Not-for-profit financial statements will receive a significant overhaul with the release of the Financial Accounting Standards Board (FASB)’s Accounting Standards Update (ASU) 2016-14, Not-for-Profit Entities (Topic 958) Presentation of Financial Statements of Not-for-Profit Entities. The ASU brings several changes, including the consolidation of net asset classes and enhanced disclosures regarding those net asset classes and governing board designations. In the second part of our series, we’ll look at these changes in more detail.
Currently, under U.S. Generally Accepted Accounting Principles (GAAP), not-for-profits classify their assets as one of three types: unrestricted, temporarily restricted and permanently restricted. Donor restrictions, or lack of restrictions, dictate asset classification.
Permanently restricted net assets reflect the historical value of gifts subject to donor-imposed stipulations, which require the corpus to be invested in perpetuity with the income produced used for general or specific purposes.
Temporarily restricted net assets are those assets whose use is limited by law or donor-imposed stipulations that will either expire with the passage of time or be fulfilled by actions of the organization.
Unrestricted net assets are not subject to donor-imposed stipulations.
Determining whether an asset is permanently restricted or temporarily restricted can be complicated for not-for-profits, depending on the complexity of donor intentions. The distinction between permanent and temporary restrictions has also been clouded by changes in state laws. Additionally, the term “unrestricted net assets” can be misleading as some funds without donor-imposed restrictions are earmarked for a specific purpose by the not-for-profit’s governing board, thus limiting their use for general operating purposes.
How the New Standard Addresses These Issues
The ASU replaces the three net asset classification structure (permanently, temporarily and unrestricted net assets) with a two net asset classification structure (net assets with donor restrictions and net assets without donor restrictions). This change is meant to reduce complexity and increase understandability of not-for-profit financial statements, while providing more relevant and useful information about an organization’s resources and changes in those resources that may be helpful to financial statement users.
The ASU defines net assets with donor restrictions as net assets subject to limitations, and the definition clarifies that donor restrictions include grants restricted for a specified use. Net assets with donor restrictions will also come with enhanced disclosures about the composition of net assets, the nature of the restrictions and how those restrictions limit the use of net assets.
For donor-restricted capital assets without specific stipulations about how long the donated capital asset must be used, not-for-profits will use a placed-in-service approach for reporting expirations of donor restrictions to acquire or construct long-lived assets. Organizations will reclassify net assets with donor restrictions to net assets without donor restrictions when the long-lived assets have been placed in service.
Simplifying the number of net asset classes from three to two also streamlines reporting. Not-for-profit entities will present in the statement of activities the change in the two net asset classes and continue to report the change in total net assets for the period.
Governing Board Designations
To address the confusion about other types of restrictions placed on net assets without donor restrictions, the new standard also contains additional guidance about board-designated use of funds. The ASU clarifies that board-designated endowment funds include net assets without restrictions that the board has invested to provide income for a long period that is not necessarily specified.
All net assets with board designations will require enhanced disclosures about the amounts and purpose of the governing board designations and appropriations.
Net Asset Evaluation Will be Required
To meet the new requirements, not-for-profits should carefully review their net assets and their board designations and determine which net assets or processes might be affected by the ASU. Organizations may want to do a “mock-up” of what their new statement of financial position, statement of activities, as well as net asset disclosures may look like under the new standard and review these changes with their external auditors, board members, grantors, debtors and other stakeholders to ensure understandability and agreement.
Further discussion of the changes to not-for-profit financial statements will be forthcoming. Up next in our series, we will discuss changes to the presentation of a not-for-profit’s operating cash flows.
If you have any comments, questions or concerns about not-for-profit financial statement reporting, please contact us.
Michelle Spriggs is a Shareholder in the Not-For-Profit & Education Practice. She can be reached at 774.206.8336 or MSpriggs@cbiztofias.com.
Copyright © 2016 CBIZ Tofias & MHM (Mayer Hoffman McCann P.C.). All rights reserved. CBIZ Tofias & MHM are separate and independent legal entities that work together to serve clients. CBIZ Tofias is a leading provider of tax and consulting services. MHM is an independent CPA firm providing audit and other attest services. This article is protected by U.S. and international copyright laws and treaties. Use of the material contained herein without the express written consent of the firms is prohibited by law. Material contained in this alert is informational and promotional in nature and not intended to be specific financial, tax or consulting advice. Readers are advised to seek professional consultation regarding circumstances affecting their business.