Category Archives for "Accounting"

Understanding the New Nonprofit Accounting Standard

By Charles Hall | Accounting

Are you ready to implement FASB’s new nonprofit accounting standard? Back in August 2016, FASB issued ASU 2016-14, Presentation of Financial Statements of Not-for-Profit Entities. In this article, I provide an overview of the standard and implementation tips.

New Nonprofit Accounting – Some Key Impacts

What are a few key impacts of the new standard?

• Classes of net assets
• Net assets released from “with donor restrictions”
• Presentation of expenses
• Intermediate measure of operations
• Liquidity and availability of resources
• Cash flow statement presentation

Classes of Net Assets

Presently nonprofits use three net asset classifications:

1. Unrestricted
2. Temporarily restricted
3. Permanently restricted

The new standard replaces the three classes with two:

1. Net assets with donor restrictions
2. Net assets without donor restrictions

Terms Defined

These terms are defined as follows:

Net assets with donor restrictions – The part of net assets of a not-for-profit entity that is subject to donor-imposed restrictions (donors include other types of contributors, including makers of certain grants).

Net assets without donor restrictions – The part of net assets of a not-for-profit entity that is not subject to donor-imposed restrictions (donors include other types of contributors, including makers of certain grants).

Presentation and Disclosure

The totals of the two net asset classifications must be presented in the statement of financial position, and the amount of the change in the two classes must be displayed in the statement of activities (along with the change in total net assets). Nonprofits will continue to provide information about the nature and amounts of donor restrictions.

Additionally, the two net asset classes can be further disaggregated. For example, donor-restricted net assets can be broken down into (1) the amount maintained in perpetuity and (2) the amount expected to be spent over time or for a particular purpose.

Net assets without donor restrictions that are designated by the board for a specific use should be disclosed either on the face of the financial statements or in a footnote disclosure.

Sample Presentation of Net Assets

Here’s a sample presentation:

Net Assets
Without donor restrictions
Undesignated	$XX
Designated by Board for endowment	XX
	XX
With donor restrictions
Perpetual in nature	XX
Purchase of equipment	XX
Time-restricted	XX
	XX
Total Net Assets	$XX

Net Assets Released from “With Donor Restrictions”

The nonprofit should disaggregate the net assets released from restrictions:

• program restrictions satisfaction
• time restrictions satisfaction
• satisfaction of equipment acquisition restrictions
• appropriation of donor endowment and subsequent satisfaction of any related donor restrictions
• satisfaction of board-imposed restriction to fund pension liability

Here’s an example from ASU 2016-14:

Presentation of Expenses

Presently, nonprofits must present expenses by function. So, nonprofits must present the following (either on the face of the statements or in the notes):

• Program expenses
• Supporting expenses

The new standard requires the presentation of expenses by function and nature (for all nonprofits). Nonprofits must also provide the analysis of these expenses in one location. Potential locations include:

• Face of the statement of activities
• A separate statement (preceding the notes; not as a supplementary schedule)
• Notes to the financial statements

I plan to add a separate statement (like the format below) titled Statement of Functional Expenses. (Nonprofits should consider whether their accounting system can generate expenses by function and by nature. Making this determination now could save you plenty of headaches at the end of the year.)

External and direct internal investment expenses are netted with investment income and should not be included in the expense analysis. Disclosure of the netted expenses is no longer required.

Example of Expense Analysis

Here’s an example of the analysis, reflecting each natural expense classification as a separate row and each functional expense classification as a separate column.

The nonprofit should also disclose how costs are allocated to the functions. For example:

Certain expenses are attributable to more than one program or supporting function. Depreciation is allocated based on a square-footage basis. Salaries, benefits, professional services, office expenses, information technology and insurance, are allocated based on estimates of time and effort.

