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Non-profit Accounting

UpdateSummer 2019

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Bradford “Brad” C. Hatchett, CPA, CVA

Partner

GranthamPoole PLLC

Ridgeland, MS

bhatchett@granthampoole.com

(601) 499-2432

Presenter

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• Gain awareness of new accounting requirements affecting non-profit organizations

• Gain understanding of the impact of new accounting requirements on non-profit organizations

• Gain understanding of the implementation challenges associated with new accounting requirements

• Gain awareness of resources available to assist you in implementation

Learning Objectives

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• Presentation of Financial Statements of Not-for-profit Entities (ASU 2016-14)

• Accounting for Non-profit Grants and Contracts (ASU 2018-08)

• Accounting for Leases (ASU 2016-02)

• General Accounting and Auditing Developments

Workshop Topics

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Presentation of Financial Statements for Not-for-profit EntitiesOverview of Accounting Standards Update (ASU) 2016-14

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• Effective for years beginning after December 31, 2017• Calendar year-end 2018

• Fiscal year-end 2019 (i.e., June 30, 2019)

• Applies to ALL not-for-profit entities (NFP)

• Objective is to improve financial reporting for NFPs• Update (not overhaul) current model

• Improve net asset classification

• Improve disclosures in financial statements

• Better enable NFPs to tell their financial story

Background & Effective Date

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Key Areas of Change

Net Asset

Classes

Liquidity &

Availability

Expense

Reporting

Investment

Return

Statement of

Cash Flows

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Old Standards

• Net assets classified in 3 groups: • Unrestricted

• Temporarily Restricted

• Permanently Restricted

• Unrestricted – net assets without any donor-imposed restrictions

• Temporarily Restricted – net assets with donor-imposed imposed restrictions as to time or purpose

• Permanently Restricted – net assets with donor-imposed restrictions that prohibit the use of the net assets (i.e., endowments)

• Board-designated net assets (those that are restricted by board action) are considered to be unrestricted.

Net Asset Reporting

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New Standard

• Groupings consolidated down to TWO:• Without Donor Restrictions

• With Donor Restrictions

• Without Donor Restrictions – net assets that do not contain any donor-imposed restrictions as to use.

• With Donor Restrictions – net assets subject to donor-imposed restrictions that are temporary in nature (i.e., passage of time, occurrence of event) or perpetual in nature (i.e., endowment)

• Previous “Temporary” and “Permanent” have been combined

Net Asset Reporting (Continued)

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Old Standards

• Two methods for recognizing expiration of donor-imposed restrictions on gifts of long-lived assets (or funds to acquire or construct)

1. At date of donation, time of acquisition, or completion of construction

2. Over the estimated useful live of the donated, acquired, or constructed asset

New Standard

• Placed-in-service approach is required

• Restricted net assets associated with assets placed in service prior to adoption must be reclassified to unrestricted upon implementation

Net Asset Reporting (Continued)

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Net Asset Disclosures – Restrictions

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Net Asset Disclosures – Restrictions (Continued)

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Net Asset Disclosures – Acct. Policies (Continued)

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Net Asset Disclosures – Endowment (Continued)

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• Requires new disclosures regarding NFP’s:• Liquidity

• Availability of Financial Assets

• NFP must provide (disclose):• Qualitative information on how NFP manages liquid resources and liquidity risk

• Quantitative information on availability of financial assets to meet cash needs for general expenditures within one year

• Require analysis that is not routine for most NFPs

Liquidity & Availability of Financial Assets

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Liquidity & Availability Disclosures (Ex. 1)

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Liquidity & Availability Disclosures (Ex. 2)

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• Most NFPs present expenses by broad function (i.e., Program, Admin or Support, Fundraising, etc.)

• Functional expense statement previously required only for health and welfare organizations

• Inconsistencies lead to confusion with NFP financial statement users

Expense Reporting

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• Now all NFPs required to present analysis of expenses by function and nature in one location

• Can be presented:• In footnotes

• On face of statement of activities

• In a separate statement of function expenses

• Purpose: disaggregation of functional expense classifications by their natural expense classifications

• Separate functional expense statement usually easiest

• Must disclose method of allocating costs across functions

Expense Reporting (Continued)

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• NFP investment expense reporting is not uniform:• Some net against investment income

• Some show as separate expense

• Some have hybrid reporting (external expense net of income, internal expense separate)

• New standards provide uniformity

• Investment expenses must be netted against investment return

• Expenses include EXTERNAL and direct INTERNAL

• No longer present investment expenses “gross” with other expenses

Investment Return

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• Two methods of presenting cash flows:• Indirect Method (more common)

• Direct Method

• Indirect starts with change in net assets and reconciles to operating cash flow

