financial statement changes for non-profit organizations...both of these will have a significant...
TRANSCRIPT
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Financial Statement Changes
for Non-Profit Organizations
Bob Kollar Assistant Professor of Accounting, Duquesne University
Shareholder, KuhlemanKollar & Associates, CPAs
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Workshop Description
The Financial Accounting Standards Board (FASB) recently
issued new financial reporting guidance for Not-for-Profit
Entities. Additionally, the FASB has recently issued new
reporting standards for leases and revenue recognition.
Both of these will have a significant impact on all
organizations. This session will review and discuss these
new accounting rules and provide suggestions on how to
prepare your organization and board for these major
reporting changes.
Agenda • Background on changes to the Non-Profit Reporting Model
• Review of the specific changes to Non-Profit financial statements:
a) Net asset classification
b) Endowment funds
c) Liquidity and availability of resources disclosures
d) Investment return
e) Expense reporting
f) Implementation considerations
• Other changes—Leases and Revenue Recognition
• More changes ahead—proposals on grant and contribution accounting
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Learning Objectives
At the conclusion of the workshop, attendees should:
a) Have a general understanding of the major changes
impacting Non-profit financial statements
b) Be familiar with the changes in net asset categories
and how this will impact an organization’s financial
statements
c) Be knowledgeable of the new required disclosures
regarding liquidity and availability of financial resources
d) Be familiar with the new accounting rules for leases and
revenue recognition
e) Understand what steps to begin taking now to
implement the new accounting standards
Historical Background
• FASB’s last major changes to the Non-Profit Financial Reporting
Model occurred in the mid-1990’s
• The historically used “fund balance” was replaced with three
categories of Net Assets, along with major changes to contribution
accounting.
• 2009—in response to questions, inconsistencies, confusion,
perceived deficiencies and concerns from users and non-profit
organizations, FASB’s Non-Profit Advisory Council began
discussing possible changes to the Non-Profit Financial Reporting
Model
• The new financial reporting model was issued in August 2016, and
updates Accounting Standards Codification (ASC) section 958
(Only 264 pages!!)
• Goal: enable non-profits to “tell their financial story” in a more
understandable manner.
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Historical Background • The new rules issued in August 2016 are Phase I of the review of the
financial reporting model
• Effective date of the new standard is fiscal years beginning after 12/15/2017 (calendar year 2018 if your organization has a December 31 year-end)
• Phase II of the review of the financial reporting model—ON HOLD
• Phase II is to review: consideration of an operating measure, certain items in the cash flow statement, and potential changes for non-profit health care entities
• Additionally, FASB just released in August 2017 proposed rules on the accounting treatment of grants and contributions. Would not be effective until calendar year 2020.
Changes in Net Asset
Classification
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Net Asset Reporting Changes • Current GAAP requires reporting of three categories of
net assets:
a) Unrestricted
b) Temporarily restricted
c) Permanently restricted
• New rules will require only two categories of net assets, with additional disclosures
a) Without donor restrictions—adding amount, purpose and nature of any board designations
b) With donor restrictions—disclosing the nature and amount of donor restrictions
Current Financial Statement
Presentation—Net Asset Classifications
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New Presentation—Net Asset
Classifications
New Presentation—Net Asset
Classifications What if your organization has “board-designated” net assets?
FASB added a definition to its master glossary:
• Net assets without donor restrictions subject to self-imposed limits by action of the governing board
• Board designated net assets may be earmarked (by the board) for future programs, investment, contingencies, purchase or construction of fixed assets, or other uses
• Some governing boards may delegate designation decisions to internal management. Such designations are considered to be included in board-designated net assets.
