Financial Statement Changes for Non-Profit Organizations Bob Kollar Assistant Professor of Accounting, Duquesne University Shareholder, KuhlemanKollar & Associates, CPAs
Workshop Description The Financial Accounting Standards Board (FASB) recently issued new financial reporting guidance for Not-for-Profit Entities. Additionally, the FASB has recently issued new reporting standards for leases and revenue recognition. Both of these will have a significant impact on all organizations. This session will review and discuss these new accounting rules and provide suggestions on how to prepare your organization and board for these major reporting changes. Agenda Background on changes to the Non-Profit Reporting Model Review of the specific changes to Non-Profit financial statements: a) Net asset classification b) Endowment funds c) Liquidity and availability of resources disclosures d) Investment return e) Expense reporting f) Implementation considerations Other changes Leases and Revenue Recognition More changes ahead proposals on grant and contribution accounting
Learning Objectives At the conclusion of the workshop, attendees should: a) Have a general understanding of the major changes impacting Non-profit financial statements b) Be familiar with the changes in net asset categories and how this will impact an organization s financial statements c) Be knowledgeable of the new required disclosures regarding liquidity and availability of financial resources d) Be familiar with the new accounting rules for leases and revenue recognition e) Understand what steps to begin taking now to implement the new accounting standards Historical Background FASB s last major changes to the Non-Profit Financial Reporting Model occurred in the mid-1990 s The historically used fund balance was replaced with three categories of Net Assets, along with major changes to contribution accounting. 2009 in response to questions, inconsistencies, confusion, perceived deficiencies and concerns from users and non-profit organizations, FASB s Non-Profit Advisory Council began discussing possible changes to the Non-Profit Financial Reporting Model The new financial reporting model was issued in August 2016, and updates Accounting Standards Codification (ASC) section 958 (Only 264 pages!!) Goal: enable non-profits to tell their financial story in a more understandable manner.
Historical Background The new rules issued in August 2016 are Phase I of the review of the financial reporting model Effective date of the new standard is fiscal years beginning after 12/15/2017 (calendar year 2018 if your organization has a December 31 year-end) Phase II of the review of the financial reporting model ON HOLD Phase II is to review: consideration of an operating measure, certain items in the cash flow statement, and potential changes for non-profit health care entities Additionally, FASB just released in August 2017 proposed rules on the accounting treatment of grants and contributions. Would not be effective until calendar year 2020. Changes in Net Asset Classification
Net Asset Reporting Changes Current GAAP requires reporting of three categories of net assets: a) Unrestricted b) Temporarily restricted c) Permanently restricted New rules will require only two categories of net assets, with additional disclosures a) Without donor restrictions adding amount, purpose and nature of any board designations b) With donor restrictions disclosing the nature and amount of donor restrictions Current Financial Statement Presentation Net Asset Classifications
New Presentation Net Asset Classifications New Presentation Net Asset Classifications What if your organization has board-designated net assets? FASB added a definition to its master glossary: Net assets without donor restrictions subject to self-imposed limits by action of the governing board Board designated net assets may be earmarked (by the board) for future programs, investment, contingencies, purchase or construction of fixed assets, or other uses Some governing boards may delegate designation decisions to internal management. Such designations are considered to be included in board-designated net assets. Two possibilities for presentation of board-designated funds: A. Disclose on the face of the balance sheet B. Present in the footnotes information regarding the designations
New Presentation Net Asset Classifications Presentation on face of the statement of financial position: NET ASSETS Without donor restrictions: Undesignated $3,057,607 Board designated for operating reserve 300,000 Board designated for endowment 15,511,186 Invested in PP&E, net of related debt 21,150,885 With donor restrictions: $40,019,678 Perpetual in nature 22,864,750 Purpose restrictions 14,228,316 Time restricted for future periods 1,392,825 38,484,891 Total net assets $78,504,569 New Presentation Net Asset Classifications Presentation of information regarding designations in the footnotes: Non-Profit XYZ s governing board has designated, from net assets without donor restrictions, net assets for the following purposes as of June 30, 20xx: Board-designated endowment $15,511,186 Operating reserve 300,000 Total designated 15,811,186 Unrestricted and undesignated 24,208,492 Total net assets without donor restrictions $40,019,678
