fasb’s proposed changes to not-for-profit financial

Issues In-Depth

FASB’s Proposed Changes to Not-for-Profit Financial Statements

May 2015

kpmg.com

Issues In-Depth® 2015

Contents

Background 2

Changes to Net Asset Classifications 3

Net Assets without Donor Restrictions 3

Net Assets with Donor Restrictions 3

Underwater Endowments 4

Other Options Considered 5

Disclosures 6

Intermediate Measures of Operations 9

Current Requirements and Practice 9

Mixed Views about Creating a Single Definition of Operations 9

Mission and Availability Dimensions 10

Impact on Health Care Entities’ Performance Indicator 11

Impact on Debt Covenants 12

Investing and Financing Activities 12

Capital Transactions and Events 14

Board Designations, Appropriations, and Similar Transfers 15

Accounting Write-offs 16

Retirement Benefits 17

Equity Transfers and Transactions 17

Presentation in Statement of Activities 18

Changes to the Statement of Cash Flows 19

Direct Method 19

Changes to Align with the Definition of Operations in Statement of

Activities 19

Noncash Operating, Investing, and Financing Activities 20

Issues In-Depth® 2015

Reporting of Expenses by Nature and Function 21

Voluntary Health and Welfare Entities 22

Disclosures Required for Expense Allocations 23

Management and General Expenses 23

Presentation of Investment Expenses and Return 24

Investment Expenses 24

Gross Investment Return 25

Total Performance of the Other Investment Portfolio 25

Additional Liquidity Disclosures 26

Effective Date and Transition 27

Alternative Views 28

Responding to the Proposed ASU 29

Appendix 1: Illustrative Statements of Activities 30

Appendix 2: Illustrative Statement of Cash Flows 35

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Issues In-Depth® — January 2015

Issues In-Depth / May 2015

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FASB’s Proposed Changes to

Not-for-Profit Financial Statements

The FASB has invited constituents to comment on a proposed

Accounting Standards Update (ASU) that would change the

presentation of financial statements of not-for-profit entities (NFPs),

including health care (HC) entities.1

Key Facts

The proposed ASU would:

Reduce the number of net asset classes presented in the financial statements from three to

two: with donor-imposed restrictions and without donor-imposed restrictions;

Define two intermediate measures of operations and require their presentation in the

statement of activities;

Eliminate the performance indicator currently required for NFP business-oriented health care

entities; and

Require presentation of operating cash flows using the direct method and recategorize items

reported in the statement of cash flows to align with the proposed definition of operations in

the statement of activities.

Comments are due August 20, 2015.

Key Impacts

Eliminating the distinction between temporary and permanent restrictions from the financial

statements would reduce reporting complexity and enhance understandability. These

proposed changes reflect changes in state laws, including de-emphasizing the historic dollar

value (original gift) for donor-restricted endowments in most jurisdictions.

Comparability across not-for-profits may be enhanced by defining operating activities, but

complexity may increase. The proposed definition may be inconsistent with how some NFPs

currently view their operations or present their financial statements.

Comparability between for-profit and not-for-profit health care entities will be reduced because

of the removal of the currently required performance indicator.

Requiring operating cash flows to be presented using the direct method may enhance

understandability and usefulness of information. However, recategorization of cash flows may

introduce complexity for users familiar with prior definitions, which also would continue to be

used by business entities.

1 FASB Proposed Accounting Standards Update, Presentation of Financial Statements of Not-for-Profit Entities, available

at www.fasb.org.

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Background

The FASB added a project to its agenda in 2011 to improve NFPs’ financial reporting. The

project’s objectives address suggestions from the FASB’s Not-for-Profit Advisory Committee

(NAC) and are focused on improving:

Net asset classification requirements; and

Information provided in financial statements and accompanying notes about liquidity, financial

performance, and cash flows.

The proposed ASU would amend current financial reporting guidance to implement the findings

of the FASB’s NFP project.2 This reporting guidance is primarily based on Statement 117, which

was issued in 1993 and has remained unchanged, other than a few technical amendments to

provide interpretative guidance.3 Based on discussions with the NAC and other constituents, the

FASB said that the existing standards for financial reporting by NFPs are generally sound.

However, the FASB also acknowledged that it was time to take a fresh look at the reporting

standards to make improvements that will meet the needs of donors, grantors, creditors,

governing boards, and other users of NFP financial statements.

The proposed changes do not address requirements for recognition and measurement of assets

and liabilities or revenues, expenses, gains, and losses. Instead, they focus on how these items

are presented and disclosed.

During the project, the FASB performed outreach activities with stakeholders in addition to the

NAC. These stakeholders included members of the National Association of College and

University Business Officers’ (NACUBO) Accounting Principles Committee; the Healthcare

Financial Management Association’s Principles and Practices Board; the American Institute of

Certified Public Accountants’ (AICPA) Expert Panels for NFPs and for HC entities; and state CPA

societies. Additional outreach is planned during the comment period. The FASB also plans to

hold two public roundtables in September and October, to obtain views about the proposed

changes.

In addition to the standard-setting project, a research project, NFP Financial Reporting: Other

Financial Communications, was added to the FASB’s agenda in 2011 to study other

communication methods, such as management’s discussion and analysis, that NFPs could use

to tell their financial story. The FASB’s research found that these communication methods were

most prevalent in the higher education and health care industries and among larger NFPs.

However, it was noted that these communications varied greatly. Many FASB members

expressed concern that providing guidance for communications outside the basic financial

statements was beyond the scope of the FASB’s traditional activities. The FASB also discussed

the availability of resources and how to prioritize efforts on more immediate standard-setting

needs. The FASB ultimately removed this research project from its agenda in 2014.

2 Current financial reporting guidance for NFPs is located in FASB ASC Topic Nos. 958, Not-for-Profit Entities, and 954,

Health Care Entities, both available at www.fasb.org.

3 FASB Statement No. 117, Financial Statements of Not-for-Profit Organizations, available at www.fasb.org.

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KPMG Observations

The proposed ASU is intended to improve the presentation of NFPs’ financial statements.

However, certain proposed changes would result in additional differences between NFPs

and business entities. These differences could impact comparability of financial

statements in some business segments that include both NFPs and business enterprises,

such as health care. Also see the discussion of the Alternative Views section in this

document.

Changes to Net Asset Classifications

The net asset classes in the financial statements would be reduced from three to two under the

proposed ASU. However, NFPs would still be required to disclose information about the nature

and amounts of donor-imposed restrictions. NFPs also would be required to disclose information

about the amounts and purposes of board-designated net assets without donor restrictions.

Current Proposed

Unrestricted Net Assets without Donor Restrictions

Temporarily Restricted

Permanently Restricted

Net Assets with Donor Restrictions

Net Assets without Donor Restrictions

The current net asset terminology was established by Statement 117 in 1993. When re-

examining this terminology, the FASB decided to change unrestricted net assets to net assets

without donor restrictions. Unrestricted net assets is defined as the part of net assets that is

neither permanently restricted nor temporarily restricted by donor-imposed stipulations.

However, some users have interpreted this term more broadly to refer to the absence of other

restrictions beyond those imposed by a donor (i.e., legal, contractual, or other). This

misunderstanding potentially leads to incorrect conclusions when assessing an NFP’s liquidity or

financial flexibility. The FASB proposed the change to make the terminology more precise to

avoid the misunderstanding that some users have experienced.

Net Assets with Donor Restrictions

The FASB decided to combine the two remaining net asset classes, temporarily restricted and

permanently restricted, to create a combined net assets with donor restrictions class.

KPMG Observations

The distinction between temporary and permanent became blurred when the model Uniform

Prudent Management of Institutional Funds Act (UPMIFA) was approved by the Uniform

Law Commission in 2006 and subsequently enacted by most states. UPMIFA governs the

investment and management of endowment funds by NFPs. UPMIFA de-emphasized the

concept of historic dollar value (original gift amount). This law changed the focus from the

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prudent spending of net appreciation of the fund to prudent spending from the entire donor-

restricted endowment fund (i.e., the original gift amount plus accumulated earnings).

UPMIFA permits NFPs to spend from a donor-restricted endowment fund even in

circumstances where the fair value of the endowment has fallen below the original amount

of the gift. This change in focus essentially allows spending from the portion of net assets

classified as permanent.

There was intense debate in the not-for-profit community about whether the adoption of

UPMIFA should affect the net asset classification of donor-restricted endowment funds.

Some constituents at the time proposed restructuring the net asset classification model so

the entire endowment fund would be classified in one net asset class. However, this view

was rejected when the FASB ultimately issued guidance in 2008.4 The net asset

classification model and the portion of the donor-restricted endowment fund classified as

permanently restricted by NFPs remained largely unchanged (i.e., generally the historic dollar

value). The FASB’s proposed changes to combine the two restricted net asset classes are

more in line with the changes in the law under UPMIFA.