Two possibilities for presentation of board-designated funds: A. Disclose on the face of the balance sheet
B. Present in the footnotes information regarding the designations
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New Presentation—Net Asset
Classifications Presentation on face of the statement of financial position:
NET ASSETS
Without donor restrictions:
Undesignated $3,057,607
Board designated for operating reserve 300,000
Board designated for endowment 15,511,186
Invested in PP&E, net of related debt 21,150,885
$40,019,678
With donor restrictions:
Perpetual in nature 22,864,750
Purpose restrictions 14,228,316
Time restricted for future periods 1,392,825
38,484,891
Total net assets $78,504,569
New Presentation—Net Asset
Classifications Presentation of information regarding designations in the footnotes:
Non-Profit XYZ’s governing board has designated, from net assets without donor restrictions, net assets for the following purposes as of June 30, 20xx:
Board-designated endowment $15,511,186
Operating reserve 300,000
Total designated 15,811,186
Unrestricted and undesignated 24,208,492
Total net assets without donor restrictions $40,019,678
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Composition of Restricted Net Assets—
Current Presentation (footnotes) Current format includes footnote disclosure showing the composition of restricted net assets, such as:
Restricted net assets as of December 31 consist of the following:
Temporarily restricted net assets:
Future capital improvements $34,189,000
Instructional support 13,959,000
Operational and program support 14,873,000
$63,021,000
Permanently restricted net assets:
Endowment 70,381,000
$133,402,000
New Presentation—Net Assets With
Donor Restrictions (footnotes) Net assets with donor restrictions are restricted as follows:
Subject to expenditure for specific purpose:
Future capital improvements $34,189,000
Institutional support 13,959,000
Subject to passage of time 14,873,000
Subject to spending policy and appropriation:
Investments in perpetuity:
Program A 11,678,000
Program B 5,987,000
Any activities of the organization 52,716,000
$133,402,000
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New Presentation—Statement
of Activities
• Currently, the Statement of Activities is a multi-
column presentation of the financial activity
within each of the three categories of net
assets: unrestricted, temporarily restricted and
permanent restricted.
• Under the new standard, the Statement of
Activities will mirror the two new categories of
net assets: without donor restrictions and with
donor restrictions. Example on the next slide.
Statement of Activities—New
Presentation
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Current Presentation—Net Assets Released
from Restrictions (footnote disclosure)
Currently, provide disclosure of amounts net assets released from temporary restrictions, as follows:
Net assets released from temporary restriction during the fiscal year consisted of the following:
Scholarships $5,789,000
Institutional support 1,645,000
Capital improvements 1,106,000
Other 35,000
$8,575,000
New Presentation—Net Assets Released from
Donor Restrictions (footnote disclosure)
Net assets released from donor restrictions by incurring expenses satisfying the restricted purpose, occurrence of the passage of time or other donor specified events during the year ending December 31 are as follows:
Purpose restrictions accomplished:
Scholarships $3,456,000
Capital improvements 1,146,000
Institutional support 879,000
Release of appropriated endowment amounts
without purpose restrictions 35,000
Release of appropriated endowment amounts
with purpose restrictions 3,059,000
$8,575,000
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Endowment Funds • Key changes:
a) Requires any “underwater” amounts to be included in net assets with donor restrictions (previously reported in unrestricted)
b) Must disclose the market value of the underwater assets
c) Disclose whether the organization has the ability to spend from underwater funds and any current appropriations from such funds
Example: Donor gift of $1.0 million; donor specifies organization can use investment earnings as long as value of gift is maintained at $1.0 million. Value drops to $950,000; the fund is now “underwater.” Disclose if the organization used other unrestricted funds to continue the purpose of the donor’s gift until such time as the original investment recovers.
Could also result if the current market value falls below the original gift amount; must also review donor specifications if this would occur.
Liquidity and Availability
of Resources
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Liquidity and Availability of
Resources • Objective is to provide users with a better understanding of the organization’s
liquidity and financial flexibility
• Interesting parallel to disclosures required by public companies (MD&A)
• Key Changes:
a) Qualitative—Disclosure in the footnotes about how the organization manages its liquid resources
b) Quantitative disclosure in the notes regarding:
i. Amounts available to meet cash needs for general expenditures
within one year of the statement of financial position date
ii. Discussion of factors that may impact the availability of financial
resources to meet general expenditures
Liquidity and Availability of
Resources • Considerations in developing this disclosure:
a) Does your organization have a “liquidity management plan?”
b) Does your organization have a liquidity reserve (operating reserve)? If yes, how accessible are the funds in the liquidity reserve? Can they be accessed to meet cash needs of general expenditures in the next 12 months?
c) Does the organization have a line of credit that can be drawn upon during the year?
d) Are there seasonal fluctuations in the timing of cash flows received from grants or contributions?
