Major Changes for Nonprofit Organizations Just Around the Corner

Transcription

1 Major Changes for Nonprofit Organizations Just Around the Corner The Internal Accounting and Auditing Editorial Team at Thomson Reuters and Susan Weiss Budak SPECIAL REPORT

2 Major Changes for Nonprofit Organizations Just Around the Corner 2 According to the National Center for Charitable Statistics (NCCS), there are more than 1.5 million nonprofit organizations registered in the United States. There are many differences between nonprofit organizations, including differences related to their mission, size, and sources of resources. But many of them have one thing in common they have only recently begun to consider the impact of a new FASB accounting standard related to preparing financial statements for nonprofit organizations. That standard, Accounting Standards Update (ASU) , Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities, was issued in 2016, and its effective date is right around the corner. Because ASU includes significant changes to the existing financial statement framework and related policies and procedures, we believe the ASU will require some time for preparers and auditors to implement it. Therefore, this Special Report discusses some of the most significant changes resulting from the ASU as well as some of the more important implementation issues. Observation: The new standard is effective for annual financial statements issued for fiscal years beginning after December 15, 2017 (for example, years ending December 31, 2018, and years ending June 30, 2019). Although application to interim periods isn t required in 2018, it is permitted, as is early adoption. The issuance of ASU is the result of a FASB project with a broad objective of reexamining the standards for financial statement presentation by nonprofit organizations, which had been developed by the FASB more than 20 years ago. The project was divided into two phases. ASU is the outcome of Phase 1. Phase 2 is focused on defining operating measures and aligning the presentation of operating measures in the statement of activities with those in the statement of cash flows. Those issues are being examined in a research project with similar issues about performance measures of business enterprises. There is currently no timeframe for the completion of Phase 2. You can monitor the status of this project at ASU makes significant changes in the following areas: Net asset classes Endowment funds Liquidity and availability of resources Expense reporting Statement of cash flows Investment return

3 Major Changes for Nonprofit Organizations Just Around the Corner 3 Net Asset Classes The three classes of net assets used in financial statements of nonprofit organizations (unrestricted, temporarily restricted, and permanently restricted) will be replaced with two classes of net assets net assets with donor restrictions and net assets without donor restrictions. Because the definition of donor-imposed restriction is essentially unchanged, the effect of the change is that temporarily restricted net assets and permanently restricted net assets are combined in the statement of financial position and the statement of activities to become the class net assets with donor restrictions. Unrestricted net assets are now referred to as net assets without donor restrictions. The ASU adds the phrase donors include other types of contributors, including makers of certain grants to seven glossary definitions, including the definition of donor-imposed restriction. There is no explanation of which grants are the certain grants referred to in the change. Observation: Since the added phrase refers to those grantors as contributors, and because the ASU doesn t change the implementation guidance in the FASB Codification for distinguishing contributions from exchange transactions, the change could ve been made merely in anticipation of the project to improve standards for characterizing grants and similar contracts with resource providers as either exchange transactions or contributions, and for distinguishing between conditional contributions and unconditional contributions. That project resulted in the recent issuance of ASU , Not-for-Profit Entities (Topic 958): Clarifying the Scope and the Accounting Guidance for Contributions Received and Contributions Made, in June Reducing the net asset classes from three to two doesn t mean that there s no longer the need to distinguish between the types of restrictions donors place on their gifts. The distinction between permanently restricted net assets and temporarily restricted net assets was no longer significant for classification, in large part because of the adoption of the Uniform Prudent Management of Institutional Funds Act (UPMIFA) in all states but one. For most nonprofit organizations, permanently restricted net assets were comprised of the portion of endowment funds that was deemed by the governing board to be required to be maintained permanently the original gift and any other additional gifts or investment return that were required by donors to be added to the amount maintained in perpetuity. Because UPMIFA gives an organization the latitude to spend from a donor-restricted endowment, including the permanent portion, as long as the governing board considers certain factors demonstrating prudence in making the spending decision, a distinction between an amount that was permanent and an amount that was temporary was no longer necessary. Observation: Reducing the net asset classes from three to two doesn t mean that there s no longer the need to distinguish between the types of restrictions donors place on their gifts. ASU acknowledges that some donors impose restrictions that are temporary in nature, for example, stipulating that resources be used after a specified date, for particular programs or services, or to acquire buildings or equipment, and that other donors impose restrictions that are perpetual in nature, for example, stipulating that resources be maintained in perpetuity. Further, laws may extend those donor-imposed limits to investment returns from those resources and to other enhancements (diminishments) of those resources.

