Liquidity Disclosures Under ASU 2016-14
As a reminder, Accounting Standards Update (ASU) 2016-14 is effective for 12/31/18 year-ends and will affect every nonprofit organization. In our last article, “Functional Allocation of Expenses,” we provided information on the guidance for allocating expenses between program and supporting services. The last provision of ASU 2016-14 is addressed in this newsletter series and relates to liquidity disclosures.
Nonprofit financial statements are sometimes seen as misleading and difficult to interpret. Because of the requirement to show contributions as revenue in the period pledged instead of the period spent, revenue and expenses related to contributions are not always recorded in the same fiscal year. This can cause large fluctuations in net income and detract from the operating results of the organization’s program activities. In addition, you might have assets on your balance sheet that aren’t available for current needs because they are restricted by certain donor stipulations. Your auditors may have tried to identify these issues when explaining your financial statements and comparing current results with those of prior periods. Under ASU 2016-14, a new concept is introduced that attempts to provide financial statement readers with this information in the form of qualitative and quantitative note disclosures.
The qualitative disclosure requirement requires nonprofits to explain how liquid resources are managed to meet cash needs for general expenditures within one year of the balance sheet date. The board of directors should approve a formal policy that addresses liquidity needs, as this policy has to be disclosed in the financial statements annually. Things to consider include strategies for addressing organization-wide risks (e.g. undesignating net assets and access to line of credit or long-term financing), establishing liquidity reserves, and the time horizon used to manage liquidity (e.g. 30, 60, or 90 days).
The quantitative disclosure requirement communicates the availability of financial assets at the balance sheet date to meet cash needs for general expenditures over the next year. Management will have to identify all financial assets and any limitations on their use in the next 12 months. This may include external limits (e.g. by donors or granting agencies) or internal limits (e.g. assets designated as a reserve for future building needs). All financial liabilities will also need to be identified. A reader will then be able to compare those liabilities with the available assets to gain an understanding of future liquidity needs. Although no specific format is required for this disclosure, it should reconcile to the balance sheet.
So, what does this look like? Here is a simple example:
The Board periodically designates a portion of any operating surplus to its liquidity reserve. As of December 31, 2018, the liquidity reserve was $1,300. This is a board-designated fund with the objective of setting funds aside to be drawn upon in the event of financial distress or an immediate liquidity need resulting from events outside the typical life cycle of converting financial assets to cash or settling financial liabilities. In the event of an unanticipated liquidity need, the organization could also draw upon $10,000 of available lines of credit or the quasi-endowment fund.
Financial assets at December 31, 2018 $229,200
Contractual or donor-imposed restrictions making
financial assets unavailable for general expenditure (192,413)
Quasi-endowment fund, primarily for long-term investing (34,628)
Amounts set aside for liquidity reserve (1,300)
Financial assets available within one year to meet cash
needs for general expenditures within one year $ 859
This example clarifies that although the balance sheet shows just over $229,000 in total assets, only $859 of those assets are available for operational needs within the next year. In addition, the reader is now aware that if liquidity becomes an issue, the organization will utilize line of credit borrowings or un-designate quasi-endowment dollars in order to make ends meet.
This is one very simple example to start the thought process of what may be relevant to your organization. Working through these disclosure requirements will be a useful tool for management and the board to assist them in better understanding the organization’s financial picture. It may also highlight instances in which going concern issues need to be addressed.
The above provisions need to be adopted for your 12/31/18 financial statements. The nonprofit experts at Ketel Thorstenson, LLP are here to help you navigate the intricacies of ASU 2016-14. Call us at 605-342-5630 to set up a meeting now.