Tracking and accounting provide the means for nonprofits to benchmark the financial health of their organizations. Donors and grant-makers are equally interested in better understanding nonprofits’ financial reports so they can make wise decisions about which nonprofits they choose to support.
In addition, nonprofits have to demonstrate to the government that they continue to operate for charitable purposes. Nonprofits have standardized rules to follow on how they report financial information to the government and their donors.
Up until recently, there haven’t been any changes in long-standing rules about how nonprofits must present financial reports, but all that is changing. Nonprofit board directors may need some training to better understand their responsibilities under the new rules. This is a good time to evaluate the benefits of board management software solutions and how they can help board directors move their organizations forward.
What Is GAAP?: GAAP for Nonprofits
GAAP is an acronym for Generally Accepted Accounting Principles, which is the preferred manner of accounting for corporations, nonprofits and all other organizations. GAAP provides the definitions of accounting concepts and principles and sets forth rules for various industries. The main purpose of GAAP is to ensure that organizations present financial information in a transparent way and also in a way that adheres to industry-specific rules.
Three separate entities work together to set the rules for GAAP:
- The Financial Accounting Standards Board (FASB)
- The American Institute of Certified Public Accounts (AICPA)
- The Securities and Exchange Commission (SEC)
The GAAP rules state that FASB pronouncements are the highest tier of financial reporting guidance and take precedence over AICPA pronouncements.
GAAP applies to public companies and nonprofit organizations. Only certain pronouncements apply to nonprofit associations.
New Rules under FASB
The new rules are the first major changes to financial statement presentation standards since 1993. New rules take effect beginning with companies whose fiscal years began after December 2017.
The goals of the new rules include providing better information to donors, grant-makers, creditors and others who may read nonprofit financial statements. The new rules improve how nonprofits can demonstrate their worth and purpose to their constituents.
Nonprofits will find the new rules improve transparency and accountability with donors while reducing the costs associated with financial reporting.
All nonprofits are bound by the new FASB rules, including:
- private colleges and universities
- health care providers
- cultural institutions
- religious institutions
- trade associations
What Do the New Rules Do?
The new rules simplify and clarify the classes of net assets, clarify available assets, ensure consistency of financial reporting, and correct misrepresentations about cash flow statements and presentation options.
The first goal of the new FASB rules is to make clear how nonprofits keep track of restrictions placed by donors. The new rules limit nonprofits to two classes of net assets—those with donor restrictions and those without donor restrictions. Nonprofits will have to continue to track net assets and follow restrictions set by donors.
This rule replaces the prior rule of describing three classes of net assets, including unrestricted assets, temporarily restricted assets and permanently restricted assets. Nonprofits won’t have to distinguish between temporary and permanently restricted assets any longer. The hope is that financial statements will be clearer about the nature and type of donor restrictions, as well as the amounts.
The second goal of the new rules is to provide clarity around liquid resources. Under the new rules, nonprofits must provide quantitative and qualitative information that explains how they manage liquid resources to meet cash needs for general expenses within one year of the balance sheet date.
To meet the requirement for qualitative information, nonprofits will need to break down the current and noncurrent assets and liabilities on financial statements. To present quantitative information, nonprofits must disclose whether they have any limitations on financial assets because of the nature of the asset; external limits imposed by donors, laws or contracts; or internal limits imposed by governing boards. The goal is to ensure that the nonprofit shows any limitations placed on liquid assets that indicate decreased cash flow.
The third goal of the new rules is to make sure that financial reports on investment expenses and returns are consistent. Prior to the new rules, nonprofits had the option of reporting investment income net of related inside and outside investment expenses, and this is now a requirement. Nonprofits no longer have to disclose the amount of those netted investment expenses. The purpose of this goal is to remove the difficulty and associated costs with identifying embedded investment fees in the investment returns that some nonprofits use, such as mutual funds and hedge funds.
Nonprofit boards need to continue to make sure they’re aware of the amounts the organization pays for investment management fees. These rules will provide a consistent presentation for all nonprofits.
The final goal of the new rules is to alleviate misunderstandings about the statement of cash flows and related presentation options. The new rules will still allow nonprofits to choose to present their cash flows using direct or indirect methods. Nonprofits that choose the indirect method won’t have to disclose the indirect method in the notes. The purpose of this goal is to provide a more meaningful statement of cash flows and decrease the costs of preparing financial statements.
What Do the New Rules Essentially Mean for Nonprofits?
Under the new rules, much of the information will remain the same, but the look of financial statements will be significantly different than what they’ve been in the past. Board directors and staff will need to understand the differences caused by the new rules and be able to explain them to grant-makers.
The new rules may require some board directors to acquire training on the changes as they pertain to their organization’s financial statements. The organization’s auditor may be the best person to explain the impact of the new rules and guide the board in making the necessary changes.
The FASB plans to address a variety of additional issues that affect nonprofits at some future point, but there are no plans to do so in the very near future.