Composition of Restricted Net Assets Current Presentation (footnotes) Current format includes footnote disclosure showing the composition of restricted net assets, such as: Restricted net assets as of December 31 consist of the following: Temporarily restricted net assets: Future capital improvements $34,189,000 Instructional support 13,959,000 Operational and program support 14,873,000 Permanently restricted net assets: $63,021,000 Endowment 70,381,000 $133,402,000 New Presentation Net Assets With Donor Restrictions (footnotes) Net assets with donor restrictions are restricted as follows: Subject to expenditure for specific purpose: Future capital improvements $34,189,000 Institutional support 13,959,000 Subject to passage of time 14,873,000 Subject to spending policy and appropriation: Investments in perpetuity: Program A 11,678,000 Program B 5,987,000 Any activities of the organization 52,716,000 $133,402,000
New Presentation Statement of Activities Currently, the Statement of Activities is a multicolumn presentation of the financial activity within each of the three categories of net assets: unrestricted, temporarily restricted and permanent restricted. Under the new standard, the Statement of Activities will mirror the two new categories of net assets: without donor restrictions and with donor restrictions. Example on the next slide. Statement of Activities New Presentation
Current Presentation Net Assets Released from Restrictions (footnote disclosure) Currently, provide disclosure of amounts net assets released from temporary restrictions, as follows: Net assets released from temporary restriction during the fiscal year consisted of the following: Scholarships $5,789,000 Institutional support 1,645,000 Capital improvements 1,106,000 Other 35,000 $8,575,000 New Presentation Net Assets Released from Donor Restrictions (footnote disclosure) Net assets released from donor restrictions by incurring expenses satisfying the restricted purpose, occurrence of the passage of time or other donor specified events during the year ending December 31 are as follows: Purpose restrictions accomplished: Scholarships $3,456,000 Capital improvements 1,146,000 Institutional support 879,000 Release of appropriated endowment amounts without purpose restrictions 35,000 Release of appropriated endowment amounts with purpose restrictions 3,059,000 $8,575,000
Endowment Funds Key changes: a) Requires any underwater amounts to be included in net assets with donor restrictions (previously reported in unrestricted) b) Must disclose the market value of the underwater assets c) Disclose whether the organization has the ability to spend from underwater funds and any current appropriations from such funds Example: Donor gift of $1.0 million; donor specifies organization can use investment earnings as long as value of gift is maintained at $1.0 million. Value drops to $950,000; the fund is now underwater. Disclose if the organization used other unrestricted funds to continue the purpose of the donor s gift until such time as the original investment recovers. Could also result if the current market value falls below the original gift amount; must also review donor specifications if this would occur. Liquidity and Availability of Resources
Liquidity and Availability of Resources Objective is to provide users with a better understanding of the organization s liquidity and financial flexibility Interesting parallel to disclosures required by public companies (MD&A) Key Changes: a) Qualitative Disclosure in the footnotes about how the organization manages its liquid resources b) Quantitative disclosure in the notes regarding: i. Amounts available to meet cash needs for general expenditures within one year of the statement of financial position date ii. Discussion of factors that may impact the availability of financial resources to meet general expenditures Liquidity and Availability of Resources Considerations in developing this disclosure: a) Does your organization have a liquidity management plan? b) Does your organization have a liquidity reserve (operating reserve)? If yes, how accessible are the funds in the liquidity reserve? Can they be accessed to meet cash needs of general expenditures in the next 12 months? c) Does the organization have a line of credit that can be drawn upon during the year? d) Are there seasonal fluctuations in the timing of cash flows received from grants or contributions?
