Not-For-Profit Financial Reporting: It’s Time for a Change

by Julleen Snyder, CPA | Nov 08, 2017
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Twenty four years ago, I was a fairly new CPA transitioning from one of the “Big Eight… Six… Four” firms to a role as controller at a not-for-profit medical research organization. I later returned to public accounting to focus on serving the needs of the not-for-profit community. However, at the time, this was a big change for me and the financial accounting standards for not-for-profit entities were also experiencing a big change.

In June 1993, the FASB issued Statement #117 Financial Statements of Not-for-Profit Organizations. This standard introduced us to the concept of donor-restricted net assets, both temporarily restricted and permanently restricted, and we have been reporting under this standard ever since. Fast forward to August 2016. The financial accounting standards are now codified and FASB issued Accounting Standards Update No. 2016-14 Not-for-Profit Entities, the first major change to financial reporting for not-for-profits since 1993. Time for old and young dogs to learn a few new tricks. Are you ready?

The effective date of the new standard is for fiscal years beginning after December 15, 2017. For example, the standard must be implemented for calendar years ending December 31, 2018 or fiscal years ending June 30, 2019 although early implementation is permitted. However, the standard may not be implemented piecemeal. All relevant requirements must be implemented in the same year.

There are seven main impacts of the new standard:

  1. Change in presentation of net assets from three classes to two classes;
  2. Enhanced disclosure relating to both classes of net assets;
  3. Additional disclosure regarding qualitative and quantitative aspects of liquidity;
  4. Option to eliminate indirect cash flow reconciliation when direct method cash flow is presented;
  5. Required presentation of both natural and functional classification of expenses, as well as enhanced disclosure of expense allocation methodologies;
  6. Change in presentation and disclosure requirements for investment expenses; and
  7. Elimination of the “over-time” release method for restrictions relating to long-lived assets.

Change in Presentation of Net Assets from Three Classes to Two Classes

First, and most significant, is the change from three classes of net assets (unrestricted, temporarily restricted and permanently restricted) to two classes (net assets with donor restrictions and net assets without donor restrictions). Although the terms unrestricted, temporarily restricted and permanently restricted are not new, they continue to be the source of significant confusion to financial statement users. This confusion was exacerbated by the adoption of the Uniform Prudent Investment of Institutional Funds Act (UPMIFA), which blurs the lines between the net asset classes included within endowment funds. Therefore, the revised standard calls for net assets and change in net assets to be shown as either Net Assets without Donor Restriction or Net Assets with Donor Restriction, further emphasizing that only donor restrictions are contemplated in the restricted net asset class.

But wait. Before you start reducing the level of tracking you currently maintain for your restricted net assets, be aware that there are enhanced disclosure requirements with respect to the nature and availability of donor restricted funds that will likely mean you will continue tracking restrictions in much the same way you do now.

For example, you will still need to disclose the amount of board-designated or quasi-endowment funds (net assets without donor restriction) separately from donor-restricted endowment funds (net assets with donor restriction). Although you no longer have to remove underwater endowments from net assets with donor restrictions, you will need to disclose the fair value of the underwater endowment funds, the amount of the original endowment gift, and the amount of the deficiencies of the underwater funds. Therefore, you will still need to track the original gift balance separately from the accumulated investment earnings, even though the break-out only needs to be disclosed if the fund goes underwater.

Enhanced Disclosure Relating to Both Classes of Net Assets

There are additional disclosure requirements with respect to any governing board designations, appropriations, or similar actions that result in self-imposed limits on the use of resources without donor restrictions. While many not-for-profits have voluntarily disclosed this type of information in the past, it will now be a requirement. As such, it is important that the actions of the governing board with respect to such activities are clearly documented, preferably in the minutes to the meetings of the governing board.

Additional Disclosure Regarding Qualitative & Quantitative Aspects of Liquidity

The next most significant new requirement is the enhanced disclosure regarding qualitative and quantitative aspects of the organization’s liquidity. The qualitative portion of the disclosure focuses on how the not-for-profit manages its liquidity to meet short-term demands for cash. This could include operating reserve policies, cash management practices and/or availability of credit (line of credit). The quantitative portion of the disclosure calculates a measure of the availability of the not-for-profit’s financial assets to meet cash needs for general expenditures within one year of the balance sheet date.

