Accounting rules never stand still. In the nonprofit accounting world, an extended period of minimal changes is giving way to a succession of new rules and requirements that will govern nonprofit accounting for years to come. This new period of nonprofit accounting rules and regulation changes began in earnest this year, as the new Office of Management and Budget (OMB) Uniform Guidance became effective for nonprofit organizations receiving federal funds starting with fiscal year-ends of December 31, 2015 and later.
Fast on the heels of this major change comes several new pieces of guidance that have the potential to significantly affect nonprofit accounting and financial statement reporting. This article summarizes the significant changes that are being currently contemplated, or are in the process of being implemented.
Revenue Recognition
A major new revenue pronouncement, Accounting Standards Update (ASU) 2014-09, aims to develop a single, principle-based revenue standard for U.S. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). The revenue standard aims to improve accounting for contracts by customers by providing a robust framework for addressing revenue issues as they arise, increasing comparability across individuals and capital markets and requiring better disclosure. The pronouncement affects all industries and sectors, and the nonprofit community has been busy assessing its impact on nonprofit reporting. The scope of the pronouncement covers all contracts with customers, excluding leases, insurance contracts, financial instruments, guarantees and non-monetary exchanges in the same line of business, to facilitate sales to customers. For nonprofit organizations, contributions are excluded, as are collaborative arrangements with “customers.”
The core principle of this new guidance is that revenue should be recognized to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The steps to apply this core principle are: (1) identify the contract, (2) identify the separate performance obligations, (3) determine the transaction price, (4) allocate the transaction price to performance obligations, and (5) recognize revenue when each performance obligation is satisfied.
These rules were not written specifically with nonprofits in mind but they do apply to nonprofits. The American Institute of CPAs nonprofit revenue recognition task force is considering several issues that could affect the nonprofit implementation of this standard and are expected to release guidance in the coming months. In general, it is expected that nonprofits affected will be those organizations that have typical fee-for-service transactions, contracts with customers, sponsorships, conferences, memberships, tuition relationships, licensing, royalty/affinity agreements, federal and state grants and contracts, and other exchange transactions throughout the year. For nonprofit entities (without public debt) this pronouncement is effective in annual reporting periods ending after December 15, 2019, so it will need to be adopted for the fiscal year ending December 31, 2019 (or June 20, 2020 for most nonprofits).
Leases Accounting
The long wait is over. On February 25, 2016, the Financial Accounting Standards Board (FASB) issued ASU 2016-02 on financial reporting for leasing transactions. The new guidance now requires companies to report most leases on their balance sheets and puts an end to the off-balance-sheet reporting of assets and liabilities related to the rights and obligations created by operating leases.
While companies are currently required to disclose lease commitments in the footnotes of their financial statements, they will now have to add lease obligations to their books as well. The new standard will now require organizations that lease assets – or lessees – to recognize assets and liabilities on their balance sheets for leases with lease terms of more than 12 months.
Previously, the recognition, measurement, and presentation of expenses and cash flows arising from a lease for lessees primarily depended on its classification as a finance (capital) lease or operating lease; but, unlike current U.S. GAAP, which requires only capital leases to be recognized on the balance sheet, the new standard requires companies to include both types of leases on their books.
The ASU will also require disclosures to help investors and other financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases. These disclosures include qualitative and quantitative requirements, providing additional information about the amounts recorded in the financial statements.
Similar to the new revenue guidance, this ASU applies to all organizations and companies. Nonpublic companies (including nonprofit organizations without public debt) will be required to apply the new leasing standard for fiscal years beginning after December 15, 2019. Therefore, it will need to be adopted for the fiscal year ending December 31, 2020 (or June 30, 2021 for most nonprofits). Early adoption will be permitted for all organizations.
Going Concern
The FASB issued ASU 2014-15, which creates new guidance on the concept of disclosure of uncertainties about an organization’s ability to continue as a going concern. This is another piece of guidance that is not written specifically for nonprofits but does affect nonprofits equally to other types of entities.
Under the new guidance, the organization will be required to self-assess its operations and its ability to continue as a going concern. The onus is now on the organization, not on the auditor, to prepare this analysis.
In addition, and perhaps more significant, the auditor is now required to consider a 12-month horizon as to whether there is substantial doubt that it is probable that the entity will not meet its obligations extending out from the audit opinion (or issuance) date. This is a significant change from the current standard that requires a 12-month consideration from the balance sheet date. For example, with the audit of a nonprofit with a fiscal year-end of June 30, 2015, previously the auditor would have to feel comfortable that the entity could meet its obligations through June 30, 2016 (12 months from the balance sheet date). Now, the auditor will have to get comfortable for 12 months from the issuance date. Therefore, if this audit were to be completed and issued on October 15, 2015, the auditor would have to evaluate the entity’s ability to meet its obligations through October 15, 2016, thereby creating a higher threshold to reach. Cooperation of each organization in maintaining its own liquidity analysis will be critical for avoiding untimely delays in audits in which there is any doubt about an organization’s ability to continue as a going concern. This pronouncement is effective for annual periods ending after December 15, 2016 so it will be affective for fiscal year ends of December 31, 2016 and beyond (including June 30, 2017 for most nonprofits).
FASB Not-for-Profit Project
In April of 2015, the FASB proposed an ASU intended to improve the financial statement presentation on nonprofit organizations. This substantial update on the nonprofit financial statement reporting model intends to improve:
- The complexity of having three classes of net assets and the current accounting for underwater endowments.
- Inconsistent reporting of intermediate measures of operations in the statement of activities.
- Lack of consistency in the type of information provided about expenses of a period.
- The utility of the statement of cash flows.
Upon the release of the proposed update, the nonprofit community was invited to comment upon the draft standard and the FASB has been working through this process for the better part of a year.
In October 2015, it was determined by the FASB board that the proposed pronouncement would be released in two phases, and the first phase (all the proposed items for which there is near universal agreement) would be released in summer of 2016. The areas expected to be covered in the first phase and to be released this summer include:
- A change in the presentation of restricted net assets from the current three categories (unrestricted, temporarily restricted and permanently restricted) to just two categories (without donor restrictions and with donor restrictions).
- A requirement for enhanced disclosures for any “underwater” endowments.
- A revision in the methodology in which capital restrictions are released (nonprofit organizations will be required to use the “place-in-service” approach).
- A requirement for all organizations to report a statement of functional expenses (currently, this is only required for voluntary health and welfare organizations).
- A requirement to net investment expenses against investment return on the face of the statement of activities.
- Enhanced qualitative and quantitative liquidity disclosures.
- Improved disclosures involving operating measures.
The effective date for this phase of this ASU is expected to be for fiscal years beginning after December 15, 2017, so it will be effective for fiscal year-ends of December 31, 2018 and beyond (including June 30, 2019 for most nonprofits). There will be specific transition guidance provided upon the final release.
The response of organizations to changing rules and regulations has a direct impact on the quality of their financial reporting. Internal accountants must understand the new rules to provide accurate financial reports, while external CPAs must fully understand these changes to continue to perform their work efficiently and effectively while providing exceptional client service. The Windes Nonprofit Group looks forward to assisting organizations and fellow professionals in implementing these new accounting standards as they become effective.
For questions or more information, please contact Michael Barloewen at mbarloewen@windes.com or toll free at 844.4WINDES (844.494.6337).