In 2016, the Financial Accounting Standards Board (FASB) updated its rules around lease accounting (ASC 842) and closed a diversity in practice in the previous standard. The major change is that organizations must now include lease assets and liabilities on their balance sheets. The upshot is that despite a recently granted extension that applies to private companies and nonprofits, the task of becoming compliant is urgent and challenging. Impacted nonprofits don’t have a moment to spare.
Under the previous standards, operating leases were off-balance sheet. That essentially allowed companies to omit certain lease assets and liabilities from their balance sheets, potentially skewing their debt-to-equity ratio. In 2016, the International Accounting Standards Board estimated that public companies using either the IFRS Standards or U.S. GAAP had around $3.3 trillion of lease commitments, 85 percent of which were not recorded on their balance sheets. This, of course, makes it difficult for shareholders (stakeholders), investors and lenders to get a true sense of an organization’s financial health. Under the previous standard, ASC 840, operating leases were only required to be disclosed in the footnotes of the financial statements. Under ASC 842, the only leases that may be omitted from financial statements are short-term leases with an original term of less than 12 months. ASC 842 increases transparency and comparability among organizations that enter into lease agreements and provided a clearer picture of an organization’s liabilities related to leasing obligations. ASC 842 also includes extensive disclosures intended to enable users of financial statements to understand the amount, timing, and judgment related to a reporting entity’s accounting for leases and the related cash flows as well as disclosure of both qualitative and quantitative information about leases.
But what it also does is implement a one-size-fits-all accounting standard that significantly increases the reporting burden on smaller and nonpublic companies, including nonprofits. Implementation will involve significant challenges and require major investments in time, money and other resources. Luckily at its October 16, 2019 meeting, FASB affirmed its decisions on two proposed Accounting Standards Updates (ASUs) – one of which extends the implementation deadline for the new standards on leases that are not yet effective for private companies and nonprofits to the first fiscal year after Dec. 15, 2020, instead of Dec. 15, 2019, as originally mandated.
This is good news for nonprofits, which now have an extra year to implement these changes. At the same time, it should also serve as a wake-up call, as many organizations weren’t even aware of the change and the task of becoming compliant. Even within this updated timeline, becoming compliant will be a significant lift.
Nonprofits face multiple significant implementation challenges such as:
- Identifying embedded leases in business arrangements
- The number of business arrangements that were previously not identified as leases may now be identified as meeting the definition of a lease or embedded lease
- Existing systems and processes may need to be modified or enhanced in order to provide information necessary to address the new reporting and disclosure requirements
- Multiple departments across the organization will be affected by this standard, including information technology, tax, legal, treasury, and financial planning and analysis, among others
- Ongoing efforts to remain compliant might be more significant than the initial implementation effort It’s clear that complying with ASC 842 is a time-consuming process. Organizations should develop an implementation timeline keeping several factors top of mind, including existing lease commitments, data governance maturity and cross-function coordination needs.
Nonprofits should also consider adopting the following best practices:
Solicit the involvement of the entire organizations: Although the implementation of ASC 842 is primarily the responsibility of the organization’s accounting department, successful implementation requires support from across the firm, especially when an organization has a large real estate portfolio or embedded leases. This may mean seeking assistance from IT, legal, or procurement departments. Soliciting executive sponsorship to champion implementation will also help to streamline the process.
Use technology to your advantage: Under the stress of deadlines, the compilation of lease terms and data can be daunting, especially within larger nonprofits where leases may exist across departments. For organizations that have developed a robust data governance program, or specific procedures to collect and manage enterprise data, implementation should be considerably easier. However, for the many organizations that have yet to build out these structures, there are off-the-shelf and purpose-built technology solutions that can help standardize and aggregate the information.
Keep an open line of communication: Organizations that maintain a large physical footprint have are impacted the most. They should factor in extra time for both implementation and keeping stakeholders informed. Unexpected roadblocks such as a delay in receiving necessary data from external sources should also be accounted for in the timeline. Benchmarking the organization’s progress on implementation against its timeline throughout the balance of the year is paramount in keeping on task and meeting goals.
The bottom line is that even with the extension it will take a concerted effort to become compliant in time. Nonprofits need to start planning now.
This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Winter 2019), authored by Lee Klumpp, CPA, CGMA, National Assurance Partner – Nonprofit & Government. Copyright © 2020 BDO USA, LLP. All rights reserved. www.bdo.com.