Intermediate Measure of Operations

If the nonprofit provides a measure of operations on the face of the financial statements and the use of the term “operations” is not apparent, disclose the nature of the reported measure of operations or the items excluded from operations. For example:

Measure of Operations

Learning Disability’s operating revenue in excess of operating expenses includes all operating revenues and expenses that are an integral part of its programs and supporting activities and the assets released from donor restrictions to support operating expenditures. The measure of operations excludes net investment return in excess of amounts made available for operations.

Alternatively, provide the measure of operations on the face of the financial statements by including lines such as operating revenues and operating expenses in the statement of activities. Then the excess of revenues over expenses could be presented as the measure of operations.

Liquidity and Availability of Resources

FASB is shining the light on the nonprofit’s liquidity. Does the nonprofit have sufficient cash to meet its upcoming responsibilities?

Nonprofits should include disclosures regarding the liquidity and availability of resources. The purpose of the disclosures is to communicate whether the organization’s liquid available resources are sufficient to meet the cash needs for general expenditures for one year beyond the balance sheet date. The disclosure should be qualitative (providing information about how the nonprofit manages its liquid resources) and quantitative (communicating the availability of resources to meet the cash needs).

Sample Liquidity and Availability Disclosure

The FASB Codification provides the following example disclosure in 958-210-55-7:

NFP A has $395,000 of financial assets available within 1 year of the balance sheet date to meet cash needs for general expenditure consisting of cash of $75,000, contributions receivable of $20,000, and short-term investments of $300,000. None of the financial assets are subject to donor or other contractual restrictions that make them unavailable for general expenditure within one year of the balance sheet date. The contributions receivable are subject to implied time restrictions but are expected to be collected within one year.

NFP A has a goal to maintain financial assets, which consist of cash and short-term investments, on hand to meet 60 days of normal operating expenses, which are, on average, approximately $275,000. NFP A has a policy to structure its financial assets to be available as its general expenditures, liabilities, and other obligations come due. In addition, as part of its liquidity management, NFP A invests cash in excess of daily requirements in various short-term investments, including certificate of deposits and short-term treasury instruments. As more fully described in Note XX, NFP A also has committed lines of credit in the amount of $20,000, which it could draw upon in the event of an unanticipated liquidity need.

Alternatively, the nonprofit could present tables (see 958-210-55-8) to communicate the resources available to meet cash needs for general expenditures within one year of the balance sheet date.

Cash Flow Statement Presentation

A nonprofit can use the direct or indirect method to present its cash flow information. The reconciliation of changes in net assets to cash provided by (used in) operating activities is not required if the direct method is used.

Consider whether you want to incorporate additional changes that will be required by ASU 2016-18, Statement of Cash Flows–Restricted Cash. If your nonprofit has no restricted cash, then this standard is not applicable.

You can early implement ASU 2016-18. (The effective date is for fiscal years beginning after December 15, 2018.) Once this standard is effective, you’ll include restricted cash in your definition of cash. The last line of the cash flow statement might read as follows: Cash, Cash Equivalents, and Restricted Cash.

Effective Date of ASU 2016-14

The effective date for 2016-14, Not-for-Profit Entities, is for fiscal periods beginning after December 15, 2017 (2018 calendar year-ends and 2019 fiscal year-ends). The standard can be early adopted.

For comparative statements, apply the standard retrospectively. 

If presenting comparative financial statements, the standard does allow the nonprofit to omit the following information for any periods presented before the period of adoption:

• Analysis of expenses by both natural classification and functional classification (the separate presentation of expenses by functional classification and expenses by natural classification is still required). Nonprofits that previously were required to present a statement of functional expenses do not have the option to omit this analysis; however, they may present the comparative period information in any of the formats permitted in ASU 2014-16, consistent with the presentation in the period of adoption.
• Disclosures related to liquidity and availability of resources.

