Is Your Not-for-Profit Preparing for the FASB Accounting Standards Update?

October 26, 2017 — In August 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-14, which has far-reaching implications for not-for-profit organizations. The FASB believes that the complexity of financial statements can be reduced and that financial statements can be made more informative. We’ve had a little over a year to digest the standard, and here is a reminder of what’s changing and the key items that your organization should be doing now to prepare.

Overview

The purpose of the update is to simplify and improve the way not-for-profits present information about their expenses, investment returns, liquidity, financial performance, cash flows and net asset classification.

Implementing the update is:

• required for 12/31/18 and fiscal year ’19 year-ends.
• on a retrospective basis with certain omissions allowed.
• a good time to use early implementation.
• a time where a partial implementation is not allowed, however, some requirements are already allowed as options under the current GAAP.

You should:

• consider whether to fully or partially implement during what’s left of calendar year 2017/fiscal year 2018.
• review the key components and discuss with your CPA to determine the impact for your not-for-profit.
• determine what actions are needed to ensure readiness in the year of implementation.

Liquidity and Availability of Resources

Changes include:

• new narrative disclosures about the not-for-profit’s policies for managing general expenditure cash needs within one year of the balance sheet date.
• new quantitative disclosures regarding the availability of financial assets as of the balance sheet date.

Redpath and Company wants you to know that:

• the expected time and effort needed to implement this for the typical not-for-profit is high.
• this update may require the most planning and be the most impactful of any of the ASU 2016-14 provisions. These are new disclosures that may not pull directly from other parts of financial statements.
• not-for-profits with cash flow challenges and/or not-for-profits that “borrow” against restricted funds to pay for other purposes will want to give this extra attention.
• “Available for General Expenditures” is not defined in ASU 2016-14. However, the standard does state that the availability of a financial asset may be affected by (1) its nature, (2) external imposed limits, and (3) internal imposed limits.

Right now, you should be:

• identifying, reviewing, or creating a cash management policy.
• planning for the new disclosures by reviewing examples contained in ASU 2016-14 and discussing them with your CPA.

Functional Expenses

Changes include:

• that detailed functional expense presentations are now required for all not-for-profits, either on the face of the financial statements or in the note disclosures.
• revised definitions of Management and General (M&G) expenses i.e. supporting activities that are not directly identifiable with one or more program, fundraising or membership-development activities (key change is adding the word “directly”)
  • This has the potential to be quite impactful. New examples provide that payroll and HR-related expenses are generally considered entirely M&G, whereas IT is often allocable across functions.
• that expanded disclosures about the allocation methods used to allocate costs among functions
• the added emphasis that the functional expense presentation should include expenses that are reported net with revenue (except for investment expenses). For example, the cost of goods sold and direct expenses of special fundraising events are often reported net with revenue.  These should be included in the functional expense presentation.

Redpath and Company wants you to know that:

• the expected time and effort needed to implement this for the typical not-for-profit is high.
• the change in the definition of M&G expenses may look subtle, but is important and may impact many not-for-profits.
• many not-for-profits don’t currently provide functional expense analysis for expenses that are netted against revenue. This may be because they are immaterial or simply overlooked.

Right now, you should be reviewing:

• your expense allocation methods to determine if changes are needed, especially as they apply to the new M&G definition and examples.
• your treatment of expenses netted against revenue and making sure that GAAP required presentation is
• (or drafting) your note disclosure on expense allocation methods to ensure adequate detail is provided.
• reviewing your general ledger/chart of account and other supporting records to ensure required functional expense information is captured if you are a not-for-profit that does not currently present functional expense detail.

Net Asset Classification

Changes include:

• that permanent and temporary restricted net assets are combined into one category called “net assets with donor restrictions.”
• increased disclosure regarding donor restrictions and board designations (self-imposed limits).
• elimination of the option to release donor restrictions on long-lived assets over the life of the asset (vs when placed in service).
• clarification that governing boards may delegate designation decisions to internal management.

Redpath and Company wants you to know that:

• the expected time and effort needed to implement this for the typical not-for-profit is moderate.
• this gives the face of the financial statements a simplified, cleaner look, with some details moved to the notes.
• this generally will not relieve the not-for-profit of its duty to internally track permanent restrictions that are subject to UPMIFA/endowment rules.
• some not-for-profits report designations “loosely” that may require additional documentation or board action to be reported under ASU 2016-14.

Right now, you should be:

• reviewing all current or planned items reported as board designated and considering if additional documentation or board action will be required.
• having your not-for-profit’s governing board consider and document whether designation decisions will be delegated to internal management.
• planning for the new disclosures by reviewing examples contained in ASU 2016-14 and discussing them with your CPA.
• identifying whether your not-for-profit will be impacted by the eliminated option on released donor restrictions on long-lived assets (in our experience, most not-for-profits don’t use this option and won’t be impacted).

Underwater Endowment Funds

Changes include:

• that the amounts of underwater endowment funds will be reported in the “with donor restriction” category (vs. unrestricted under current GAAP).
• increased disclosures about not-for-profit policies regarding the spending of underwater funds, the original gift amounts and current values, and the net underwater amounts.

Redpath and Company wants you to know that:

• the expected time and effort needed to implement this for the typical not-for-profit is low
• classifying underwater amounts to “with donor-restricted” is a welcome change. In our view, including with unrestricted was misleading.
• not-for-profits will want to remain aware that decisions impacting underwater endowments will be disclosed in the notes to the financial statements.

Right now, you should be planning for the new disclosures by reviewing examples contained in ASU 2016-14 and discussing them with your CPA, if applicable.

Investment Expenses

Changes include that:

• investment income is now required to be reported as net of investment expense (both external and direct internal investment expense).
• the required disclosure of investment expenses has been eliminated.

Redpath and Company wants you to know that:

• the expected time and effort needed to implement this for the typical not-for-profit is low.
• many not-for-profits already net investment expense and also don’t have material direct internal investment expense.
• IRS Form 990 currently requires investments expenses to be reported gross, meaning there will be a GAAP-to-Tax difference for investment expenses

Right now, you should be:

• reviewing your current practices with reporting investment expenses to determine if changes will be needed.
• reviewing the guidance on “direct internal investment expense” to determine applicability. Direct internal investments expenses involve the direct conduct or direct supervision of the strategic and tactical activities involved in generating investment return.  Examples include:
  • salaries,
  • benefits,
  • travel, and
  • other costs

They are associated with the officer and staff responsible for the development and execution of investment strategy, and allocable costs associated with internal investment management and supervising, selecting, and monitoring of external investment management firms.

Cash Flow Statement

Changes include the elimination of the requirement under the direct method to present the reconciliation to the indirect method.

Redpath and Company also wants you to know that:

• the expected time and effort needed to implement this for the typical not-for-profit is low.
• many financial statement users find the direct method to be more useful, but the indirect method is simpler and the most common in practice.
• ASU 2016-14 provides some incentive for changing to the direct method by eliminating the indirect reconciliation which many believe clutters the financial statements.
• If making a change, consider early implementation of 2016-18 at the same time (requires restricted cash and cash equivalents to be included).

Right now, you should:

• consider whether a change to the direct method would benefit your financial statement users if you’re currently using the indirect method.
• consider eliminating the reconciliation to the indirect method if you’re currently using the direct method.

Are you considering early implementation? Do you have questions about what you should be doing now to prepare? Contact Cathy Lydon today at 651-255-9337 or clydon@redpathcpas.com.