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New FASB Proposal Brings Sea Change to Nonprofit Financial Reporting

Chris Gaetano
Published Date:
May 11, 2015

Refresh symbolThe Financial Accounting Standards Board (FASB) has taken the next step in its bid to update reporting rules for nonprofit organizations, the first overhaul of this area in more than 20 years. The board released an exposure draft, Presentation of Financial Statements of Not-for-Profit Entities,” outlining likely changes, on April 22. 

It takes aim at several hurdles in current practice, including  complexities in how net assets are classified; inconsistencies in how intermediate measures of operations are reported; inconsistencies in the type of information provided about a period’s expenses; and misunderstandings about the utility of the statement of cash flows, particularly when reporting operating cash flows.  

In a statement, FASB member Lawrence W. Smith said the modifications would “refresh the model in ways that will make not-for-profit financial statements even more useful to donors, lenders, and other users.”

The proposed changes come as no surprise. According to Candice R. Meth, chair of the NYSSCPA’s Not-for-Profit Organizations Committee, the board had been discussing these matters with nonprofits long before it released the exposure draft. The proposal, she said, was the culmination of years of outreach between stakeholders and the FASB, which she commended for maintaining a constructive dialogue.

One of the more significant revisions concerns how assets will be classified. Under the current model, the use and purpose of assets are conveyed by reporting them in one of three classes: unrestricted, temporarily restricted or permanently restricted. The proposed standard, however, would collapse these three classes into two: net assets with donor restrictions and net assets without donor restrictions. Changes in net assets without donor restrictions would be further divided between those that arose from external factors (e.g., gains and losses, expenses and support) and those that came from internal actions (e.g., appropriations and internal transfers). 

The proposal also calls for a major about-face in operating cash flow reporting—namely, requiring organizations to switch from using either the indirect method of reporting (adjusting changes in net assets to reconcile that amount to net operating cash flow) or the direct method (reporting the sum of gross cash receipts and gross cash payments from operating activities) to requiring the direct method. Cash flows would then be divided into operating cash flows, financing cash flows and investing cash flows. 

According to the FASB, both of these proposed changes are ultimately intended to cut down on confusion. Realigning the net asset classes into with donor restrictions and without donor restrictions, it said, would help financial statement users “distinguish between resource flows that are and are not related to the operations of a period.” Similarly, the FASB felt that by using the direct method of reporting and classifying operating cash flows in a way that’s more consistent with classifications in the statement of activities, it would be easier for financial statement users to make sense of information. 

Noting that the indirect method is, by and large, what most nonprofits use, Meth said the transition could be tough for organizations—especially smaller nonprofits. She added, however, that she was confident there would be enough outreach and education to help them prepare. 

The proposal also includes several new disclosure requirements relating to net assets with donor restrictions and net assets without donor restrictions, as well as the liquidity of financial assets, the status of underwater endowment funds, and the expirations of cash gift restrictions used to acquire or construct a long-lived asset. 

Gina Goodenow, a Not-for-Profit Committee member and the corporate controller for the March of Dimes, was less than thrilled with the increased disclosures. Footnotes are already lengthy, she said, and most users don’t even read them. On the other hand, she felt the proposed changes to underwater endowment reporting would make things easier for CPAs, and understood the need for the new liquidity disclosures, as many nonprofits struggle with cash flows.

“I think it will be good for the donors to see,” she said. 

Putting the changes in perspective

Allen L. Fetterman, who typically presents the nonprofit accounting and auditing update at the Not-for-Profit Organizations Committee’s annual conference, said that the proposed standard had few changes to the actual accounting, with most of the impact centered around “presentation and communication.” 

Despite this, he described the proposal as a “sea change,” and said the new standard would help to bring nonprofit financial reporting into the 21st century. 

“The last major change in nonprofit financial presentation was in 1993, when FASB 117 came out, so it’s been a number of years coming,” he said.  

Though FASB 117, he added, was revolutionary in its day, expanding the presentation for nonprofits and making reporting more consistent, “twenty-two years is a long time and the business world changes.” 

Kelly S. Mathews, the chief operating officer of the New York Council of Nonprofits, Inc., agreed that, on the whole, the proposal would be a positive development for the nonprofit sector, as it better reflects how nonprofits tend to think about their financial statements and run their organizations. 

For example, she noted that under the current three-asset setup, boards of directors sometimes have trouble seeing how their actions impact the financials. To illustrate her point, Mathews posed a hypothetical situation of a board that, after it has determined the organization has had a good year, decides to set money aside for a rainy-day fund, which today would simply be put in the “unrestricted” category. 

“The board is then confused when they see the financial statements,” she said. “They will say, ‘where’s our restricted money?’” 

But under the FASB proposal, she said, there would be an enhanced disclosure to memorialize the fact that the board has indeed restricted a certain component of the net assets. Those disclosures would include a description of the purpose, amounts and types of transfers (for example, those done because of standing board policies, as one-time decisions, or for other reasons) and qualitative and quantitative information about any period-end balances of board designations of net assets without donor restrictions.

Overall, she believes that the proposed changes will help nonprofits better focus on how their activities relate to their mission, as there would be more attention given to the link between operational activities and the money used to enable them, as well as what the donors feel should be done with it. This framework, she said, would also help make the financial information more understandable to users. 

“The broader nonprofit sector, the smaller and mid-sized organizations, will be able to wrap their head around that,” Mathews said. 

Stakeholders have until Aug. 20 to submit comments about the plan. Meth said that the Not-for-Profit Organizations Committee is working with the Society’s Financial Accounting Standards Committee to draft a comment letter. In addition, she said the committee’s next annual conference will include a session given by a FASB representative addressing the proposed changes.

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