Underwater Endowments

If the fair value of an individual donor-restricted endowment fund is less than the original gift

amount required to be maintained by the donor or by law, that deficiency would be reported in

the net assets with donor restrictions class. Currently, these amounts are reported in the

unrestricted net assets class.

KPMG Observations

In 2008, the FASB retained its guidance that classified donor-restricted underwater

amounts within unrestricted net assets. However, continuing to include these underwater

amounts in the unrestricted net assets class created misconceptions. This categorization

implied that these deficiencies would need to be funded or repaid from unrestricted

sources, which conflicted with UPMIFA’s basic tenets. The FASB’s current proposal to

classify these amounts in the net assets with donor restrictions class better reflects

UPMIFA’s basic tenets. UPMIFA incorporates the view that institutions invest their

endowments using a total-return approach, which may result in fluctuations in the fund’s

value. UPMIFA allows institutions to determine spending based on the total assets of the

fund. However, while UPMIFA de-emphasized the distinction of principal versus income,

institutions still must track principal under UPMIFA. In fact, as the drafters of UPMIFA

have stated:

Although the Act does not require that a specific amount be set aside as “principal,”

the Act assumes that the institution will act to preserve “principal”…while spending

“income” (i.e., making a distribution each year that represents a reasonable

spending rate, given investment performance and general economic conditions).

Thus an institution should monitor principal in an accounting sense, identifying the

original value of the fund (the historic dollar value) and the increases in value

necessary to maintain the purchasing power of the fund.5

4 FASB Staff Position No. FAS 117-1, Endowments of Not-for-Profit Organizations: Net Asset Classification of Funds

Subject to an Enacted Version of the Uniform Prudent Management of Institutional Funds Act, and Enhanced Disclosures

for All Endowment Funds (subsequently codified into Topic 958), available at www.fasb.org.

5 National Conference of Commissioners on Uniform State Laws, Uniform Prudent Management of Institutional Funds

Act (2006), www.uniformlaws.org/shared/docs/prudent%20mgt%20of%20institutional%20funds/upmifa_final_06.pdf

http://www.uniformlaws.org/shared/docs/prudent%20mgt%20of%20institutional%20funds/upmifa_final_06.pdf

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Example 1: Presentation of Donor-Restricted Endowment Funds

Under current guidance, Gift A, a $105 million donor-restricted endowment received on

January 1, 2015, which has fallen in value to $100 million at March 31, 2015, is presented

as $105 million in permanently restricted net assets and negative $5 million in

unrestricted net assets at March 31, 2015.

Gift B, comprised of a historic dollar value (original gift) of $75 million and accumulated

gains of $25 million, is presented as $75 million in permanently restricted net assets and

$25 million in temporarily restricted net assets at March 31, 2015.

Under the FASB’s proposed ASU, the $100 million balance of each endowment would be

reported in the net assets with donor restrictions category.

KPMG Observations

Colleges and universities participating in student financial assistance programs of the U.S.

Department of Education (Education Department) must comply with certain general

standards of financial responsibility. These standards were published in 1997 and include

a composite score based on the institution’s primary reserve, equity, and net income

ratios.

A Senate task force recently indicated that the Education Department has not kept up

with changes in accounting practices in applying the ratios.6 The Senate task force

referred to an earlier study by the National Association of Independent Colleges and

Universities (NAICU).7 The Senate task force noted that the study concluded that the

Education Department’s regulators “were not using generally accepted accounting

standards...in calculating the financial ratios.” For example, the report found that the

Education Department was treating endowment losses as expenses and excluding

accumulated endowment earnings from temporarily restricted net assets when

calculating the primary reserve ratio.

The changes in the net asset classifications proposed by FASB may create additional

challenges in the application of the financial responsibility ratios. However, the changes

also could prompt the Education Department to take a fresh look at the ratios and its

application of relevant U.S. GAAP.

Other Options Considered

The FASB considered other net asset classification models, including whether net assets should

be distinguished not only based on donor restrictions but also legal, contractual, or other

restrictions. They also considered requiring NFPs to distinguish net assets by purpose (e.g.,

operations, net investment in plant, or long-term investment). However, after further research

and outreach, the FASB decided to update, but not overhaul, the net asset classification model.

6 Recalibrating Regulation of Colleges and Universities, Report of the Task Force on Federal Regulation of Higher

Education, available at www.help.senate.gov/imo/media/Regulations_Task_Force_Report_2015_FINAL.pdf.

7 Report of the NAICU Financial Responsibility Task Force, November, 2012, available at

www.naicu.edu/docLib/20121119_NAICUFinan.Resp.FinalReport.pdf.

http://www.naicu.edu/docLib/20121119_NAICUFinan.Resp.FinalReport.pdf

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KPMG Observations

Some NFPs currently delineate categories (such as net investment in plant) within the

unrestricted net assets class either on the face of the financial statements or in the

disclosures. This disaggregation within the net assets without donor restrictions class

would not be prohibited by the proposed ASU.

Disclosures

Donor-Imposed Restrictions

NFPs would still be required to disclose information about the nature and amounts of different

types of donor-imposed restrictions. This disclosure would focus on both how and when, if ever,

the resources could be used rather than applying a bright-line distinction between temporary and

permanent restrictions. The following example shows how an NFP may disclose this information.

Example 2: Net Assets with Donor Restrictions Disclosure

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KPMG Observations

Increased Importance of Disclosures. Given the streamlining on the face of the financial

statements, the net asset disclosures would become more important to provide donors,

creditors, and other users with relevant information about NFPs’ financial flexibility. The

level of disaggregation of the nature of restrictions would be left to NFPs’ discretion.

There would be no requirement to continue to differentiate between permanently and

temporarily restricted net assets. However, NFPs may opt to provide information to allow

financial statement users to make a similar distinction.

To illustrate, Example 2 discloses the total accumulated earnings included in the donor-

restricted endowments. While not required, some NFPs may consider disclosing these

amounts (or the inverse, historic dollar value) either in a similar aggregated manner or in

further disaggregated components (e.g., by purpose). The FASB decided not to prescribe

these disclosures to give NFPs the flexibility to decide what additional disclosures would

be useful.

NFPs also could opt to present disaggregated, descriptive line items on the balance sheet

to further delineate the nature and types of restrictions within the net assets with donor

restrictions balance.

Impact on Statement of Activities. Streamlining the net asset classes would help

reduce reporting complexity. However, the combination of the two restricted columns in

the statement of activities also would eliminate some information about the differing

types of donor-restricted contributions received during the period. (See Appendix 1 for

illustrative statements of activities). There would be no requirement to distinguish

between the different types of restrictions (e.g., a gift for the following period’s

operations versus a gift for a permanent endowment) either on the face of the statement

of activities or in the accompanying notes. This gap would be partially offset by the

disclosures presented about the type of restrictions in the net asset balances at the end

of the period. NFPs may also provide additional information about the types of restrictions

imposed on the contributions received during the period, either on the face of the

statement of activities or in the accompanying notes.

Board Designations

NFPs would be required to disclose information about the amounts and purposes of board-

designated net assets without donor restrictions. Current FASB guidance includes specific

disclosure requirements relating to board-designated endowment funds (including a

reconciliation of the beginning and ending balances). Some NFPs also disclose information about

other types of board-designated net assets. However, this is not currently required. Under the

proposed ASU, disclosures of the amounts and purposes would be required for all board-

designated net assets without donor restrictions, including those for a specific future

expenditure. The following example shows how this information may be disclosed.

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Example 3: Board-designated Net Assets Disclosure

KPMG Observations

While not required, NFPs may also opt to show board-designated net assets as a

component of net assets without donor restrictions on the balance sheet, either in the

aggregate or in its disaggregated components.

Underwater Endowments

The required endowment disclosures would be expanded under the proposed ASU to include

the:

NFP governing board’s policy on spending from underwater endowment funds (and whether

this policy was followed);

Original gift amount (or level required by donor stipulations or law) of underwater endowment

funds in the aggregate; and

Fair value of underwater endowment funds in the aggregate.

Some constituents have questioned whether such disclosures remain useful in light of the de-

emphasis of the original gift amount and the focus on total return in UPMIFA. However, the

FASB believes that these disclosures (in addition to the current requirement to disclose the

aggregate underwater amount) would assist users in analyzing NFPs’ liquidity and financial

flexibility, particularly during a downturn in the financial markets.

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Intermediate Measures of Operations

The proposed ASU defines two intermediate measures of operations and requires their

presentation in the statement of activities by all NFPs, including HC entities.

