Now is the time for not-for-profit organizations to begin implementing the new changes to their financial statements. Changes issued under the Financial Accounting Standards Board (FASB) Accounting Standards Update 2016-14, Presentation of Financial Statements of Not-for-Profit Entities is effective for calendar year-end entities in 2018, and fiscal year-end entities in 2019.

Major changes fall into five main categories: net asset classes, underwater endowments, expenses, liquidity, and investment return reporting. For each of the main categories, not-for-profit organizations should be prepared for the implication of the changes, which are likely to impact policies and procedures in addition to the financial statements themselves.

Transitioning Net Asset Classes

The new financial statement creates two net asset classes—those without donor restrictions (previously unrestricted assets) and those with donor restrictions (previously temporarily restricted and permanently restricted assets). Changes to net asset classes will have broad impact and affect the Statement of Financial Position and Statement of Activities, as well as disclosures.

Not-for-profit organizations will likely find the net asset classes among the easiest of the changes to make. Early adopters carried over most of their current information with a few tweaks but found they needed to update their report writer, chart of accounts, and spreadsheets of supporting information in some cases.

Additionally, some decisions may need to be made about the treatment of board-designated net assets. Not-for-profits should delineate board-designated net assets in their disclosures to distinguish these assets from other net assets without donor restrictions, such as operating reserves, capital funds, and future programs. Early adopters with board-designated net assets found they did not need to make changes to existing footnotes, but they needed to consider how to properly disclose the board-designated funds in their liquidity note. Not-for-profits may also want to confer with their board about the manner of its asset designations because asset designations may be more transparent under the new standard.

Underwater Endowments

Underwater endowments will no longer be charged to net assets without donor restrictions (formerly unrestricted net assets) but instead listed among the assets with donor restrictions. They will need enhanced disclosures as well. In addition to existing disclosures for underwater endowments, organizations will be required to disclose original gift and fair value amounts in the aggregate.

To implement the changes to underwater endowments, not-for-profits will need to change their report writer structure to include underwater endowments in net assets with donor restrictions and reaffirm their policy on spending from underwater endowments. Early adopters found that most of their existing tracking mechanisms collected information on all of these required elements, and therefore not many changes were needed during adoption.

Expense Reporting

All not-for-profit organizations will need to report expenses by function (program, management, fundraising, etc.) and natural classification (salaries, fringe benefits, occupancy, etc.). These expenses will need to be listed in a separate statement or in the footnotes. The change will require further disclosures about the methods used to allocate costs among program and support functions. Direct conduct or direct supervision of activities will now be the standard to allow for allocation from supporting expense categories to program expenses.

Some not-for-profit organizations, such as voluntary health and welfare organizations, have already been required to report expenses by function and natural classification. Therefore, the only change for those organizations is to review their allocation from supporting categories to program expenses under the new rules of direct conduct or direct supervision of activities.

To implement, not-for-profit organizations will need to determine where the expense reporting will live, and the appropriate level of natural classifications. Organizations will also want to revisit allocation methods and update systems as needed to capture the needed information. Early adopters used the Form 990 to jumpstart the changes to the expense reporting because the tax reporting systems are already set up to capture natural classification.

Liquidity

Not-for-profit organizations will need to make qualitative and quantitative disclosures related to their liquidity and availability of resources. Liquidity may be affected by the nature of certain assets, limits imposed by donors and other external sources, or constrained by internal limits (such as board designations).

Including liquidity disclosures may also signal that new policies are required related to net asset designation and the operating reserve policy.

Early adopters found the liquidity measures to be the most difficult to implement. Keep financial statement users in mind when deciding how to present liquidity disclosures. Information on the availability of assets is commonly presented to both internal and external constituents. Therefore, organizations should consider consistency when drafting the new disclosures for presentation in their external financial statements.

Investment Return

Reporting for investment returns will include changes in presentation as well as changes in disclosures. Not-for-profits will include investment expenses with overall investment returns on the face of the Statement of Activities (previously expenses may have been netted only against interest and dividends). Investment expenses allowed to be netted have been more clearly defined as external and direct internal expenses that involve the direct conduct or direct supervision of the strategic and tactical activities involved in generating investment return. Disclosures on investment expenses will no longer be required, nor will disclosure of investment return by interest, dividends, realized gains or losses and unrealized gains or losses.

The updates should make it easier to compare investment returns across different not-for-profit organizations as well as eliminate the difficulties in identifying embedded fees resulting in inconsistencies in reported amounts of investment expense.

When implementing, not-for-profit organizations will need to identify which investment return costs are being netted under prior generally accepted accounting principles (GAAP), and evaluate which of those costs may be appropriate to net under the new standard. Not-for-profits may also want to communicate the impact of any of the changes on budgeting. Early adopters found that in execution, the modifications to investment return reporting only required small tweaks to financial statements.

Next Step: Allocate Implementation Resources

Now that the effective date is here, not-for-profit organizations should have a concrete plan of action for making the changes. Keep in mind that the changes will also need to be reviewed with boards and others tasked with governance. Verifying with external auditors prior to commencement of the year-end audit that the appropriate updates have been made is also recommended.

Compiling an action timeline with a key point person, participants, and completion dates can help make sure your financial reporting changes are on track. Below is an example for a fiscal year-end entity:

For more information about implementing the new not-for-profit financial statement, please contact us.