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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.

How to Lessen Segregation of Duties Problems in Two Easy Steps

By Charles Hall | Auditing , Fraud

Darkness is the environment of wrongdoing.

Why?

No one will see us–or so we think.

As you’ve seen many times, fraud occurs in darkness.

In J.R.R. Tolkien’s Hobbit stories, Sméagol, a young man murders another to possess a golden ring, beautiful in appearance but destructive in nature. The possession of the ring and Sméagol’s hiding of self and his precious (the ring) transforms him into a hideous creature–Gollum. I know of no better or graphic portrayal of how that which is alluring in the beginning, is destructive in the end.

Fraud opportunities have those same properties: they are alluring and harmful. And, yes, darkness is the environment of theft. What’s the solution? Transparency. It protects businesses, governments, and nonprofits. And while we desire open and understandable processes, often businesses have just a few employees that operate the accounting system. And many times they alone understand how it works.

It is desirable to divide accounting duties among various employees, so no one person controls the entire process. This division of responsibility creates transparency since multiple eyes see the accounting processes–but this is not always possible.

Lacking Segregation of Duties

Many small organizations lack appropriate segregation of duties and believe that solutions do not exist or that fixing the problem is too costly. But is this true? Can we create greater transparency and safety with simple procedures and without significant cost?

Yes.

Below I propose two processes to reduce fraud:

1. Bank account transparency and
2. Surprise audits.

1. Bank Account Transparency

Here’s a simple and economical control: Provide all bank statements to someone other than the bookkeeper. Allow this second person to receive the bank statements before the bookkeeper. While no silver bullet, it has power.

Persons who might receive the bank statements first (before the bookkeeper) include the following:

• A nonprofit board member
• The mayor of a small city
• The owner of a small business
• The library director
• A church leader

What is the receiver of the bank statements to do? Merely open the bank statements and review the contents for appropriateness (mainly cleared checks).

In many small entities, accounting processes are a mystery to board members or owners since only one person (the bookkeeper) understands the disbursement process, the recording of journal entries, billing and collections, and payroll.

One set of eyes on an accounting process is not a good thing. So how can we shine the light?

Second Person Sees the Bank Statements

Allow a second person to see the bank statements.

Fraud decreases when the bookkeeper knows someone is watching. Suppose the bookkeeper desires to write a check to himself but realizes that a board member will see the cleared check. Is this a deterrent? You bet.

Don’t want to send the bank statements to a second person? Request that the bank provide read-only online access to the second person, and let the bookkeeper know that the other person will review bank activity.

Even the appearance of transparency creates (some) safety.

Suppose the second person reviewer opens the bank statements (before providing them to the bookkeeper) and does nothing else. The perception of reviews enhances safety. I am not recommending that you don’t perform the review, but if the bookkeeper even thinks someone is watching, fraud will lessen.

2. Surprise Audits

Another way to create small-entity transparency is to perform surprise audits. These reviews are not opinion audits (such as those issued by CPAs) but involve random inspections of various areas such as viewing all checks clearing the May bank statement. Such a review can be contracted out to a CPA or performed by someone other than the bookkeeper–such as a board member.

Adopt a written policy stating that the surprise inspections will occur once or twice a year.

The policy could be as simple as the following:

Twice a year a board member (or designee other than the bookkeeper) will inspect the accounting system and related documents. The scope and details of the inspection will be at the judgment of the board member (or designee). An inspection report will be provided to the board.

Why word the policy this way? You want to make the system general enough that the bookkeeper has no idea what will be inspected but distinct enough that an actual review occurs with regularity (thus the need to specify the minimum number of times the review will be performed).

Sample Inspection Ideas

Here are some sample inspection ideas:

• Inspect all cleared checks that clear a particular month for appropriate payees and signatures and endorsements
• Agree all receipts to the deposit slip for three different time periods
• Review all journal entries made in a two week period and request an explanation for each
• Review two bank reconciliations for appropriateness
• Review one monthly budget to actual report (to see that the report was appropriately created)
• Request a report of all new vendors added in the last six months and review for appropriateness

The reviewer may not perform all of the procedures and can perform just one. What is done is not as important as the fact that something is done. In other words, the primary purpose of the surprise audit is to make the bookkeeper think twice about whether he or she can steal and not be caught.