The calculation of availability can be affected by the nature of the financial assets (external limits imposed by donors, grantors, laws, contracts with others, etc.) or internal limits imposed by governing board decisions. I suggest that all not-for-profits start calculating the available financial asset measure now so that if any changes are needed, action can be taken prior to implementation of the new standard.

Option to Eliminate Indirect Cash Flow Reconciliation When Direct Method Cash Flow Is Presented

During the deliberation of the exposure draft of the new standard, there was discussion of requiring not-for-profit organizations to use the direct method cash flow statement. However, as for-profit entities are not required to use the direct method, it did not seem appropriate to require not-for-profits to do so. The direct method, however, is the preferred method, as it is generally easier for non-accountants to understand. Under the new standard, if the direct method is presented, the presentation of the indirect reconciliation becomes optional.

Required Representation of Natural & Functional Classification of Expenses & Enhanced Disclosure of Expense Allocation Methodologies

The goal of the remaining aspects of the standard is to improve comparability across not-for-profit financial statements by addressing certain variance in practice. The impact of these changes, if any, on your organization’s financial statements will depend on your current practice.

The statement of functional expenses, which shows both the natural and functional categories of expenses, has long been a required statement for voluntary health and welfare organizations. All other not-for-profit organizations have been required to report expenses by function, either on the face of the statements or in the notes.

However, due to the value of this information to users of the financial statements, many organizations have chosen to report expenses in a functional statement format as a basic statement, in the notes, or as a supplemental statement. The new standard does not technically require a statement of functional expenses, which is generally a columnar statement reporting natural classification down the side and the functions as columns.

However, it does require that the nature and function of expenses be shown in the same location, either on the face of the statement of activities, as a separate statement, or in notes. As the traditional statement of functional expenses is an easy way to accomplish this requirement, I anticipate that many not-for-profits will opt to include this statement.

Change in Presentation and Disclosure Requirements for Investment Expenses

Investment expense reporting is another area where current practice varies among not-for-profits. Some entities currently net investment expense against investment returns and disclose the total investment expense, while others include these costs within supporting service expenses. Under the new standard, all organizations will report investment returns net of both external and direct internal investment expense and will no longer be required to disclose the amount of the investment expenses.

Requiring not-for-profits to report their investment returns net of direct investment expenses provides a more comparable measure of investment returns across all not-for-profits, regardless of whether they manage their investments using internal staff, outside managers, volunteers, or a combination.  It also addresses the issue of embedded fees included in mutual funds, hedge funds, and other investment vehicles. It is often difficult to accurately identify all embedded fees. Eliminating the requirement to disclose total investment expenses will eliminate the difficulties and related costs in identifying embedded fees and the resulting inconsistencies in the reported amounts of investment expenses.

Elimination of the "Over-time" Release Method for Restrictions Relating to Long-lived Assets

The final area of diversity in current practice addressed by the new standard relates to the method of releasing restrictions related to long-lived assets. Currently, in the absence of explicit donor stipulations, not-for-profits have the option of releasing the restriction on gifts of cash or other assets to be used to acquire or construct a long-lived asset, either when the asset is placed in service or over the estimated useful life of the asset. Under the new standard, such restrictions must be released when the long-lived asset is placed in service. While the practice of releasing restrictions when the asset is placed in service is the more commonly selected method, those organizations who have chosen to release over time will see a significant change to their net asset classifications upon implementation of the new standard, as all remaining unreleased balances relating to long-lived assets will be reclassified to net assets without donor restriction.

I am excited to assist my clients in implementing the various provisions of this new standard and I do believe it will improve the understandability and comparability of not-for-profit financial statements. The standard continues to allow for diversity in presentation style that gives not-for-profit entities some choice as to how best to present their financial picture, while tightening up in areas that resulted in the most confusion among financial statement users. I enjoy change and the learning opportunities it presents. Nonetheless, if the next not-for-profit financial presentation standard is another 20+ years away, rest assured this will be my last opportunity to implement this type of change.

Julleen Snyder headshotJulleen Snyder, CPA, CGMA, is a partner with Jacobson Jarvis & Co PLLC in Seattle.  You can contact her at

This article appeared in the fall 2017 issue of the WashingtonCPA Magazine. Read more here.

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