Miscellaneous Provisions of 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, “New Presentation Rules for Donor Restrictions,” we provided information on the main provision of ASU 2016-14 – moving from three classes of net assets (unrestricted, temporary, and permanent) to two classes of net assets (with and without donor restrictions). Several other miscellaneous provisions may affect your organization, and this article explores those provisions.
Under current accounting rules, nonprofit organizations had the option to net investment fees against investment income (in which case, disclosure of the expense amount was required), or to present the fees as an expense. Under ASU 2016-14, investment return must be presented on a net basis. In other words, all external and direct internal investment management and custodial expenses must be netted against the income to show a net investment return. No separate disclosure of the expense is required, and the individual components of the investment return (e.g. interest, gains, etc.) are not required to be disclosed. The statement of activities will now show one line item labeled “investment return.” However, don’t forget these details are still required to be presented separately in Form 990, so you will need to continue tracking each component.
The concept of “direct internal investment expenses” is likely unfamiliar to most nonprofit organizations. The formal definition of this is “any internal expense that includes the direct conduct or supervision of the strategic and tactical activities involved in generating investment return.” In laymen’s terms, this:
- Includes salaries, benefits, travel, and other costs associated with staff responsible for the development and execution of investment strategy, including supervising, selecting, and monitoring external managers.
- Excludes costs not associated with generating investment return, such as administrative management, contracts, and pooled-fund administration (e.g. soliciting funds to add to an endowment are not directly associated with increasing investment return).
This portion of ASU 2016-14 is not applicable to programmatic investments. For example, if your organization makes loans to low-income individuals to promote home ownership, the expenses related to granting and monitoring these investments are not allowed to be netted against the interest income earned on the loans.
Organizations will need to ensure their accounting processes identify all external and direct investment management and custodial expenses so such costs can be reported in a separate general ledger account (or at least identified for reclassification at a later date). Some allocation methods may need to be implemented (e.g. CFO salary may include overseeing the investment portfolio). Management should be aware this change will also impact functional expense allocations – these expenses were likely allocated to management or fundraising costs in the past, and will now be excluded from expense totals.
Statement of Cash Flows
Most nonprofit organizations utilize the indirect method of reporting when presenting a statement of cash flows (i.e. start with change in net assets and adjust for changes in assets and liabilties). However, organizations have always had the option to utilize the direct method of reporting (i.e. show actual cash paid and received from various activities). Under legacy accounting rules, the direct method of reporting also required a reconciliation between the two methods. ASU 2016-14 removes this reconciliation requirement in the hopes of encouraging more organizations to consider utilizing the direct method of presentation. Management should consider the two methods and determine which presentation they find more useful – many financial statement users have argued that the direct method is intuitively easier for them to understand.
When nonprofit organizations receive contributions restricted for the purchase or acquisition of fixed assets, two options exist under current accounting rules as to when such restrictions are considered released:
- Placed-in-service approach: the restriction expires at the time the asset is placed in service
- Over time approach: the restriction is released over the asset’s useful life (e.g. release 1/5 of the contribution each year to match the 5-year useful life of the asset acquired)
ASU 2016-14 removes the second option above from the accounting guidance (unless a donor explicitly requires this method to be used). Most organizations have historically used the first option due to its simplicity, so it is not expected this change will affect many nonprofits.
As the above provisions are adopted for your 12/31/18 financial statements, remember that if comparative financial statements are being presented, they must be restated to conform to the new accounting rules.
Watch for future articles on additional provisions of this new standard that will apply to your organization. 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.