Again multiple people seeing the accounting processes reduces the threat of fraud.

Shine the Light

The beauty of these two procedures (bank account transparency and surprise audits) is they are straightforward and cheap to implement but nevertheless powerful. So shine the light.

What other procedures do you recommend for small entities?

For more information about preventing fraud, check out my book: The Little Book of Local Government Fraud Prevention.

How to Account for Cash Overdrafts

By Charles Hall | Accounting

How should you account for cash overdrafts (also called negative cash balances) on a balance sheet and in a cash flow statement?

It is year-end and your audit client has three bank accounts at the same bank. Two of the accounts have positive balances (the first with $50,000 and the second with $200,000). The third account has a negative cash balance of $400,000. Since a net overdraft of $150,000 exists, how should we present cash in the financial statements?

Balance Sheet

In the balance sheet, show the negative cash balance as Cash Overdraft in the current liabilities. Or you can also include the amount in accounts payable.

If you are netting the three bank accounts, consider using the Cash Overdraft option. If you bury the overdraft in accounts payable, the financial statement reader may think, “there is a mistake, where is cash?” Using Cash Overdraft communicates more clearly. (The right of offset must exist in order to net bank accounts. The right of offset commonly exists for multiple bank accounts with one bank.)

Some companies have multiple bank accounts with multiple banking institutions. In such cases, the net balance of one bank might be positive and the net balance of the second bank might be negative. Then the company would reflect the positive balance as cash and the negative cash balance (of the second bank) as an overdraft.  

Suppose a company has bank accounts with two different banks and the net balance of the first bank is $1,350,000 and the net balance of the second bank is an overdraft of $5,000. Then show cash as one amount on the balance sheet ($1,345,000). The $5,000 overdraft is not material.

Cash Flow Statement

Some companies do not include cash overdrafts in the definition of cash; instead, they include the overdraft in accounts payable. Consequently, the company treats the overdraft as an operating activity (change in accounts payable). So, the company includes the overdraft as a change in a liability in the operating section of the cash flow statement. (Some accountants treat overdrafts as a financing activity, but overdrafts clear quickly. Therefore, an operating activity classification is more appropriate.)

Alternatively, include the overdraft in the definition of cash (rather than in accounts payable). In doing so, you combine the cash overdraft with other cash (that with positive balances) in the cash flow statement. The beginning and ending cash–in the cash flow statement–should include cash overdrafts.

FASB ASC 230-10-45-4 requires that the total amounts of cash and cash equivalents in the cash flow statement agree with similarly titled line items or subtotals in the balance sheet. If a cash overdraft is included in the definition of cash, the cash captions in the statement of cash flows should be revised accordingly (e.g., Cash (Cash Overdraft) at end of year).

If the balance sheet contains a positive cash balance in assets and a cash overdraft in liabilities, provide a reconciliation at the bottom of the cash flow statement (or in a disclosure). In the reconciliation, show the composition of cash (cash overdraft)–one line titled Cash, one line titled Cash Overdraft, and a total line titled Total Cash (Cash Overdraft). 

One Other Consideration

If checks are created but not released by year-end, reverse the payment. Merely printing checks does not relieve payables. Payables are relieved when payment is made (checks are printed and mailed, or electronic payments are processed).

Restricted Cash

FASB recently issued a new standard dealing with how restricted cash is to be reported in the cash flow statement. Click here for more information.

Financial Reporting Framework for Small- to Medium-Sized Entities: Questions and Answers

By Charles Hall | Accounting and Auditing

CPAs have asked for relief from the burden of complying with GAAP for many years. So, a few years back the AICPA created the Financial Reporting Framework for Small- to Medium-Sized Entities (aka FRF for SME). The following is a Q&A that will assist you in understanding this reporting framework.

What is FRF for SMEs?

It’s an other comprehensive basis of accounting (OCBOA) that can be used as an alternative to generally accepted accounting principles (GAAP) as issued by the Financial Accounting Standards Board.

Who created FRF for SME?

The AICPA.

What is the size of FRF for SME?

A little over 200 pages.

What is the size of GAAP?

Thousands of pages.

How often will FRF for SME change?

About once every three to four years. That’s one of the beauties of it: Stability.

Why was FRF for SME created?