4 Major Changes for Nonprofit Organizations Just Around the Corner 4 Disclosure of the nature and extent of donor-imposed restrictions remains a requirement for financial statements. An example note in ASU shows disaggregated information about purposes for which net assets are restricted within the following five categories: (a) subject to expenditure of specific purposes, (b) subject to the passage of time, (c) subject to spending policy and appropriation, (d) subject to appropriation and expenditure when a specified event occurs, and (e) not subject to appropriation or expenditure. Observation: As explained in ASU , the two required net asset classes are a minimum classification scheme. The exception is only one class is used if the organization doesn t have any net assets with donor restrictions. A nonprofit organization can choose to further disaggregate the two net asset classes. For example, an organization might continue to distinguish between net assets expected to be maintained in perpetuity (such as donor-restricted endowments) and those expected to be spent over time or for a particular purpose (such as net assets restricted to the support of program activities or purchase of property and equipment). Endowment Funds In conjunction with the changes in the net asset classes, there are new accounting and disclosure requirements for underwater endowment funds. An underwater endowment fund is one in which the fair value of the endowment fund at the reporting date is less than either the original gift amount or the amount required to be maintained by the donor or law that extends donor restrictions. Current standards require the deficit of a donor-restricted endowment fund to be included in unrestricted net assets. ASU requires the deficit of a donor-restricted endowment fund to be included in net assets with donor restrictions the endowment balance is simply reduced. In other words, the endowment balance for a donor-restricted endowment fund is classified entirely within net assets with donor restrictions, and the endowment balance for a board-designated endowment fund is classified entirely within net assets without donor restrictions (unless the governing board designated resources that were purpose-restricted by the donor to serve as an endowment). Observation: If an organization has deficits that have previously been reported within unrestricted net assets, these deficits will need to be reclassified when ASU is implemented and reported as net assets with donor restrictions on the statement of financial position. ASU requires the deficit of a donor-restricted endowment fund to be included in net assets with donor restrictions the endowment balance is simply reduced. To help financial statement users understand the effects on availability of resources caused by an underwater condition, ASU includes the following required disclosures (in addition to the numerous disclosures required by existing standards): The aggregate fair value of the underwater funds The aggregate amount of the original endowment gifts (or other level required to be maintained by donor stipulation or by law that extends donor restrictions) The aggregate amount by which the funds are underwater (included in existing standards) The governing board s interpretation of laws affecting the ability to spend from underwater endowment funds The organization s policies for spending from underwater endowment funds Any actions taken by the organization during the period concerning appropriation from underwater endowment funds

5 Major Changes for Nonprofit Organizations Just Around the Corner 5 Liquidity and Availability of Resources Among the key objectives of the ASU project was the need to make it easier for financial statement users to assess the organization s liquidity and to determine the availability of restricted resources to fund general expenditures. As a result, ASU makes significant changes to the amount of required information about liquidity and availability. A nonprofit organization will still be required to provide information about the liquidity of assets or the maturity of liabilities, including the effects of restrictions and self-imposed limits, by: 1. Sequencing assets according to their nearness of conversion to cash and liabilities according to their nearness of use of cash due to maturity 2. Classifying assets and liabilities as current and noncurrent 3. Disclosing any additional relevant information about the liquidity or maturity of assets and liabilities In addition, an organization will be required to disclose qualitative and quantitative information about how the organization manages its liquid resources to meet cash needs for general expenditures within one year of the date of the statement of financial position and whether its financial assets are available to meet those cash needs. Availability of a financial asset may be affected by its nature, by external limits imposed by donors, laws, and contracts with others, and by internal limits imposed by governing board decisions. For example, a receivable that is due in more than one year and most investments of donor-restricted endowments aren t available to meet cash needs within one year. Observation: The ASU doesn t define general expenditures. Because that definition is important to the understanding of whether a financial asset is available to meet cash needs for general expenditures, disclosing the accounting policy for determining what is a general expenditure and whether a financial asset is available to pay general expenditures is an important part of the disclosure. ASU doesn t provide details as to the types of qualitative or quantitative information to include. However, it includes examples of notes that meet the requirements. Collectively, those examples include qualitative disclosures about the following: The organization s responsibility to maintain resources to meet donor-imposed restrictions, which makes those resources unavailable for general expenditures The organization s goals for maintaining financial assets The organization s policies for investing excess cash The organization s policies for spending from board-designated endowment funds Contractual agreements that make certain financial assets unavailable to fund general expenditures, such as trusts established under split-interest gifts or investments that can t be sold due to lock-up provisions Lines of credit that would be drawn down if the organization didn t have any liquid, available financial assets One of the examples provides quantitative information in the form of a reconciliation, as of the financial statement date, of total financial assets to financial assets available to meet cash needs for general expenditures within one year. The reconciling items include amounts for financial assets that aren t available for general expenditures, which are financial assets restricted by donors (time or purpose restrictions), endowment assets subject to appropriation and satisfaction of donor-imposed restrictions, investment assets held in split-interest trusts, board-designated endowment funds, and financial assets held as a liquidity reserve.

