Classification of Net Assets
Under the previous guidance, organizations would report net assets as three classifications: 1) unrestricted, 2) temporarily restricted, and 3) permanently restricted. The new guidance has changed “unrestricted” to “without donor restrictions” and combined temporarily and permanently restricted into one classification called “with donor restrictions.” The concepts of temporarily and permanently restricted net assets have not gone away, however, they will no longer be presented on the face of the financial statements.
Previously, nonprofits had the option of releasing restricted funds used to purchase a long-lived asset (ie: a building) over the estimated useful life of the asset rather than when the asset was placed in service. However, in practice, very few nonprofits followed this method, so FASB has eliminated it and now all nonprofits will release restricted funds used to purchase long-lived assets when the asset is placed in service.
The new standards also require investment return to be presented net of investment expenses. Previously, nonprofits could present investment expenses separately on the financials if they chose, but many netted investment expenses with investment income anyway. There are also expanded disclosures for underwater endowment funds and some changes as to how these will be presented on the statement of activities.
Potentially, the biggest impact of this standard will be the new disclosures about the liquidity of the organization’s financial assets. Some organizations may raise funds in a capital campaign over a number of years if the item they are planning to purchase or build is very large. As they raise funds for the project, their cash balance will rise making it appear at first glance that the organization has a lot of cash to fund operations for the upcoming year. However, this is not the case, as those funds are restricted for the purchase of that asset and should not be diverted to fund operations. FASB recognized that it was not always clear what assets were available to fund general expenditures for the upcoming year, so they now require qualitative and quantitative information regarding the availability of an organization’s financial assets to fund upcoming expenditures and how the organization manages its liquid resources to manage cash needs for the upcoming year.
If an organization evaluates their liquidity under the new guidance and it does not appear favorable, one thing organizations can do is look to their boards to release some of the board-designated assets to allow them to be used for general operations. It is common when organizations receive large or unusual contributions for the board to create a quasi-endowment or otherwise limit the use of the funds. These funds are then not available to cover general operations and may make the organizations be less liquid. There are justifiable reasons a board may want to restrict the use of funds as well, so this will be something organizations will look at on a case-by-case basis.
Reporting expenses by function (ie program, administrative, and fundraising) will now be required for all nonprofits. The IRS already requires all 501(c)(3) and 501(c)(4) organizations that file the full Form 990 (over $200,000 in gross receipts or over $500,000 in total assets) to present expenses by function. Furthermore, generally accepted accounting principles (GAAP) already required this for certain charities that rely on voluntary contributions to support their operations. We expect that most nonprofits that are doing GAAP basis financial statements will already have some or all of this information already, but this may be a good opportunity to look through your chart of accounts to ensure the allocation of expenses is still in line with the nature of your operations. For those organizations that have not been presenting expenses by function on their statements or 990, they will need to develop policies and procedures for tracking and allocating expenses to the program and supporting (administrative and fundraising) functions.
Statement of Cash Flows
The FASB has long stated they believe the direct cash flow method to be preferable to the indirect cash flow method, however, under previous and current guidance, either are permissible. FASB believed one of the factors limiting the widespread adoption of the direct method cash flow statement was the requirement to present the indirect method in the notes to the financial statements if the direct method was used. The FASB eliminated this requirement in an effort to promote the adoption of the direct method cash flow statement.
The implementation of this standard is expected to be a challenge. It is important that organizations have strong communication with their accountants as we begin to implement this beginning with fiscal years ending December 31, 2018. Should you have any questions or concerns, please contact one of our team members and they will be happy to assist.