GAAP had become too complex for small- to medium-sized private businesses, driving up the costs of creating GAAP-compliant financial statements. Existing OCBOA (e.g., modified-cash basis) lacked standardization.

Does FRF for SME define a small- to medium-sized entity? Is there a dollar threshold?

No. It’s subjective. There is no dollar threshold.

Is “FRF for SME” GAAP?

No. It’s not GAAP.

Can entities with debt covenants requiring GAAP use FRF for SMEs?

No. But they can see if the lender will amend the debt agreement to allow its use.

Can financial statements created using FRF for SME be audited, reviewed or compiled?

Yes (for all three).

What are some of the characteristics of companies that might use FRF for SME?

• For-profit
• Closely-held
• Not a public company
• No regulatory requirements for GAAP
• Individuals with controlling ownership also manage the company

What entities should not use FRF for SME?

• Nonprofits
• Those with complex transactions
• Governments

Is FRF for SME principles-based?

Yes. Use the flexibility and disclose the accounting policies used.

Do the FRF for SME financial statements look like GAAP statements?

Yes. This is a downside (at least to me). I do think a user might mistakenly believe the financial statements are GAAP. You will need to clearly disclose that FRF for SME was used. Also, your opinion or SSARS report will refer to FRF for SME (rather than GAAP).

What are some key points of FRF for SME?

• No comprehensive income
• Investments will be at historical cost (market value used when held-for-sale)
• Derivatives (e.g., swaps) are not recognized on the balance sheet
• There is no hedge accounting
• Goodwill amortized over the same period as that used for tax purposes or 15 years
• All intangibles are amortized over their economic life
• Income taxes recognized using taxes payable method (what you owe at period-end) or the deferred income tax method (as GAAP requires)
• No requirement to accrue uncertain tax positions (no FIN 46)
• Leases are recognized as operating or capital leases 
• Policy choice to consolidate subsidiaries or account for them using the equity method
• Parent-only presentation is allowed (use equity method accounting for subsidiaries)
• Variable interest entities are not consolidated
• No assessment of long-lived assets for impairment
• Going concern assessment required by management 
• Revenue recognition is principles-based (disclose how you recognize revenue); percentage-of-completion can be used by contractors
• Stock-based compensation not booked as a liability (disclosure only)
• Defined benefit plan liabilities can be recognized using contribution payable method (record current pension plan payments not made; no projected benefit obligation required)
• Disclosure requirements are greatly simplified

Can’t I just continue issuing tax-basis financial statements?

Yes. But tax-basis statements do not incorporate some of the more traditional accounting concepts of FRF for SME.

How will the use of FRF for SME change the peer review process?

No change; FRF for SME is just another OCBOA – like tax-basis or modified-cash basis.

Does the AICPA offer any implementation tools?

Yes. Click here for toolkits.

 

Consolidating Not-for-Profit Entities

By Charles Hall | Accounting and Auditing

How would you respond to the question, “how do I know when a not-for-profit entity should consolidate a related not-for-profit entity?”

Here’s a brief overview.

Key Consolidation Issue

The main key in determining whether a not-for-profit should consolidate another entity is control.

FASB defines control as the direct or indirect ability to determine the direction of management and policies through ownership, contract, or otherwise.

Consolidation Decision

The FASB Codification addresses not-for-profit (NFP) consolidations as follows:

• Consolidation is required for 1. through 3. below.
• Consolidation is permitted but not required for 4. below.
• Consolidation is not permitted for 5. below.

Controlling Financial Interest

1. 958-810-25-2 – The reporting entity is the sole corporate member of the related NFP
2. 958-810-25-2 – The reporting entity has a controlling financial interest through direct or indirect ownership of a majority voting interest in the other NFP

Control Combined with an Economic Interest

3. 958-810-25-3 – The reporting entity controls another NFP through a majority voting interest in its board and has an economic interest in that other entity (e.g., reporting entity appoints 3 of the 5 voting members of the related NFP)
4. 958-810-25-4 – The reporting entity controls an NFP through a form other than majority ownership, sole corporate membership, or majority voting interest in the board of the other entity and has an economic interest in that other entity (control may be established by contract or an affiliation agreement)

Other

5. 958-810-25-5 – If the reporting entity does not have both control of and an economic interest in the related NFP, then consolidation is not permitted.

Note – There are additional rules for consolidating for-profit entities into NFP financial statements.