New Developments Summary

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New Developments Summary

FASB proposes sweeping changes for NFPs

Proposed guidance would improve presentation and disclosure standards

Summary

The FASB recently issued a proposed ASU, Presentation of Financial Statements of Not-for-Profit Entities, to improve the existing financial statement presentation and disclosure standards for not-for- profit entities (NFPs).

The proposed amendments are intended to improve the current net asset classification requirements, as well as the information presented in the financial statements and notes about an NFP’s liquidity, financial performance, and cash flows. The proposal was prompted by constituents, including members of the FASB’s Not-for-Profit Advisory Committee, who expressed concern over complexities and inconsistencies that result from applying the existing standards.

Some of the more significant proposed improvements include the following:

 Reducing the number of net asset classes from three to two (with donor restrictions and without donor restrictions)

 Requiring separate subtotals for operating activities without donor restrictions and transfers from restricted assets

 Requiring the direct method of reporting operating cash flows and permitting, but no longer requiring, the indirect method

 Providing information about expenses by both nature and function

In addition, the proposed amendments would eliminate the requirement for business-oriented health care NFPs to present a performance indicator and would require enhanced disclosures in all NFP financial statements.

This document summarizes the proposed changes and how they compare to existing U.S. GAAP guidance.

Comments to the FASB on the proposal are due by August 20, 2015.

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A. Introduction

The current reporting model for not-for-profit entities was established in 1993 with the issuance of FASB Statement 117, Financial Statements of Not-for-Profit Organizations, which some argue is outdated and does not meet the needs of a changing financial reporting environment for not-for-profit entities (NFPs).

As a result, in 2011, the FASB added a project to its agenda to update the NFP reporting model and recently released a proposed ASU, Presentation of Financial Statements of Not-for-Profit Entities, to address constituents’ concerns. The scope of this proposed standard includes all NFPs, including charities, foundations, private colleges and universities, nongovernmental health care providers, cultural institutions, religious organizations, and trade associations.

The key features of the proposed ASU address

 Presentation of net asset classifications on the statement of financial position

 Presentation of the changes in net asset classifications on the statement of activities

 Presentation of operating cash flows in the statement of cash flows

 Classification of certain cash flows within the statement of cash flows

 Methods for recognizing the expiration of donor-imposed restrictions on amounts contributed to acquire or construct a long-lived asset

 Reporting of net investment income

 Enhanced disclosures about donor restrictions, self-imposed restrictions, underwater endowments, liquidity, and expenses

B. Key presentation provisions

The FASB is proposing changes that affect the presentation of the statement of financial position, the statement of activities, and the statement of cash flows for NFPs. These provisions are summarized below.

Presentation on the statement of financial position

Currently, NFPs are required to present three classes of net assets on the face of the statement of financial position: unrestricted net assets, temporarily restricted net assets, and permanently restricted

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net assets. Under the proposed guidance, NFPs would present only two classes of net assets on the face of the statement of financial position: net assets with donor restrictions and net assets without donor restrictions.

NFPs would still be required to provide information on the nature and amount of the different types of donor-imposed restrictions either on the face of the statement of financial position or in the notes to the financial statements.

The reduction in net asset class categories from three to two (with and without donor restrictions) is expected to reduce complexity, enhance understandability, and promote the use of multi-period

comparative financial statements. In addition, when coupled with the required enhanced disclosures, this proposed change is expected to provide more relevant and useful information to financial statement users, including donors and creditors.

Endowment funds

The assets of an endowment fund can be with or without donor restrictions. Donor-restricted endowment funds are created by donors to provide income to an NFP in perpetuity or for a specified term. Board- designated endowment funds (also referred to as “funds functioning as endowment” or “quasi-endowment funds”) are created from funds without donor restrictions when a governing board designates a portion of its net assets to be invested to provide income for a long period.

Under the proposed guidance, donor-restricted permanent, term, and similar endowment funds would be classified as net assets with donor restrictions. Board-designated and similar endowment funds that result from internal designation of net assets would be classified as net assets without donor restrictions.

An NFP would need to consider whether the endowment fund is subject to the Uniform Prudent Management of Institutional Funds Act of 2006 or trust law in addition to the donor stipulations when assessing whether a fund should be classified in net assets with donor restrictions.

Underwater donor-restricted endowment funds

An underwater donor-restricted endowment fund exists when the fair value of the fund at the reporting date is less than either the original gift amount or the amount that must be maintained based on stipulations by the donor or by a law that extends donor restrictions.

Under the proposed ASU, NFPs would be required to include accumulated losses together with that fund in the donor-restricted net asset class.

Presentation on the statement of activities

The presentation requirements for the statement of activities would mirror those for the statement of financial position. Therefore, NFPs would present the following items on the face of the statement of activities:

 The change in restricted net assets

 The change in unrestricted net assets

 The total change in net assets for the period

In addition, NFPs would be required to present the following two subtotals within the change in unrestricted net assets:

 A subtotal that includes operating revenues, support, expenses, gains, and losses (without donor- imposed restrictions) before internal transfers

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 A subtotal that includes the effects of internal transfers resulting from governing board actions that place or remove self-imposed limits on the use of resources

Operating expenses by nature and function

The proposed guidance would require all NFPs to provide information about operating expenses by both nature and function. An NFP could choose to provide this disaggregated operating expense information on the face of the statement of activities, in a separate statement, or in the notes to the financial

statements. Currently, only voluntary health and welfare entities are required to provide this information.

