The time has come to begin implementing the new not-for-profit financial statement presentation standard. ASU 2016-14 is effective for all not-for-profit entities with calendar years ended December 31, 2018 or fiscal years ended in 2019. Do not let the name of the standard mislead you, there are more to these new rules than wording changes.
As a quick refresher, the standard addresses changes to five main areas: Cash flows presentation, net assets classification, reporting of investment income, reporting of expenses and liquidity information. The changes to an organization’s financial statements will vary widely from one entity to the next. Additionally, while some of the changes are very straight forward, others are not. It is important that each organization takes the time at the start of the implementation year to understand the changes in order to continue telling their story with their financial statements.
This article will focus on the three areas that will require the most advanced planning:
The ASU requires that all not-for-profit organizations report expenses by both nature and function. Commonly prepared as a separate statement, the statement of functional expenses will require each organization to allocate their natural expense categories (E.g., salaries, occupancy, professional fees, and supplies) across two major functional areas: program services and supporting services (E.g., management and general, fundraising and membership development, if applicable).
Organizations have the choice to allocate expenses based on the direct or indirect method and will likely use a combination of the two. Common indirect allocation methods are those based on time and effort studies or square footage. The level of detail and frequency of a time and effort study will vary between organizations. However, it is important to remember that whatever the organization chooses, the allocation method is now a required footnote disclosure and must be auditable. If your organization chooses to use a time and effort study as an allocation method, the study MUST be done during the year being audited. If your organization waits until after year-end to implement this change, it will be too late.
All not-for-profit organizations are now required to disclose quantitative and qualitative information about the availability of your organization’s financial assets at the balance sheet date to meet cash needs for general expenditures within one year (of the balance sheet date). Availability of funds will be dependent on the nature of the assets, as well as external and internal limitations. The standard allows for a lot of flexibility in how this requirement is satisfied. We recommend that organizations take the time to draft this disclosure in a way that is meaningful to the users of your financial statements.
Unfortunately, some organizations are going to find that this disclosure could cause users of their financial statements to be concerned about the overall health of the organization. The earlier that this is discovered, the better. Some organizations could choose to amend or eliminate policies surrounding board designated net assets, freeing up additional liquid assets. Others may choose to be proactive and reach out to major funding sources to explain their liquidity position so that there are no surprises when the financial statements are delivered. Regardless of an organization’s liquidity, this disclosure will take time and thought, and you should not wait until year-end to draft the disclosure.
Net assets classification
While this change is primarily a labeling change (moving from three net asset classes to two) and an increase in required disclosures (E.g., underwater endowments), there are considerations to be made surrounding board designated net assets. Organizations that choose to have board designated net assets, or quasi endowments, are now required to disclose the nature and amount of these funds. This is a great opportunity to revisit existing designations to determine if they are still appropriate and in line with your organization’s strategic plan. When was the last time the board updated the policy? Does maintaining board designated net assets complicate the new required liquidity disclosure? Where do you want to present this information—on the face of the statements or in the footnotes? The sooner your organization answers these questions, the better.
As you can see, it is critical that your organization does not wait until the start of your next audit to understand the implications of this standard. For those organizations with a December 31, 2018 year-end, we are already more than halfway through the reporting year, and for those with fiscal year ends in 2019, the reporting year has likely already begun. We encourage you to reach out to your engagement team to discuss how this new standard affects your specific financial statements and any implications to the audit.