Update: The FASB released its Accounting Standards Update in August of 2016, Not-For-Profit Entities (Topic 958), found here.
The Financial Accounting Standards Board (FASB) has proposed changes to how charities must report their net assets and is accepting public comment until August 20, 2015. The changes are intended to improve the usefulness of financial statements for both internal and external stakeholders while reducing the complexities and costs shouldered by charities required to produce financial data about their operations.
Currently, charities required to produce annual financial statements must report their total net assets as of fiscal year-end, and, in addition, break out this total into three distinct categories on the face of the Statement of Financial Position (aka, Balance Sheet) based on how the funds are restricted.
These include:
Unrestricted Net Assets – These are assets available for the non-profit to use without restriction. Unrestricted does not necessarily mean highly liquid, however. In addition to cash it may include investments like securities or CDs, equity in fixed assets, inventory, and other assets that can be converted to cash without requiring permission from parties outside of the organization.
Temporarily Restricted Net Assets – These include assets that will become available for the charity to use at some point, but to which some restrictions as to their use are attached. For example, time-restricted net assets may include contributions receivable that were recognized as revenue when pledged, but are not expected to be received by the organization for more than a year. Another example is purpose-restricted net assets. These are assets that were pledged to the non-profit for a specific purpose that the organization is prohibited from using for any alternate purpose; a $100,000 donation pledged specifically by a donor to build a school playground cannot be used by the charity to pay teacher salaries, for example, and must be reported as temporarily restricted until costs of building a playground are incurred.
Permanently Restricted Net Assets – These are assets that the non-profit is permanently barred by an outside party from disposing of in some cases, or from using in operations in other cases. For example, a donor may grant an environmental charity or historical society land or buildings that the charity is required to maintain in perpetuity for a conservational or educational purpose and is barred from selling. Or, a donor may leave a charity a $1 million permanently restricted gift of cash in his or her will. The charity is prohibited from using any of the original $1 million. However, the charity may invest the $1 million and is free to use any interest earned on the investments in its general operations.
The reporting changes proposed by FASB would reduce the net asset classifications from three categories to two on the face of the Statement of Financial Position. Essentially, the categories of Temporarily and Permanently Restricted Net Assets would be combined into a single category and presented in aggregate alongside Unrestricted Net Assets. According to FASB, charities would still be required in the notes to the financial statements to disclose “the nature of donor-imposed restrictions and their effects on liquidity...” to ensure that stakeholders do not lose necessary information once reporting changes are adopted.
The reduction of net asset classifications in many cases will not reduce the amount of time required for a charity to report on its net assets. The non-profit must still maintain adequate internal records of all of its restricted net assets for legal reasons, for other reporting requirements, and for purposes of composing the newly required notes to the financial statements about liquidity.
The FASB's proposed changes in accounting standards for non-profits would also affect how a charity must report underwater endowment funds. Say a donor contributes $1 million in permanently restricted cash to a charity which the charity then invests in securities. A few years later the economy takes a nose dive and the principal value of the securities is now only $800,000. Since the charity is required by the donor or by law to maintain the principal balance of $1 million, but the balance is now only $800,000, this represents an endowment that is “underwater” and that must be “covered” by reporting a reduction in the charity's Unrestricted Net Assets to the tune of $200,000.
In 2006 new rules affecting charity endowments were adopted as part of what is now known as the Uniform Prudent Management of Institutional Funds Act (UPMIFA). It modernized the rules governing spending from endowment funds to offer better guidance and to help charities more easily cope with fluctuations in principal value of such funds. Due to the complexity of these rules and how other factors may impact a charity's fiduciary duties and reporting requirements, charities should consult an accountant for specific guidance.
On a high level, FASB's proposed changes would require charities to report underwater endowment funds net of fluctuations within each separate net asset classification of Unrestricted vs. Restricted Net Assets. In other words, fluctuations within Unrestricted Net Assets would be reported net of changes in value within Unrestricted Net Assets; and fluctuations within Restricted Net Assets would be reported net of changes in value within Restricted Net Assets. Decreases in principal value would not be reported inter-fund. In addition, a non-profit would be required to describe in its audit notes its policy on spending from underwater endowment funds, as well as report “the aggregated original gift amount or the amount that is required to be maintained by donor or by law...” to help stakeholders assess the non-profit's liquidity and ability to provide services.
These and other changes in non-profit reporting standards have not yet been adopted, but if adopted, may require retrospective application and a restatement of certain financial information in future reporting periods.