Liquidity and Availability of Resources (Continued) Additional considerations about disclosures: e) Nature of the financial assets f) External limitations imposed by donors, laws, contracts, etc. g) Internal limits imposed by board decisions Qualitative Liquidity Disclosure Example XYZ Non-Profit utilizes a 60-day time horizon to assess its immediate liquidity needs. This period of time was established based upon managements review of the typical cycle of converting its financial assets to cash and the typical payments of its trade payables and expenses such as payroll, etc. The entity invest cash in excess of its daily requirements in short-term investments.
Qualitative Liquidity Disclosure Example (Continued) Occasionally, the Board designates a portion of any operating surplus to its liquidity reserve. As of June 30, 20xx, the liquidity reserve was $25,000. This is a governing board designated fund with the objective of setting funds aside that can be drawn upon in the event of financial distress or an immediate liquidity need resulting from events outside the organization s typical cycle of converting financial assets to cash or settling financial liabilities. In the event of an unanticipated liquidity need, XYZ could also draw upon its $100,000 available line of credit (as further discussed in Note x) or its boarddesignated endowment fund. Quantitative Liquidity Disclosure Example Financial Assets, at year-end $279,200 Less: Contractual or donor-imposed restrictions making financial assets unavailable for general expenditures (192,413) Quasi-endowment fund, primarily for long- term investing (34,628) Amounts set aside for liquidity reserve (25,000) Financial assets available within one year to meet cash needs for general expenditures within one year $27,159
Additional Quantitative Disclosures Organizations presenting a classified statement of financial condition can provide footnote disclosure discussing its liquidity management practices and the composition of its financial assets. Example: XYZ Non-Profit s financial assets due within one year of the statement of financial position date available for general expenditure are as follows: Cash and cash equivalents $4,575 Accounts and interest receivable 2,130 Contributions receivable 1,825 Short-term investments 1,400 Other investments appropriated for current use 1,650 $11,650 Liquidity Disclosures Impact of the Changes All non-profits are required to present the liquidity and availability of resources disclosures Greater requirements for organizations not using a classified balance sheet; may want to consider (if practical) Non-profits in financial distress will need to give careful consideration to their disclosures in this area Consider impact and response by users of the financial statements upon reviewing this disclosure
Investment Returns Reporting of Investment Returns New rules allow net presentation of investment return Previous requirement to disclose gross investment income and expenses has been removed; investment expenses can be netted against investment earnings and appreciation Will require re-classification of prior year amounts for comparability Organizations can voluntarily disclose gross investment income and expense Investment expenses includes both EXTERNAL (such as investment managers) and direct INTERNAL (salaries and related costs of a staff responsible for investment monitoring and strategy)
Expense Reporting New Requirements for Expense Reporting Must present an analysis of expenses by function and nature in one location in the financial statements Options: a) In the Statement of Activities b) In a separate statement c) In the notes to the financial statements Requires disaggregation of functional expense classifications by their natural expense category Must include a description of method used to allocate costs among programs and supporting functions
New Requirements for Expense Reporting See separate handout showing the different options for reporting expenses Defining Functional Expenses Program services expenses activities that result in goods and services being distributed to the non-profits beneficiaries, customers or members in support of their mission Supporting activities all other activities of the non-profit other than program services, such as: a) Management and general activities b) Fundraising activities c) Membership development activities
Management and General Expenses--Examples General oversight and business management Record-keeping and payroll Budgeting Financing Contract administration, including billing and grant reporting Production of the annual report Human resources function Other management and administrative expenses, except for conduct of program services, fundraising activities or membership development Additional Guidance on Management and General Expenses Activities conducted that are directly related to programs or direct supervision of those programs or supporting activities should be allocated from management and general Examples: a) IT benefits various functions and should be allocated b) CEO could be allocated to programs, fundraising and management and general c) Human resources function generally assigned all to management and general d) Grant Accounting and reporting program specific reports (program) but financial reports and related accounting are management and general
