Alyssa Federico, CPA, was in a fairly strong position as she began to implement FASB’s new financial reporting standard for not-for-profit organizations.
Federico, the vice president and finance director of Foundation For The Carolinas, has an extensive, detailed coding and recordkeeping system for the funds of the organization, a community foundation with more than $2.2 billion in assets. This made it easy for her to locate and consider the appropriate data as she adopted the standard.
Nonetheless, Federico found the implementation effort time-consuming and said some not-for-profits may find it challenging to adopt Accounting Standards Update No. 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities. The standard brings about the most substantial changes in not-for-profit financial reporting in more than 20 years.
“Start early,” she said, “because it takes time. It took time to rebuild reports. It took time to reclassify … If you’re not going to early adopt, start preparing for it, before it’s upon you.”
Foundation For The Carolinas, based in Charlotte, N.C., did early adopt the standard for the fiscal year ending in December 2016. The standard takes effect for fiscal years beginning after Dec. 15, 2017, and for interim periods within fiscal years beginning after Dec. 15, 2018. So not-for-profit finance departments can’t afford to delay this implementation work much longer.
Federico advises her peers to thoroughly review net asset reporting to make sure the classification is correct; keep financial reporting consistent with tax reporting on IRS Form 990, Return of Organization Exempt From Income Tax, as much as possible; and have a dialogue with the audit committee about the changes.
Here is how her organization handled some of the major changes associated with the standard.
Classifying net assets
FASB’s new not-for-profit standard decreases the number of net asset classes from three (unrestricted, temporarily restricted, and permanently restricted) to two (with donor restrictions and without donor restrictions).
In theory, it should have been easy to consolidate two columns (temporarily restricted and permanently restricted) into one (with donor restrictions). In practice, the exercise was more time-consuming.
Federico undertook a thorough review of the organization’s records to make sure all funds were classified in the right place initially. The review enabled her to verify that the foundation is adhering to all donor restrictions and using all unrestricted dollars in a way that’s best for the organization.
“I think that was a big benefit for us,” she said.
Most of the time Federico spent with the audit committee was spent defining the net asset categories so committee members would understand them. She also gave the audit committee an explanation of the other major changes the organization would encounter related to the standard (such as the liquidity disclosures, functional expense reporting, and reporting of net investment returns).
Under “without donor restrictions,” the foundation reported separate line items for amounts designated for donor-advised grants, operations, discretionary grants, and endowments, and for amounts invested in property and equipment.
Under “with donor restrictions,” the foundation reported separate line items for amounts restricted in perpetuity, restricted for specified purposes, restricted by the passage of time, and restricted subject to the foundation’s spending policy, and for amounts of underwater endowments.
In a new disclosure in the financial statement notes, the foundation also provided amounts for the net assets that were released from restrictions by:
- Satisfying the restricted purpose;
- The passage of time; or
- Other events specified by the donors.
The new standard requires reporting of expenses by function and nature, as well as an accompanying analysis of expenses.
For Federico, this meant preparing a statement of functional expenses for financial reporting purposes for the first time. The organization previously has prepared a statement of functional expenses for Form 990, though, so it used the same methodology for the financial statement as it does for its tax returns.
That methodology allocates expenses to the categories of program management, general, and fundraising primarily based on an analysis by the foundation’s employees of the time they spent serving in each category.
“But I think the key is, however you’re allocating them, you’re allocating them across consistently in the best way for your organization,” Federico said. “I don’t think it necessarily has to be time[-based]. But for us, more than 80% of our expenses on the operating side are related to salaries and benefits. So that made the most sense for us.”
Federico said a desire to provide consistency in reporting led the organization to keep the categories the same in the financial statements as they are on Form 990.
In a financial statement note, the foundation explains that expenses are allocated on the basis of estimates of time and effort. The note says functional expenses include both the foundation’s operating expenses and passthrough expenses directly related to donor funds. Operating expenses totaled $11,007,429 and $9,832,732 for years ending Dec. 31, 2016 and 2015, respectively, according to the note.
The new standard requires a not-for-profit to provide in the financial statement notes qualitative information about how it manages its liquid available resources and liquidity risks. Quantitative information on the availability of assets to meet cash needs for general expenditure within one year of the balance sheet date is required on the face of the financial statement and/or in the notes.
Among the new disclosures in the standard, this was where Federico spent the most time. Although the foundation has $11,765,592 available to spend within 12 months, $7,739,497 of that is in donor-advised funds. So the organization truly has only about $4 million in reserves, and the disclosure reflected that.
This information is spelled out carefully in a financial statement note.
“We spent a lot of time … making sure that we weren’t counting things that really weren’t available,” Federico said. “It’s not as easy as pulling the cash number off the balance sheet.”
Disclosing in this way provides donors an accurate view of the foundation’s situation. If a donor were to read the financial statement and see almost $12 million available, Federico said that would deliver a misleading message.
Direct vs. indirect
After initially considering mandating direct-method cash flow statements, FASB allowed not-for-profits to choose between the direct method and the indirect method.
Foundation For The Carolinas decided to continue using the indirect method, as Federico said the cash flow statement is not a widely read statement for the organization because it does not have debt.
“But I think for any organization that does have debt, they probably need to think seriously about changing to the direct method. It does tell a different story,” Federico said. “If their financial statements are often used by lending organizations, they’re probably better off switching to the direct method so they can tell why they need credit.”
The standard also requires organizations to report net investment returns rather than gross investment returns and disclosure of expenses.
By no longer requiring disclosure of investment fees, the standard allows not-for-profits to provide financial statement users with simplified information that is more useful to them, Federico said.
“Giving them the net number I think was a more accurate presentation for us,” she said. “It allows us to tell the whole picture versus half of a picture.”
For consistency, the foundation made a similar transition on the individual fund statements that it produces for donors. That way, this statement provides donors with the same information that they receive in the audited financial statements.
The new standard requires reporting of underwater amounts of donor-restricted endowment funds in net assets with donor restrictions. The standard also enhances disclosures about underwater endowments.
Previously, Foundation For The Carolinas was reporting all underwater amounts in unrestricted funds, even if they were coming from temporarily restricted funds. So the organization had to reclassify $2,056,416 in underwater amounts, increasing net assets without donor restrictions and decreasing net assets with donor restrictions by that amount.
In the auditor’s report, CPA firm Cherry Bekaert LLP explained that the not-for-profit standard has been applied retrospectively to all periods presented and resulted in a reclassification of the opening balance of net assets as of Jan. 1, 2015, of $2,056,416. The audit report directed readers to Note 2 in the financial statement, which explained the underwater classification as well as the general changes associated with the new standard and the foundation’s decision to early adopt the standard.
The organization had been meticulously tracking underwater endowment amounts, so the reclassification was fairly simple and straightforward.
—Ken Tysiac (Kenneth.Tysiac@aicpa-cima.com) is a JofA editorial director.