The required implementation of Accounting Standards Update (ASU) 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities is nearing. The ASU becomes effective for entities’ fiscal years beginning after December 15, 2017. While many of the required changes are to the appearance of the financial statements and will not affect how you record and track transactions in your accounting system, they may influence how your stakeholders perceive the strength of your organization. After all, one of the primary objectives of the ASU is to increase the usefulness of the financial statements to donors and creditors by giving them information that speaks to the appropriate use of their resources. Highlighted below are the requirements of the ASU that we believe deserve some advance consideration.
Under the ASU, specific quantitative and qualitative information on liquidity and availability of assets must be disclosed. Quantitative information will communicate the availability of current financial assets at the statement of financial position date to meet cash needs for general expenditures within one year. Qualitative information will address how you manage such liquid resources and your liquidity risk.
The following is a statement of financial position and example liquidity disclosure:
You should start thinking about what this disclosure might look like for your organization and about what message it could send to those who read your financial statements. After considering that the availability of your financial assets may be affected by the nature of the assets, external limits imposed by grantors, donors, laws or contracts with others, and internal limits imposed by governing board decisions, you may find that the information communicated is not necessarily desirable. On the other hand, perhaps, it is overly desirable and therefore, grantors and donors may not see a need to further fund your operations. The goal is to spend time now determining what is desirable and to take action on methods of getting to where you want to be ahead of the required disclosures. Some strategies to improve liquidity may include obtaining an operating line of credit from a bank, removing unnecessary internal designations placed on funds, or drafting and complying with an operating reserve policy.
INTERNAL NET ASSET DESIGNATIONS
In addition to disclosing the effects of internal designations on liquidity as previously described, the ASU will require that you provide more information on net assets without donor restrictions subject to self-imposed limits. Additional disclosures with respect to board-designated net assets will include the amount, purpose, and type of designation. Board-designated net assets are often earmarked for future programs, investment, contingencies, purchase or construction of fixed assets, or other uses by formal board action.
In advance of implementation, you will want to evaluate your board-designated net assets. Designations may be removed by board action if you determine that a designation is no longer necessary. You should also give careful consideration to future designations as you will be required to properly track these amounts and their related purposes to meet the ASU’s disclosure requirements, and they will be more specifically outlined for the readers of your financial statements.
The ASU introduces a requirement to present expenses by nature (e.g., salaries and wages, professional services, utilities) and function (e.g., program, management and general, and fundraising) in a single location in the financial statements. Additionally, disclosures must include methods used to allocate costs that are attributable to more than one program or supporting function. The ASU clarified that only activities that represent direct conduct or direct supervision of program or other supporting activities require allocation from management and general activities. For example, a CFO’s responsibilities usually benefit the entire entity rather than specific programs, so the CFO’s compensation and benefit costs would remain a component of management and general.
You should assess your current allocation methods to determine appropriateness both in relation to direct conduct or supervision and in relation to reasonableness in relation to program or other supporting activities’ usage/benefit. You will want to avoid assigning arbitrary percentages to allocations and instead calculate percentages based on meaningful current data (e.g. square footage of space, employee time tracking, etc.). The ASU expense requirements will create more transparency and comparability between organizations, so you will want to ensure you are detailed and accurate in your tracking and reporting.
An underwater endowment is defined as a donor-restricted endowment fund for which the fair value of the fund at the reporting date is less than either the original gift amount or the amount required to be maintained by the donor or by law. Under the ASU, the entire balance of the endowment fund will be reported within the “with donor restrictions” class of net assets. Disclosure of your interpretation of your ability to spend from underwater endowment funds, your policy, and any actions taken during the period, concerning appropriation from underwater endowment funds, and fair value, the amount required to be maintained, and net deficiency of underwater endowment funds will be required.
If you have endowment funds, you should consider drafting and adopting a policy to address the spending or appropriation of underwater endowment funds.
Advance attention to the impact of these specific ASU requirements will guarantee that you are prepared to tell your organization’s financial story in the most impactful and beneficial manner. Should you have any questions, please contact a member of HBE’s Nonprofit Specialty Team at (402) 423-4343.