Currently, nonprofit financial statements present an organization’s net assets in three broad categories: unrestricted, temporarily restricted and permanently restricted. In the past, some people looking at nonprofit financials have misunderstood the meaning of these three categories, which has led to misconceptions about an organization’s overall financial position.
However, a new accounting standard will help make nonprofit financial statements a little easier to understand, while providing critical insight into an organization’s liquidity.
Understanding unrestricted net assets
The term “unrestricted” has caused a lot of confusion among those not well-versed in the nuances of nonprofit GAAP.
“Unrestricted” does not mean without any restrictions whatsoever. It simply means without donor restrictions.
Net assets may be classified as unrestricted, but still be subject to restrictions from government funding sources, regulators, creditors, or others.
Because of misconceptions about the term “unrestricted”, FASB has posited that some financial statement users may have misinterpreted a nonprofit’s balance sheet in evaluating the organization’s liquidity.
How new nonprofit liquidity disclosure requirements make things more transparent …
ASU 2016-14 attempts to address these concerns in a couple of ways:
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A change in terminology in the basic financial statements
“Unrestricted net assets” will be replaced by “net assets without donor restrictions”, while “temporarily” and “permanently restricted net assets” will be combined into “net assets with donor restrictions”.
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The footnotes will have new required disclosures about the organization’s liquidity and how it manages liquidity
Some people think of the footnotes as the fine print to the financial statements; a series of boilerplate disclosures drafted by the auditor and pretty consistent from organization to organization.
However, the new nonprofit liquidity disclosure requirements will differ from many of the existing boilerplate disclosures in that they will require much more participation from management. Think of management’s discussion and analysis (MD&A) included in the financial statements of large, publicly traded companies.
Going forward, any nonprofit that issues annual audited, reviewed, or CPA-compiled financial statements will essentially be required to publish a form of MD&A relating to the organization’s liquidity.
Key components of the new nonprofit liquidity disclosure requirements
There are both quantitative and qualitative components of the new nonprofit liquidity disclosure requirements:
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Qualitative
This will include a discussion of:
- “how the nonprofit manages its liquid resources available to meet cash needs for general expenditures within one year of the balance sheet date”, and
- “the availability of an NFP’s financial assets at the balance sheet date to meet cash needs for general expenditures within one year of the balance sheet date.”
Management’s discussion here can include its use of minimum cash reserve levels, certificates of deposit, money market funds, or other short-term investments.
It can also include anticipated distributions from the organization’s endowment(s), if applicable, as well as the availability of a line of credit to meet cash flow needs.
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Quantitative
This is a quantitative presentation of the second qualitative component described above, which can be included within the existing balance sheet or in the notes to the financial statements.
We anticipate that organizations will typically choose the latter in order to avoid muddying the balance sheet with even more data and subtotals than it already includes.
The quantitative presentation will be similar to the current assets section of the balance sheet, with some exceptions:
- It will only include financial assets (excluding things like inventory and prepaid expenses).
- It will also exclude cash and current receivables that may be presented as current assets on the balance sheet, but that are not available for the nonprofit’s use on general expenditures, such as grants that are restricted for a particular program or project.
However, it can get tricky determining if something should be included in “financial assets available for general expenditures within one year of the balance sheet date”.
Available vs. not available does not mirror restricted net assets vs. unrestricted net assets, nor does it mirror current vs. non-current assets.
For example, a nonprofit’s board may have designated a portion of its cash for a specific project. That “designated” cash might appear in the current asset section of the balance sheet but be excluded from the new quantitative disclosure requirement, since it is not available for general expenditures.
Likewise, a nonprofit organization may have on its balance sheet receivables for donor-restricted grants. These grants may appear under the “with donor restriction” net asset classification.
However, if they are loosely restricted (e.g. restricted only by time or for broad programmatic support), they may still be included in the new quantitative liquidity analysis, which will look something like the following:
Cash $980,085
Accounts receivable 242,052
Pledges receivable 78,838
Investments available for general operations 209,584
Distribution from permanent endowment in accordance with organization’s spending policy 50,000
Total $1,560,559
However, there is no one required format for the quantitative presentation. As an alternative to the above, an organization could also give a presentation that starts out with total financial assets from the balance sheet and then deducts resources that are not currently available.
For further guidance on the new liquidity disclosure requirements, we recommend that you refer to the text of ASU 2016-14. Developing the disclosures should be a collaborative process between management and the organization’s accountants. Also, while your independent auditor cannot draft the disclosures for you, they can serve as an invaluable resource by providing examples that you can use as a starting point.
