In an effort to provide more useful information to donors, grantors, creditors and other users of the financial statements, the Financial Accounting Standards Board (FASB) released ASU 2016-14 Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities on August 18, 2016. While the ASU focuses on five main areas that are changing, this article will highlight just one: Expense reporting by nature and function.
Before the release of ASU 2016-14, only Voluntary Health and Welfare Organizations had to report expenses by nature and function; however, many organizations still reported expenses by nature and function either as a supplemental schedule to the financial statements and/or on the Organizations Form 990 Part IX Statement of Functional Expenses.
From now until implementation, for financial statements dated December 31, 2018 or June 30, 2019, it is critical that organizations take the time to analyze their expenses in order to be in compliance with this new requirement. While breaking expenses into natural categories is pretty straightforward, many organizations will find the functional breakout to be more challenging. Each expense will need be categorized as either a program service or a supporting activity. And, for many expenses, like payroll, it is likely that these expenses will fall into multiple functional categories.
There are three steps involved in breakout:
- The first step in understanding how to make this distinction is knowing the definitions. The FASB defines program services as activities that result in goods and services being distributed to beneficiaries, customers, or members, that fulfill the purpose or mission for which the not-for-profit exists. The FASB defines supporting activities as all activities of a not-for-profit other than program services. The three most common categories for supporting activities are management and general, fundraising activities and membership development activities.
- The second step is analyzing each natural expense category for allocation between functions. For some expenses, it will be clear that the expense should be allocated 100% to a functional category; however, for others like salaries/benefits or occupancy expenses, it will be necessary to allocate. Each organization will need to develop an allocation policy, the details of which will be a required disclosure to the financial statements. Some common allocation methods include the use of timesheets or an analysis of square footage.
- The third step is summarizing the data for inclusion in the financial statements. The FASB has provided organizations with three possible locations for this information:
- On the face of the statement of activities
- As a schedule in the notes to the financial statements
- In a separate financial statement
It is important to note that including this information in a supplemental schedule is no longer permissible.
While these three steps seem simple enough, the second step could be particularly time consuming for organizations. The enhanced definitions made by the FASB surrounding supporting activities could result in a shift in how organizations have allocated expenses in the past. The FASB stresses, via their examples, that in order for an expense to be allocated to program services, the expense must be the result of direct conduct and/or direct supervision of a program activity and that the expense must be allocated to the program or support function(s) that receive(s) the direct benefit. Any expense that has a benefit to the organization as a whole automatically falls into the supporting activities function. What this means, for example, is that time spent by the accounting staff administering government, foundation and similar customer-sponsored contract, including billing and collecting fees and grants and contract financial reporting, is a supporting activity, not program services. While these reports are critical to the success of the grant, they are not part of the direct conduct/supervision of the grant.
Organizations should be proactive and start this analysis as soon as possible. It will take time to develop an allocation policy and then implement it. Organizations that have not previously used time sheets will need time to educate the staff who will now be responsible for using them. Users of the financial statements will need time to understand this new schedule and what it means. December 31, 2018 will be here before you know it. We encourage you to reach out to your CPA or call us to discuss how this new standard affects your specific financial statements and any implications to the audit.