Current Requirements and Practice

NFP business-oriented HC entities are currently required to present in the statement of activities

a performance measure known as the performance indicator, as defined in current accounting

guidance for health care entities. The performance indicator is designed to be the equivalent of

net income from continuing operations. These entities also have the option to present other

intermediate measures.

Other NFPs are not currently required to present an intermediate measure in the statement of

activities but have the option to define and present this measure. If NFPs present an

intermediate measure of operations, they currently are required to ensure that their definition of

operations is apparent from the face of the statement of activities or disclosed in the notes.

Given the lack of a defined intermediate measure, there is currently great diversity in the

presentation of such a measure by NFPs. However, in some NFP industry segments, some

organizations have opted to use a consistent definition of operations. NACUBO’s Accounting

Principles Council issued a position paper in 2007 that discussed its views on defining an

operating measure for private colleges and universities.8 However, while the position paper

recommended certain transactions and events that would be classified as nonoperating, it also

acknowledged that total consensus was not anticipated due to different internal board policies or

interpretations of operations. Indeed, while many colleges and universities follow the

recommendations in NACUBO’s paper, adherence to every aspect of the recommended model

is not universal.

Mixed Views about Creating a Single Definition of Operations

During the FASB’s outreach, there was a mixed reaction to the decision to create a consistent

definition of operations for all NFPs. While this would enhance comparability across NFPs, it also

was recognized that it would be challenging given their diversity. Some constituents supported

developing multiple definitions of operations based on the type of NFP. Many constituents

supported the current flexibility and believed that this should be maintained. These constituents

believed that this flexibility was necessary and its benefits outweighed the enhanced

comparability, which was the goal of a single definition of operations.

Some also questioned the necessity of defining one consistent measure of operations for NFPs

when consideration of this requirement for business entities is in its very early stages. A FASB

research project currently is evaluating ways to improve the relevance of information presented

in the performance statement of business entities and to determine whether a consistent

operating performance metric should be developed. Some supported delaying the requirement

to have a consistent measure of operations for NFPs until the research project for business

entities was further along, which would allow for a unified decision for both NFPs and business

entities. However, this delay was supported by only a minority of FASB members. See the

Alternative Views section.

The FASB concluded that financial reporting for NFPs could be improved and made more

comparable if a principled approach could be developed to define operations for all NFPs,

including HC entities. Using a single definition also would remove the current requirement for

NFPs to disclose the organization’s definition of operations, if an intermediate measure of

operations is reported.

8 Defining an Operating Measure for Independent Colleges and Universities, available at www.nacubo.org.

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Various alternatives were considered, including distinguishing between activities that are

recurring and non-recurring; large, unusual, or both; or beyond management’s control. However,

there were challenges to each of these approaches. The FASB ultimately decided to define

operations on the basis of two dimensions: mission and availability. Classification of an item as

revenue, expense, gain, or loss would not determine whether it is considered inside or outside of

the defined intermediate measures of operations. The two dimensions of mission and availability

would be the only determining factors.

Mission and Availability Dimensions

Under the proposed ASU, the statement of activities would be separated into operating and

nonoperating on the basis of two dimensions.

Mission Dimension Availability Dimension

Resources that are from, or directed

at, carrying out the NFP’s purpose for

existence

Resources that are available for

current period activities, considering

both external limitations and internal

actions of the NFP’s governing board

Most constituents are generally supportive of the availability notion that results in the

intermediate measures of operations being a subset of the change in net assets without donor

restrictions. This is consistent with current reporting of many organizations. Many constituents

conceptually favor the mission dimension. However, the proposed application of the mission

dimension has resulted in significant debate, as discussed below.

The proposed ASU would require all NFPs (including business-oriented HC entities) to present

two measures (subtotals) associated with the change in net assets without donor restrictions in

the statement of activities:

Operating Excess (Deficit) Before

Transfers

Operating Excess (Deficit) After

Transfers

Revenues, expenses, gains, and

losses that are from or directed at

carrying out the NFP’s purpose for

existence and are available for use in

the current period, and

Donor-restricted support that became

available in the period for carrying out

the NFP’s purpose for existence

Activities included in the operating

excess (deficit) before transfers, and

Effects of internal actions resulting

from governing board designations,

appropriations, and similar transfers

that make resources unavailable (or

available) for carrying out an NFP’s

current-period purposes

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KPMG Observations

It is debatable which measure (subtotal) would be more meaningful to users of the

financial statements. The operating excess (deficit) before transfers is likely to be more

comparable across NFPs given the way it is defined. However, it is arguable whether this

subtotal would be as meaningful for some NFPs who have traditionally defined operations

differently for internal or external communications.

The operating excess (deficit) after transfers subtotal has the potential to be more

meaningful to NFPs because the proposed ASU provides flexibility related to internal

transfers. NFPs would have more control over this subtotal through transfers and would

be able to move this subtotal closer to their internal view of operations. Transfers include

those that would be required by the proposed ASU as well as those made at the

discretion of the NFP’s governing board or designees. However, this flexibility also may

provide the opportunity for NFPs to use arbitrary or discretionary items to structure

operating results to meet desired objectives. This may reduce comparability among NFPs

or in financial statements in one period versus another. Using transfers may create

additional effort for external users who may need to read the disclosures to analyze the

operating performance of NFPs with significant transfers.

Impact on Health Care Entities’ Performance Indicator

The FASB has indicated that there is no longer a compelling need for NFP business-oriented HC

entities to present the performance indicator because all NFPs would be required to provide

standardized intermediate measures of operations. NFP business-oriented HC entities would not

be precluded from presenting the performance indicator. However, the proposed ASU would

remove the performance indicator from U.S. GAAP and if it was presented, it would be

considered a non-GAAP measure.

KPMG Observations

While the proposed standard would provide comparability among NFP entities, including

those in the HC industry, it would result in significant diversity in reporting between NFP

and for-profit HC entities. Currently, there is comparability in the presentation of financial

performance between NFP business-oriented HC entities and for-profit HC entities. Many

NFP HC entities are run as business entities similar to for-profit HC entities. The current

U.S. GAAP NFP HC model was developed with this in mind. The performance indicator

was designed to be analogous to income from continuing operations of a for-profit entity,

not operating income. Having a reporting model under the proposed ASU in which NFP

business-oriented HC entities and for-profit HC entities differ would increase complexity

for HC financial statement users.

As discussed below, there are conflicts between the classification of certain transactions

(e.g., equity transfers, capital transactions, interest expense, and investment return) in the

current HC performance indicator and the proposed definition of operations. While the

FASB neither prohibits nor encourages continuing to report the performance indicator, it

has indicated that presenting a non-GAAP measure would add complexity to the financial

statements and run the risk of confusing users. Given the conflicts between the

performance indicator and the intermediate measures of operations, it would not be

practical to present the performance indicator in the statement of activities.

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Impact on Debt Covenants

KPMG Observations

Debt agreements may include financial covenants that are based on the performance

indicator used by HC entities or, in some cases, the intermediate measure of operations

currently defined by individual NFPs. There also may be covenants based on the existing

net asset classification model. NFP entities should consider discussions with bond

counsel and debt holders to determine whether any amendments to their debt

agreements would be necessary if the proposed ASU becomes effective.

While the definition of operations is principle-based, the proposed ASU does specifically address

the reporting of certain transactions. The more significant transactions are discussed below.

Investing and Financing Activities

Investing and financing activities, other than those directed at carrying out NFPs’ programs,

would not meet the mission dimension, and would therefore be classified as nonoperating

activities. The FASB views these activities as tools for NFPs to achieve their mission rather than

resources that are from or directed at carrying out their mission.

Investment Return

Investment revenues, expenses, gains, and losses that result from programmatic investing

(activity of making loans or other investments that are directed at carrying out the NFP’s mission)

would be reported as operating activities. Programmatic investing would include joint venture

arrangements, partnerships, and similar strategic investments in related entities that health care

systems typically engage in to achieve their purposes. Subsidized and forgivable loans that

foundations often make to help finance charities and student and faculty loans made by

universities also would be considered programmatic investing and included in operating

activities.

Net investment return that results from non-programmatic investment activity, such as total

return investing, would be reported as nonoperating activity.

Current U.S. GAAP guidance for health care entities provides very specific guidance on which

components of investment return are included in the performance indicator for NFP business-

oriented HC entities. For example, interest, dividends, and realized gains are included in the

performance indicator. Unrealized gains and losses on trading securities are included in the

performance indicator. Other unrealized gains and losses are excluded. Under the proposed

definition of operations, there is no such distinction and all non-programmatic investment return

would be nonoperating.

The proposed ASU specifies that investment return appropriated for spending on current-period

operations (including through a spending rate policy on investment return earned by endowment

funds) would be presented as an internal transfer. However, under the proposed ASU, the

operating excess (deficit), both before and after transfers, would include all donor-restricted

support that becomes available (i.e., is released) in the period for carrying out the NFP’s purpose.