6 Major Changes for Nonprofit Organizations Just Around the Corner 6 Another example provides quantitative information in the form of a list of financial assets that are available to meet cash needs for general expenditures. It includes financial assets classified as current in the classified statement of financial position. The note also states that income from donorrestricted endowments is restricted for specific purposes and, therefore, isn t available for general expenditure. The note then gives information on the availability of appropriations from the boarddesignated endowment funds. Organizations that rely on restricted contributions and grants may find that the quantitative disclosures about liquidity and availability of resources paint a stark picture of the organization s financial position. The following disclosures, which are unchanged from the existing requirements, may be combined with the new disclosures: Unusual organization circumstances, such as special borrowing arrangements, requirements imposed by resource providers that cash be held in separate accounts, and known significant liquidity problems The fact that the organization hasn t maintained appropriate amounts of cash and cash equivalents to comply with donor-imposed restrictions Information about significant limits that result from contractual agreements, including the existence of loan covenants A description of the kind of any asset whose use is limited, including information about the nature of the restriction or designation (that is, the amount and purpose) Relevant information about the nature and amounts of restrictions or limitations (including donorimposed restrictions) on the organization s use of cash and cash equivalents Observation: The new disclosures related to liquidity and availability of resources may require information that organizations aren t currently tracking. If so, procedures should be put into place to track that information. More importantly, organizations that rely on restricted contributions and grants may find that the quantitative disclosures paint a stark picture of the organization s financial position. The current financial reporting model doesn t always draw attention to circumstances in which a nonprofit organization fails to maintain an appropriate composition of assets in amounts needed to comply with all donor restrictions. If an organization used restricted resources to pay for expenditures that didn t meet the underlying restriction (in essence, borrowing the resources, sometimes without the ability to restore those resources promptly), the liquidity disclosure will make that situation apparent. If an organization expects the disclosure to indicate that it is in a deficit financial asset position, it may want to focus on actions that will repair its liquidity and availability before the implementation of ASU Expense Reporting ASU expands to all nonprofit organizations the requirement to present an analysis of expenses by functional and natural expense classifications. The information, currently required only of voluntary health and welfare organizations, must be provided in one location on the face of the statement of activities, as a schedule in the notes to the financial statements, or in a separate financial statement. The analysis must disaggregate the functional expense classifications (such as major classes of program services and supporting activities) by their natural expense classifications (such as salaries, rent, electricity, interest expense, supplies, depreciation, awards and grants to others, and professional fees).

