This article highlights important financial reporting changes on the horizon for not-for-profit organizations.
Lease Accounting Standards Update
With the Financial Accounting Standards Board issuing the Lease Accounting Standards Update, there are some changes in accounting procedures non-profits should be aware of. This Update is effective for fiscal years beginning subsequent to December 15, 2018 (including interim periods) for non-profits that have issued, or are conduit bond obligors for, securities that are traded/listed/quoted on an exchange or an over the counter market. The December 15, 2018 deadline also applies to employee benefit plans that file with the SEC and public business entities. For all other non-profit entities, the update is effective for years beginning after December 15, 2019, and interim periods beginning after December 15, 2020.
Note that a lease is defined as a “contract, or part of a contract that conveys the right to control the use of identified property, plant, and equipment (an identified asset) for a period of time in exchange for consideration.”
Important changes in accounting procedures you should be aware of include the following:
- Lessees must recognize all lease contracts on the balance sheet. Arrangements not meeting the lease definition laid out in the Update are scoped out of the Update and an exception exists for short-term leases where a policy election is made.
- Specifically, the lessee must recognize the following
at the contract’s commencement date:
A. Right-of-use (ROU) asset: the right to use the underlying
asset for the period of the lease term; and,
B. Lease liability (LL): the lessee’s contractual obligation to
be paid over the lease term.
- Present lease arrangements separately on the balance
sheet. Operating and finance leases are not to be co-mingled. Another option is
to present lease arrangements together within similar classes of assets and
liabilities. Disclosure is necessary.
- For finance leases, record interest expense on the LL
and record amortization expense of ROU.
- Note the Lessee should display both
lease interest and amortization expenses consistently with other interest and
amortization expenses (i.e. present combined or separate).
- For operating leases, present interest on LL and
amortization of ROU together as a component of income from continuing
operations (i.e. single amount for lease expense).
- Lessees must disclose the following:
A. Nature of lease arrangement/contract (e.g. lease term,
options, etc.) and accounting judgments used;
B. Information regarding significant leasing arrangements that
have not yet commenced;
C. Transactions between related parties;
information for operating and finance lease liabilities, including:
analysis showing undiscounted cash flows;
remaining lease term;
average discount rate; and,
payments made and supplemental non-cash payments made.
expedient elections applied (e.g. short-term leases, no separation of lease and
non-lease components, etc.)
F. Note: No
specific formatting is required (Tabular example is provided in the ASU).
However, professional judgement is necessary to determine the level
ASU 2016-14 Changes
The Financial Accounting Standards Board (FASB) revised the not-for-profit reporting model in its Accounting Standards Update (ASU) 2016-14, released in August 2016. ASU 2016-14 is effective for fiscal years beginning after December 15, 2017. Key changes associated with ASU 2016-14 include:
- Unrestricted net assets become net assets without donor
restriction. This category includes board designated net assets.
- Temporary and permanently restricted net assets are
combined into one category to become net assets with donor restriction.
- New disclosure requirements for net assets include
composition of net assets with donor restrictions with an emphasis on how/when
resources can be used (purpose, time, perpetual).
- Expanded disclosures regarding Board-designated net
A. Amounts and purposes of board designations
B. Similar actions resulting in self-imposed limits on the use of resources without donor imposed restrictions
C. Documented policies and procedures on establishment of board designations, amounts, and how such board designated net assets may be released from designation
Absent explicit donor stipulations, a placed-in-service
approach is now required for reporting expirations of restrictions on gifts of
cash or other assets to be used to acquire or construct a long-lived asset. For entities that have not been using that
approach, the impact of implementing this Update is that a reclassification of
net assets is reported to reflect the decrease in net assets with donor
restrictions and an increase in net assets without donor restrictions. Underwater
endowments are to be reported completely as part of net assets with donor
restrictions. Underwater endowments also require additional disclosures:
of the ability to spend from underwater endowment funds
- The organizations’ policy, and any actions taken during the period,
concerning appropriation from underwater endowment funds
of the following, in the aggregate, for all underwater endowment funds:
A. The fair value of the underwater endowment funds
B. The original endowment gift amounts (or level required to be maintained by donor stipulations or by law that extends donor restrictions)
C. The amount by which the original gift amount exceeds the fair value (the deficiency = ii less i)
Non-profits should report the net of all external and direct internal investment expenses. Internal expenses include the direct conduct or direct supervision of the strategic and tactical activities involved in generating investment return. New disclosures are required for information on how a non-profit manages its liquid resources available to meet cash needs for general expenditures within 1 year of the balance sheet date. Additionally, the non-profit must provide 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.
There are new requirements for reporting expenses. All non-profits, including voluntary health and welfare entities, must present an analysis of expenses by function and nature in one location. This location could include a separate statement of functional expenses, table in the notes, and be incorporated into the statement of activities. A description of the methods used to allocate costs among program and support functions should also be included. Management and general expenses are defined as:
- Business management and budgeting
- General accounting, payroll, and annual reporting
- Financing, including unallocated interest costs
- Billing and collecting fees
- Human Resources
- All other management and administration except for the direct conduct or direct supervision of program services, fundraising activities, or membership development activities
For the statement of cash flows, use of either the
direct or indirect method of reporting 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.
Revenue Recognition Standards Update
FASB’s Revenue Recognition Accounting Standards Update (2014-14, as subsequently updated) was developed to improve accounting for contracts with customers by providing a principles-based framework to address revenue issues as they arise. The core principle of the Standard is that an entity should recognize revenue to depict the transfer of promised good or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. A 5-step approach to apply the standards exists. Please refer to www.aicpa.org for an implementation roadmap, communication materials for audit committees, and other resources.
NOTE: Contribution accounting is outside the scope of the revenue recognition standards. The FASB is currently re-deliberating an exposure draft on revenue recognition of grants and contracts by not-for-profit entities; review our other blog post on this subject or visit www.fasb.org for more information.