The proposed ASU includes illustrations that demonstrate that net assets released from

restrictions, which originate from investment return appropriated from a donor-restricted

endowment fund, is included in operating revenues, gains, and other support and the resulting

operating excess (deficit) before transfers. Investment return appropriated from a quasi-

endowment would be shown in the transfers section and therefore excluded from the operating

excess (deficit) before transfers subtotal.

NFP business-

oriented HC entities

would no longer be

required to classify

investments as

trading versus other

than trading

securities.

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KPMG Observations

Many NFPs currently budget a portion of investment return to fund operations. The

investment return may be earned on investments included in either a donor-restricted

endowment fund, a board-designated endowment fund, or a general portfolio held to

support operations. The difference in presentation between appropriations from donor-

restricted endowment funds and appropriations from other investment portfolios would

result in some investment return (appropriated from donor-restricted endowments)

included in operating revenues, gains, and other support and in the operating excess

(deficit) before transfers. Other investment return would be excluded from operating

revenues, gains, and other support and only included in the operating excess (deficit) after

transfers (as illustrated in Example 4).

Example 4: Investment Return

NFP A has a donor-restricted endowment fund valued at $500 million that has no purpose

restrictions on the investment return. Under UPMIFA, NFP A appropriates investment

return to be used for operations using a 4 percent spending rate. In 20X1, $20 million is

released from restrictions and included in operating revenues, gains, and other support.

This amount is also included in both operating subtotals, operating excess (deficit) before

transfers and operating excess (deficit) after transfers.

NFP B has a board-designated fund that was created from donor contributions received

with no donor restrictions. The NFP’s governing board decided to designate the funds to

be held in the NFP’s board-designated endowment with the return used to support

operations. NFP B also has a 4 percent spending rate and appropriates $20 million to be

used for operations in 20X1. In this instance, the $20 million is excluded from operating

revenues, gains, and other support and included in the transfers section as a board

appropriation. This amount would be excluded from the first operating subtotal, operating

excess (deficit) before transfers, and included only in the second subtotal, operating

excess (deficit) after transfers.

All other activity being equal between the two entities, NFP A could potentially show an

operating excess before transfers and NFP B an operating deficit before transfers, as a

result of the difference in presentation of the investment return used for operations.

Financing Activities

Many NFPs currently view interest expense as an operating cost. For NFP business-oriented

HC entities, interest expense is currently included within the performance indicator. Under

the proposed ASU, interest expense would be excluded from operating expenses.

Example 5: Interest Expense

NFP A elects to rent its facilities while NFP B elects to borrow funds to acquire its

facilities. Under the proposed ASU, NFP A would report rent expense as an operating

expense while NFP B would report the interest on the borrowing as a nonoperating

expense. As a result, the operating excess (deficit) reported for NFP A versus NFP B

could be significantly different.

NFP business-

oriented HC

entities would no

longer be

permitted to use

cash flow hedge

accounting for

derivatives (e.g.,

interest rate

swaps) as these

entities would no

longer report a

measure

equivalent to other

comprehensive

income.

14





Capital Transactions and Events

All gifts of long-lived assets without donor restrictions would be reported as operating revenues.

These gifts would meet the mission dimension because all contributions are considered to carry

out the NFP’s mission. Because these gifts are received without donor restrictions, they would

also meet the availability dimension. However, unless the gifted long-lived asset is sold, NFPs

also would report a transfer out of operations for the entire amount of the gifted long-lived asset.

This would occur because the inherent long-term nature of the gifted asset makes it not fully

available for current operations. If the NFP decided to sell the capital asset, the gift would be

included in operating revenues with no transfer out of operations prescribed by the proposed

ASU.

Purpose-restricted gifts of long-lived assets and gifts of cash restricted for acquisition or

construction of long-lived assets generally would be reported initially as revenues that increase

net assets with donor restrictions (i.e., outside of operations). Absent specific donor stipulations

describing how long these assets must be used, NFPs would report the release from donor

restrictions when the asset is placed in service. The release would be reported as an increase in

net assets without donor restrictions within operating activities and a decrease in net assets with

donor restrictions. The proposed ASU retains the ability for NFPs to report donor-restricted

contributions whose restrictions are met in the same period as support within net assets without

donor restrictions. NFPs following such a policy would instead immediately report restricted

capital gifts within net assets without restrictions (and operating activities) if the restrictions are

met in the same period. Consistent with the treatment of gifts of long-lived assets without donor

restrictions, NFPs also would report a transfer out of operations for the entire amount in the

same reporting period.

Non-HC NFPs currently have an option of electing a policy of implying a time restriction on

donated long-lived assets. Under such a policy, the time restriction expires over the useful life of

the donated long-lived asset. Some NFPs currently elect this policy because it allows the release

to be matched by the asset’s depreciation expense. This option would be eliminated for all NFPs

under the proposed ASU. All restrictions on long-lived assets would be released when the assets

are placed in service.

KPMG Observations

NFPs that currently report an intermediate measure of operations often report capital

transactions outside of operations. The performance indicator used by NFP business-

oriented HC entities also excludes contributions of (and net assets released from donor

restrictions related to) long-lived assets. Reporting capital transactions within operations

could result in significant yearly fluctuations given their irregular nature.

In response to constituents who argued that these activities should be shown outside

operations, the FASB decided that while they would be shown within operating revenues,

unless the institution decides to sell the capital asset, a transfer out of operations also

would be shown. Therefore, these amounts would be included in the first subtotal

(operating excess (deficit) before transfers) but excluded from the operating excess

(deficit) after transfers. However, the expense (depreciation) associated with the capital

asset would continue to be reported in operations in subsequent periods over the asset’s

useful life while the revenue would be reported in operations only in the initial period.

To address this mismatch in revenues and expenses, the FASB initially considered

requiring NFPs to transfer an amount back into operations as the assets were used (to

offset the annual depreciation expense). However, this was considered too complex and

burdensome for recordkeeping purposes. The FASB ultimately decided that there should

The current

requirement to

generally include

impairment losses

and gains/losses

on sales of long-

lived assets within

operations would

be retained under

the proposed ASU.

15





be no subsequent transfers after the initial transfer out of operations.

This proposed treatment has been one of the most hotly contested decisions by the

FASB because it contradicts how many institutions view their operations. This decision

could significantly impact NFPs that receive large, sporadic capital gifts or gifts of cash to

acquire or construct capital assets and currently report these activities, including the

release from restrictions, outside of operations. This decision was discussed by the FASB

at multiple meetings and some decisions were reversed. However, the ultimate result is

that (1) these activities would be included in operating revenues and (2) transfers to move

them outside of operations would be included with other transfers made at the NFP’s

discretion. Using transfers for these activities may create additional complexity for

external users to differentiate them from other transfers that are unusual and unique to a

specific NFP.

Board Designations, Appropriations, and Similar Transfers

Under the proposed ASU, NFPs would present all operating revenues and support before

reductions for amounts designated by the governing board or its designees (i.e., management)

for use in future periods. Accordingly, NFPs would not report revenue and support net of those

amounts transferred. If an NFP’s governing board designates, appropriates, or similarly transfers

a portion of operating revenues for use in a future period, the NFP would report a transfer out of

operating activities to reflect the portion of resources no longer available. Conversely, if the

NFP’s governing board makes available certain nonoperating returns or previously transferred

amounts to support fiscal needs of current operations, the NFP would report a transfer into the

operating activities section to reflect the portion of resources made available for current-period

operations.

All designations, appropriations, and similar transfers made by the governing board or its

designees that affect current period operating activities would be shown in a separate section in

the statement of activities between the two required subtotals. The transfers would be shown in

the statement either in aggregate (transfers in separate from transfers out) or individually. If

shown in aggregate, the details would need to be disclosed in the notes. NFPs would be

required to disclose the purpose, amounts, and types of transfers (e.g., whether the transfer

occurred because of standing board policies, a one-time decision, or other reason).

KPMG Observations

Presenting Board Designations and Appropriations on a Gross Level. The

requirement to display operating and nonoperating revenues and board appropriations

gross in the statement of activities would represent a significant change from current

presentation. NFPs that currently define operations present activities that meet the

definition within operations. Those activities that do not meet the definition are shown in

nonoperating activities. For example, if an NFP has a policy to designate bequests to a

board-designated endowment, the NFP may currently report all bequests in nonoperating

activities. Under the proposed ASU, all bequests without donor restrictions would be

shown in operating activities and the board’s designation would be shown in the transfers

sections within the operating and nonoperating sections of the statement of activities.

The FASB believes that this presentation is more transparent.