7 Major Changes for Nonprofit Organizations Just Around the Corner 7 Observation: To the extent that expenses are reported by other than their natural expense classification (such as salaries included in cost of goods sold or facility rental costs of special events reported as direct benefits to donors), they should be reported by their natural expense classification in the analysis of expenses by nature and function. For example, salaries, wages, and fringe benefits that are included as part of the cost of goods sold on the statement of activities should be included with other salaries, wages, and fringe benefits in the analysis of expenses by nature and function. In addition, certain expenses aren t included in the analysis. For example, external and direct internal investment expenses that have been netted against investment return shouldn t be included. The analysis includes only expenses; therefore, gains and losses are excluded. Organizations must describe the methods used to allocate costs among program and support functions. Organizations must also describe the method(s) used to allocate costs among program and support functions. ASU provides guidance (in the form of examples) on activities that constitute direct conduct or supervision of program activities (and thus are program expenses rather than management and general expenses). There are examples for the costs related to the chief executive officer, the chief financial officer, the human resource department, and for grant accounting and reporting. Observation: Although the term matrix isn t included in the standards, a matrix format is the only method illustrated in the ASU of providing the information. It also would be possible to provide the information in a list form, with headings for the functional expense classifications and line items for the natural expense classifications within each functional expense classification. Statement of Cash Flows ASU continues to permit an organization to choose whether to provide a statement of cash flows using the direct or indirect method of reporting operating cash flows. However, to encourage greater use of the direct method, a presentation of the reconciliation from the change in net assets to cash flows from operating activities is no longer required when using the direct method. There are no changes to the classification of operating, investing, and financing cash flows. Investment Return Although nonprofit organizations generally report the gross amounts of revenues and expenses in the statement of activities, investment return has been an exception. The current option to report investment return net of related expenses has been changed by ASU Instead of permitting an organization to choose whether to net investment expenses against investment return, an organization is now required to do so. Investment return should be reported net of related external and direct internal investment expenses. Observation: External investment expenses include the fees paid to outside investment managers, as well as fees embedded in the investment vehicle (such as mutual funds and hedge funds). Direct internal investment expenses are the costs of the direct conduct or direct supervision of activities involved in generating an investment return. Those include costs associated with the employees responsible for developing and executing the investment strategy, such as salaries, benefits, and travel, as well as other allocable costs associated with internal investment management and selecting, supervising, and monitoring the external investment management firms. Only costs incurred in generating investment return are direct internal investment expenses. For example, the costs associated with unitization and other such aspects of endowment bookkeeping wouldn t be direct internal investment expenses.

8 Major Changes for Nonprofit Organizations Just Around the Corner 8 ASU distinguishes between programmatic investing (making investments that are directed at carrying out the organization s mission) and total return investing (making investments for the production of income and capital gains). Only the investment expenses of total return investing are netted against the related investment return on the statement of activities. It will no longer be necessary to disclose the amount of investment expenses that have been netted. That change was made to provide a more comparable measure of investment return across all nonprofit organizations, regardless of whether the investment activities are managed internally or by outside investment managers, volunteers, or some combination. Observation: The new measure is also more comparable across organizations that invest in mutual funds, hedge funds, or other vehicles for which the management fees are embedded in the investment return of the vehicle. Because the disclosure of the netted expenses is eliminated, the difficulties and related costs in identifying embedded fees are eliminated, and the resulting inconsistencies in the reported amounts of investment expenses are avoided. Other Changes In addition, nonprofit organizations will now be required to: Use the placed-in-service approach to report expirations of restrictions on gifts of cash or other assets to be used to acquire or construct a long-lived asset (in the absence of specific donor restrictions stating otherwise). Previously, the nonprofit organization could choose whether to release restrictions either when the assets were placed in service or over their useful lives. If an organization had adopted a policy to release the restriction over the useful lives of the capital assets, any remaining net assets classified as temporarily restricted will be reclassified as net assets without donor restrictions upon the implementation of ASU Disclose, as of the end of the reporting period, the amounts and purposes of board designations, appropriations, and similar actions that result in self-imposed limits on the use of resources that are free of donor-imposed restrictions. The following self-imposed limits are specifically mentioned: Resolutions to designate a portion of net assets without donor-imposed restrictions to function as an endowment (sometimes called board-designated endowment funds or quasi-endowment funds). Resolutions to designate a portion of net assets without donor-imposed restrictions for a specific future expenditure (called board-designated net assets). Resolutions to designate a portion of net assets with donor-imposed restrictions to function as a board-designated endowment fund. For example, in rare circumstances, the governing board may set aside for long-term investment donor-restricted contributions that the organization is unable to spend in the near term. Observation: ASU also states that if governing boards delegate the power to designate net assets to internal management, those designations are required to be included in board-designated net assets.

