The biggest accounting news in 2016 was the culmination of a five-year project by the Financial Accounting Standards Board to revise its not-for-profit (NFP) reporting model. FASB released its anticipated Accounting Standards Update (the ASU) in August. ASU 2016–14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities, is effective in FY19 for most colleges and universities, with early adoption permitted. Whether or not your institution plans early adoption of the ASU, all institutions should be considering the impact of the changes on their financial statements.
The ASU represents the first significant changes to the not-for-profit financial reporting model in more than two decades. The ASU addresses several areas considered problematic in NFP reporting today:
- Confusion about the three net asset classes and the difference between restrictions that are temporary and those that are permanent.
- Deficiencies in the transparency and utility of information useful in assessing an entity’s liquidity caused by potential misunderstandings and confusion about (1) the term unrestricted net assets and (2) how restrictions or limits imposed by donors, grantors, contracts, and governing boards affect an entity’s liquidity, net asset presentation, and financial performance.
- Inconsistencies about the type of information provided about reporting period expenses; some but not all NFPs provide information about the nature of expenses within functional or programmatic categories.
- Creating a hurdle to reporting direct cash flows by requiring an indirect method reconciliation.
While some of the ASU’s required changes are straightforward and will be relatively easy to adopt, others will require more time and consideration. The following narrative focuses on each of the required changes, with an emphasis on those that are likely to be more challenging to implement (specifically, liquidity disclosures and expense analysis).
Liquidity and Availability
The market crisis of 2008 and concerns about cash flow and financial sustainability persisted through the 2011 start of FASB’s NFP reporting research. Consequently, redefining net asset classes and improving how liquidity and resource availability are portrayed within the legal and accounting parameters of net assets, restricted by donors or set aside by the reporting entity, became a pervasive tenet of the NFP reporting project.
The ASU requires NFPs to provide both qualitative and quantitative information about liquidity and availability of resources as follows:
- Qualitative information that communicates how the NFP manages its liquid resources available to meet cash needs for general expenditures within one year of the balance sheet date.
- Quantitative information that communicates the availability of the NFP’s financial assets (typically assets other than inventory; prepaid expenses; and property, plant, and equipment) at the balance sheet date to meet cash needs for general expenditures within one year of the balance sheet date. The availability of a financial asset may be affected by its nature; external limits imposed by donors, laws, and contracts with others; and internal limits imposed by governing boards.
Although this requirement is described as a “liquidity disclosure,” the intent is actually to provide information that allows a user to understand the availability of an institution’s resources. This new disclosure may be the most challenging of the changes to implement, because it confronts common assumptions about cash as a fungible resource. External restrictions and even internal designations are dimensions that limit resource availability, even the use of cash, and must be explained.
Therefore, it’s necessary to consider both liquidity and restrictions when preparing the disclosure. Liquidity is the nearness of an asset to cash, while restrictions are constraints on how resources can be used. This disclosure should contain elements of both concepts, for example, what assets will be available as cash to cover expenditures and what resources are available either because they are unrestricted or restricted for purposes that are consistent with the organization’s mission.
The disclosure can take many forms depending on the relative liquidity of an institution’s resources, donor-imposed restrictions on those resources, internal board designation of resources, and so on. The following examples are just two possible formats that could be used. A statement of financial position (see Figure 1) is included to facilitate understanding of the amounts included in the disclosures.
Table 1 shows an example university’s balance sheet:
NFP Table 1: ABC University's Statement of Financial Position, June 30, 20XX
| ASSETS | |
| Cash and cash equivalents | $33,145 |
| Accounts receivable (net) | 9,450 |
| Inventories and prepaid expenses | 2,875 |
| Contributions receivable (net) | 23,700 |
| Student loan receivables (net) | 22,825 |
| Investments | 257,230 |
| Land, buildings, and equipment | 86,625 |
| Total assets | $435,850 |
| LIABILITIES AND NET ASSETS | |
| Accounts payable | $12,910 |
| Refundable advance | 7,680 |
| Notes payable | 9,850 |
| Annuity obligations | 16,955 |
| Long-term debt | 72,000 |
| Total liabilities | 119,395 |
| NET ASSETS | |
| Without donor restrictions | 127,540 |
| With donor restrictions | |
| Restricted by time or purpose | 92,040 |
| Restricted in perpetuity | 96,875 |
| Total net assets | 316,455 |
| Total liabilities and net assets | $ 435,850 |
Liquidity Example No. 1 includes qualitative as well as quantitative information as required by the ASU. Similar information would need to be included in example No. 2 in order to fully meet the requirements within the ASU.