ASU 2018-17: A VIEry Good Gift from FASB

By Charles Hall | Accounting

Going Concern Accounting and Auditing

By Charles Hall | Accounting , Auditing

Are you preparing financial statements and wondering whether you need to include going concern disclosures? Or maybe you’re the auditor, and you’re wondering if a going concern paragraph should be added to the audit opinion. You’ve heard there are new requirements for both management and auditors, but you’re not sure what they are.

This article summarizes (in one place) the new going concern accounting and auditing standards.

Going Concern Standards

For many years the going concern standards were housed in the audit standards–thus, the need for FASB to issue accounting guidance (ASU 2014-15). It makes sense that FASB created going concern disclosure guidance. After all, disclosures are an accounting issue. 

Going Concern Accounting Standard

ASU 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, provides guidance in preparing financial statements. This standard was effective for years ending after December 15, 2016.

GASB Statement 56, Codification of Accounting and Financial Reporting Guidance Contained in the AICPA Statements on Auditing Standards, is the relevant going concern standard for governments. GASB 56 was issued in March 2009. (GASB 56 requires financial statement preparers to evaluate whether there is substantial doubt about a governmental entity’s ability to continue as a going concern for 12 months beyond the date of the financial statements. As you will see below, this timeframe is different from the one called for under ASU 2014-15. This post focuses on ASU 2014-15 and SAS 132.)

Meanwhile, the Auditing Standards Board issued their own going concern standard in February 2017: SAS 132.

Going Concern Auditing Standard

Auditors will use SAS 132, The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern, to make going concern decisions. This SAS is effective for audits of financial statements for periods ending on or after December 15, 2017. SAS 132 amends SAS 126, The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern.

So, let’s take a look at how to apply ASU 2014-15 and SAS 132.

Two Going Concern Decisions

In the past, the going concern decisions were made by auditors in a single step. Now, it is helpful to think of going concern decisions in two steps:

1. Management decisions concerning the preparation of financial statements 
2. Auditor decisions concerning the audit of the financial statements

First, we’ll consider management’s decisions.

1. Management Decisions about Going Concern Accounting

ASU 2014-15 provides guidance concerning management’s determination of whether there is substantial doubt regarding the entity’s ability to continue as a going concern.

What is the Going Concern Accounting Definition?

FASB defines going concern with the words substantial doubt. So, how does FASB define substantial doubt? 

Substantial doubt about the entity’s ability to continue as a going concern is considered to exist when aggregate conditions and events indicate that it is probable that the entity will be unable to meet obligations when due within one year of the date that the financial statements are issued or are available to be issued.

What is Probable?

So, how does management determine if “it is probable that the entity will be unable to meet obligations when due within one year”?

Probable means likely to occur. 

If for example, a company expects to miss a debt service payment in the coming year, then substantial doubt exists. This initial assessment is made without regard to management’s plans to alleviate going concern conditions. 

ASC 205-40-50-4 says:

The evaluation initially shall not take into consideration the potential mitigating effect of management’s plans that have not been fully implemented as of the date that the financial statements are issued (for example, plans to raise capital, borrow money, restructure debt, or dispose of an asset that have been approved but that have not been fully implemented as of the date that the financial statements are issued).

But what factors should management consider?

Factors to Consider

Management should consider the following factors when assessing going concern:

• The reporting entity’s current financial condition, including the availability of liquid funds and access to credit
• Obligations of the reporting entity due or new obligations anticipated within one year (regardless of whether they have been recognized in the financial statements)
• The funds necessary to maintain operations considering the reporting entity’s current financial condition, obligations, and other expected cash flows
• Other conditions or events that may affect the entity’s ability to meet its obligations

Moreover, management is to consider these factors for one year. But from what date?

Timeframe

The financial statement preparer (i.e., management or a party contracted by management) should assess going concern in light of one year from the date “the financial statements are issued or are available to be issued.”