9 Major Changes for Nonprofit Organizations Just Around the Corner 9 Transitioning to ASU ASU is to be applied to the financial statements using a retrospective application. The nature of any reclassifications or restatements and their effects, if any, on the changes in net asset classes for each period that is presented is required to be disclosed. However, if comparative financial statements are presented, organizations have the option to omit the following information that relates to periods prior to the adoption of ASU : The analysis of expenses by both their natural and functional expense classifications in one location The new disclosures about liquidity and availability of resources In the first year that ASU is adopted, an organization has the option to omit the analysis of expenses by both functional expense classification and natural expense classification for any comparative prior years presented. Organizations that choose not to present the analysis for the comparative prior years must present a separate presentation of expenses by functional classification and expenses by natural classification. We believe that the easiest way to do this is to present a matrix of expenses for the current year by functional and natural classifications in its typical format (columns for the functional expense classifications and rows for the natural expense classifications, with a total column on the right) and add a column on the right for the prior year s expenses by natural expense classification that agrees in total to the total expenses by functional expense classification on the face of the statement of activities. Observation: Voluntary health and welfare organizations don t have the option to omit the comparative year information since existing standards require them to provide that information currently. However, they may present it in any of the permitted formats, consistent with the presentation in the period of adoption. In the first year ASU is adopted, organizations are also not required to present the qualitative and quantitative information for prior comparative periods about how the organization manages its liquid resources to meet cash needs for general expenditures within one year of the date of the statement of financial position and whether its financial assets are available to meet those cash needs. However, liquidity information required by existing standards must be included for the comparative period(s). Because the new framework in ASU will significantly change the existing financial reporting framework and require new disclosures, there s a lot to be done now to ensure a smooth transition. What Should Nonprofit Organizations and Their Auditors Do Now? Because the new framework in ASU will significantly change the existing financial reporting framework and require new disclosures (including disclosures related to liquidity, board designations, availability of financial assets, and underwater investments), there s a lot to be done now to ensure a smooth transition. Things nonprofit organizations should be doing to prepare include: Revise existing accounting and financial reporting policies and procedures, including ensuring that the organization has documented its functional expense allocation methodology Identify board designations and appropriations Consider changes to existing general ledger accounts Identify required reclassification entries, such as the following: Underwater endowments that the organization netted with unrestricted net assets. Those will need to be reclassified to be netted with net assets with donor restrictions. Restricted assets that include donations of, or contributions restricted for the purchase of, property and equipment and that have an implied (not explicit) time restriction. Those will need to be retroactively reclassified to net assets without donor restrictions.

10 Major Changes for Nonprofit Organizations Just Around the Corner 10 When helping nonprofit organizations manage the implementation of the new framework, auditors should take care not to perform any management functions or make management decisions. Modify financial reporting templates. Draft new financial statement disclosures to identify additional information that new disclosures may require. Consider whether any changes in the financial statements will trigger necessary changes to debt covenants or grant requirements. If you re the auditor of an organization, you may assist in performing some of the previously mentioned activities, such as drafting new financial statement disclosures based on information provided by management. When helping nonprofit organizations manage the implementation of the new framework, you should take care not to perform any management functions or make management decisions. You won t impair your independence with respect to attest services by simply keeping the organization informed about requirements or providing technical assistance, training, or advice on best practices. However, if communication will go beyond answering limited questions, you need to formalize the engagement. According to the AICPA Code of Professional Conduct at ET 1.295, before performing nonattest services, you should establish and document in writing the understanding with the client regarding the following: the objectives of the engagement, the services to be provided, the client s acceptance of its responsibilities (which include appointing an individual with suitable skills, knowledge, and/or experience to oversee the nonattest services), your responsibilities as the auditor, and any limitations of the engagement. Those items can be documented in an engagement letter or internal firm file. The auditor should also consider whether multiple nonattest services are being provided and whether the cumulative services create a threat to independence. Observation: The AICPA has provided a nonattest services toolkit (available at www. aicpa.org/interestareas/professionalethics/resources/downloadabledocuments/ ToolkitsandAids/Nonattest-Services-Toolkit.pdf) and an FAQ Document (available at www. aicpa.org/interestareas/professionalethics/resources/tools/downloadabledocuments/ NonattestServicesFAQs.pdf) that may be helpful. If you aren t going to be able to meet the requirements of ET (for example, the nonprofit organization doesn t have anyone with the skills, knowledge, and/or experience to oversee the nonattest services, or the nonprofit organization can t accept responsibility for the nonattest services), then the nonprofit organization might need to hire a separate CPA to help with the implementation of ASU (and possibly other accounting standards on the horizon such as ASU on leases) so that you can maintain your independence. Observation: Sometimes the responsible person with the skills, knowledge, and experience and able to accept responsibility for the nonattest services may be a volunteer board member who is willing to be involved in overseeing the nonattest service.