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Liquidity and Availability of
Resources (Continued)
• Additional considerations about disclosures:
e) Nature of the financial assets
f) External limitations imposed by donors, laws, contracts, etc.
g) Internal limits imposed by board decisions
Qualitative Liquidity
Disclosure—Example
XYZ Non-Profit utilizes a 60-day time horizon to
assess its immediate liquidity needs. This period
of time was established based upon managements
review of the typical cycle of converting its financial
assets to cash and the typical payments of its
trade payables and expenses such as payroll, etc.
The entity invest cash in excess of its daily
requirements in short-term investments.
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Qualitative Liquidity Disclosure—Example
(Continued)
Occasionally, the Board designates a portion of any
operating surplus to its liquidity reserve. As of June 30,
20xx, the liquidity reserve was $25,000. This is a
governing board designated fund with the objective of
setting funds aside that can be drawn upon in the event of
financial distress or an immediate liquidity need resulting
from events outside the organization’s typical cycle of
converting financial assets to cash or settling financial
liabilities. In the event of an unanticipated liquidity need,
XYZ could also draw upon its $100,000 available line of
credit (as further discussed in Note x) or its board-
designated endowment fund.
Quantitative Liquidity
Disclosure—Example
Financial Assets, at year-end $279,200
Less:
Contractual or donor-imposed restrictions
making financial assets unavailable for
general expenditures (192,413)
Quasi-endowment fund, primarily for long-
term investing (34,628)
Amounts set aside for liquidity reserve (25,000)
Financial assets available within one year to meet
cash needs for general expenditures within one
year $27,159
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Additional Quantitative
Disclosures
• Organizations presenting a classified statement of financial condition can provide footnote disclosure discussing its liquidity management practices and the composition of its financial assets.
• Example:
XYZ Non-Profit’s financial assets due within one year of the statement of financial position date available for general expenditure are as follows:
Cash and cash equivalents $4,575
Accounts and interest receivable 2,130
Contributions receivable 1,825
Short-term investments 1,400
Other investments appropriated for current use 1,650
$11,650
Liquidity Disclosures—Impact
of the Changes • All non-profits are required to present the
liquidity and availability of resources disclosures
• Greater requirements for organizations not
using a classified balance sheet; may want to
consider (if practical)
• Non-profits in financial distress will need to give
careful consideration to their disclosures in this
area
• Consider impact and response by users of the
financial statements upon reviewing this
disclosure
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Investment Returns
Reporting of Investment
Returns
• New rules allow “net” presentation of investment return
• Previous requirement to disclose gross investment income and
expenses has been removed; investment expenses can be netted
against investment earnings and appreciation
• Will require re-classification of prior year amounts for comparability
• Organizations can voluntarily disclose gross investment income
and expense
• Investment expenses—includes both EXTERNAL (such as
investment managers) and direct INTERNAL (salaries and related
costs of a staff responsible for investment monitoring and strategy)
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Expense Reporting
New Requirements for
Expense Reporting
• Must present an analysis of expenses by function and nature in one location in the financial statements
• Options:
a) In the Statement of Activities
b) In a separate statement
c) In the notes to the financial statements
• Requires disaggregation of functional expense classifications by their natural expense category
• Must include a description of method used to allocate costs among programs and supporting functions
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New Requirements for
Expense Reporting
• See separate handout showing the different
options for reporting expenses
Defining Functional Expenses
• Program services expenses—activities that result in goods and services being distributed to the non-profits beneficiaries, customers or members in support of their mission
• Supporting activities—all other activities of the non-profit other than program services, such as:
a) Management and general activities
b) Fundraising activities
c) Membership development activities
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Management and General
Expenses--Examples
• General oversight and business management
• Record-keeping and payroll
• Budgeting
• Financing
• Contract administration, including billing and grant reporting
• Production of the annual report
• Human resources function
• Other management and administrative expenses, except for conduct of program services, fundraising activities or membership development
Additional Guidance on Management and
General Expenses
• Activities conducted that are directly related to programs or direct supervision of those programs or supporting activities should be allocated from management and general
• Examples:
a) IT – benefits various functions and should be allocated
b) CEO – could be allocated to programs, fundraising and management and general
c) Human resources function—generally assigned all to management and general
d) Grant Accounting and reporting – program specific reports (program) but financial reports and related accounting are management and general
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Example Footnote Disclosure
The organization’s expenses are summarized and categorized based
upon their functional classification as either program or supporting
services. Specific expenses that are readily identifiable to a specific
program or activity are charged directly to that function. Certain
categories of expenses are attributable to more than one program or
supporting function. Certain categories of expenses are attributable to
more than one program or supporting function. Therefore, these
expenses require allocation on a reasonable basis that is consistently
applied. Allocated expenses include depreciation and amortization,
interest and insurance, which are allocated on the basis of square
footage, as well as salaries, wages and related employee benefits,
which are allocated based on estimates of employee time and effort.
