In our recent Understanding Nonprofit Audits blog series, we discussed the ins and outs of a nonprofit financial statement audit. Now that the end of the year is approaching, we wanted to inform you of several important changes regarding your financial statements as a nonprofit organization. Here’s what you’ll need to know to have a successful planning and reporting process in 2018 and beyond.
Key Changes for Your Financial Statements
The forthcoming changes aim to reduce the complexity and increase transparency in nonprofit financial statements, especially for potential donors. The update, Accounting Standards Update (ASU) 2016-14, requires new disclosures for your financial statements and may require your organization to adopt additional accounting policies. There are several components to the new format, but the most important changes are:
- Net Asset Classes
- Expense Reporting
- Investment Returns
- Liquidity and Availability
- Statement of Cash Flows
Net Asset Classes
The number of net asset classes will be reduced from three to two. Previously, net assets have been categorized as unrestricted, temporarily restricted, or permanently restricted. With ASU 2016-14, assets will be categorized as either “donor-restricted” or “without donor restrictions.” In other words, donations are either allocated for a specific purpose per the donor’s instructions or can be used as your nonprofit board chooses. Enhanced disclosures will be required on donor restrictions, requiring you to describe the composition of net assets with donor restrictions.
A nonprofit board may set aside funds for their purposes, such as developing a specific program. Since the board is not a donor, those funds will be categorized as “without donor restrictions.” In that case, you’ll need to make sure that you provide financial statement disclosures which describe how those funds are appropriated based upon the board’s policies.
Your expense reporting will now need to include both the nature and function of your expenditures in one location. For example, you’ll need to determine whether rent expense should be allocated as program, general/administrative, fundraising, or a combination of these functions. You can present that information in either a separate statement, in the statement of activities, or in the financial statement disclosures. Since most nonprofits are reporting this information either on the Form 990 or in the financial statements, chances are you already have a policy in place. However, it may need to be revised for the new reporting standards, so check with your accounting firm for details.
For your investments, ASU 2016-14 requires that you net any investment fees or expenses against your investment returns. For example, direct expenses such as brokerage fees or investment salaries may need to get allocated against the net investment returns. However, you’ll no longer be required to disclose the components of your investment expenses. This is a perfect opportunity for your organization to review your current investment policies for recording investment returns and expenses.
Liquidity and Availability
You’ll now need to provide information on the organization’s liquidity by including both qualitative and quantitative information (such as how funds are managed to provide for general expenditures and the availability of such funds). A presentation will need to be provided that identifies those accounts that are easily converted to cash (such as cash equivalents, receivables and other accounts). This new stipulation is intended to give potential donors more transparency into your nonprofit’s liquidity.
Statement of Cash Flows
The updates to your statement of cash flows is really just an adjustment to how they’re reported. Your statement of cash flows can be reported using either the direct or indirect method. Currently, if you choose the direct reporting method, you have to attach the indirect method reconciliation. After ASU 2016-14 is implemented, you’ll no longer have to attach your indirect method reconciliation with your direct method reporting.
Plan Today for Future Success
If your nonprofit follows a fiscal year, these changes will be implemented in 2019. If it follows a calendar year, you’ll implement these changes in 2018. Either way, since nonprofit financial statements are in comparative form (the current year’s report is provided alongside the previous year), we recommend planning for these changes as 2017 comes to a close. That way, you’ll have the support and policies in place once the requirements take effect.
Remember, your financial statements are an opportunity to tell your organization’s story to potential donors. The new policies enacted by ASU 2016-14 enable a way for your nonprofit to reveal vital information to donors in a clear, understandable way. We recommend having a conversation with your accounting firm so you have a thorough understanding of the impact of these changes. If you have any questions, please contact us. We’d be happy to help you get your policies and support in place for the new financial statement reporting rules.