Accounting standards update (“ASU”) No. 2016-14 changed how not-for-profits communicate with stakeholders, specifically how not-for-profits report net assets, added disclosures about liquidity, required functional expense reporting for all entities, and eliminated the indirect method cash flow reconciliation. The change was effective for fiscal years beginning after December 15, 2017.
Not-for-profits with a fiscal year that ends on June 30 must implement these changes in their 2019 financial statements. Below are some reminders for data collection and questions management should be asking to ensure appropriate presentation of financial statements.
1) Net Asset Reporting
Although the reporting is simpler, additional disclosure may be needed. When ASU 2016-14 is first applied, the footnotes will need to clearly disclose the nature of any reclassifications or restatements and their impact on the changes in the classes of net assets for each period presented.
What not-for-profits need to know: the same information will largely be available as was previously reported; however, readers of the financial statements will need to be educated on where to find that information in the updated presentation in the statement of financial position and its footnotes.
While net asset reporting has changed, nearly all the same information will be available but could be worded differently or located elsewhere in the financial statements. Not-for-profit entities need to ensure that readers of the financial statements are aware of how the change in accounting standards impacted reporting of net assets.
2) Addition of a Liquidity Footnote
To meet the new requirements, not-for-profits will need to create a new footnote to describe cash and other financial assets available to the entity over the next year. Management should consult guidance from experts, involve their audit and/or finance committees, review preliminary analysis with auditors, and carefully consider all available sources and restrictions on cash to ensure the entity’s liquidity position is reflected accurately on the financial statement date.
It is never too early to begin this process, as some line items on the balance sheet may not be apparent as to inclusion or exclusion from the liquidity footnote. An example of an item that is excluded from liquidity is a board designation of certain cash or other assets for specified purposes. There are also items that are not on the balance sheet that can be included in the liquidity disclosure – for example, the unused portion of a line of credit arrangement with a lender.
Consideration of the form of the disclosure should be given ahead of preparation. How does the entity manage its liquid resources? How much is not included in the footnote currently that can become available by an act of board of directors? Are there known liquidity problems, special borrowing arrangements, or other unusual circumstances related to the entity’s liquidity? Does the entity have enough cash to comply with donor-imposed restrictions?
This new footnote will require management to work with stakeholders to ensure relevant and accurate data is presented in the liquidity footnote.
3) Functional Expense Reporting
Before ASU 2016-14, only not-for-profit entities that were considered health and welfare entities were required to report expenses by both functional classification in addition to natural classification. After ASU 2016-14, all not-for-profit entities are required to report expenses by functional and natural classifications together.
If the entity is reporting functional expense for the first time, then multiple considerations will need to be made by management. For example, what are the various categories in which expenses fall (i.e. management and general, program, and fundraising)? Would the readers benefit from additional classifications if multiple, distinct programs exist? Should the expenses be reported by function in their own statement, a separate footnote, or included in the statement of changes in net assets? How will the expenses for each category be determined (i.e. will there be separate accounts for each or an allocation of accounts at each reporting period)? Do internal controls exist for preparation of expenses by functional classification? Management will need to prepare a footnote to describe the accounting policy for the functional allocation of expenses. This footnote should include the basis of allocation.
The basis of allocation of expenses likely will include data retrieval or discovery. Therefore, if the entity is reporting functional expense for the first time, management will need to ensure it has appropriate data for classification. This may result in a time study or evaluation of time and expense records in order to determine how employees’ activities are split up during a typical work schedule. Relevant data for occupancy costs includes square footage for rent, utilities, and maintenance expenses.
The allocation of expenses based on functional category will require management to make decisions regarding how the information will be presented in financial statements and additional effort to ensure data is accurate.
If your not-for-profit has a June 30, 2019 year-end, set aside time and resources now to prepare and comply with ASU 2016-14.
Drew McCullough is a Senior Manager in LBMC’s Audit group. He can be reached at dmccullough@lbmc.com.