Impact on Operating Performance. The decision to include designations and

appropriations by the governing board as well as its designees (i.e., management) may

allow NFPs to structure operating performance to reach desired results. The FASB’s

proposed requirement to describe the purpose, amounts, and types of transfers may help

16





alleviate this concern or at a minimum provide enough transparency for external users to

further analyze the operating results reported.

For NFP business-oriented HC entities that presently display the performance indicator

based on prescribed criteria, the ability to include internal designations in the measure of

operations could result in a significant difference in practice and move from a measure

that is now comparable to one that could be less comparable depending on entities’

designation and appropriation practices.

Transfers Not Affecting Current Period Operations. It is not clear whether the FASB’s

intent is that transfers shown in the statement of activities would include only those that

affect current period operations. While the language in the proposed ASU appears to

indicate this, some have questioned whether current period transfers of prior year

accumulated operating surpluses also would be reflected in the statement of activities.

For example, an NFP’s governing board may decide in the current period to transfer net

assets without donor restrictions to create a board-designated fund from operating

surpluses accumulated in prior periods. Including such a transfer in the current period’s

statement of activities would distort the operating results of the current period. It would

appear more appropriate to reflect the results of this transfer only in the disclosure of

board-designated net assets without donor restrictions at year-end.

Disclosure of Board-designated Net Assets. The disclosure of current period board

transfers should align with the disclosure of board-designated net assets without donor

restrictions at period end required under the proposed ASU. This information may be

combined in the same note disclosure.

Accounting Write-offs

Under the proposed ASU, the immediate write-off of goodwill and noncapitalized collections

would be reported separately from revenues, expenses, gains, and losses, but included in the

operating excess (deficit) before transfers.

Immediate Write-off of Goodwill

Current guidance specifies that if an NFP acquires another entity whose operations are expected

to be primarily supported by contributions and returns on investments, the NFP acquirer does not

recognize goodwill. Instead, the NFP acquirer recognizes a separate charge in the statement of

activities. Conceptually, this has not been considered revenue, expense, gain, or loss, but a

practical expedient to allow immediate write-off. Currently, the separate charge is required to be

presented within the performance indicator by NFP business-oriented HC entities. Acquisitions

are often non-recurring, so other NFPs that report an intermediate measure of operations have

generally reported the separate charge outside of operations.

Under the proposed ASU, the immediate write-off of goodwill upon acquisition of an entity would

be considered an operating activity for all NFPs despite the very unusual nature of the

transaction. The FASB believes that it is reasonable to assume that the purpose of acquiring the

entity is to carry out the NFP’s purpose. Although the write-off is an accounting accommodation

rather than a current period expense, it is a current period event that is generally undertaken to

further an NFP’s mission. Therefore, these transactions would be considered operating activities,

unless the acquired entity’s purpose is not directed at carrying out the acquirer’s mission.

17





Noncapitalized Collections

Similarly, NFPs that have permanent collections (e.g., works of art, historical treasures, and

similar items held by museums) may elect not to capitalize them. If so, these NFPs may currently

report the write-off (noncapitalization) outside of operations if they report an intermediate

measure of operations. However, similar to their consideration for goodwill write-offs, the FASB

believes it is reasonable to assume that collections are acquired and maintained to carry out the

NFP’s mission. Therefore, unless the collection items are acquired from net assets with donor

restrictions, these acquisitions would be reported as a separate line within operating activities

under the proposed ASU.

For noncapitalized collections acquired with resources without donor restrictions, proceeds from

the sale and from insurance recoveries of lost or destroyed collection items would be similarly

reported as operating activities, separately from revenues, expenses, gains, and losses.

Retirement Benefits

The change in net assets arising from a defined benefit plan (or a postretirement benefit plan),

but not yet reclassified as a component of net periodic pension cost (or net periodic

postretirement benefit cost), would be displayed as a separate line outside of the operating

activities section of the statement of activities. Under current U.S. GAAP, the display of the

separate line within or outside an intermediate measure of operations or the performance

indicator, if presented, is not prescribed. That said, most NFPs currently display the separate line

outside of operations, if presented.

Equity Transfers and Transactions

Equity transfers (i.e., transfers between a parent and subsidiary or entities under common

control in standalone financial statements) and equity transactions between financially-

interrelated entities would be reported as operating activities, unless they are not for the current

period’s use in carrying out the reporting entity’s mission. The FASB believes that it is reasonable

to assume that these transactions are made to further the ability of the related NFPs to carry out

their purpose. Therefore, they should be classified as operating activities unless the resources

are not available for current-period activities. These transactions would be reported separately

from revenues, expenses, gains, and losses, but included in the operating excess (deficit) before

transfers subtotal.

Under current U.S. GAAP, equity transfers are required to be reported separately as changes in

net assets and excluded from the performance indicator by NFP business-oriented HC entities.

Equity transfers are not directly addressed within U.S. GAAP for other NFPs, and there is

diversity in presentation of these transactions (which may be referred to as grants) in or outside

of operations. Equity transactions are currently required to be reported as a separate line in the

statement of activities, but presentation in or outside of operations is at NFPs’ discretion. NFPs

often report such transactions currently outside of operations.

KPMG Observations

The inclusion of accounting write-offs, equity transfers, and equity transactions within

operations appears to conform to the two key dimensions in the definition. This could

create significant change, particularly for NFP business-oriented HC entities with equity

transfers currently reported outside of the performance indicator. These provisions of the

proposed ASU on transfers from a parent or a brother-sister entity may impact the results

of operations reported in standalone financial statements of HC and other NFP entities.

Equity transfers are

not part of the

transfers that are

required to be

shown in a separate

section in the

statement of

activities between

the two operating

subtotals. Those are

internal transfers

made by the NFP’s

board.

18





Presentation in Statement of Activities

The proposed ASU continues to permit diversity in presenting revenues, expenses, and other

changes in net assets using a one- or two-statement approach. Additionally, NFPs would no

longer be required to report the intermediate measure of operations in a statement that also

reports the change in unrestricted net assets (or the equivalent, net assets without donor

restrictions).

Statement of activities options are included in the proposed ASU that illustrate the permitted

flexibility. While the illustrations include various NFPs, including a university, NFP business-

oriented HC entity, private foundation, and charity, each presentation is not intended to be

prescriptive to the type of entity.

This Issues In-Depth also includes illustrations of the following potential statement of activities

options in Appendix 1.

Illustration 1: Sample University – One-Statement Approach: Multi-Column, Single Year

Illustration 2: Sample University – One-Statement Approach: Layered/ Single Column

(“Pancake”), Comparative

Illustration 3: Sample Charity – One-Statement Approach, Multi-Column, Summarized

Comparative

Illustration 4: Sample NFP Health Care Entity – Two-Statement Approach: Statement of

Operations and Statement of Changes in Net Assets, Comparative

KPMG Observations

The FASB decided to retain the current flexibility in presentation given the diversity of the

NFP industry and the pros and cons for each approach. Currently, the columnar approach

is often used to show totals of certain line items such as contributions and net assets

released from restrictions. However, this advantage is complicated under the new

reporting model. The proposed ASU includes an illustration where contributions with

donor restrictions are presented in the upper portion of the statement on the same line as

contributions without donor restrictions. Similarly, net assets released from restrictions

are shown in both columns in the upper portion of the statement. This allows the

organization to display total contributions and also to clearly show that net assets

released from restrictions net to zero. However, the rows for the operating subtotals only

apply to the without donor restrictions column, not the with donor restrictions or total

columns. Therefore, the with donor restrictions and total columns are blank for these

rows.

The columnar presentation in Illustrations 1 and 4 in Appendix 1 shows all activity relating

to the net assets with donor restrictions class in the lower part of the statement (after the

operating subtotals). That presentation allows subtotals to be shown for all columns but it

does not include totals for contributions or net assets released. NFPs will need to

consider the pros and cons of the presentation options and select the presentation that

works best for their circumstances.

19





Changes to the Statement of Cash Flows

The statement of cash flows, which was first required for NFPs when Statement 117 was

issued, has been poorly understood and often underutilized by users. The FASB discussed

options to improve the understandability and usefulness of information reported in the statement

of cash flows. The FASB ultimately decided that requiring all NFPs to use the direct method of

reporting operating cash flows and recategorizing certain cash flows to conform to the proposed

definition of operations used in the statement of activities would achieve this goal.

Direct Method

Current guidance for all entities, including NFPs, provides two options for presenting operating

cash flows. These two options are referred to as the direct method and the indirect method.

While the FASB has encouraged use of the direct method, in practice most entities use the

indirect method of presenting operating cash flows, perhaps because it is easier to prepare.

However, the FASB’s outreach concluded that this presentation often is not useful to assess

financial performance and liquidity. Investing and financing cash flows are required to be

presented using the direct method, and these sections of the statement are often easier to

understand.

