The Financial Accounting Standards Board (FASB) has been busy re-writing the nonprofit financial reporting model, a model that has been in place since 1993. While many financial statement preparers and users have become accustomed to the current nonprofit model, industry leaders have questioned whether it appropriately addresses the accounting needs of the users of nonprofit financial statements. In April 2015, the FASB issued an exposure draft of the proposed accounting standards update for the “Presentation of Financial Statements of Not-for-Profit Entities.” To see the complete proposal, visit: www.fasb.org. Universities, foundations, accounting firms, and other nonprofits have provided comment letters to the FASB and redeliberations took place in October and December with further discussion expected in late January.
Summarized below are the critical changes that that have been affirmed by the FASB from this proposed standard. As these changes have been affirmed by the Board, it is expected that they will be included in the final standard, once issued.
Net Asset Classification
The FASB has affirmed that the new standard will modify the existing net asset classifications from a three part model: unrestricted, temporarily restricted, and permanently restricted to a two part model: net assets with donor restrictions (which is a combination of temporarily restricted and permanently restricted net assets) and net assets without donor restrictions (which is equivalent to unrestricted net assets). Nonprofits would retain the requirement to provide relevant information about the nature and amounts of donor restrictions on net assets either on the face of the statement of financial position or in notes. We believe this change is in line with the changes in the law under the Uniform Prudent Management of Institutional Funds Act (UPMIFA) and should help to reduce complexity in the financial statements.
In addition, under the current model, nonprofit organizations have the option to release from restriction those donor gifts that relate to purchases of property or construction projects either over time or when the property is placed-in-service. Many nonprofits with significant property and construction activities make the election to release the donor restricted gift over time as that better aligns the release with the use of the property, most notably the depreciation. However, the FASB has affirmed, in the absence of explicit donor instructions, nonprofits would be required to reclassify net assets with donor restrictions that are for the acquisition or construction of long-lived assets as net assets without donor restrictions when the long-lived asset is placed-in-service.
Board Designated Net Assets
For many nonprofit organizations, the Board of Directors/Trustees will self-designate certain net assets for specific purposes such as capital improvements or special programs. These Board of Directors/Trustees designated amounts are deemed board-designated net assets and are included in unrestricted net assets under the current model. The FASB has affirmed that under the proposed standard the amounts and purposes of the these funds will be classified as net assets without donor restrictions and continue to require disclosure either on the face of the financial statement or in the notes.
During significant economic downturns, nonprofits with endowments often experience losses on those endowment earnings and in some cases, endowment funds may decline to a value that is less than the original gift amount. Circumstances where values decline below the original gift balances are termed “underwater” funds. The FASB affirmed its proposal to require underwater endowment funds to be classified within net assets with donor restrictions rather than the current unrestricted category. The proposal will also require certain enhanced disclosures for underwater funds: the policy to either reduce expenditure or not spend from underwater endowment funds; the fair value; the original endowment gift amount or level required by donor stipulations or by law to be maintained; and the amount of the deficiencies.
Presentation of Operating Cash Flows
Currently, most nonprofit organizations, have the option to report under the direct or indirect method for operating cash flows in the financial statements, although those that elect a direct method, must also present the indirect method. The proposed standard would have required nonprofit organizations to present operating cash flows using the direct method. However, in the most recent deliberations, the FASB determined the direct method would not be required and nonprofits may continue to elect to use either the direct method or indirect method. Further, the FASB decided to no longer require the indirect reconciliation if an nonprofit chooses to use the direct method. This may be the silver lining of the entirety of the proposed pronouncement.
We expect the FASB to continue its deliberations in January and reach a consensus on defining the operating measure and realignment of certain line items within the statement of cash flows. The nonprofit team will continue to monitor these developments and provide updates about these changes.