NFP Table 2: Liquidity Example No. 1.
This example takes the approach of showing only those amounts that are available to meet general expenditures of the university within one year of the balance sheet date. Some of the information (cash and cash equivalents, accounts receivable, and other assets) can be tied directly to the statement of financial position. Amounts related to contributions receivable come from another note disclosure. The amount of investments maturing within one year and available to meet general expenditures is not readily available within the financial statements and, therefore, would require additional audit work to substantiate.| Cash and cash equivalents | $33,145 |
| Accounts receivable (net) | 9,450 |
| Contributions for unrestricted purposed due in one year or less (note X) | 8,500 |
| Investments maturing within one year available for general purposes | 59,546 |
| $110,641 |
NFP Table 3: Liquidity Example No. 2
This example starts by presenting all the university’s financial assets and then, in a separate table, presents the amounts that are available to meet general expenditures within one year of the balance sheet date. This presentation has the advantage of providing the reader with a big picture view of the university’s financial assets and then a narrower view of those assets that are available to meet the general expenditures of the university over the coming year. Note that this disclosure provides detailed information about available investment resources by breaking out amounts that have been approved for spending from the institution’s endowment. As noted previously, additional qualitative information would need to be included in the disclosure.| FINANCIAL ASSETS AT YEAR-END | |
| Cash and equivalents | $ 33,145 |
| Accounts receivable (net) | 9,450 |
| Contributions receivable | 23,700 |
| Student loan receivables | 22,825 |
| Investments convertible to cash in the next 12 months | 149,861 |
| Other long-term-investments | 107,369 |
| Total financial assets at year-end | $ 346,350 |
| FINANCIAL ASSETS AVAILABLE TO MEET GENERAL EXPENDITURES OVER THE NEXT 12 MONTHS: | |
| Cash and equivalents | $ 33,145 |
| Accounts receivable (net) | 9,450 |
| Contributions for operations due in 1 year or less | 8,500 |
| Payout on donor restricted endowments | 7,468 |
| Payout on quasi-endowments | 1,400 |
| Investments not encumbered by donor or board restrictions | 50,678 |
| $ 110,641 |
Reporting of Expenses
The new standards require an analysis of operating expenses by both their function and nature in a single location either on the face of the statement of activities, as a schedule in the notes to financial statements, or in a separate financial statement. Enhanced disclosures about how costs are allocated among functions are also required.
Analysis of operating expenses. Institutions will need to consider the level of granularity they want to present in order to make the information most useful to readers. The disclosure in Figure 2 shows only five functional categories. While this is acceptable and, perhaps, preferable for financial statement purposes, it is important to note that the Integrated Postsecondary Education Data System (IPEDS) categories have not changed. Therefore, functional expense information should continue to be captured at a more detailed level in order to accurately report the data in IPEDS.
Below is a sample of operating expenses:
NFP Table 4: Analysis of Operating Expenses
| Education and Instruction | Research | Auxiliaries | Management and General | Student Services | Total | |
|---|---|---|---|---|---|---|
| Salaries and benefits | $54,485 | $5,715 | $8,573 | $19,050 | $10,478 | $98,301 |
| Supplies and services | 11,542 | 9,405 | 10,260 | 8,122 | 3,420 | 42,749 |
| Depreciation | 5,605 | 1,520 | 950 | 760 | 665 | 9,500 |
| Interest | 425 | 115 | 72 | 58 | 50 | 720 |
| Total expenses | $72,057 | $16,755 | $19,855 | $27,990 | $14,613 | $151,270 |
Net Assets Classes
The three classes of net assets used today have been replaced with two classes: those with donor-imposed restrictions and those without.
