The Financial Accounting Standards Board released Accounting Standards Update 2016-14 on August 18, 2016. This update, which will take effect for periods beginning after December 15, 2017, will change how nonprofit entities present their net asset classes. Currently, net assets are classified as unrestricted, temporarily restricted, or permanently restricted:
- Unrestricted net assets are assets that have no restrictions and can be used in any manner by the organization.
- Temporarily restricted net assets are assets that have a time or purpose restriction. Assets with a time restriction must be used during the period the donor has restricted them for, and assets with a purpose restriction must be used for the purpose specified by the donor.
- Permanently restricted net assets must be indefinitely retained by the organization, per restrictions set by the donor. These include assets such as endowments and real estate. The organization can invest the endowment and receive the interest, but cannot spend the principle.
The new standard will simplify the reporting to two classes: net assets with donor restrictions and net assets without donor restrictions. Assets with any type of donor restriction will be classified as a net asset with donor restrictions, regardless of whether it is a temporary or permanent restriction. Contributed assets with a purpose-restriction, but no time restriction, will be reclassified to net assets without donor restrictions once the asset is placed in service, instead of over the life of the asset, which was an option under the old model. Additionally, any cash contributed for the purpose of purchasing or constructing a capital asset will be reclassified from a net asset with donor restrictions to a net asset without donor restrictions upon completion of the project. Board-designated net assets will be classified as net assets without donor restrictions. Additional footnote disclosures will be required to disclose the details of the restricted assets. The notes will describe the nature, type of donor restriction, and the amount of the restricted asset.
Another change required by this standard is the reporting of investment income. Not-for-profits will report investment income as a net asset without donor restrictions, unless there is a donor imposed restriction on how those funds can be used. They will also be required to report their investment income net of internal and external investment expenses. This will allow for enhanced comparability between all not-for-profits, whether their investments are managed internally at a low cost or by an investment firm.
Finally, this standard also changed requirements for the classification of underwater endowments. Underwater endowments are endowments that have a current market value that is less than the original donation amount. The deficit in these assets is currently classified as an unrestricted asset, but the new standard will require organizations to report them as a net asset with donor restrictions. This will show a loss to net assets with donor restrictions rather than a loss of unrestricted net assets. In the notes to the financial statements, the organization must disclose the original amount of the endowment, the current fair value, the amount the endowment is deficient, and the organization’s policy about underwater endowments.
For more information on these changes or any questions regarding our firm’s nonprofit services, please feel free to contact a member of our team.