So, if December 31, 2017, financial statements (for a nonpublic company) are available to be issued on March 15, 2017, the preparer looks forward one year from March 15, 2017. Then, the preparer asks, “Is it probable that the company will be unable to meet its obligations through March 15, 2018?” If yes, substantial doubt is present and disclosures are necessary. If no, then substantial doubt does not exist. As you would expect, the answer to this question determines whether going concern disclosures are to be made and what should be included.

Substantial Doubt Answer Determines Disclosures

If substantial doubt does not exist, then going concern disclosures are not necessary.

If substantial doubt exists, then the company needs to decide if management’s plans alleviate the going concern issue. This decision determines the disclosures to be made. The required disclosures are based upon whether:

1. Management’s plans alleviate the going concern issue
2. Management’s plans do not alleviate the going concern issue

What if Management’s Plans Alleviate the Going Concern Issue?

If conditions or events raise substantial doubt about an entity’s ability to continue as a going concern, but the substantial doubt is alleviated as a result of consideration of management’s plans, the entity should disclose information that enables users of the financial statements to understand all of the following (or refer to similar information disclosed elsewhere in the footnotes):

1. Principal conditions or events that raised substantial doubt about the entity’s ability to continue as a going concern (before consideration of management’s plans)
2. Management’s evaluation of the significance of those conditions or events in relation to the entity’s ability to meet its obligations
3. Management’s plans that alleviated substantial doubt about the entity’s ability to continue as a going concern

Management’s plans should be considered only if is it probable that they will be effectively implemented. Also, it must be probable that management’s plans will be effective in alleviating substantial doubt.

So, if management’s plans are expected to work, does the company have to explicitly state that management’s plans will alleviate substantial doubt? No. 

When management’s plans alleviate substantial doubt, companies need not use the words going concern or substantial doubt in the disclosures. And as Sears discovered, it may not be wise to do so (their shares dropped 16% after using the term substantial doubt even though management had plans to alleviate the risk). Rather than using the term substantial doubt, consider describing conditions (e.g., cash flows are not sufficient to meet obligations) and management plans to alleviate substantial doubt.

Sample Going Concern Disclosure – Substantial Doubt Alleviated

An example note follows:

Note 2 – Company Conditions

The Company had losses of $4,525,123 in the year ending March 31, 2017. As of March 31, 2017, its accumulated deficit is $11,325,354. 

Management believes the Company’s present cash flows will not enable it to meet its obligations for twelve months from the date these financial statements are available to be issued. However, management is working to obtain new long-term financing. It is probable that management will obtain new sources of financing that will enable the Company to meet its obligations for the twelve-month period from the date the financial statements are available to be issued.

Notice this example does not use the words substantial doubt.

What if Management’s Plans Do Not Alleviate the Going Concern Issue?

If conditions or events raise substantial doubt about an entity’s ability to continue as a going concern, and substantial doubt is not alleviated after consideration of management’s plans, an entity should include a statement in the notes indicating that there is substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are available to be issued (or issued when applicable). Additionally, the entity should disclose information that enables users of the financial statements to understand all of the following:

1. Principal conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern
2. Management’s evaluation of the significance of those conditions or events in relation to the entity’s ability to meet its obligations
3. Management’s plans that are intended to mitigate the conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern

Sample Going Concern Disclosure – Substantial Doubt Not Alleviated

An example disclosure follows:

Going Concern Accounting Summary

2. Auditor Decisions Regarding Going Concern

SAS 132 provides guidance concerning the auditor’s consideration of an entity’s ability to continue as a going concern.

Auditing Going Concern Accounting

SAS 132, paragraph 10, states the objectives of the auditor are as follows:

An example of a going concern paragraph is as follows:

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company has suffered recurring losses from operations, has a net capital deficiency, and has stated that substantial doubt exists about the company’s ability to continue as a going concern. Management’s evaluation of the events and conditions and management’s plans regarding these matters are also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. Our opinion is not modified with respect to this matter.

The auditor should not use conditional language regarding the existence of substantial doubt about the entity’s ability to continue as a going concern. 

