News from the FASB front: Update on the proposed changes to not-for-profit financial statements
There’s been much interest from not-for-profit organizations on the status of the Financial Accounting Standards Board’s proposed ASU, Presentation of Financial Statements of Not-for-Profit Entities. The changes proposed in this update would significantly impact how not-for-profits report financial information. Significant elements of the proposed standard include:
- Inclusion of required operating measure on the statement of activities
- Overhaul of the statement of cash flows Significant new disclosures on liquidity
- One donor restricted category of net assets, rather than two
Comment letters on the proposed standard were due in August 2015. FASB received over 260 comment letters from various practitioners, not-for-profit entities, and other interested parties.
What has happened since the comment due date
FASB held a series of roundtable meetings in September and early October. These meetings were designed to provide an opportunity for those who submitted comment letters to discuss the proposed standard with FASB staff and board members before they begin deliberating on what, if any, changes to make to the proposed standard.
Plante Moran’s Joan Waggoner, a senior professional standards partner, was selected to participate by FASB in the first roundtable meeting on September 21 in Norwalk, Conn. Katie Thornton, a senior manager from Plante Moran, also attended as an observer.
Notes from the roundtable
The roundtable discussions focused on four key areas of the proposed standard:
1. Operating measures
While there was overall support for the requirement to present an operating measure, the main focus of this discussion was on how the operating measure should be presented. Some respondents felt that capital activity should be excluded from the operating measure. Others made the case for including items such as investment income and investment expenses within operations. A few participants questioned whether the design of the proposed operating measure is too complicated to be useful to most financial statement users. Another concern discussed at the meeting was whether allowing the presentation of board transfers in and out of the operating measure creates an opportunity for income smoothing from year to year that would not be allowable in any other industry; while others indicated that presenting these transfers in the operating measure could better reflect how not-for-profit entities manage the achievement of their missions. In the second roundtable meeting, there was discussion around the possibility of basing an operating measure on the current healthcare performance indicator tailored for not-for-profit organizations; however, no consensus was reached on that suggestion.
2. Presentation of operating cash flows
The new standard requires the use of the direct method of cash flow, without requiring the indirect method reconciliation. The discussion focused on whether the benefit of the direct method presentation outweighs the additional costs of preparing the statement using the direct method. The general consensus of the respondents was concern that it was not necessarily fair to require the direct method for not-for-profit entities when it’s not required for other industries. FASB staff responded that the main reason the direct method is not required for other industries is the significant difficulty that the extremely large international for-profit organizations have in compiling a direct method cash flow statement. The FASB staff indicated they don’t see this as a barrier in the not-for-profit industry, and they don’t anticipate a significant cost to preparing a direct method cash flow statement. The FASB board members were very interested in hearing feedback from users of financial statements about how they use cash flow statements and what information is important to them. The general feedback from users was that the statement of cash flows is an important but under-utilized statement.
3. Liquidity disclosures
Feedback on the proposed liquidity measures was mixed. Many respondents felt that providing more information about liquidity is an important goal; however, some expressed concern that the requirements in the proposed standard are vague and will allow for manipulation by management given each entity will be required to define its own time horizon for managing and presenting liquidity. Another possibility expressed is the potential that management would not put sufficient effort into defining its time horizon, resulting in the disclosure losing its meaning. Some respondents suggested FASB consider including more plain language examples within the standard to illustrate the more typical liquidity management procedures used by not-for-profits. Questions discussed at the roundtable meeting included whether FASB should provide a more defined time horizon for measuring liquidity and whether requiring a classified balance sheet would be helpful.
4. Other topics
The other topics on the agenda at the meeting, including requiring a presentation of expenses by both nature and function, changes to the presentation of investment return, and changes to the treatment of underwater endowments, didn’t generate much disagreement among the respondents. In summary, the general theme of the roundtable discussions and comment letters is overall support of FASB’s objective to update the financial reporting model and to require the presentation of an operating measure; however, there were differing views on how the operating measure should be presented and there was an expressed desire by some respondents to maintain comparability between not-for-profit and for-profit reporting models, particularly with the cash flow statement. FASB staff and board members stressed that they don’t currently have any plans to revisit the for-profit financial reporting model for the statement of cash flows. Some respondents also requested FASB consider differences between not-for-profit entities, such as different industry characteristics and entity size. In the roundtable meetings, FASB staff and board members appeared open to incorporating feedback received from the comment letters and discussions and expressed an interest in “getting it right” versus just proceeding with the current proposal.
FASB’s next steps
FASB has decided to split its deliberation efforts into two phases. The first phase will address the least controversial aspects of the exposure draft, including:
- Changes to net asset classification, including:
- Classifying net assets into two categories: net assets without donor restrictions and net assets with donor restrictions.
- Disclosure of board-designated funds.
- Shifting the amount by which permanent endowments are underwater from net assets without donor restriction to net assets with donor restriction and requiring expanded disclosures about underwater endowments.
- Presentation of expenses by both their natural and functional classifications.
- Enhancing disclosures by not-for-profit entities that choose to present an operating measure.
- Improving disclosures of information useful in assessing liquidity.
- Requiring the direct method presentation in the statement of cash flows.
FASB expects to complete this phase by the middle of 2016.
The second phase will address the areas of the exposure draft that created the most disagreement among respondents, including:
- Presentation of an operating measure on the statement of activities.
- Realignment of certain line items on the statement of cash flows.
FASB did not issue an expected timeline for the completion of the second phase; however, we expect this process will take an extended amount of time given the nature and volume of feedback they received.
Plante Moran’s next steps
We will continue to monitor FASB’s progress on the proposed standard and will provide updates to you as appropriate.
If you have any questions or would like to discuss the impact of the proposed changes on your organization’s particular circumstances, please contact your Plante Moran engagement team.