Example Footnote Disclosure The organization s expenses are summarized and categorized based upon their functional classification as either program or supporting services. Specific expenses that are readily identifiable to a specific program or activity are charged directly to that function. Certain categories of expenses are attributable to more than one program or supporting function. Certain categories of expenses are attributable to more than one program or supporting function. Therefore, these expenses require allocation on a reasonable basis that is consistently applied. Allocated expenses include depreciation and amortization, interest and insurance, which are allocated on the basis of square footage, as well as salaries, wages and related employee benefits, which are allocated based on estimates of employee time and effort. Statement of Cash Flows Can continue to use either direct or indirect method If using direct method, no longer required to include indirect method reconciliation
Implementation Considerations New Financial Reporting Model Implementation Considerations Effective date fiscal years beginning after December 15, 2017 Auditor s report in the year of adoption, may include an emphasis of matter paragraph referencing the adoption of the new reporting model Early adoption is permitted; not necessary to re-state Analysis of Expenses by function for prior year and may exclude liquidity and availability of resources discussion for prior year Review significant agreements that may have an impact on the organization s liquidity or ability to meet its obligations, such as loan agreements, donor agreements, contracts, etc.
Implementation Considerations (Continued) Review board-designated/internal endowment policies and update if needed Review methodologies for allocation of management and general expenses for reasonableness and accuracy Begin to educate your board on the changes that are forthcoming Talk with your CPA firm now and ask for their input on any specific areas that your organization should address as you plan the transition Other Changes Leases and Revenue Recognition
Other Changes Leases After over ten years of review, in February 2016 FASB significantly changed the accounting requirements for leases (ASC Topic 842) The most significant change in lease accounting is the recognition of lease assets and lease liabilities by lessees for leases classified as operating leases. Existing GAAP accounted for these types of leases on a pay as you go basis. This means that operating leases will now appear on the statement of financial position! Capital leases will now be referred to as finance leases and the determination of operating vs finance will require more judgement (no percentage tests, etc.) Other Changes Leases How changes in lease accounting for operating leases will affect the Statement of Financial Position A. Assets: 1. At inception of the lease, lessee will recognize in its statement of financial position a right-of-use asset initially measured at the present value of the lease payments over the lease term 2. The right-of-use (ROU) asset will then be amortized over the lease term on a straight-line basis B. Liabilities: 1. At inception of the lease, lessee will recognize in its statement of financial position a lease liability initially measured at the present value of the lease payments over the lease term 2. As payments are made on the lease, the liability will decrease and the interest component of the payment will be treated as part of amortization expense
Other Changes Leases Financing Leases: At lease inception, lessees will record a right-of-use (ROU) asset measured at the present value of the total lease payments, including any purchase options The ROU will be amortized over the useful life of the underlying asset At lease inception, lessees will record a lease liability will be recorded, measured at the present value of the total lease payments (as above). As payments are made, interest expense will be recognized over the lease term (similar to current treatment). Minimal changes for this type of lease for the lessor Implementation Tips New Lease Standard Effective date for most NPO s, will be for fiscal years beginning after December 15, 2019 However, for NPOs that have issued registered debt securities, effective date is one year earlier, for fiscal years beginning after December 15, 2018 Implementation of the new standard could have significant impact on financial metrics and ratios, such as the current ratio or other measures of liquidity or financial solvency Assemble a current inventory of your leases; develop some pro-forma financial statements to ascertain the impact of the new standard Discuss with financial statements users (board, lenders, significant donors) the effect of the new standard
