Numbers tell a story. Effective nonprofit leaders understand this concept and produce accurate and up-to-date financial statements for internal board purposes, disclosures to current and prospective donors, and government reporting. The Financial Accounting Standards Board’s (“FASB”) newly issued standards will affect many nonprofits’ financial statements, particularly regarding asset classification and required financial disclosures.
Financial Reporting Generally and FASB’s ASU 2016-14
The key to all nonprofit accounting is making sure that an organization’s financial reporting is sufficiently clear for the audiences involved – typically the board, donors, creditors, and the IRS and other government regulators. For small organizations that rely exclusively on contributions for revenues and focus their expenditures on narrow program categories, their finances may be quite straightforward. Other organizations may be far more complex, particularly with respect to IRS Form 990 reporting requirements, and thus need to pay careful attention to the new FASB standards.
The FASB issued Accounting Standards Update 2016-14, Presentation of Financial Statements for Not-for-Profit Entities (the “ASU”) on August 18, 2016. The FASB is a leading organization that issues accounting standards for nonprofit organizations, promoting uniformity in how various types of revenues are reported, how costs should be categorized, and how distinctions should be made among expenses for program services, fundraising, and operations.
According to FASB leadership, the ASU responds to concerns expressed among stakeholders about the complexity, insufficient transparency, and limited usefulness of current nonprofit standards.
The ASU aims to simplify and improve financial information presentation and to enhance disclosures (particularly within financial statement notes), allowing nonprofits to better and more efficiently communicate their financial condition. This project has long been in the works, and it reportedly marks the biggest change for nonprofit financial accounting in 20 years. It will affect all nonprofits that follow Generally Accepted Accounting Principles (GAAP) and those involved with such nonprofits and their resources.
Specific ASU Changes
The FASB ASU’s nonprofit accounting standards include the following areas.
1. Simplified net asset classifications. The current classes are unrestricted, temporarily restricted, and permanently restricted. The new standard collapses these classes into two categories: “net assets without donor restrictions” and “net assets with donor restrictions.” Footnote disclosures should be used to indicate additional conditions, such as particular donor restrictions, any board-imposed restrictions, and related timing considerations, but the overall classifications are more streamlined.
2. Liquidity and availability of resources. A common concern among stakeholders is whether a nonprofit will have enough cash to meet its needs. The ASU’s new standard seeks to address this concern through improved disclosure about liquidity and availability of resources, as shown in quantitative and qualitative balance sheet information. New disclosures in the financial statement notes should better reflect availability of assets for current operating expenses and how a nonprofit manages such availability, to meet cash needs for general expenditures within one year.
3. Comparable expenses and investment return data. The FASB ASU seeks to standardize how nonprofit organizations present their expenses and investment return reporting, which in turn should help donors, creditors, and other stakeholders assess such information in comparison to other organizations. All operating expenses must now be reported and analyzed by both function (i.e., programs and supporting activities) and by nature (i.e., salaries, electricity, rent, repairs, etc.). Such reporting may be on a separate statement, on the face of the statement of activities, or in the footnotes. Additional disclosures are required regarding cost allocation among program and support functions. A net presentation of investment expenses against investment return will also be required.
4. Statement of cash flows. Understanding the ebbs and flows of a nonprofit organization’s cash helps the Board of Directors make smart management decisions that protect its overall sustainability. The new FASB standard provides nonprofits with flexibility to use either the direct method or the indirect (reconciliation) method of reporting operating cash flows, with the indirect method permitted but no longer required. Such approach should encourage organizations to report by the direct method more often, particularly since it is more user-friendly and understandable to an average user.
The ASU becomes effective for fiscal years beginning after December 15, 2017 and for interim periods within fiscal years beginning after December 15, 2018. Early adoption of the standard is permitted. A second phase is expected to follow, addressing broader reporting uses for both for-profit and nonprofit organizations.
Additional Governance Considerations
Nonprofit leaders owe a fiduciary responsibility to handle their organizations’ finances well. Among other things, they should require financial records to be maintained, strive to understand financial reports, hold the preparers of financial reports fully accountable, effectively communicate their organizations’ financial condition to donors and other supporters, and ensure that all financial and other reporting requirements are fulfilled. Financing accounting standards can quickly get complex, with challenging specific applications. Consequently, responsible leaders should work collaboratively with experienced and knowledgeable accountants, as well as legal counsel, to determine appropriate financial record-keeping and reporting protocols.