There are significant new requirements for expense reporting coming for not-for-profit entities with the release of ASU 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities by the Financial Accounting Standards Board (FASB).
In this article, we’ll examine expense reporting and give an overview of how the new requirements change current practices and some related best practices. If you’d like to know more about changes to net asset classifications—another significant change—we give an in-depth overview in the first article in this series on the new standard.
The Current Standard
Not-for-profit entities currently report expenses under the FASB Accounting Standards Codification (ASC) Topic 958, Not-for-Profit Entities. Under current guidance, voluntary health and welfare entities have an additional requirement to present a statement of functional expenses.
What the Standard Changes
The new standard changes expense reporting in a few ways for not-for-profits.
The new standard requires all not-for-profit entities to concurrently present their expenses by natural and functional classifications. Here’s a closer look at those classifications as defined in the new standard:
- Natural expense classification. This is a method of grouping expenses according to the kinds of economic benefits received in incurring those expenses. Examples of natural expense classifications include salaries and wages, supplies interest expense, rent and utilities, and depreciation.
- Functional expense classification. This is a method of grouping expenses according to the purpose for which costs are incurred. The primary functional classifications of a not-for-profit entity are program services and supporting services.
There’s an added option for voluntary health and welfare entities. Previously, this type of entity was the only one required to present the analysis of expenses by both classifications. While this is still the case, voluntary health and welfare entities now have the option of presenting their information in either a statement of functional expenses or one of the other presentation methods permitted by the new standard. (The methods are described below.)
Entities must present the relationship between the functional classification and the natural classification of expenses in an analysis that disaggregates the functional expenses by natural classification.
Some entities may report expenses in classifications other than their natural classification—salaries expense is included as part of cost of goods sold and rent expense is allocated among programs, for example. Such expenses are to be reported by their natural classification in the functional expense analysis.
This expense reporting can be presented either on the face of the statement of activities as a separate statement or in the notes to the financial statements. Presenting this information as supplementary information doesn’t meet the requirements of the standard.
Additional disclosures will be required relating to methods used to allocate costs among functions.
The intent of this requirement is to provide additional useful information to users of the not-for-profit entity’s financial statements and help them assess:
- The link between the nature of expenses and their relation to program and support activities
- The proportion of expenses that are fixed versus discretionary
- The allocation method used in allocating expenses among functions
- The cost incurred to provide services
When to Implement the Standard
Early adoption of all aspects of the standard is permitted before the standard’s effective date of fiscal years beginning after December 15, 2017. It will also become effective for interim periods within fiscal years beginning after December 15, 2018.
Not-for-profits should apply the amendments retrospectively to their financial statements. However, when presenting comparative financial statements, they can elect to omit the analysis of expenses by both functional and natural classifications for any periods presented before the period of adoption of the new standard.
For the first year the amendment is applied, not-for-profit entities are required to disclose the nature of reclassifications, restatements, and their effects—if any—on the changes in net asset classes for each year presented.
How to Prepare
Not-for-profits will need a process to gather information to comply with the new expense reporting requirements. This may require input from and discussion with all departments of the entity, internal and external stakeholders, and other users of the financial statements. Communication is key to help ensure all information and challenges that will impact this process are considered.
Consideration should also be given to the methodology used to allocate the expenses by function and whether enhancements or changes need to be made to the methodology to comply with the new standard.
Entities may also want to evaluate other factors, including:
- Cost efficiency. Compare the cost of providing additional information beyond what’s required by the standard with the benefit an entity and external users of the financial statements may receive from providing that information.
- Level of detail. Determine the appropriate level of detail necessary to provide meaningful information to the various users of the entity’s financial statements, especially contributors and grantors.
- Peer comparison. Consider how the quality and quantity of information presented compares to what peer entities are presenting.
We're Here to Help
We’ll continue to provide insight and implementation suggestions through a series of articles on this new standard. To learn more about the new standard, or to gain a better understanding of the specific changes coming for not-for-profit financial statement requirements in general, contact your Moss Adams not-for-profit professional.