Opinion – Inadequate Going Concern Disclosures

Paragraph 26. of SAS 132 states that an auditor should issue a qualified opinion or an adverse opinion, as appropriate, when going concern disclosures are not adequate.

Going Concern Auditing Summary 

Now, let’s circle back to where we started and review the objectives of SAS 132.

The objectives are as follows:

• Conclude about whether the going concern basis of accounting is appropriate
• Determine whether substantial doubt is present
• Determine whether the going concern disclosures are adequate
• Issue an appropriate opinion 

Conclusion

As you can see ASU 2014-15 and SAS 132 are complex. So, make sure you are using the most recent updates to your disclosure checklists and audit forms and programs.

Finally, keep in mind that going concern is also relevant to compilation and review engagements.

Simplifying the Measurement of Inventory

By Charles Hall | Accounting

Are you up to speed on ASU 2015-11 Simplifying the Measurement of Inventory? This post assists in understanding the new accounting measurement for inventory.

Inventory Measurement Accounting

ASU 2015-11 requires that entities measure inventory at the lower of cost or net realizable value (LCNRV), provided they don’t use the last-in-first-out method (LIFO) or the retail inventory method. Entities using LIFO or the retail inventory method will continue to use the lower of cost or market (where market is replacement cost). Entities using the first-in-first-out (FIFO), average cost, or any other cost flow methods (other than LIFO and the retail inventory methods) should use the lower of cost or net realizable value approach.

So, where applicable, market is being replaced by net realizable value.

The Financial Accounting Standards Board’s glossary defines net realizable value as follows:

Estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.

Why the change? FASB is working to simplify some accounting standards. FASB had received comments from stakeholders that the requirement to subsequently measure inventory was “unnecessarily complex because there are several potential outcomes.”

Why did FASB not require the LCNRV method for all entities? The summary section of ASU 2015-11 says,  “The Board received feedback from stakeholders that the proposed amendments would reduce costs and increase comparability for inventory measured using FIFO or average cost but potentially could result in significant transition costs that would not be justified by the benefits for inventory measured using LIFO or the retail inventory method…Therefore, the Board decided to limit the scope of the simplification to exclude inventory measured using LIFO or the retail inventory method.”

What Disclosure is Required for the Change in Accounting Principle?

BC16 of ASU 2015-11 states the following:

The Board decided that the only disclosures required at transition should be the nature of and reason for the change in accounting principle. The Board concluded that the costs of a quantitative disclosure about the change from the lower of cost or market to the lower of cost and net realizable value would not justify the benefits because a reporting entity would be required in the year of adoption to measure inventory using both existing requirements and the amendments in this Update, and because the change would not be significant for some entities.

An entity is required only to disclose the nature and reason for the change in accounting principle in the first interim and annual period of adoption.

Sample ASU 2015-11 Disclosures

Here is a sample disclosure from Mercer International Inc.’s 10-K:

Accounting Pronouncements Implemented

In July 2015, the FASB issued Accounting Standards Update 2015-11, Simplifying the Measurement of Inventory (“ASU 2015–11”) which requires that inventory within the scope of this update, including inventory stated at average cost, be measured at the lower of cost and net realizable value. This update is effective for financial statements issued for fiscal years beginning after December 15, 2016. The adoption of ASU 2015–11 did not impact the Company’s financial position.

Here is a sample disclosure from Delta Apparel, Inc.’s 10-K:

Recently Issued Accounting Pronouncements Not Yet Adopted

In July 2015, the FASB issued ASU No. 2015-11, Simplifying the Measurement of Inventory, (“ASU 2015–11“).  This new guidance requires an entity to measure inventory at the lower of cost and net realizable value. Currently, entities measure inventory at the lower of cost or market. ASU 2015–11 replaces market with net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. Subsequent measurement is unchanged for inventory measured under last-in, first-out or the retail inventory method.  ASU 2015–11 requires prospective adoption for inventory measurements for fiscal years beginning after December 15, 2016, and interim periods within those years for public business entities.  Early application is permitted.  ASU 2015–11 will, therefore, be effective in our fiscal year beginning October 1, 2017. We are evaluating the effect that ASU 2015–11 will have on our Consolidated Financial Statements and related disclosures, but do not believe it will have a material impact.

