The Financial Accounting Standards Board (FASB) recently released its first update to the financial reporting rules for nonprofits since 1993. The new Accounting Standards Update (ASU) No. 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities, will affect the financial statements of most nonprofits when it takes effect. So now is the time to get ready for the coming changes.

What are the new net asset classes?

The new standard consolidates the current net asset classes (unrestricted, temporarily restricted and permanently restricted) into net assets with donor restrictions and net assets without donor restrictions. It also requires additional disclosures related to board designations and donor-imposed restrictions, such as: 
The ASU changes the reporting of “underwater” endowments whose fair value is less than the original gift amount. It now requires the underwater portion to be classified as net assets with donor restrictions, and enhanced disclosures will be required. 
The new standard also generally eliminates the over-time method for reporting the expiration of restrictions on capital gifts used to purchase or build long-lived assets such as buildings. Unless the gift includes additional donor restrictions, you must use the placed-in-service approach to reclassify these gifts as net assets without donor restrictions in the year the asset is placed in service, rather than spreading out the expiration of the restrictions over the asset’s useful life. This could affect debt service ratios and other loan covenants.

How has liquidity and available resources reporting changed?

Under ASU 2016-14, your financial statements must include certain qualitative and quantitative disclosures of information to help the financial statement user evaluate your organization’s liquidity. The quantitative information — which will show the availability of your financial assets to meet cash needs for general expenses within the year following the balance sheet date — is now required in a more specific format. The newly mandated qualitative information will show how you plan to manage liquid available resources to meet cash needs for general expenses within a year of the balance sheet date.
The qualitative disclosure requirements might prove among the most challenging to implement because they call for a high degree of judgment. But the standard gives you a lot of flexibility and includes examples of disclosures (although you aren’t required to replicate the format used in the examples).

What about reporting your expenses and investment return?

The new standard requires you to classify expenses by both nature and function in one location (function was already required) and present an analysis of expenses by both nature and function. “Nature” refers to expense categories such as salaries and wages, rent and utilities. “Function” primarily means program services and supporting activities, such as management and general and fundraising. This information also is required on IRS Form 990, “Return of Organization Exempt From Income Tax,” so you shouldn’t have trouble collecting it. 
You must present investment income net of all related external expenses (expenses paid to third parties such as investment managers) and direct internal expenses. The new standard also eliminates the current requirement to disclose the components of net investment income.

How to present operating cash flows?

The FASB had previously proposed requiring nonprofits to use the direct method to present the net amount of operating cash flows. But the new standard lets you opt for either the direct or indirect method. If you opt for the direct method, you won’t need to include an indirect method reconciliation, as is currently required. 

What should you do next?

The FASB doesn’t expect ongoing compliance costs to be significant for most not-for-profits. Even your initial costs should be manageable, as changes to your financial reporting will require only a one-time reformatting. But it may take some time to familiarize stakeholders, such as the board of directors and management, with the requirements and changes to how information is presented. You might want to revise a recent set of financial statements according to the ASU and share them with your board and management teams to help them understand the changes to come. 

Effective date

The new standard takes effect for annual financial statements issued for fiscal years beginning after December 15, 2017, and for interim periods within fiscal years beginning after December 15, 2018. Early application is allowed.


The Financial Accounting Standards Board (FASB) has issued the first major changes to the accounting standards for nonprofits’ financial statement presentation in more than two decades. Accounting Standards Update (ASU) No. 2016-14, Not-for Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities, affects just about every nonprofit, including charities, foundations, private colleges and universities, nongovernmental health care providers, cultural institutions, religious organizations, and trade associations.

The new standard is intended to provide improved net asset classification requirements and information about nonprofits’ resources (and changes in those resources) to donors, grantors, creditors and other users of nonprofits’ financial statements. It changes the classification of net assets and the information presented in the financial statements and footnotes about an organization’s liquidity, financial performance and cash flows. As a result, stakeholders should find it easier to understand how nonprofits manage their funds.

Background on the ASU

Nonprofits’ financial statements currently are prepared according to guidance published in 1993 as Statement of Financial Accounting Standards No. 117, Financial Statements of Not-for-Profit Organizations (incorporated into Topic 958 in the FASB Accounting Standards Codification). The FASB believes that this reporting model remains sound, but stakeholders have expressed concerns regarding several areas, including:

In response, the FASB issued an Exposure Draft, Presentation of Financial Statements of Not-for-Profit Entities, in April 2015. After receiving an unusual amount of feedback, much of it negative, the FASB decided to split its deliberations into two phases.