The FASB performed outreach with NFPs and similar entities that currently utilize the direct

method of reporting operating cash flows. This included public universities that follow GASB

standards, which require the direct method of reporting for operating cash flows (including the

indirect reconciliation) as well as some private universities and other NFPs that have voluntarily

elected to do the same. These entities generally reported that their governing board members

and other stakeholders found the information in the direct method to be clearer and more

insightful. They generally reported minimal additional costs that were limited primarily to first

year implementation costs to train personnel and map information from existing systems. Many

entities that report using the direct method determine the operating cash receipts and payments

indirectly (i.e., by adjusting revenue and expense amounts for the change during the period in the

related asset and liability accounts). This method, which is discussed in the Basis for Conclusions

of Statement 95, is considered a more cost-effective method for organizations without the ability

to track gross operating cash receipts and payments directly from their accounting systems.9

Topic 230 requires entities that report operating cash flows under the direct method to provide a

reconciliation of net income (change in net assets for an NFP) to net cash flows from operating

activities (i.e., also report operating cash flows using the indirect method).10

Under the proposed

ASU, this reconciliation would no longer be required for NFPs.

Changes to Align with the Definition of Operations in Statement of

Activities

The FASB decided to amend the classification of certain cash inflows and outflows to better align

operating cash flows with the proposed definition of operations in the statement of activities.

The amendments are listed in the following table.

9 FASB Statement No. 95, Statement of Cash Flows (subsequently codified in Topic 230), available at www.fasb.org.

10 FASB ASC Topic 230, Statement of Cash Flows, available at www.fasb.org.

Under the proposed

ASU, the proper

presentation and

classification

requirements for the

statement of cash

flows in

consolidated

financial statements

of an NFP and a

business entity

would be

determined by

whether the parent

(reporting) entity is

an NFP or a

business entity.

20





Recategorized to Operating

Cash Flows

Recategorized from Operating

Cash Flows

Cash payments at the time of purchase

or soon before or after purchase to

acquire property, plant, or equipment or

other productive assets (currently

investing)

Cash receipts from the sale of property,

plant, or equipment or other productive

assets (currently investing)

Cash payments to acquire and cash

proceeds from the sale of collection

items (currently investing)

Cash gifts restricted for acquisition of

long-lived assets, including property,

plant, and equipment, and collection

items (currently financing)

Cash receipts of interest and dividends

on loans and investments, excluding

those made for programmatic purposes

(to investing)

Cash payments of interest on debt (to

financing)

Noncash Operating, Investing, and Financing Activities

The current requirement to disclose noncash investing and financing activities would be

expanded to include significant noncash operating activities. These are transactions or other

events that affect recognized assets and liabilities, but which do not result in cash receipts or

payments in the current period. They do, however, have the potential to have a significant effect

on future cash flows. The proposed ASU includes several examples of noncash activities, for

instance, acquiring long-lived assets by gift.

KPMG Observations

Comparison to Business Entities. While acknowledging the benefits of the direct

method, some have questioned the necessity of requiring this method for NFPs while

allowing business entities greater flexibility. The current cash flow classifications are

consistent with those in other industries following FASB standards and are familiar to

creditors, governing board members, and other users. If the requirements differ for NFPs,

this could increase complexity and create potential confusion for both sets of financial

statement users. Differences are easier to understand when they occur because of NFP

transactions that do not exist in a business entity (e.g., contributions and restricted net

assets). When the differences occur due solely to different standards for the same

transactions, they become a distraction. This would be particularly evident for the HC

industry, which includes NFP and for-profit entities that operate similarly.

Some constituents, including some FASB members, would prefer that this topic be

considered and addressed by the FASB more holistically to include all types of entities.

They would like any amendments for NFPs to be delayed until the debate is complete.

For more details, see the Alternative Views section. While the FASB has a current project

on its agenda relating to the statement of cash flows, it is directed at reducing diversity in

practice with respect to the classification of certain cash receipts and payments. The

21





FASB does not currently have a project on its agenda to broadly re-examine the existing

principles within Topic 230. In addition, the FASB’s research project that is evaluating

ways to improve the relevance of information presented in the performance statement of

business entities does not currently have an objective of improving the linkage between

the performance statement and the statement of cash flows.

Indirect Method Reconciliation. The reconciliation of the change in net assets to net

cash flows from operating activities, which would no longer be required, may be useful to

some financial statement users. As discussed in the Basis for Conclusions of Statement

95, this reconciliation focuses on the differences between net income (change in net

assets) and net cash flow from operating activities. This information is useful to creditors

and others who are concerned with assessing the future cash flows and trends in leads

and lags between cash flows and revenues or expenses. This reconciliation also provides

information for those users who want to identify the differences between organizations in

the measurement and recognition of noncash items that affect income.

Recategorization of Cash Flows. The FASB acknowledged that even with the above

recategorizations, the definition of operations for the statement of cash flows was not

fully (perfectly) aligned with the definition for the statement of activities. Currently, many

NFPs that rely on investment return to support operations report negative cash flows

from operations in the statement of cash flows given that investment gains are excluded

from operating cash flows. That likely may expand under the proposed ASU as a result of

moving the interest and dividends to investing activities. This was done by the FASB to

align with the definition of operations in the statement of activities, where investment

return is considered nonoperating. However, investment return may be included in the

operating excess (deficit) in the statement of activities either by virtue of being released

from a donor-restricted endowment fund or through a transfer by board action. This is just

one example of where the definition of operations is not fully aligned between the two

statements.

Noncash Operating Activities. The expansion of the disclosure requirement to include

significant noncash operating activities may not result in additional disclosures for many

NFPs. Many of the events that would result in noncash operating activities under the

proposed ASU are currently considered investing or financing activities and are disclosed

under the current requirements.

An illustrative statement of cash flows is included in Appendix 2.

Reporting of Expenses by Nature and Function

The FASB also decided that information about financial performance could be improved by

providing greater transparency about how NFPs use their resources to carry out their mission.

Currently, all NFPs are required to present expenses by function (i.e., within categories of

program services and supporting activities). Presentation of expenses by natural classification

(e.g., salaries, benefits, rent, and depreciation) is currently required only for voluntary health and

welfare entities, which are required to report a statement of functional expenses. To achieve

greater transparency, the FASB decided to require all NFPs to present operating expenses by

both nature and function.

22





NFPs would be required to report information about all expenses in one location (statement of

activities, schedule in the notes, or a separate financial statement). All operating expenses would

need to be presented by both natural expense and functional expense classification. One option

would be to provide the information in a matrix format, but no specific format is prescribed.

Nonoperating expenses (e.g., interest expense) would be reported by natural expense

classification; reporting by function would be optional.

Investment expenses that are netted against investment return would not need to be included in

the expense analysis. However, consistent with current guidance, to the extent that other

expenses are reported differently than their natural classification in the statement of activities,

they also would need to be reported in their natural expense classification (and functional

classification if it is an operating expense). This would include salaries reported in the cost of

goods sold and facility rental costs of special events reported as direct donor benefits.

KPMG Observations

Currently, some NFPs choose to report the required functional classifications of total

expenses in the notes and to display total expenses by natural classification on the face

of the financial statements (or vice versa). These NFPs, including some in the health care,

higher education, and trade association segments, believe that the natural classification

information is more informative to their financial statement users than the now-required

functional classification.

Given the proposed ASU’s requirement that all operating expenses need to be presented

by both natural and functional expense classification in the same location, this

presentation would not comply with the requirements in the proposed ASU.

However, given that the matrix format, which was previously required for voluntary health

and welfare entities, is not prescribed under the proposed ASU, some questions have

been raised about the level of detail intended by the FASB. While the matrix format is

used in the illustration included in the proposed ASU, this expanded expense information

may not be equally useful across all segments of the diverse NFP industry. It is not clear

whether including two separate columns in the same location (e.g., note disclosure), the

first showing expenses by functional classification and the second showing expenses by

natural classification, would also meet the requirements under the proposed ASU.

Voluntary Health and Welfare Entities

Voluntary health and welfare entities would be allowed the same flexibility in presentation as

other NFPs under the proposed ASU. This would remove the current challenge with the broad

definition of voluntary health and welfare entity in the FASB Master Glossary, which has created

diversity in how the statement of functional expenses requirement is applied. In an effort to

reduce the diversity, the AICPA’s Audit and Accounting Guide, Not-for-Profit Entities (the Guide)

currently recommends that all NFPs supported by the general public present a statement of

functional expenses. The Guide also states that an NFP could be presumed to be supported by

the general public if contributions, excluding government support, are 20 to 30 percent or more

of total revenue and support. The removal of the statement of functional expenses requirement

would eliminate the current application diversity.

