Revisiting Not-for-Profit Functional Expenses as part of the Implementation of ASU 2016-14
Accounting Standards Update (ASU) 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities marked a significant change in the way nonprofits report on their results of operations. The ASU is effective for annual financial statements issued for fiscal years beginning after December 15, 2017, thus nonprofits with calendar year-ends are currently implementing the provisions in their financial statement reporting for the first time. Having successfully assisted clients in this process, I wanted to share some insight in an oft-overlooked area of the new pronouncement.
One of the new requirements is that all organizations now must present an analysis of expenses by both nature and function in the financial statements. Previously, only voluntary health and welfare organizations had this requirement and satisfied it via the inclusion of a schedule of functional expenses. Now, this information is required for all and the organization can decide whether to present in the statement of activities, as a separate statement of functional expenses that is part of the main financial statements, or as part of the footnotes.
This is an opportunity for all Not-for-Profit organizations, including those already presenting a statement of functional expenses, to determine what is the most beneficial and efficient way to satisfy this requirement going forward. For many organizations, it is clear that the continuation of the use of a statement of functional expenses or the inclusion of one will be the choice made. However, some thought should be given to what presentation is most efficient to be generated internally and, most importantly, would be most useful for the users of the financial statements.
Preparing the Information
As part of the preparation of this information, Not-for-Profit Entities are examining their current cost allocation methodology, as well as what components—both program and natural expense classifications—they want to include. A recurring theme is that our clients tend to include too much detail in the financial statements relevant to this analysis. We recommend a straight-forward approach that will prevent the presentation from becoming overly complex and unwieldy. We encourage our clients to focus on the information useful to the reader of the financial statements in understanding the costs of the activities of the entity and to decide on which natural classification groupings are most important and relevant. Too much detail can be overwhelming. While there is no magic number for natural expense line items to present, we’d recommend somewhere from 9-15 line items as typically reasonable to provide the most important information to financial statement users.
Revisit Allocation Methodologies
In addition to tweaking presentation, the adoption of the new standard is a good opportunity for all organizations to revisit their allocation methodologies and ensure that they are in accordance with the new standard. The ASU changes some examples of what constitutes management and general activities, such as adding employee benefits management and oversight (human resources) to the list. Not-for-Profit entities should look at their internal policies to determine how these costs have been traditionally treated and, if allocated, adjust prior year numbers for the financial statements to remain comparable. Another required change is that organizations should also ensure that all investment related expenses no longer appear in the expense presentation and are netted with investment returns. Note that all expenses, with the exception of external and direct internal investment expenses, should be reported by their natural classification in the analysis of expenses by nature and function.
Once these allocations are reviewed by the entity, it should update its policies and develop the new required footnote disclosure that provides a description of the methods used to allocate costs among program and support functions.
If you would like more information, please contact Michael Barloewen at email@example.com or 844.4WINDES (844.494.6337).