• Direct presents operating inflows and outflows with separate reconciliation of change in net assets to operating income

• Still have option to use INDIRECT or DIRECT method

• If DIRECT, no longer required to show operating cash flow reconciliation

• Other initially proposed changes were deferred:• Reclassifications between type of activity (i.e., operating, investing, financing)

• Alignment of Cash Flow Statement with Statement of Activities

Statement of Cash Flows

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• Already effective for December and June year-end organizations

• Requires RETROSPECTIVE presentation if you show comparative financial statements

• Disclosures for liquidity & availability of financial resources do not have to be made for prior comparative periods

Implementation Pointers

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• Schedule of Functional Expenses for NFPs that haven’t had this before

• Elimination of time-implied restrictions option

• Drafting policy language for liquidity management

• Determining resources available to meet obligations

• Disclosure of net assets with donor restrictions

Implementation Challenges

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Questions?

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Accounting for Nonprofit Grants and ContractsOverview of Accounting Standards Update (ASU) 2018-08

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• Applies to all entities (businesses and NFPs) that receive or make contributions (unless excepted)

• Applies to both contributions received by recipient and made by resource provider

• Terminology used for revenue doesn’t govern whether an agreement is within scope

• Effective dates:• Annual periods beginning after 12/15/18 (public business and NFP with public debt)

• Annual periods beginning after 12/15/19 (all other entities)

Background & Effective Date

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• Revenue can be either a contribution or an exchange

• Contributions and exchanges fall under two different sets of accounting standards

• Confusion over how to distinguish these has led to diversity in practice

• ASU Intended to assist in distinguishing contributions from exchanges

• Provides 2 things:• Framework for determining if a transaction is an exchange or a contribution

• Guidance to assist in determining if a contribution is conditional or unconditional

Purpose

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Exchanges:

• Exchange transactions are a form of reciprocal transaction

• Both parties give and receivesomething of economic value

Contributions:

• Contributions are non-reciprocaltransactions

• Resource provider doesn’t receive or expect to receive economic value in return for donation

Exchanges & Contributions – What’s the Difference?

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• Primarily in area of grant and contract accounting (particularly government grants)

• Some NFPs treated all revenues from governments as exchanges

• Some NFPs treated revenues from governments as contributions to support their overall mission, conditioned only upon continuing to incur expenses

Diversity in Practice

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Exchange or Contribution? – How to Decide

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Commensurate Value Received by Resource

Provider?

ContributionExchange

Transaction

Yes No

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Considerations:

• Look only at value directly transferred to resource provider

• Positive sentiments from acting as a donor are not commensurate value

• Intent to exchange resources for goods/services of equal value is an exchange

• Resource provider has discretion to determine amount transferred indicates contribution

• Penalties limited to return of unspent amounts for failure comply with agreement indicate contribution

Exchange or Contribution? – How to Decide (Cont.)

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Exchange or Contribution? – How to Decide (Cont.)

Benefit Received by

Public

Mission of Resource Provider

OR

Commensurate Value Received

by Resource Provider

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• Contributions can be conditional or unconditional

• Recipient must determine which type

• Conditions to be conditional:• One or more barriers exist that must be overcome before recipient entitled to assets

• Right of return to the contributor, or a right of release of the contributor

• Terminology in agreement not most important

• Intent is what matters:• Conditional – Clear that asset received only if a barrier is overcome

• Unconditional – no indication of a barrier

It’s a Contribution – What Now?

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• Must determine if agreement contains a barrier

• Indicators to consider:• Agreement contains measurable performance-related barrier

• Recipient has limited discretion on conducting an activity

• Agreement includes stipulations related to purpose of agreement

• Focus on the following when evaluating:• The stipulations relate to the purpose of the agreement

• The transfer of assets is linked to meeting stipulations

Barriers and Indicators

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• Probability or likelihood was a consideration

• If it was remote, no recognition

• Likelihood no longer consideration

• Barrier must be overcome

• Evaluate based on facts and circumstances

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What Has Changed?

Remote Barrier

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Conditions

• Dictate what and entity must do or achieve to recognize the grant or contribution

• Govern recognition of revenue

Restrictions

• Stipulate how or when the resources must be used

• Govern classification of revenue and net assets

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Condition or Restriction?

Conditions are not the same as Restrictions…

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Facts

• Foundation gives grant to NFP

• $400k to provide career training to disabled veterans

• Grant requires NFP to train 8k veterans each year

• Foundation specifies will only give NFP $100k per quarter if it serves 2k veterans in that quarter

Solution

• Grant should be conditional

• Agreement contains right of release

• NFP must achieve specified service level per quarter

• This is a performance-related barrier

• Revenue recognized each quarter as barrier is overcome

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Measurable Performance-related Barrier (Ex.)