The issuance of ASU No. 2016-14 represents the conclusion of Phase 1. Phase 2 will focus on certain issues considered more challenging, such as aligning the presentation of measures of operations between the statements of activities and cash flows, as well as those that might depend on a related FASB project addressing financial performance reporting by for-profit entities. The FASB hasn’t yet announced a timeline for the second phase.

New net asset classifications

One of the more notable changes in the new standard is the replacement of the existing three net asset classes (unrestricted, temporarily restricted and permanently restricted) with two new classes (net assets with donor restrictions and net assets without donor restrictions). The FASB expects this to reduce the complexity of financial reporting for nonprofits, while increasing the understandability for stakeholders. 

The new approach recognizes changes in the law that now allow organizations to spend from a permanently restricted endowment even if its fair value has fallen below the original endowed gift amount. Such “underwater” endowments will now be classified as net assets with donor restrictions, rather than the current presentation as unrestricted net assets. The guidance also requires expanded disclosures regarding underwater endowments.

In addition, the new standard eliminates the current “over-time” method for handling the expiration of restrictions on gifts used to purchase or build long-lived assets such as buildings. Nonprofits must use the placed-in-service approach (in the absence of explicit donor stipulations to the contrary). In other words, nonprofits must reclassify these gifts as net assets without donor restrictions when the asset is placed in service, rather than over the asset’s useful life. As a result, organizations won’t be able to match the depreciation expense with the release of these restricted net assets unless stipulated by the donor.

Information about liquidity and availability of resources

The new standard includes specific requirements to help financial statement users better assess a nonprofit’s available financial resources. Organizations must provide:

An asset’s availability may be affected by its nature; external limits imposed by donors, grantors, laws and contracts with others; and internal limits imposed by board decisions. Disclosure is also required for board designations or other internal limits on the use of net assets without donor restriction.

Information about expenses 

To provide a clearer picture of a nonprofit’s spending, the new standard requires reporting of expenses by both function (which is already required) and nature in one location. This presentation, showing how the nature of expenses (for example, salaries and wages, employee benefits, supplies, and rent) relates to the functions (program services and supporting activities), can be presented on a separate statement, on the statement of activities or in the footnotes. In addition, the standard calls for enhanced disclosures regarding specific methods used to allocate costs among program and support functions. 

This information will help financial statement users assess the degree to which expenses are fixed or discretionary, how the related resources are allocated, and the costs of the services provided.

Information about investment returns

Nonprofits will now be required to net all external and direct internal investment expenses against the investment return presented on the statement of activities. Financial statement users will be better able to compare investment returns among different nonprofits, regardless of whether investments are managed externally (for example, by an outside investment manager who charges management fees) or internally (by staff).

The new standard also eliminates the current required disclosure of those netted expenses. This should eliminate the difficulty some nonprofits had with identifying management fees embedded in investment returns.

Presentation of operating cash flows

One of the more controversial components of the FASB’s Exposure Draft was its requirement that organizations use the “direct method,” not the “indirect method,” to present net cash from operations on the statement of cash flows. The two methods produce the same results, but the direct method provides more understandable information to financial statement users.

The final version of the new standard allows nonprofits to use either method. But, should an organization opt for the direct method, it will no longer need to include an indirect method reconciliation. The FASB hopes this change, which should reduce the costs of the direct method, will encourage more nonprofits to use it.


The new standard takes effect for annual financial statements issued for fiscal years beginning after December 15, 2017, and for interim periods within fiscal years beginning after December 15, 2018. Early application is allowed. 

Nonprofits should resist the temptation to delay preparations even though they may also be dealing with the implementation of the new accounting standards for lease accounting and revenue recognition. If you have questions about how the new standard will affect your nonprofit, please contact us.


The Financial Accounting Standards Board (FASB) has issued its long-awaited update revising the proper treatment of leases under U.S. Generally Accepted Accounting Principles (GAAP). Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842), will affect entities that lease real estate, vehicles, equipment, and other assets. The standard requires these entities to recognize most leases on their balance sheets, potentially inflating their reported assets and liabilities. 


According to the FASB, most lease obligations today aren’t recognized on the balance sheet, and transactions often are structured to achieve off-balance-sheet treatment. A 2005 U.S. Securities and Exchange Commission (SEC) report estimated that SEC registrant companies held approximately $1.25 trillion in off-balance-sheet lease obligations. As a result of these obligations being left off balance sheets, users of financial statements can’t easily compare companies that own their productive assets with those that lease their productive assets. 
To address this issue, the FASB launched a joint lease accounting project with the International Accounting Standards Board (IASB) in 2006. The joint project was unsuccessful, however. The boards couldn’t agree on how to report leases on the income statement and decided to issue separate standards. The IASB issued its standard (International Financial Reporting Standards 16) in January, and now the FASB has released its own standard.

