Understanding the New Accounting Standards for Nonprofits

Change has become a constant in the nonprofit sector. Recently we saw new regulations under the 2017 Tax Cuts and Jobs Act that eliminated certain deductions. The Financial Accounting Standards Board (FASB) has also been hard at work instituting sweeping changes in procedures aimed at reducing complexities while making it easier to understand nonprofit financial information — notably, updates to the accounting standards in 2016 (impacting 2018 financial statements) and in 2018 (impacting 2019 financial statements).

Here's a summary of the most significant revisions.

New Revenue Recognition Standard Focus Clarifies Contributions
You might think that, when it comes to charitable giving, a dollar is a dollar. But in the nonprofit sector, it's important to determine the giver's expectations in providing that dollar. Are the expectations nonreciprocal and unconditional, meaning the nonprofit can spend that full dollar however (and whenever) it sees fit? Or does the giver expect something in return of equal (or "commensurate," in FASB parlance) value, thus an exchange transaction? That return could range from "membership" status to branded merchandise, like a pin or a mug, to funding clinical drug trials, performing public services or conducting scientific research under a grant.

These new revenue recognition standards put the onus on nonprofit organizations to split those increasingly fine hairs. For every dollar that comes in, nonprofits must first determine if there is an exchange of commensurate value. If there isn't, then nonprofits must follow the contribution accounting model, which further splits the dollar as either a "conditional” or "unconditional” contribution. The clarification will likely shift many grants from an exchange to a nonexchange/contribution recognition model, which will impact the accounting required.

Why? The reasons are complicated. But in simple terms, it comes down to how (and when) the revenue is recognized. With exchange transactions, the dollar is subject to more formal revenue recognition criteria in a different standard, which could prolong the recognition of revenue. With conditional contributions, nonprofits must meet certain criteria before recognizing the revenue.

It's important to show a good track record of growth in revenues and net assets available to show the nonprofit's mission can have a long-lasting impact. This also attracts new donor interest and more donors' dollars, but prospective donors might not fully read or understand nonprofit financials and the implications of different types of donations. It's important for nonprofits to have financial statements that can tell a story, which takes us to the next change.

Less Complexity, More Transparency
The other significant change designed to improve transparency involves presentation of financial statements and financial disclosure. Basically, nonprofits have to make it easier for members of the public to follow the money.

One improvement is combining temporarily restricted and permanently restricted net assets into "net assets with donor restrictions" and renaming unrestricted net assets as "net assets without donor restrictions." Another is the functional expense allocation, essentially a matrix statement that has natural classifications (e.g. salaries, rent, printing) versus the program's services and supporting services to more clearly show where the money is spent. (Are more dollars going towards fundraising or managing the nonprofit compared to the nonprofit's initiatives?) This also extends into both the liquidity necessary for a nonprofit to meet its operating expenses within a year and any board-designated assets set aside for emergencies, as the National Council of Nonprofits explains.

As Rick Cole, Supervising Project Manager at FASB, put it, "These changes are intended to make it easier to see, by looking at a nonprofit's financial statements, if there are liquidity issues. In other words, does the nonprofit really have the ability to pay its bills, or are the funds earmarked for other things?"

Where That Leaves Executive Directors with Nonprofit Bookkeeping
In a nutshell: Many executive directors will need help. Very few have the financial expertise — or the time — to navigate the bookkeeping complexities at a nonprofit organization, especially in light of the ever-evolving standards. It's yet another reason why more and more nonprofits are turning to outsourced nonprofit bookkeeping services to help them stay on course. The right resource can help nonprofits understand each donor's expectations and ensure the statements best tell the story of where the nonprofit was yesterday, is today and wants to be tomorrow.