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Facts

• NFP has research program

• NFP receives federal grant for research

• Terms require NFP must incur certain qualifying costs in accordance with OMB rules

• Grant paid on cost-reimbursement Basis by NFP initiating drawdowns

• Any unused assets are forfeited

• Unallowed costs must be refunded

Solution

• Grant should be conditional

• Grant limits discretion of NFP because of requirements on how money can be spent

• Grant includes release from promisors obligation for unused assets

• Requirement for qualifying expenses is a barrier to entitlement

• Revenue recognized during grant period when barriers have been overcome

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Limited Discretion on Conducting an Activity (Ex.)

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• Arrangement with barrier only conditional if contains:• Right of return

• Right of release

• Barrier narrower than recipients mission, but no right of return/release:• Not conditional

• Unconditional with donor-imposed restriction

• Caution: Conditional must contain RoR; However, RoR not always Conditional

Right of Return or Release

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Facts

• NFP performs research on diseases and allergies

• Receives grant to perform research on gluten-related allergies during next year

• Grant includes right of return

• NPF must report to foundation at end of grant re: how spent

Solution

• Grant is unconditional

• Grant purpose narrower than NFP mission

• No barriers that must be overcome before entitled to assets

• Reporting requirement is administrative and not tied to purpose of agreemement

• Includes right of return, but not conditional

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Right of Return or Release (Ex.)

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Questions?

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Accounting for LeasesOverview of Accounting Standards Update (ASU) 2016-02

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• Applies to all entities

• Perceived confusion because obligations under operating leases don’t appear on balance sheet

• Believed it will provide more transparency as to obligations under leases

• Originally effective for non-public entities in years beginning after 12/15/19

• Mid-July, FASB proposed to delay implementation for another year

• Proposed new effective date will be years beginning after 12/15/2020

Background & Effective Date

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• Core principle: Lessee should recognize the assets and liabilities that arise from leases

• Liability – obligation to make lease payments

• Asset – the right to use the underlying asset for the lease term

• All leases require asset and liability recognition

• Leases are of two types:• Operating

• Financing (previously capital)

• Prior guidance only required asset & liability recognition capital leases

Key Provisions

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Lease Types – How to Distinguish

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Lease Transfers ownership of asset?

Option to purchase asset that is reasonably certain of exercise?

Lease covers “major part” of assets useful economic life?

Lease consideration “substantially all” of assets fair value?

Lease conveys right to use asset so specialized it has no alternative use to lessor at

end of lease?

Fin

anci

ng L

ease

Operating Lease

Y

Y

Y

Y

Y

N

N

N

N

N

1

2

3

4

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• Automatic transfer of ownership gives lessee control of asset

• Automatic transfer of ownership makes lease akin to sale

• Indicators of automatic transfer:• Lease specifies automatic transfer at lease termination

• Requirement for lessee to pay nominal fee to receive asset at lease termination

• Provision allowing, but not requiring, payment to transfer asset does not constitute automatic transfer (considered an option)

Transfer of Ownership

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• Option to purchase gives lessee right to purchase asset at lease termination

• Option price can be nominal or significant

• Options that are reasonably certain of exercise are akin to automatic transfer

• Reasonably certain is a high threshold

• Example: purchase asset at substantially below market value (previously called a bargain purchase option)

Option to Purchase

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• Key term – “Economic Life”

• “Economic Life” is period over which an asset is expected to be economically usable

• Standard considers remaining economic life rather than total economic life

• Lease term spanning “major part” of remaining economic life is akin to sale

• No bright-line test, but 75% is generally considered a benchmark

Lease Term

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• Evaluate lease payments compared to fair value of asset

• Evaluate lease payments:• Determine present value of lease payments

• Determine present value of residual value guaranteed by lessee

• Sum these two items

• Compare lease payments to asset’s fair value

• Recovery of “substantially all” of asset’s fair value akin to sale

• No bright-line test, but 90% is generally considered benchmark

Fair Value of Leased Asset

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• Lease of highly specialized assets can be akin to sale

• Is the asset highly specialized?• Does it have alternative use to lessor at end of lease?

• Would lessor have significant cost to rework asset for alternative use?

• If yes to above, then lessee deemed to have consumed all the assets economic benefits

• Examples:• Asset in remote location

• Asset contains proprietary technology that lessee prohibits from being transferred

No Alternative Use

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• Recognize the assets & liabilities from the lease transaction

• Lease liability• Lessee’s obligation to make lease payments arising from a lease, measured on a

discounted basis

• Right-of-use asset• Asset representing the lessee’s right to use an underlying asset for the lease term

• These are new concepts for operating leases

• Similar to concepts from old capital lease guidance

Lease Classified – What Now?

