater Endowment Funds
Prior to ASU 2016-14, non-profits presented the aggregate amount by which endowments are underwater in unrestricted net assets. Under ASU 2016-14, underwater endowments are now defined as donor-restricted endowments funds, for which the fair value of the fund at the reporting date is less than either the original gift amount or the amount required to be maintained by the donor or by law that extends donor restrictions. The entire balance of the endowment fund is to be reported as net assets with donor restriction.
The following are new disclosure requirements of underwater endowments:
- Interpretation of the non-profit’s ability to spend from underwater endowment funds
- The non-profit’s policy and any actions taken during the period concerning appropriation from underwater endowment funds
- And each of the following, in the aggregate for all underwater endowment funds:
1. the fair value of the underwater endowment funds
2. the original endowment gift amounts (or the level required to be maintained by donor stipulations, or by law that extends donor restrictions)
3. and the amount by which the original gift amount exceeds the fair value (the deficiency = 2 less 1)
2. Liquidity Information
Prior to ASU 2016-14, non-profits were required to provide information about liquidity by any of the following methods:
- Sequencing assets according to their nearness of cash and sequencing liabilities according to nearness to maturity
- Classifying assets and liabilities as current and non-current
- Disclosing in the notes to the financial statements relevant information about the liquidity
Under ASU 2016-14, the disclosure requirements for liquidity information are as follows:
- Qualitative information on how the non-profit manages its liquid resources available to meet cash needs for general expenditures within 1 year of the balance sheet date
- Quantitative information that communicates the availability of financial assets at the balance sheet date to meet cash needs for general expenditures within 1 year of the balance sheet date
3. Statement of Cash Flows
- Under ASU 201-14, the use of either the direct or indirect method is allowed.
- Non-profits are no longer required to show reconciliation of change in net assets to cash flows from operating activities if using the direct method.
4. The Operating Measure Information Provided
- Prior to ASU 2016-14, non-profits were allowed, but not required, to have a self-defined operating measure on the statement of activities (Operating versus Non-Operating). If a non-profit chose to do this, they were required to report the change in unrestricted net assets. If the use of the term operations was not apparent from the details, non-profits were required to include a note to the financial statements describing the nature of the reported measure of operations.
- Under ASU No. 2016-14, non-profits will continue to follow the prior guidance.However, non-profits that choose to present internal board designations, appropriations, and similar actions on the face of the financial statements affecting that measure will have additional reporting requirements.Specifically, these non-profits will be required to report those types of internal transfers appropriately disaggregated and described by type, either on the face of the financial statements or in the notes.
5. Reporting of Expenses
The reporting of expenses changes in four key areas under ASU 2016-14:
- Changing how investment expenses are reported
- Providing additional information related to allocated costs
- Refining/updating the definition of management and general activities
- Adjusting how non-profits report functional and nature expense information
Investment Return: Non-profits are now required to report the net of all external and direct internal investment expenses. Non-profits are no longer required to disclose components of netted expenses.
Internal expenses include the direct conduct or direct supervision of the strategic and tactical activities involved in generating investment return. This includes salaries, benefits, travel, and other costs associated with staff responsible for development and execution of investment strategy, including supervision, selecting and monitoring external managers. However, this excludes costs not associated with generating investment return, such as administrative management, contracts, pooled-fund administration.
Additional Information Related to Allocated Costs: Currently a non-profit is required to disclose certain information related to joint costs (costs which are part fundraising and part other functional category). ASU No. 2016-14 requires including a description of the method(s) used to allocate costs among program and support functions.
Refining/Updating the Definition of Management and General Activities: Under ASU No. 2016-14, management and general activities of non-profits are now defined as supporting activities that are not directly identifiable with one or more programs, fundraising, or membership development. These activities include business management and budgeting, general accounting, payroll, and annual reporting, financing, including allocated interest costs, billing and collecting fees, human resources, and all other management and administration except for the direct conduct or direct supervision of program services, fundraising activities, or membership development activities.
When should management and general activities expenses be allocated? Examples from the ASU include:
- IT (benefits various functions and generally would be allocated)
- CEO functions (could be allocated to programs, fundraising, and management and general activities)
- CFO functions (could be allocated to management and general activities, and investment expense)
- HR (generally would be assigned to all management and general activities)
- Grant accounting and reporting (program reports will be granted related but financial reports and related accounting will be classified under management and general activities).
Adjusting How Non-Profits Report Functional and Natural Expense Information: Over the years, various opinions have been expressed on the importance of functional and natural expense information. For creditors, natural expense information is more important than functional expenses. For donors/rating agencies, functional expense information is more important than natural expenses.
Under ASU 2016-14, all non-profits must present an analysis of expenses by function and nature in one location (separate statement of functional expenses, table in the notes, and incorporated into the statement of activities).
Summary of ASU 2016-14 Changes
- Reduce net asset classes from three to two
- Expanded disclosures for net assets, including board designated net assets
- 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
- Additional disclosures for underwater endowments
- New liquidity and availability disclosures required
- Use of direct method in a statement of cash flows eliminates reconciliation of change in net assets to cash flows from (used for) operating activities
- Expanded disclosure if showing an operating measure
- Net investment return
- Reporting of expenses by nature and function is required, and description of the methods used to allocate costs among functional categories
Lastly, your independent auditor will include an emphasis of matter paragraph in the auditor’s report if the adoption results in changes that have a material impact on the financial statements.
The preceding article is an abstract from a seminar held in May by Maher Duessel.