Statement of Cash Flows
• Can continue to use either direct or indirect method
• If using direct method, no longer required to include indirect method reconciliation
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Implementation
Considerations—New Financial
Reporting Model
Implementation Considerations
• Effective date—fiscal years beginning after December 15, 2017
• Auditor’s report—in the year of adoption, may include an “emphasis of matter paragraph” referencing the adoption of the new reporting model
• Early adoption is permitted; not necessary to re-state Analysis of Expenses by function for prior year and may exclude liquidity and availability of resources discussion for prior year
• Review significant agreements that may have an impact on the organization’s liquidity or ability to meet its obligations, such as loan agreements, donor agreements, contracts, etc.
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Implementation
Considerations (Continued) • Review board-designated/internal endowment
policies and update if needed
• Review methodologies for allocation of management and general expenses for reasonableness and accuracy
• Begin to educate your board on the changes that are forthcoming
• Talk with your CPA firm now and ask for their input on any specific areas that your organization should address as you plan the transition
Other Changes—Leases and
Revenue Recognition
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Other Changes—Leases
• After over ten years of review, in February 2016 FASB significantly changed the accounting requirements for leases (ASC Topic 842)
• The most significant change in lease accounting is the recognition of lease assets and lease liabilities by lessees for leases classified as operating leases. Existing GAAP accounted for these types of leases on a “pay as you go basis.”
• This means that operating leases will now appear on the statement of financial position!
• Capital leases will now be referred to as “finance leases” and the determination of operating vs finance will require more judgement (no percentage tests, etc.)
Other Changes—Leases • How changes in lease accounting for operating leases will affect the
Statement of Financial Position
A. Assets:
1. At inception of the lease, lessee will recognize in its statement of financial position a “right-of-use asset” initially measured at the present value of the lease payments over the lease term
2. The right-of-use (ROU) asset will then be amortized over the lease term on a straight-line basis
B. Liabilities:
1. At inception of the lease, lessee will recognize in its statement of financial position a “lease liability” initially measured at the present value of the lease payments over the lease term
2. As payments are made on the lease, the liability will decrease and the “interest component” of the payment will be treated as part of amortization expense
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Other Changes—Leases
Financing Leases:
• At lease inception, lessees will record a right-of-use (ROU) asset measured at the present value of the total lease payments, including any purchase options
• The ROU will be amortized over the useful life of the underlying asset
• At lease inception, lessees will record a lease liability will be recorded, measured at the present value of the total lease payments (as above). As payments are made, interest expense will be recognized over the lease term (similar to current treatment).
• Minimal changes for this type of lease for the lessor
Implementation Tips—New
Lease Standard
• Effective date—for most NPO’s, will be for fiscal years beginning after December 15, 2019
• However, for NPOs that have issued registered debt securities, effective date is one year earlier, for fiscal years beginning after December 15, 2018
• Implementation of the new standard could have significant impact on financial metrics and ratios, such as the current ratio or other measures of liquidity or financial solvency
• Assemble a current inventory of your leases; develop some pro-forma financial statements to ascertain the impact of the new standard
• Discuss with financial statements users (board, lenders, significant donors) the effect of the new standard
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Other Changes—Revenue
Recognition
• In 2014, FASB passed new guidance on revenue recognition, specifically Revenue From Contracts with Customers (updating ASC Topic 606)
• The standard applies to any entity that either enters into contacts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets, unless those contracts are within the scope of other standards (such as insurance or lease contracts)
Revenue Recognition
Five Step Model:
1. Identify the contract with the customer
2. Identify the performance obligations in the contract
3. Determine the transaction price
4. Allocate the transaction price to the performance obligations in the contract
5. Recognize revenue when (or as) the entity satisfies a performance obligation
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Revenue Recognition
• The most significant ramifications for non-profits relates to grants and contracts and exchange transactions.
