By Jim Simpson, CPA and director, Financial Technologies & Management
The way nonprofits prepare and present financial reports is about to change. It is the first significant changes in over 20 years.
In 2011, the Nonprofit Advisory Committee recommended modification of the 1993 financial reporting mode to the Financial Accounting Standards Board (FASB). In April, the FASB issued an exposure draft that proposed updated accounting standards. The released draft has a comment period that ends on Aug. 20.
So what does this mean for your nonprofit organization?
Before the change is official, you may want to consider formal training for board and staff members. It may be good idea to adopt some of the proposed changes before they are mandatory because they will create more relevant financials and comparable measurements.
These updated accounting standards will have an impact on six major financial reporting areas. These include net-asset classifications, financial performance, cash flows, expense reporting, liquidity and enhanced disclosures.
Under the new standards, the precise distinction between temporary and permanently restricted would be combined to net assets with donor restrictions focused how and when resources are used. The nonprofit can focus more on the restriction itself. Currently, nonprofits focus is on determining the two classifications which would be eliminated.
Operational activities financial reporting changes would make it easier to compare and determine these activities based on mission and resource availability. Now, organizations have significant flexibility in operational reporting which allows two similar organizations to be reported differently.
Cash flow financial reporting changes are intended to help an organization understand and communicate financial performance.
Here are additional details for each reporting area:
For some, the existing term “unrestricted net assets” has been misunderstood. They thought it meant these were liquid resources for the organization when these resources may or may not be available. To clarify, the new standards for net assets would have two classifications – with donor restrictions and without donor restrictions.
A standardized method to measure operational activities would be required. Operational activities would be defined to operating revenue, support, expenses, gains and losses. This excludes amounts unavailable to the nonprofit because of donor-imposed restrictions.
Expense reporting will be required to be presented by nature and function. Functional expense reporting is required and an organization would report its expenses by individual program, management in general and fundraising. Natural expense reporting is currently optional and reports expenses by salary, supplies, occupancy and professional services. Many stakeholders believe that natural expense reporting by function is more useful than functional expense reporting to assess how a nonprofit uses and stewards its resources.
Liquidity, which includes the assets readily available and that can be used to meet current and debt obligations, would be required to be disclosed. The liquidity disclosure would encourage liquidity policies and reserves that should help nonprofits to manage risk. Organizations should know if they have liquid assets to meet their operational needs and related activities. This liquidity measure should help inform if a nonprofit is financially healthy or not.
Cash flows will need to be presented using the direct method, which presents the actual cash flows received and disbursed by the nonprofit. The cash flow statement using the direct method should be more understandable and useful for more stakeholders.
The enhanced disclosures would include the following:
· limits placed by the board and donors towards financial flexibility, liquidity and financial resources allocation towards needed services
· how an organization manages liquidity and meets its future needs
· how resources are used and how are they allocated towards operating activities.
Jim Simpson, CPA and director of Financial Technologies & Management, is a financial leader and trainer, Software Advisor, CFO advisor, controller and forensic accountant to nonprofit organizations since 1999, serving over 350 nonprofit clients. He has worked as a CFO, controller and software advisor for over 25 years.