Donor-imposed restrictions. Because the definition of “donor-imposed restriction” is essentially unchanged, the result of this change is that temporarily and permanently restricted net assets will be collapsed into one category: net assets with donor restrictions.
Although these two classes of net assets will be combined on the face of the financial statements, institutions will need to continue to track donor-restricted net assets at a more granular level for disclosure as well as stewardship purposes. Institutions will be required to provide relevant disclosures about the nature and amounts of donor restrictions on net assets—both temporary and perpetual—either on the face of the statements or in the notes.
Unrestricted net assets. The composition of unrestricted net assets is unchanged. Those net assets will now be labeled “net assets without donor restrictions.” Institutions will be required to disclose the amounts and purposes of board-designated net assets. In addition, institutions that utilize an operating measure and show governing board designations, appropriations, and similar actions within that measure will now be required to disaggregate and describe them by type (either on the face of the financial statements or in the notes).
Although there are no additional disclosure requirements related to net assets without donor restrictions, NACUBO recommends providing additional information that may assist a reader in assessing the liquidity and availability of unrestricted net assets. For example, an institution that has extensive infrastructure may wish to show the amount of net assets without donor restrictions that is tied up in capital assets.
Additional Reporting Details
Several other reporting categories are affected by the new requirements.
Underwater endowment funds. Amounts by which endowment funds are underwater will be reported within net assets with donor restrictions rather than in unrestricted net assets as currently required. In addition, institutions will be required to disclose their policy for spending on underwater endowments and the aggregate original gift amounts of underwater funds, along with the fair value of those funds. Institutions that had underwater funds in the year prior to adoption will have a change in their beginning net asset balances as a result of this requirement.
Expiration of capital restrictions. The current option to imply a time restriction that expires over the useful life of an asset, sometimes referred to as the “bleeding-in” method, will no longer be available. Instead, absent specific donor stipulations, restrictions on capital assets will be released when the asset is placed in service. For institutions that previously used the bleeding-in method, any amounts remaining in restricted net assets will have to be reclassified to net assets without donor restrictions upon adoption.
Investment expenses. Investment returns will be presented net of external and direct internal expenses in the statement of activities. The current requirement to disclose the amount of netted investment expenses will be eliminated. In addition, NFPs will no longer be required to display the investment return components (income earned and net realized and unrealized gains or losses) in the rollforward of endowment net assets. Investment expenses netted against returns may not be included in the functional to natural expense analysis.
Statement of cash flows presentation. An organization may choose to present cash flows from operations using either the direct or indirect method. For those that choose to use the direct method, the indirect reconciliation will no longer be required (but may still be provided, if desired). Public institutions that follow GASB are required to present cash flows from operations using the direct method, and many users of their financial statements have expressed appreciation for the increased understandability of this statement as a result of this presentation. Therefore, in an effort to provide more comparable and meaningful information to financial statement users, NACUBO recommends that institutions currently using the indirect method consider changing to the direct method.
Other Implementation Considerations
While the changes to the NFP reporting model are numerous, the majority should be relatively easy to implement. All changes must be adopted at the same time. As such, an entity that wishes to adopt one of the changes, must adopt them all. For example, if an entity wants to present only two net asset classes, it may do so only if it adopts all the other changes, such as the netting of investment expenses, classifying underwater endowments within net assets with donor restrictions, and so on.
FASB recognizes that the liquidity and availability disclosure and the functional to natural expense analysis could require more effort to implement. Therefore, in the year of adoption, an entity that presents comparative financial statements may choose to present those disclosures for the current year only.
NACUBO continues to study the new standards and will be providing industry guidance and best practice recommendations. In addition, a number of examples are being developed to assist institutions with implementation of the new standards.