Split-interest agreements

In a split-interest agreement, the donor makes an initial contribution to an NFP or a trust in which the NFP has a beneficiary interest but is not the sole beneficiary.

Under the proposed guidance, contribution revenues recognized under split-interest agreements would be classified as nonoperating activities if there are donor restrictions and as operating activities if not restricted.

Presentation of cash flows

The Board is proposing two fundamental changes to the statement of cash flows.

The first proposed change would require an NFP to use the direct method to report operating cash flows.

As a result, an NFP would separately report, at a minimum, the following classes of operating cash receipts and payments:

 Cash collected from customers

 Receipts from sales of property, plant, or equipment or other productive assets

 Receipts of contributions from donors for any purpose other than those classified as financing cash flows

 Receipts of contributions that are donor-restricted for the purpose of acquiring, constructing, or improving property, plant, or equipment; other long-lived assets; or collections

 Certain payments to acquire property, plant, or equipment, or other productive assets, such as down payments or advance payments, including interest capitalized as part of the cost of those assets

 Cash paid to employees and other suppliers of goods or services

 Income taxes paid

 Other operating cash payments, if any

In addition to reporting operating cash flows using the direct method, an NFP would also be permitted, but not required, to report operating cash flows using the indirect method. NFPs would not be required to provide a reconciliation of change in net assets to net cash flow from operating activities, but could choose to present the reconciliation.

The second proposed change would realign the classification of certain line items in the statement of cash flows to be more consistent with how those items are classified in the statement of activities. Under the existing guidance, there is diversity in practice in the classification of activities within the statement of cash flows, particularly for operating cash flows.

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Under the proposed guidance, NFPs would classify certain cash flows differently than how they are classified under current guidance. Proposed changes would include

 Classifying cash flows resulting from purchases of long-lived assets, contributions restricted to acquire long-lived assets, and sales of long-lived assets as operating cash flows instead of investing cash flows

 Classifying cash flows resulting from payments of interest on borrowings, including cash management activities, as financing cash flows instead of operating cash flows

 Classifying cash flows resulting from receipts of interest and dividends on nonprogrammatic loans and investments as investing cash flows instead of operating cash flows

C. Other provisions

The proposed ASU includes proposals regarding how gifts of long-lived assets with donor-imposed restrictions and investment income are reported. The highlights of those provisions are discussed below.

Placed-in-service approach

The proposed guidance would eliminate the option for an NFP to release a donor-imposed restriction over the estimated useful life of contributed property, plant or equipment (or cash to acquire or construct such an asset) and instead would require the use of the “placed-in-service approach” for reporting expirations of such restrictions.

Under the placed-in-service approach, an NFP would reclassify contributions from net assets with donor restrictions to net assets without donor restrictions in the operating section of the statement of activities when the acquired or constructed property, plant, or equipment is placed in service, unless the donor explicitly stipulates how long the donated asset must be used. If the property, plant, or equipment was contributed to the NFP with an explicit donor-imposed restriction on the length of time for use, the item would be reclassified from net asset with donor restrictions to net assets without donor restrictions as the restrictions expire.

Reporting investment income

The proposed guidance would require investment returns to be presented net of related external and direct internal expenses as a separate line item in the same net asset category as the related investment return. Net returns from programmatic activities would be reported in operating activities. Other net returns would be reported in the nonoperating section on the statement of activities. The net investment return would be reported separately from any governing board designation, appropriation, or similar transfer to designate a portion of the endowment or other investments as support for operations.

D. Enhanced disclosures

The proposed guidance requires NFPs to include enhanced disclosures to complement the change in presentation, including the following information:

 Any governing board designations, appropriations, and similar transfers, which create or modify self- imposed limits on the use of resources without donor-imposed restrictions, including a description of the purpose, amounts, and types of transfers as well as qualitative and quantitative information about any period-end balances

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 The composition of net assets with donor restrictions at the end of the period and how the restrictions affect the use of resources

 How the entity manages liquidity, as well as quantitative information about financial assets available to meet near-term demands for cash

 The composition of expenses, including amounts for operating expenses by both their nature and function, on the face of the statement of activities, in a separate statement, or in the notes to the financial statements

 The methods used to allocate costs among program and support functions

 The aggregate amount of the original gift amounts (or level required by donor or law) for underwater endowment funds and any governing board policies or decisions to spend or not to spend such funds

E. Effective date and transition

The effective date of the proposed guidance will be determined by the Board after it receives stakeholder feedback.

NFPs would apply the proposed amendments retrospectively. NFPs would not be required to apply the guidance to interim periods in the year of adoption; however, interim information that is reported with annual financial statements should be restated.

Transition disclosures would include the nature of any reclassifications or restatements and their effects on changes in the net asset classes for each year presented.

This Grant Thornton LLP bulletin provides information and comments on current accounting issues and developments. It is not a comprehensive analysis of the subject matter covered and is not intended to provide accounting or other advice or guidance with respect to the matters addressed in the bulletin. All relevant facts and circumstances, including the pertinent authoritative literature, need to be considered to arrive at conclusions that comply with matters addressed in this bulletin.

For additional information on topics covered in this bulletin, contact your Grant Thornton LLP professional.

New Developments Summary