• NPO’s should START NOW to review these new rules, specifically by reviewing existing contracts. Identification of performance obligations, especially if there are multiple obligations in a given contract, could result in significant changes in how revenue will be recognized in the future.
• FASB is currently reviewing revenue recognition for exchange transactions and contributions and just released (August 2017) proposed guidance on how to account for these.
Proposed Changes—Exchange Transactions
and Contribution Accounting
• In Early August 2017, the FASB issued an exposure draft entitled “Not-for-Profit Entities: Clarifying the Scope and the Accounting Guidance for Contributions Received and Contributions Made.”
• FASB’s primary reason for issuing the proposed new rules is because stakeholders reported difficulty in characterizing grants and similar contracts with resource providers as either exchange transactions or contributions. Difficulties were also reported in distinguishing between conditional and unconditional contributions when applying the existing revenue recognition rules for Not-for-Profits.
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Proposed Changes—Exchange Transactions
and Contribution Accounting
• Is it an exchange transaction or a contribution???
• Contribution—an unconditional transfer of cash or other assets to an entity or a settlement or cancellation of its liabilities in a voluntary nonreciprocal transfer by another entity acting other than as an owner.
• Exchange transactions—are reciprocal transfers in which each party receives and sacrifices approximately commensurate value.
• Both grants and contributions will require close scrutiny to determine the appropriate accounting treatment.
Unconditional Promises vs.
Conditional Promises
• Not-for-Profit entities will still need to evaluate whether a contribution is unconditional or conditional.
• Generally, a donor-imposed condition(s) to receive a contribution represent barriers that must be overcome before the recipient shall be entitled to receive the promised transfer of assets (and therefore record as contribution revenue).
• See handout on reviewing treatment of contributions
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Proposed Changes—Exchange Transactions
and Contribution Accounting
• Determination of an exchange transaction, consider:
• Does the resource provider receive any direct value in exchange for the assets transferred?
• Is the expressed intent of the resource provider and the recipient to exchange resources for goods and services that are of commensurate value?
• If resource provider has full discretion in determining amount of the transferred assets, treat as a contribution.
• If the recipient and resource provider agree on amount of assets transferred in exchange for goods or services are of commensurate value, indicative of exchange transaction.
Proposed Contribution
Accounting
• Must still consider “conditional” vs. “unconditional” in evaluating contributions
• After a contribution has been determined to be unconditional, the entity must consider whether or not the contribution is restricted (i.e., contains a donor-imposed restriction).
• A donor-imposed condition must have:
a) A barrier
b) A right of return to the promisor for assets transferred, or a right of release of the promisor from its obligation to transfer assets
• Must be determinable from the agreement that the recipient is only entitled to the gift if the barrier has been overcome.
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Proposed Contribution
Accounting
• The determination of the existence of a barrier is a facts and circumstances test. Some examples:
a) Measurable performance related barrier or other measurable barrier
b) Stipulations that are related to the purpose of the agreement
c) Limited discretion by the recipient over the how transferred assets should be spent
d) Additional actions required by the recipient—this may be indicative of a conditional contribution
QUESTIONS???
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Contact Information Bob Kollar, CPA/CGMA
Assistant Professor of Accounting
Duquesne University
412.396.4906
Shareholder
KuhlemanKollar & Associates, CPAs
412.221.8585
References
• Financial Accounting Standards Board, Exposure Draft—Proposed Accounting Standards Update, Issued August 3, 2017. Not-for-Profit Entities.
• Financial Accounting Standards Board, Accounting Standards Codification, Not-for-Profit Entities (ASU No. 2016-14, Topic 958)
• AICPA Example Illustrative financial statements and related disclosures for not-for-profit entities (www.aicpa.org)