11 Major Changes for Nonprofit Organizations Just Around the Corner 11 Recommended Guidance, Resources and Solutions PPC s Guide to Preparing Nonprofit Financial Statements PPC s Guide to Preparing Nonprofit Financial Statements will help you skillfully prepare nonprofit financial statements in accordance with the latest professional requirements. It takes you from the trial balance to the completed financial statements (including notes) in accountby-account, statement-by-statement sequence. PPC s Guide to Nonprofit GAAP The challenge of interpreting and implementing the authoritative literature comprising nonprofit GAAP is greater today than at any time in recent history. PPC s Guide to Nonprofit GAAP helps you meet that challenge. The format of our Guide allows you to locate answers quickly and easily. You ll get content that s arranged alphabetically in an easy-to-use topical format as well as clear and concise coverage of the FASB Accounting Standards Codification (ASC) and recent Accounting Standards Updates affecting nonprofit organizations. PPC s Guide to Audits of Nonprofit Organizations Nonprofit organizations may require compilations, reviews, audits, or Single Audits. PPC s Guide to Audits of Nonprofit Organizations includes tailored practice aids to help you perform audits and engagements for your nonprofit clients in accordance with professional standards. The PPC Nonprofit Update Newsletter It s important to stay current on issues impacting nonprofit organizations throughout the year. PPC s Nonprofit Update is the only monthly newsletter that covers accounting, auditing, and tax issues affecting nonprofit organizations. This six-page, monthly newsletter will keep you up-to-date on current developments and show you how to apply the newest accounting, auditing, and tax rules and regulations. PPC s SMART Practice Aids Audit Suite Transform your engagement process and make your audits work smarter with the SMART Practice Aids Audit Suite. This fully automated and intuitive suite brings together our award-winning and patented risk-based audit approach so it is easier than ever for you to maximize audit efficiency. Checkpoint Learning Online Course: TCJA and Nonprofits with Endowments The TCJA contains significant changes for many tax-exempt entities effective January 1, It is important that practitioners be aware of the changes to properly advise both tax-exempt entities and donors. Checkpoint Learning Online Course: Impact of the New Nonprofit Reporting Model This course covers the overall goals and the types of nonprofit entities affected by ASU , Presentation of Financial Statements of Not-for-Profit Entities. It will also clarify impacts the new reporting model will have for net asset classification, look at enhancements made for the basic financial statements and what practitioners can expect in terms of certain disclosures.

12 About the Authors The Internal Accounting and Auditing Editorial Team at Thomson Reuters Susan Weiss Budak CPA, consultant and contributing author to PPC s Guide to Preparing Nonprofit Financial Statements. Thomson Reuters Thomson Reuters is the world s leading source of news and information for professional markets. Our customers rely on us to deliver the intelligence, technology, and expertise they need to find trusted answers. The business has operated in more than 100 countries for more than 100 years. Thomson Reuters shares are listed on the Toronto and New York Stock Exchanges (symbol: TRI). For more information, visit tr.com. Thomson Reuters Checkpoint Thomson Reuters Checkpoint tackles market disruption through integrated research, editorial insight, productivity tools, online learning, and news updates along with intelligent links to related content and software. It is relied on by hundreds of thousands of tax and accounting professionals and counts among its customers 97 of the Top 100 U.S. law firms, 99 of the Fortune 100 companies, and all of the top 100 U.S. CPA firms. For more information, visit tax.tr.com/checkpoint. Contact us today: Visit tax.tr.com TA569366_July 2018 _pd