FASB’s Proposed Changes to Not-for-Profit Reporting Has Mixed Reviewsby
The accounting and reporting guidance for not-for-profit entities has remained largely unchanged for more than 20 years. Stakeholders have regularly expressed concerns regarding the complexities and inconsistencies in applying the existing standards for not-for-profit financial statements, resulting in a lack of comparability in the financial statements of not-for-profits.
In response to these concerns, the Financial Accounting Standards Board (FASB) issued proposed Accounting Standards Update (ASU) No. 2015-230, Not-for-Profit Entities (Topic 958) and Health Care Entities (Topic 954): Presentation of Financial Statements of Not-for-Profit Entities, in April. The main objective of the proposal is to improve the usefulness of not-for-profit financial statements by providing more transparent information regarding a not-for-profit entity's liquidity, financial performance, and cash flows to donors, creditors, and other users of the financial statements.
The proposal includes several amendments that would significantly change current accounting and reporting guidance for not-for-profit entities. The main provisions require not-for-profits to:
- Present net assets in two classes in the statement of financial position: net assets with donor restrictions and net assets without donor restrictions.
- Present two additional subtotals as intermediate operating measures in the statement of activities.
- Present operating cash flows using the direct method in the statement of cash flows.
- Report the amount of underwater endowment funds in net assets with donor restrictions and increase disclosures for these funds.
- Present expenses by both their nature and purpose.
- Disclose how liquidity is managed.
The comment period ended in August, and the FASB received mixed reviews on several aspects of the proposal. The FASB received 264 comment letters responding to the proposed ASU.
One of the main objections to the proposal centers on the differences that it would create between business entities and not-for-profit entities. Existing guidance for not-for-profits notes that while there are important differences between the objectives of financial statement users of for-profit and not-for-profit organizations, the basic financial reporting principles are the same: Stakeholders of all entities look for information about economic resources and obligations.
The proposal calls for not-for-profit entities to present the statement of cash flows using the direct method. The direct method requires entities to separately report major classes of gross cash receipts and gross cash payments to arrive at the net cash flows from operating activities. The indirect method begins with net income and adjusts revenue and expense amounts for changes in the related assets and liabilities during the period. Business entities today are encouraged, but not required, to use the direct method; however, most present cash flows by using the indirect method.
A majority of respondents commented that the significant costs and complexity of preparing the direct method of cash flows outweigh the benefits and that the requirement would create a divide between the reporting of business entities and not-for-profit entities. Further, not-for-profit entities often have fewer accounting resources than business entities do, so they may struggle to implement a more complex method of cash-flow presentation.
Another controversial aspect of the proposal is the requirement to present two measures of operating activities. The first proposed measure is a subtotal of operating excess or deficit that excludes amounts that are unavailable because of donor-imposed restrictions. The second proposed measure is a subtotal that includes the first subtotal and adjusts for the impact of transfers to or from operating activities.
The FASB received mixed feedback on whether intermediate measures of operations should be required. Several respondents agreed that an intermediate measure of operations would be useful to not-for-profit financial statement users, but did not agree with the measures proposed by the FASB. Many noted that the use of two operating measures is unnecessarily complex and that the proposed measures may prohibit comparability among not-for-profit entities. Respondents also cited that the inconsistencies in reporting an intermediate measure of operations are not unique to not-for-profit entities and should be addressed as a broader research project to include business entities.
The feedback was not all negative. Stakeholders were generally supportive of several of the other aspects in the proposal. Most respondents agreed with presentation of net assets in two classes instead of the three classes required today. Respondents also widely agreed with the proposed changes to underwater endowment reporting and the requirement to report expenses by function and nature. Overall feedback indicated that these changes provide consistency for not-for-profit reporting and increase the usefulness of the financial statements.
In October, the FASB decided to separate its redeliberations on the proposed ASU into two phases as a result of the controversial feedback. This move will allow the FASB to primarily focus on the aspects of the proposal that are widely supported in order to finalize this guidance in the near term.
The first phase will focus on improvements to the net asset classification scheme, the reporting of expenses, and liquidity disclosures. The first phase will also target modest improvements for entities that voluntarily present an operating measure, but will not seek to make this a requirement for all not-for-profit entities. Lastly, even though the FASB received overwhelming criticism of the proposed requirement to present cash flows using the direct method, the board decided to continue researching this area as part of the first phase.
The second phase will focus on the controversial topic of requiring all not-for-profit entities to present measures of operating activities. Because of the volume of alternatives suggested by respondents in comment letters, the FASB determined that this topic will likely require more time to resolve.
The FASB aims to complete its work on the first phase by mid-2016.
Mandi Polick, CPA, is the managing editor of the GAAP Reporter product with Thomson Reuters Checkpoint with the Tax & Accounting business of Thomson Reuters. She is a CPA in both the state of New York and the state of Iowa. Mandi has nine...