Last August, the Financial Accounting Standards Board (FASB) announced some major changes to accounting rules titled, “Presentation of Financial Statements of Not-for-Profit Entities.” By implementing these changes, the FASB hopes to bring increased visibility into nonprofit financial statements, what goes into the statements, and how the statements are presented.
While this shouldn’t be a surprise to anyone—as it’s been in the works for several years—there remains a lot of confusion about the updates. It’s important for the finance team at your nonprofit organization to understand these fundamental changes to accounting standards. The FASB reviewed a number of things, and the changes we will be discussing in this article are considered Phase 1.
Accounting Rules Have Changed
According to the FASB, their latest update aims to improve the current net asset classification requirements and information in financial statements including reports on performance, liquidity, and cash flow. The FASB hopes to address the current problems in reporting requirements with some needed improvements.
These Phase 1 improvements will address the following problems with reporting requirements:
- Net asset classification complexities
- Transparency and utility deficiencies
- Inconsistent information for period expenses
- Direct and indirect reconciliation hindrances
Let’s drill down into the Phase 1 changes to accounting and reporting rules for nonprofits.
Net Asset Classes
The biggest change occurs with net asset classes. We went from three classes to two: with donor restrictions and without donor restrictions. Where you once had three columns (unrestricted, temporarily restricted, and restricted), under the changes you will now have only two columns in your financial statement presentation.
The FASB felt there needed to be very clear disclosure around what was happening on endowments and expanded disclosures. Endowments are considered underwater when the fair value is less than the original gift amount or the amount required to be maintained by the donor or by law. When the economy struggled during the recession, these underwater endowments sprang up and there was no visibility into them. The FASB aims to clear this process and restore visibility. Now, your organization must have a written endowment policy that includes fair market value of the endowment, original gift amount, and the aggregate amount by which funds are underwater.
The FASB continues to stress the importance of disclosing the information clearly. You want to be sure you’re communicating with your CPA firm or partner and discuss any impact this will have on your organization.
Once again, as the current rules lack the visibility the FASB desires, the new update aims to bring clarity and visibility into investments. Ensure you present the amount of change for each net asset class for investments and present net of all investment expenses, both internal and external.
Liquidity comes down to two definitions: qualitative and quantitative. Qualitative asks the status of liability and availability of funds within one year of the statement of financial position. Quantitative asks the availability of your unrestricted liquid assets as of the date of the financial statement to meet your operating needs within one year. This will show the reader of your statements that you have the funds to meet your operating needs for the upcoming year. This also increases the ability to hold organizations accountable through its financial statements.
You can now decide whether to use the direct or indirect method. For most of our clients, cash flow is an often difficult and misunderstood statement. However, at JMT, we are big advocates of the cash flow statement and believe it should be used as part of every organization’s monthly (or quarterly at the minimum) financial packet. This update lets you change the method to one that is more understandable for your organization.
With the current rules, using the direct method to present cash flows hindered you from preparing indirect method reconciliation. Now, if you use the direct method, you no longer need to do reconciliation over to indirect, a major boon to many organizations.
Statement of functional expenses, though a dreaded statement often done outside of any automated system, is now required reporting by both nature and function. It can be included as part of the statement of activities, as a separate statement, or in note disclosures. Disclosures must include methods to allocate costs between different areas of your program and supporting activities.
When Do the FASB Changes Go into Effect?
Calendar-year organizations need to start reporting on the changes in 2018. If your fiscal year later than December 31, 2017, you will need to adopt these changes by the beginning of your 2018 fiscal year (i.e., July 1, 2018). Of course, you can always adopt these changes sooner. In the first year of adopting these changes, you will need to apply retro but you can omit disclosures about liquidity and available resources.
Manage Changes with Cloud Accounting Software
As more regulations and requirements are being put on nonprofits, more will be required of your financial team. Without a reliable financial management system to automate your reporting and other processes, you will be facing a lot more work that you have to do by hand (not to mention the increase in error risk). The best way to manage all of these changes is by using accounting software to automate as much of this process as possible.
Historically, nonprofits have been years behind on technology because they can’t afford the investment. Over the last three to five years, however, nonprofits have started recognizing the cloud and its value. Today, nonprofits can have the same level of technology as a Fortune 500 company can without the cost. And it’s making all the difference.
Learn more about nonprofit cloud accounting software in this guide, Financial Management for Nonprofits. This ebook offers guidance to understand the tools and procedures you need and how to choose the technology best aligned with your operations and goals. Download the ebook now.