AAFCPAs advises nonprofits in assessing the impact of the new Accounting Standards Update (ASU) No. 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities, and we provide guidance throughout the transition process. The new financial statement framework affects nonprofit organizations in all industries (i.e. healthcare, affordable housing, social services, foundations, and education) and is effective for fiscal years beginning after December 15, 2017 (CY 2018 or FY 2019).
To better evaluate how a nonprofit performs a variety of tasks and functions, ASU 2016-14 requires all nonprofits to report expenses by both nature and function. Under the existing guidance, only voluntary health and welfare entities are required to present a statement of functional expenses.
Instead of reporting expenses in a separate statement of functional expenses, the new standard provides more flexibility to report this information in one location that is either:
- On the face of the statement of activities,
- In a schedule in the notes to the financial statements, or
- In a separate financial statement. In other words, voluntary health and welfare entities who are currently required to report expenses in a separate statement of functional expenses now have the option to report expenses in another location allowed under the new standard.
This may significantly reduce costs for certain voluntary health and welfare entities that have a simple program structure. In addition, since reporting expenses by nature and function is a required disclosure under the new standard, it is no longer appropriate to report expenses only in a supplemental schedule as a supplemental schedule is not considered part of the financial statements.
ASU 2016-14 requires nonprofits to present major classes of program services and supporting activities by natural classification. Examples of natural expense classification include: salaries and wages, employee benefits, professional services, supplies, interest, occupancy, awards and grants to others, and depreciation.
During implementation, AAFCPAs advises nonprofits to first determine the major classes of program services to be reported in the financial statements.
The considerations for determining major classes of programs include:
- The organization’s mission and program purpose,
- The interrelationship between program revenue and expenses (research contracts revenue vs. research costs),
- Relative size of revenue and expenses,
- Program results in relation to the performance measurement (i.e. budgetary categories or internal oversight),
- Geographic area, and
- The program information to be provided in the Form 990 that is available for public inspection.
Identifying too many major programs may increase administration cost for the expense reporting. On the other hand, aggregating program activities may not provide meaningful information about the costs of the nonprofit’s service efforts.
In general, support activities include (1) management and general (M&G) activities, (2) fundraising activities and (3) membership development activities. ASU 2016-14 allows nonprofits to allocate from M&G activities to program or other supporting activities when these activities represent direct conduct or direct supervision. In addition, certain costs should be allocated if they benefit more than one function (i.e. information technology costs). ASU 2016-14 provides the following examples to illustrate direct conduct and direct supervision of program or support activities that should be allocated among functions that receive a benefit:
- Direct programmatic oversight from a Chief Executive Officer (CEO) – the CEO’s compensation and benefits can be allocated to the programs that receive the direct oversight.
- Direct fiduciary oversight of the investment strategy involved in generating investment return from a Chief Financial Officer (CFO) – the CFO’s compensation and benefits could be allocated to the investment expenses, which would be netted against investment return.
- Specific program reporting prepared by program staff – the program staff’s time spent on the program reporting can be allocated to the grant.
ASU 2016-14 further clarifies that any costs or activities that benefit the overall organization would still remain as M&G activities, for example: payroll processing and benefit administration from the human resources department; and general accounting, financing, budgeting, and grant & contract financial reporting from the fiscal department.
Functional and natural expense presentation should contain all expenses, including those netted with revenue on the statement of activities, such as direct costs of special events, and salary included in cost of goods sold. Direct investment expense should not be included.
Under ASU 2016-14, a description of the method used to allocate costs among program and support functions will be required to be disclosed in the financial statements. Nonprofits are also required to assess which activities constitute direct conduct or direct supervision of a program or support function and therefore, would require allocation of costs.
During the implementation period, AAFCPAs advises nonprofits to:
- Establish a formal written cost allocation policy or revisit the existing policy to ensure the policy and allocation methodology is still appropriate and in accordance with the new guidance.
- Determine the functional category or revisit the existing category to best tell how your organization is using the resources.
- Review system coding for the defined or redefined functional categories for accuracy.
- Consider the impact on changes to the cost allocation policy, if any.
- Assess the impact on changes to the cost allocation methodology, if any. For example, reclassification or restatement of prior year’s financial statements may be required if comparative financial statements are present.
- eBook: AAFCPAs’ Guidance on New Nonprofit Financial Statement Framework
- Net Asset Classification Considerations for Nonprofits Implementing the Financial Statement Presentation Standards
- Liquidity Considerations for Nonprofits Implementing the New Financial Statement Presentation Framework
AAFCPAs advises nonprofits in assessing the impact of the new standards, and provides guidance throughout the transition process. In addition, we advise clients on reviewing and updating accounting policies and procedures to reflect any changes, including solutions for processing information and producing financial reporting in line with the new reporting standard. Learn more. >>
If you have any additional questions about how the new ASU will impact you, please contact Matt Hutt, CPA, CGMA, at 774.512.4043, firstname.lastname@example.org; Hui-Ting Grady, CPA, at 774.512.4106, email@example.com; or your AAFCPAs Partner.