Impacts on lessees

Currently, entities that lease assets (lessees) account for a lease based on its classification as either a capital (or finance) lease or an operating lease. Lessees recognize capital leases (for example, a lease of equipment for nearly all of its useful life) as assets and liabilities on their balance sheets. But they don’t recognize operating leases (for example, a lease of office or retail space for 10 years) on the balance sheet. Such leases appear in financial statements only as a rent expense and disclosure item.
The new standard will require lessees to recognize on their balance sheets assets and liabilities for all leases with terms of more than 12 months, regardless of their classification. Lessees will report a right-to-use asset and a corresponding liability for the obligation to pay rent, discounted to its present value. The discount rate is the rate implicit in the lease or the lessee’s incremental borrowing rate.
The recognition, measurement and presentation of expenses and cash flows arising from a lease by a lessee will continue to depend primarily on its classification as a capital or operating lease:
The standard requires additional disclosures to help users of financial statements better understand the amount, timing and uncertainty of cash flows related to leases. Lessees will disclose qualitative and quantitative requirements, including information about variable lease payments and options to renew and terminate leases.
These changes may have additional repercussions for lessees. Entities with significant leases may incur costs to educate their employees on the proper application of the new requirements and financial statement users on the impact of the requirements. They’ll need to develop supplemental processes and controls to collect the necessary lease information. 
The reporting changes could affect financial ratios and, in turn, have implications for debt covenants. They might also lead to higher borrowing costs for lessees whose balance sheets look weaker with their operating leases included. Entities could consider buying instead of leasing, because they’ll end up with similar leverage on their balance sheets from either transaction.

Impacts on lessors

Entities that own leased assets (lessors) will see little change to their accounting from current GAAP. The new standard does, however, include some “targeted improvements” intended to align lessor accounting with both the lessee accounting model and the updated revenue recognition guidance published in 2014 (ASU No. 2014-09, Revenue from Contracts with Customers)
For example, lessors may be required to recognize some lease payments received as liabilities in cases where the collectability of the lease payments is uncertain. Users of financial statements will have more information about lessors’ leasing activities and exposure to credit and asset risk related to leasing.
Lessors also could see the changes to lease accounting play out in lease negotiations. Existing lessees may seek to modify their leases to reduce the impact of the new standard on their balance sheets by, for example, securing lease terms of one year or less. 

Combined contracts

Contracts sometimes include both lease and service contract components (for example, maintenance services). ASU 2016-02 continues the requirement that entities separate the lease components from the nonlease components, and it provides additional guidance on how to do so. 
The consideration in the contract is allocated to the lease and nonlease components on a relative standalone basis for lessees. For lessors, it’s done according to the allocation guidance in the revenue recognition standard. Consideration attributed to nonlease components isn’t a lease payment and, therefore, is excluded from the measurement of lease assets or liabilities.

Interplay with international standards

Many aspects of ASU 2016-02 are converged with IFRS 16, including the definition of a lease and initial measurement of lease liabilities. But there are some significant differences.
For example, the IASB opted for a single-classification model that requires lessees to account for all leases as capital leases. That means leases classified as operating leases will be accounted for differently under GAAP vs. IFRS, with different effects on the statement of comprehensive income and the statement of cash flows.

Effective dates and transition

Public companies are required to adopt the new standard for interim and annual periods beginning after December 15, 2018. Nonpublic entities following GAAP will need to comply for annual periods beginning after December 15, 2019, and for interim periods beginning a year later. Early adoption is permitted.
The standard requires entities to take a “modified retrospective transition approach,” which includes several optional “practical expedients” entities can apply. An entity that elects to apply the practical expedients will, in effect, continue to account for leases that begin before the effective date in accordance with previous GAAP unless the lease is modified. 
The exception is that lessees are required to recognize a right-of-use asset and a lease liability for all operating leases at each reporting date based on the present value of the remaining minimum rental payments that were tracked and disclosed under previous GAAP. 

Act soon if you have extensive lease portfolios

Because of this standard’s long gestation period, many entities have taken a wait-and-see approach to tackling the lease accounting changes. But now that the new standard has been released, entities would be wise to begin their preparations if they have extensive lease portfolios.