Other Changes Revenue Recognition In 2014, FASB passed new guidance on revenue recognition, specifically Revenue From Contracts with Customers (updating ASC Topic 606) The standard applies to any entity that either enters into contacts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets, unless those contracts are within the scope of other standards (such as insurance or lease contracts) Revenue Recognition Five Step Model: 1. Identify the contract with the customer 2. Identify the performance obligations in the contract 3. Determine the transaction price 4. Allocate the transaction price to the performance obligations in the contract 5. Recognize revenue when (or as) the entity satisfies a performance obligation
Revenue Recognition The most significant ramifications for non-profits relates to grants and contracts and exchange transactions. NPO s should START NOW to review these new rules, specifically by reviewing existing contracts. Identification of performance obligations, especially if there are multiple obligations in a given contract, could result in significant changes in how revenue will be recognized in the future. FASB is currently reviewing revenue recognition for exchange transactions and contributions and just released (August 2017) proposed guidance on how to account for these. Proposed Changes Exchange Transactions and Contribution Accounting In Early August 2017, the FASB issued an exposure draft entitled Not-for-Profit Entities: Clarifying the Scope and the Accounting Guidance for Contributions Received and Contributions Made. FASB s primary reason for issuing the proposed new rules is because stakeholders reported difficulty in characterizing grants and similar contracts with resource providers as either exchange transactions or contributions. Difficulties were also reported in distinguishing between conditional and unconditional contributions when applying the existing revenue recognition rules for Not-for-Profits.
Proposed Changes Exchange Transactions and Contribution Accounting Is it an exchange transaction or a contribution??? Contribution an unconditional transfer of cash or other assets to an entity or a settlement or cancellation of its liabilities in a voluntary nonreciprocal transfer by another entity acting other than as an owner. Exchange transactions are reciprocal transfers in which each party receives and sacrifices approximately commensurate value. Both grants and contributions will require close scrutiny to determine the appropriate accounting treatment. Unconditional Promises vs. Conditional Promises Not-for-Profit entities will still need to evaluate whether a contribution is unconditional or conditional. Generally, a donor-imposed condition(s) to receive a contribution represent barriers that must be overcome before the recipient shall be entitled to receive the promised transfer of assets (and therefore record as contribution revenue). See handout on reviewing treatment of contributions
Proposed Changes Exchange Transactions and Contribution Accounting Determination of an exchange transaction, consider: Does the resource provider receive any direct value in exchange for the assets transferred? Is the expressed intent of the resource provider and the recipient to exchange resources for goods and services that are of commensurate value? If resource provider has full discretion in determining amount of the transferred assets, treat as a contribution. If the recipient and resource provider agree on amount of assets transferred in exchange for goods or services are of commensurate value, indicative of exchange transaction. Proposed Contribution Accounting Must still consider conditional vs. unconditional in evaluating contributions After a contribution has been determined to be unconditional, the entity must consider whether or not the contribution is restricted (i.e., contains a donor-imposed restriction). A donor-imposed condition must have: a) A barrier b) A right of return to the promisor for assets transferred, or a right of release of the promisor from its obligation to transfer assets Must be determinable from the agreement that the recipient is only entitled to the gift if the barrier has been overcome.
Proposed Contribution Accounting The determination of the existence of a barrier is a facts and circumstances test. Some examples: a) Measurable performance related barrier or other measurable barrier b) Stipulations that are related to the purpose of the agreement c) Limited discretion by the recipient over the how transferred assets should be spent d) Additional actions required by the recipient this may be indicative of a conditional contribution QUESTIONS???
Contact Information Bob Kollar, CPA/CGMA Assistant Professor of Accounting Duquesne University kollar@duq.edu 412.396.4906 Shareholder KuhlemanKollar & Associates, CPAs bob@kkacpas.com 412.221.8585 References Financial Accounting Standards Board, Exposure Draft Proposed Accounting Standards Update, Issued August 3, 2017. Not-for-Profit Entities. Financial Accounting Standards Board, Accounting Standards Codification, Not-for-Profit Entities (ASU No. 2016-14, Topic 958) AICPA Example Illustrative financial statements and related disclosures for not-for-profit entities (www.aicpa.org)