23





Disclosures Required for Expense Allocations

Certain categories of expenses are attributable to more than one program or supporting service

expense category and therefore require allocation. Qualitative disclosure of the methods used to

allocate costs among program and supporting service categories would be required. This

additional disclosure was prompted by concerns from some stakeholders that the lack of specific

guidance on cost allocations may create diversity in functional expense ratios that are often used

as a benchmarking tool for comparison purposes across NFPs. The FASB discussed whether the

disclosures should be quantitative, qualitative, or both. Ultimately, the FASB decided that only

qualitative disclosures would be required. The proposed ASU does not prescribe the contents of

this disclosure, but does include example disclosures on cost allocation methods used.

Management and General Expenses

In an effort to increase clarity as well as promote further consistency and comparability among

NFPs, the FASB also focused on management and general activities. Current guidance provides

a list of activities that comprise management and general activities such as oversight, general

recordkeeping, disseminating information to inform the public of the NFP’s stewardship of

contributed funds, etc. This list also includes “all other management and administration except

for direct conduct of program services…, fundraising activities…, or membership development

activities.” However, this phrase has led to diversity about what costs are allocated to other

program or supporting functions versus remaining in management and general costs.

The proposed ASU refines the definition of management and general activities and includes

additional examples of the types of activities included in this category. For example, recruiting

and employee benefits activities (human resources department) and payroll were added to the

list of management and general activities. Additional implementation guidance also is included to

better depict which activities represent direct conduct and direct supervision of program or

support activities and, therefore, would be allocated to the program or support function or

functions receiving the benefit. The proposed ASU includes the following illustrative example:

Example 6: Human Resources Department Allocation

The human resources department at NFP C generally is involved in the recruitment of all

personnel of the NFP. If NFP C hired an employee to work in Program A, the human

resources department’s related costs would not be allocated to that program. Rather,

those costs would remain a component of management and general activities. This

occurs because the human resources department’s efforts to hire an employee for a

particular function are not deemed to be direct conduct or direct supervision of

programmatic activity.

KPMG Observations

Proposed Changes May Prompt a Fresh Look at Expense Allocations. These

clarifications could result in a change in practice for some NFPs that may currently

interpret direct conduct and direct supervision or the definition of program services more

broadly than the illustrations in the proposed ASU would support. The added requirement

to disclose the methods used to allocate costs also may prompt some NFPs to take a

fresh look at their expense allocations.

Considerations for Higher Education. NACUBO and others have said that there is

inconsistency throughout higher education with respect to how the same expenses may

be reported by function by one institution versus another. Some colleges and universities

The current

disclosure

requirements for

joint costs would

remain in effect,

but would be

expanded by the

proposed expense

allocation

disclosures.

24





have been more focused on natural classification and the functional classification has

historically received less attention. However, there has been additional focus by external

parties, including media outlets, public officials, and other stakeholders with an interest in

comparing the cost of obtaining a degree at different institutions or evaluating the

institution’s effectiveness at conducting research or other programs. This has caused

some in the higher education community to recognize the increased importance of the

functional classifications. This environment, combined with the proposed requirements to

present operating expenses by both function and nature and disclose expense allocation

methods, may prompt higher education institutions to take a fresh look at their functional

allocations.

Presentation of Investment Expenses and Return

Investment Expenses

The proposed ASU eliminates the requirement to disclose the amount of total investment

expenses and the option to report these amounts within total expenses for non-programmatic

investing. All NFPs would be required to net investment expenses against non-programmatic

investment return. When internal salaries and benefits are included in the amount netted against

investment return, the total of these costs would need to be disclosed.

Under existing guidance, NFPs are permitted to present investment expenses as an expense or

to net them against investment return. While many NFPs currently elect the option to net the

expenses against the return, the requirement to disclose the total amount of netted investment

expenses presents challenges, particularly as it relates to embedded fees. Embedded fees, such

as those charged by hedge funds, mutual funds, and funds of funds, are often difficult to identify

and accumulate on a timely basis for financial reporting purposes. Therefore, the investment

expenses disclosed by NFPs currently are often not all-inclusive and may only reflect those

expenses that are readily accessible.

The AICPA’s Financial Reporting Executive Committee and other constituents asked the FASB to

reconsider the reporting requirements for investment expenses. The FASB concluded that the

costs and effort to obtain the information seemed to exceed the benefit that the information may

provide to financial statement users. This is in part because most users find the net investment

return to be the most relevant, comparable, and useful information. The FASB decided to

eliminate the requirement to disclose total investment expenses. The disclosure of netted

internal salaries and benefits was added to address concerns by some constituents about the

potential loss of relevant salary and benefit-related information with the removal of the

investment expense disclosure.

The FASB also concluded that the netted investment expenses would be limited to external

investment expenses and direct internal investment expenses incurred during the period. NFPs

would not be required, or permitted, to net indirect internal investment expenses against

investment return. The FASB also decided to remove the option to present non-programmatic

investment expenses gross, within expenses, to improve comparability among NFPs.

The proposed

changes to the

reporting of

investment expenses

and return do not

relate to

programmatic

investing.

25





Gross Investment Return

NFPs would no longer be required to disclose the components of gross investment return.

Current U.S. GAAP requires disclosure of the disaggregated components of gross investment

return for the entire portfolio. There also is a separate disclosure requirement to disaggregate the

components of gross investment return relating to the endowment portfolio at a minimum

between investment income and net appreciation/depreciation. The difficulties related to

disclosing investment fees, which are often embedded in investment return, also complicate the

process of disclosing gross investment return. Therefore, the FASB decided to also remove the

existing requirements to disclose the components of gross investment return.

KPMG Observations

The changes to the presentation of investment return and expenses are more in line with

the total return concept inherent in UPMIFA and investment analysis in the current

environment.

Considerations for Private Foundations. Private foundations are subject to a 1 or 2

percent excise tax on net investment income, as defined by the Internal Revenue Code.

This excludes unrealized gains and losses. Therefore, private foundations will still need to

track, and may choose to continue to report in the financial statements, the components of

gross investment return.

Total Performance of the Other Investment Portfolio

The current requirement to disclose the total performance of the other investment portfolio

would be eliminated. Institutions of higher education are currently required to present the total

performance (investment income and realized and unrealized gains and losses) of the other

investment portfolio in the statement of activities or accompanying notes. Other investments are

defined in FASB’s investment guidance for not-for-profit entities.11

Those investments include,

among others, certain investments in real estate, mortgage notes that are not debt securities,

venture capital funds, certain partnership interests, oil and gas interests, and certain equity

securities that do not have a readily determinable fair value. The FASB decided to eliminate this

disclosure requirement consistent with the other proposed changes in this area.

11

FASB ASC Subtopic 958-325, Not-for-Profit Entities – Investments-Other, available at www.fasb.org.

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Additional Liquidity Disclosures

NFPs would be required to define the time horizon used to manage liquidity (e.g., 30, 60, or 90

days) and disclose the following quantitative and qualitative information:

Quantitative Information Qualitative Information

Total amount of financial assets

Amounts that are not available to meet

cash needs within the self-defined time

horizon due to both:

External limits, and

Internal designations, appropriations,

and transfers made by the NFP’s

governing board.

Total amount of financial liabilities due

within the same self-defined time horizon

How liquidity is managed, for example:

Strategy for addressing entity-wide

risks that may affect liquidity, including

lines of credit;

Policy for establishing liquidity

reserves; and

Basis for determining the time horizon

used for managing liquidity

While the required quantitative information is prescriptive, the qualitative information is not. The

proposed ASU requires that NFPs provide information about how liquidity is managed and

provides examples of what may be disclosed to achieve this requirement. However, these are

only examples and not prescribed components of the disclosure.

One of the major objectives of the FASB’s project is to improve the quality of information users

have to assess liquidity and how NFPs manage their exposure to liquidity risk. NFP business-

oriented HC entities are required to classify assets and liabilities as current and noncurrent and

separately present assets whose use is limited on the balance sheet. Other NFPs are required to

provide information about liquidity of assets and liabilities through either: (1) sequencing such

items based on liquidity; (2) classifying such items as current or noncurrent; or (3) providing

disclosures about the liquidity or maturity of such items, including restrictions on use. However,

some have observed that it is often still difficult to assess liquidity, in part because assets may

appear to be liquid based on their nature, but restrictions imposed by contracts, laws, or donor

stipulations may impact liquidity and result in these assets being unavailable to meet short-term

cash requirements.

The FASB considered requiring one or more of the following for all NFPs to improve information

about liquidity in NFP financial statements:

(1) Classified balance sheet;

(2) Separate presentation of assets whose use is limited;

(3) Liquidity information added to and integrated with notes currently required for specific assets

(e.g., investments and contributions receivable); and

(4) Quantitative and qualitative information about the liquidity of assets and near-term demands

for cash as of the reporting date and about how liquidity is managed.