Here is a sample disclosure from Dr. Pepper Snapple Group, Inc.’s 10-K:

Effective Dates for ASU 2015-11

For public business entities, the amendments are effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2016, and interim periods within fiscal years beginning after December 15, 2017. The amendments should be applied prospectively with earlier application permitted as of the beginning of an interim or annual reporting period.

Do Loan Guarantees Create Liabilities?

By Charles Hall | Accounting

Can a loan guarantees create liabilities that go on the balance sheet of the guarantor?

Yes.

Recording Loan Guarantees

FASB 5 (now ASC 450) has been with us for some time. It states that a company should record a contingent liability if two things occur:

1. The liability is subject to estimation (you can calculate it)
2. It is probable that the liability will be paid

ASC 450 addresses these contingent liabilities.

FIN 45 (now ASC 460) was issued in the early 2000s to clarify that some loan guarantees create liabilities–even when there is no loan default. ASC 460 deals with noncontingent liabilities. And it’s the noncontingent piece that confuses everyone (including me). So let’s first take a look at noncontingent liabilities.

Noncontingent Liability

ABC Co. guarantees a $2,000,000 loan of XYZ Co. (an unrelated entity); in exchange, XYZ agrees to pay a fee of $50,000.

Should ABC Co. record a liability for the guarantee? Yes.

What’s the entry?

                                                         Dr.                 Cr.

Accounts Receivable                $50,000

Guarantee Liability                                           $50,000

The standard allows the guarantor to use the guarantee fee as a practical expedient to valuing the loan guarantee.

What if there is no guarantee fee? For instance, let’s say ABC Co. guarantees a loan for Sidewalk Safety Nonprofit, Inc. This guarantee is provided to the nonprofit free of charge. How would ABC Co. record this guarantee?

First ABC Co. would need to determine the value of the guarantee. If Sidewalk Safety’s interest rate is 8% without the guarantee, but now it’s 4%, then you can compute the differential using present value calculations. Let’s say the result is $40,000, what is the entry?

                                                                       Dr.                Cr.

Guarantee Expense (Contribution)      $40,000

Guarantee Liability                                                       $40,000

Guarantee of Related Party Debt

What if the loan guarantee is for an entity owned by the same parties? If the guarantee is on the debt of a related entity under common control, ASC 460-10-25-1 exempts the guarantor from the requirement to record the guarantee liability.

Next, we’ll see how to relieve the guarantee liability.

Guarantee Liability – In Subsequent Periods

After inception, the fair value liability (for both examples above) is taken to income as the guarantor is released from risk; the liability is to be adjusted to fair value at the period end.

ASC 460 does not provide detailed guidance as to how the guarantor’s initial liability should be measured after its initial recognition. Depending on the nature of the guarantee, the guarantor’s release from risk is recognized with an increase to earnings using one of three methods:

1. Systematic and rational
2. Deferring until expiration or settlement of the guarantee
3. Remeasurement at fair value (for guarantees accounted for as derivatives)

You now know how to account for the noncontingent liability, but what if the guaranteed party defaults on the loan. Now the guarantor needs to record the loan as a liability.

Contingent Liability

For example, what if Sidewalk Safety defaults on the loan? Then ABC Co. needs to book a liability for the remaining debt. Sidewalk Safety’s default triggers ASC 450.

This is the contingent piece of the equation (for which no amount is typically recorded at the inception of the guarantee). Upon Sidewalk Safety’s default, the debt amount is subject to estimation and payment is probable. ABC Co. is on the hook for the remaining debt.