If you are in the non-profit or accounting space, you probably already know that the financial reporting requirements are about to change for non-profits. The question is, are you ready? When the Financial Accounting Standards Board (FASB) issued ASU 2016-14 they allowed about two years to prepare for the changes before requiring non-profits to adopt it. The time is upon us now to implement these changes so if you haven’t been paying attention, here is what you need to know.
First, this standard applies to non-profit organizations preparing financial statements under generally accepted accounting principles (GAAP), for years beginning with the 2018 calendar year or 2019 fiscal year. This includes compilations, reviews, and audits of non-profit financial statements under GAAP, but would not apply to financial statements prepared using any other financial reporting framework, such as cash basis. The underlying purpose for all of the changes in this standard is to make the financial statements more understandable to the public and to enable each organization to tell its story better.
Second, although there are many details within the financial statements that will be affected, the changes really boil down to 5 key items:
- Net asset classifications
- Liquidity disclosures
- Functional and natural expense classification
- Investment expenses, and
- Statement of cash flows presentation.
While that might seem like a lot, some organizations are already in compliance with the new standard in most of these areas and will require very little change. Let’s talk about the three biggest changes to tackle now.
Net asset classification is the most obvious change you will note when looking at financial statements under the new standards. You may be familiar with the term “restricted net assets” which has been used for a long time in the non-profit world and refers to funds that donors have given to an organization, but restricted for a certain purpose. In the past, we have had these net assets split into temporarily restricted (for things like a special project or a pledge to be paid next year) and permanently restricted (for an endowment where only the income on the gift may be spent), but these terms were confusing to a lot of people. The new terminology for both of these restricted classes will be “with donor restriction” to clarify that it is the donor, not the organization’s management or Board of Directors, who has the ability to restrict donations. Funds previously classified as unrestricted will now be classified as “without donor restriction.” This is mostly a change in terminology and presentation, and doesn’t really change the accounting for these funds.
The next biggest change is the requirement of a statement of functional expenses, which presents all of the expenses by line item (such as rent, salaries, travel) as well as across the organization’s programs and administrative costs, usually in a matrix format. In the past, this was only required for certain types of non-profit organizations and was optional for all others. Accordingly, many non-profits are already presenting this statement, so there will be very little change for those organizations, aside from providing a little bit more information in the footnotes. Organizations that are not currently presenting this statement will need to be able to gather information about their costs and what programs each cost benefits in order to allocate the various expenses accordingly.
Finally, there is now a requirement to present information about the organization’s liquidity. This is entirely new, and it is a great opportunity for the organization to tell its story better. The requirement is to provide both a numerical calculation of the assets that may be used to meet the organization’s operational needs within the next year, as well as a narrative to accompany the numbers. Grant organizations consider a variety of factors when deciding to which non-profits to make grants, and sometimes the financial statements don’t fully explain the situation. With this disclosure, organizations will be better able to explain why they are deserving and in need of grant funds.
Intimidating though these changes might seem, they are certainly manageable if you are prepared. If you haven’t started thinking about these changes yet, there is no time like the present to get started!
Several changes to the federal tax code were signed into law in December 2017. These changes, which affect both corporate and individual tax rates, went into effect at the start of the 2018 tax year. One specific change, an increase to the standard deduction, could have a major impact on non-profit organizations.
By raising the standard deduction, fewer Americans will need to itemize their tax returns. Those that do not itemize their return will no longer be able to write-off charitable donations. This has many non-profits concerned about the number of donations they will receive in 2018.
Fewer Itemized Returns
The new tax law nearly doubles the standard deduction for both individuals and couples filing jointly. This was meant to simplify tax returns by eliminating the need for tax deductions.
Currently, about one-third of American taxpayers itemize their return. Under the new tax law, only five percent are expected to itemize. This means that many people that regularly claim charitable donations on their return will no longer be able to do so. Without this incentive, many people will stop donating altogether, and the donations people do give will likely be lower. It is estimated that charitable giving might decline by as much as $13 billion a year. This level of change will have a significant impact on non-profit organizations.
Effects of the Tax Overhaul
It’s impossible to know the exact effect that changes to the federal tax code will have on charitable giving in 2018. We will have a much clearer idea once 2018 tax returns are filed, and organizations provide reports on the number of donations received throughout 2018.
Unfortunately, if charitable giving is reduced because of recent changes to the tax code, many organizations will not be able to provide the services the public has come to expect. Many smaller organizations might even be forced to halt their operations.
Some states are already trying to encourage people to continue to give. For example, Minnesota taxpayers may still subtract a portion of their charitable donations on their state income tax return.
Burdette Smith and Bish can help you make sense of changes to the federal tax code. Please contact us for a consultation.
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