The existing liquidity

disclosure and

presentation

requirements for HC

and other NFPs

would also be

retained under the

proposed ASU.

27





The FASB considered these alternatives as well as whether existing requirements about liquidity

information in the financial statements was adequate. Some FASB members said that while

some NFPs may not be fully complying with the spirit of the existing disclosure requirements,

the current requirements, as written, were adequate. These members believed that none of the

debated options would provide additional useful information not already intended in the current

requirements. It was acknowledged that a full understanding of an entity’s management of, and

exposure to, liquidity risks may require forward-looking information and discussion that may go

beyond the boundaries of financial reporting. The FASB ultimately concluded that of the

alternatives considered, the fourth would be the most effective way to provide additional

information within the boundaries of financial reporting that would be the most useful,

understandable, and auditable for all NFPs. It was also believed that these additional disclosures

would not require new systems or impose significant costs on NFPs.

The FASB acknowledged that there may be instances where the proposed disclosures were not

needed or useful, and considered an alternative where the disclosures would be conditional (e.g.,

required only when the liquidity of the entity was not apparent through the face of the financial

statements or other disclosures or exclude NFPs that have little or no donor-restricted

resources). However, the FASB ultimately decided to require the disclosures for all NFPs.

Some of the FASB members felt that leaving the definition of the time horizon up to each NFP

would result in a lack of comparability, but they also did not believe that any specific time horizon

would apply to all NFPs. Therefore, the FASB decided not to define a single time horizon but

include disclosure of the NFP’s basis for determining a time horizon in the example qualitative

disclosures.

Effective Date and Transition

The FASB did not propose an effective date. The FASB discussed various options for an effective

date and whether there should be different effective dates based either on the size or type of

NFP or on the proposed ASU’s individual provisions. The FASB also discussed whether the

effective date should be similar to the time frame prescribed for the last significant change in

NFP financial reporting. Statements 116 and 117, which resulted in a more extensive overhaul of

financial reporting for NFPs, were effective for fiscal years beginning approximately 18 months

after the issuance of the standards for NFPs with total assets and expenses greater than $5

million and $1 million, respectively.12

Smaller NFPs were given an additional year before adoption

was required.

However, the FASB ultimately decided not to include an effective date in the proposed ASU, but

instead include specific questions soliciting comments from respondents on the effective date.

The effective date (and whether it should be the same for all NFPs, as well as whether early

adoption would be permitted) will be determined after considering constituents’ comments.

Retrospective application would be required upon initial application. In the initial period of

application, the financial statements would disclose the nature of any reclassifications or

retrospective adjustments and their effects on the change in the net asset classes for each year

or period presented. However, interim financial statements would not need to reflect the

standard’s application in the initial year of application.

12

FASB Statement No. 116, Accounting for Contributions Received and Contributions Made, available at www.fasb.org.

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KPMG Observations

While the proposed standard’s primary impact would be on how financial information is

displayed, some NFPs could experience reclassifications between net asset classes. For

example, eliminating the option to release restrictions over an asset’s estimated useful

life would require NFPs currently using this option to immediately release any remaining

restricted net assets relating to those assets already placed in service upon

implementation of the proposed ASU.

The change in the reclassification of donor-restricted endowment deficiencies from the

current unrestricted net assets category to the proposed net assets with donor

restrictions category also would result in an immediate reclassification of net assets upon

implementation for those NFPs with underwater endowments.

Alternative Views

Both the FASB Chairman and Vice Chairman disagreed with the publication of the proposed ASU.

Both supported updating the existing presentation and disclosure standards for financial

statements of NFPs, particularly related to issues specific to or more uniquely encountered by

NFPs. However, they disagreed with the proposed requirements that go beyond specific NFP

issues and establish differences between NFPs and business entities. They specifically cited the

following examples.

Intermediate Measures of Operations. The dissenting FASB members do not support an

approach of developing comprehensive guidance for NFPs while the FASB research project

exploring essentially the same issue for business enterprises is ongoing. They believe that this

approach could establish different conclusions when an aligned approach may be best. These

FASB members believe that an important objective is to eliminate, rather than create, accounting

and reporting differences that are not justified by underlying facts and circumstances. They

believe that this piecemeal approach is likely to introduce unnecessary complexity in

understanding the differences that may be mandated by addressing the NFP reporting model

separately.

Statement of Cash Flows. The dissenting FASB members do not believe that the nature of

changes in cash, or other differences of NFPs when compared to other entities, is sufficient to

warrant a fundamentally different approach to statement of cash flows reporting. They agree

with the Board’s approach in developing Statement 117 that did not impose cash flow

requirements on NFPs that are more stringent than those for business entities. They also believe

that the changes among the three cash flow categories that were proposed to be more

compatible with the proposed definition of operations in the statement of activities would not

align these two definitions. For example, under the proposed ASU, cash payments for long-lived

assets would be reported as operating cash flows, but depreciation on fixed assets would be

reported based on whether the asset is used to promote the NFP’s mission. They also do not

support the change to report cash flows related to long-lived assets as operating rather than

investing cash flows. They expressed reservations about the cohesiveness notion that is partially

being pursued by the proposed changes.

29





The dissenting FASB members also do not agree with imposing a requirement to report two

measures of operating performance, one of which reflects internally-imposed limits. In their

view, it is inappropriate to include in operating results the impact of internal and arbitrary events,

including discretionary items that are not the result of transactions with third parties, changes in

the measurement of assets and liabilities, or other outside events. They believe that this

provides NFPs with the ability to stress a U.S. GAAP measure of operating performance that

they select and choose to report. They agreed that internally-imposed limits are, or can be,

significant, but believe that they should be reported in the notes rather than on the face of the

financial statements.

Responding to the Proposed ASU

The proposed ASU includes the following main sections:

(1) Summary and Questions for Respondents

(2) Amendments to the FASB Accounting Standards Codification

(3) Background Information, Basis for Conclusions, and Alternative Views

The Summary outlines the main provisions and how they differ from current U.S. GAAP. The

Background Information, Basis for Conclusions, and Alternative Views section also will help

readers of the proposed ASU to better understand the considerations the FASB discussed prior

to making the decisions incorporated in the proposed ASU. This section includes alternative

views expressed by some FASB members about certain aspects of the proposed ASU. Some of

the amendments stimulated extensive discussion and debate not only by NAC members and

other constituents but also by FASB staff and board members. As a result, the votes on the

individual decisions by the FASB members were not always unanimous and as further discussed

in the Alternative Views section, the final vote to approve the proposed ASU also was not

unanimous.

The proposed ASU primarily includes amendments to Topics 958 and 954 of the FASB

Codification. In addition, there are conforming amendments to some related Topics, most

significantly Topic 230. The second section of the proposed ASU includes a marked-up version of

the FASB Codification for the applicable topics, including the amended paragraphs as well as

related paragraphs to provide context. Given the pervasive changes to Topic 958, this section is

extensive.

The Questions for Respondents section includes a comprehensive list of specific questions.

While the FASB invites comment on all matters discussed in the proposed ASU, it decided to

include very specific questions to solicit the views of respondents, particularly in those areas

where there was extensive discussion and debate.

We encourage those interested in financial reporting by NFPs to consider providing comments to

the FASB before the comment deadline. Commenting on the proposed ASU will help ensure that

your views are considered before the final ASU is issued. The FASB requests comments from

both those who agree as well as those who disagree with the proposed amendments. Given the

number of proposed changes in the proposed ASU, it is likely that respondents may agree with

some but disagree with others. This should be made clear in your response.

30





Appendix 1: Illustrative Statements of Activities

The illustrative statements of activities assume that Topic 606, Revenue from Contracts with

Customers, has not been adopted.

31





32





33





34





35





Appendix 2: Illustrative Statement of Cash Flows

36





Contact us: This is a publication of KPMG’s Department of Professional Practice 212-909-5600

Contributing authors: Lisa C. Hinkson, Amanda E. Nelson, Maricela Frausto, and Jared S. Silver

Contributing reviewers: David R. Gagnon, National Audit Leader, Higher Education & Other Not-for-Profits, and

Marc B. Scher, National Audit Leader, Healthcare

Earlier editions are available at: http://www.kpmg-institutes.com

Legal–The descriptive and summary statements in this newsletter are not intended to be a substitute for the

potential requirements of the proposed standard or any other potential or applicable requirements of the

accounting literature or SEC regulations. Companies applying U.S. GAAP or filing with the SEC should apply the

texts of the relevant laws, regulations, and accounting requirements, consider their particular circumstances, and

consult their accounting and legal advisors. Defining Issues® is a registered trademark of KPMG LLP.

http://www.kpmg-institutes.com/institutes/financial-reporting-network.html

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