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• May elect accounting policy to ignore for “short-term” leases

• What is a “short-term” lease?• Lease term of 12 months or less

• No option to purchase leased asset that is reasonably certain of exercise

• No need to recognize right-of-use asset

• No need to recognize lease liability

• Recognize lease expense on straight-line basis over lease term

Short-term Lease Exclusion

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• Measured at lease commencement

• Equal to present value of remaining lease payments

• Lease payments include:• Fixed payments, less lease incentives paid or payable

• Variable payments that depend on a rate or index (i.e., LIBOR)

• Exercise price of reasonably-certain purchase options

• Amounts probable to owe under residual value guarantee

• Termination penalty if lease assumes termination option will be exercised

• Structuring fees paid to special-purpose entity owners

• Discount rate = rate implicit in lease or lessee’s incremental borrowing rate

• Nonpublic entities may also use risk-free rate

Determine the Lease Liability

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• Measured at lease commencement

• Equal to the lease liability plus or minus:• Plus lease payments made at or before commencement

• Minus lease incentives received at or before commencement

• Plus initial direct costs incurred by the lessee

• Additions/subtractions to right-of-use asset don’t affect lease liability

Determine the Right-of-use Asset

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• Unique accounting after commencement

• Asset and liability must be adjusted (amortized) each reporting period

• Different approach for operating and financing

Subsequent Accounting

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• Adjust lease liability:• Increase to reflect interest expense recognized

• Decrease for lease payments made

• Adjust right-of-use asset:• Amortized on a straight-line basis over lease term

• Similar to old capital lease rules

Subsequent Accounting – Financing Lease

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Lease Liability Right-of-use Asset

Year

Beginning

Balance

Interest

Expense

Lease

Payment

Ending

Balance

Beginning

Balance

Asset

Amortization

Ending

Balance

1 65,328$ 4,246$ (15,000)$ 54,574$ 65,328$ (13,066)$ 52,262$

2 54,574 3,547 (15,375) 42,746 52,262 (13,066) 39,196

3 42,746 2,778 (15,759) 29,765 39,196 (13,066) 26,130

4 29,765 1,935 (16,153) 15,547 26,130 (13,065) 13,065

5 15,547 1,010 (16,557) - 13,065 (13,065) -

Journal Entries

ROU Asset Amtz Expense 13,066

ROU Asset - Acc. Amtz 13,066

Interest Expense 4,246

Lease Liability 10,754

Cash - Lease Payment 15,000

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• Reduce ROU asset & lease liability

• Steps:• Calculate straight-line lease expense

• Calculate interest on lease liability

• Deduct interest from SL lease expense

• Difference plugged to ROU amortization

Subsequent Accounting – Operating Lease (Plug Approach)

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Lease Liability Right-of-use Asset

(A) (B) (A-B)

Year

Beginning

Balance

Liability

Accretion

Lease

Payment

Ending

Balance

Lease

Expense*

Beginning

Balance

Asset

Amortization

Ending

Balance

1 65,328$ 4,246$ (15,000)$ 54,574$ 15,769$ 65,328$ (11,523)$ 53,805$

2 54,574 3,547 (15,375) 42,746 15,769 53,805 (12,222)$ 41,583

3 42,746 2,778 (15,759) 29,765 15,769 41,583 (12,991)$ 28,592

4 29,765 1,935 (16,153) 15,547 15,769 28,592 (13,834)$ 14,758

5 15,547 1,010 (16,557) - 15,769 14,758 (14,758)$ -

* Represents lease payments on straight-line basis (total lease payments divided by lease term)

Journal Entries

Lease expense 15,769

ROU Asset - Acc. Amtz 11,523

Lease liability 4,246

Lease Liability 15,000

Cash - Lease Payment 15,000

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• Other provisions not discussed here – consult your CPA

• Lease classification approach is similar to old rules with slightly different terminology

• Financing lease accounting similar to old capital lease accounting

• Operating lease accounting is significantly different

• Never too early to prepare

Points to Remember

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• New auditing standard affecting auditor reports

• Changes form and content of auditor’s report

• Key changes:• Opinion paragraph will appear as first paragraph

• Basis for Opinion section will appear second

• Expanded description of responsibilities (management and auditor)

• Effective for audits of years ending after 12/15/2020

General Accounting & Auditing Developments

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Questions?

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Bradford “Brad” C. Hatchett, CPA, CVA

Partner

GranthamPoole PLLC

Ridgeland, MS

bhatchett@granthampoole.com

(601) 499-2432

If You Have Questions…

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