Understanding the Proposed Changes to Nonprofit Financial Statements

Ripples in the surface of a body of water.

When I was a senior at St. John's University (MN) back in 1993, about to obtain my Accounting and Business Management degrees, I remember the Financial Accounting Standards Board (FASB) coming out with two pronouncements that, in a sense, became the new gospel for nonprofit accounting in the United States. Since I was working for a nonprofit organization at the time, I clearly remember our organization and our auditors wrestling with these sweeping changes.

These two new pronouncements issued in June 1993 - Statement 116, "Accounting for Contributions Received and Contributions Made" and Statement 117, "Financial Statements of Not-For-Profit Organizations" - introduced some new concepts to nonprofit accounting and clarified other practices. Some of those major changes included:

  • Clarification that an "unconditional promise to give" is recorded at the time of the promise notification whereas oral promises and other intentions to give are not recorded.

  • Removal of the "matching principle" with multi-year donations, pledges, and grants. In other words, if a grantor organization awards your nonprofit $10,000 per year for 10 years, all $100,000 must be recorded as revenue in the year of the award notification, no matter when it will eventually be received and spent. Before 1993, revenue was generally recorded only as amounts were received.

  • Classification of remaining "donor-imposed" restricted amounts as either temporarily restricted net assets or permanently restricted net assets. Board-designated (internally-imposed) amounts, then, fall within a third classification: unrestricted net assets.

  • Presentation of expenses by functional category. The categories generally used are: Program, Management/General, and Fundraising.

  • Recommendation (but not a requirement) that the statement of cash flows report cash flows from operating activities using the direct method, instead of the indirect method. FASB wanted to require the direct method, but enough accountants balked to the point that FASB decided to allow the continuance of the indirect method. (Note: the indirect method is usually much easier for accountants to prepare; hence all of the balking from us accountants.)

In April 2015, FASB issued a proposed Accounting Standards Update (ASU) that will potentially contain the most significant changes to the nonprofit financial statement reporting model since 1993. Some of the significant proposed changes include:

  • Replace the terms "permanently restricted" and "temporarily restricted" with one term, "restricted."

  • Provide two measures of operating performance within the statement of activities: Amounts received, used, and available for operations (that are not restricted) and non-operating amounts. The intent, here, is to provide readers with clear information on what revenues and expenses directly relate to the organization's mission and what remains available for current operations.

  • Enhance information regarding expenses by requiring that all operating expenses be reported by functional allocation as well as by nature and investment return.

  • Requirement that the statement of cash flows now present cash flows from operating activities using the direct method. (We accountants say, "Bummer…more work.”) But frankly, the direct method will likely help readers of the statement of cash flows better understand what happened to the organization's cash.

While I believe that many of these enhancements will provide clarity to the financial statements, it's perhaps somewhat interesting that FASB is not addressing the matching principal issue from 1993. Over the years, we have seen many nonprofit organizations struggle with the concept of reporting profits in the year that grant support is recorded while incurring losses in subsequent years when those funds are expended. This can also cause a situation that is difficult to explain to grantor organizations who do not want to see sharp reductions in the bottom lines of those organizations they are funding. Perhaps this topic will be address in a future pronouncement.