Article by Larry Smith & Ken Euwema | Featured on Journal of Accountancy 

As a part of the response to the call for increased transparency and accountability among not-for-profit entities (NFPs), FASB has taken on a project to improve the existing NFP financial reporting model. The goal is to improve the usefulness of NFP financial statements by providing better information about an NFP’s liquidity, financial performance, and cash flows to the primary users of financial statements, governing boards, donors, grantors, creditors, and other stakeholders of NFPs.

The fundamental reporting model for NFPs has existed for over 20 years. During that time, NFP organizations have developed different methods of reporting their operating results in a way that conveys the connection between financial choices and mission execution because existing GAAP does not prescribe a specific way of reporting operating performance. Additionally, changes in endowment laws together with the existing framework for reporting restricted and unrestricted net assets, and the lack of required information about the liquidity of an organization, have contributed to the confusion in determining whether an NFP is in sound or poor financial condition.

On April 22, FASB issued an exposure draft, Proposed Accounting Standards Update (ASU), Not-for-Profit Entities (Topic 958) and Health Care Entities (Topic 954): Presentation of Financial Statements of Not-for-Profit Entities. In reaction to feedback from NFP constituents, primarily FASB’s Not-for-Profit Advisory Committee (NAC), FASB is proposing fundamental changes to both the presentation and disclosures in financial statements of not-for-profit organizations. This article explains the basic requirements of the proposal and the reasons for the proposed changes, and it describes the planned activities of the board and its staff to assess whether stakeholders believe the benefits of the proposal through improved financial reporting of NFPs justify the costs to implement it.

The authors of this article believe that the changes proposed in the ED result in a significant improvement in financial reporting of an NFP by:

  • Reflecting in one measure of operating performance, amounts that have been made available to support the mission of an NFP, through current operations, including net assets released from donor-imposed restrictions.
  • Reflecting in another measure of operating performance how decisions of an NFP’s governing board (or its designees) affect the activities of the NFP in terms of either “setting aside” resources from current operations to support the mission of the NFP in future periods or using resources previously “set aside” to support current operations.
  • Highlighting, in a consistent fashion, the impact of financing and investing activities on the net assets of an NFP.
  • More clearly articulating the composition of net assets and whether they are currently available to support an NFP’s mission or whether certain restrictive conditions need to be met before net assets are available to support the mission.
  • Providing information to enable users to understand how an NFP manages its liquidity and assess an NFP’s liquidity position as of the balance sheet date.
  • Making the cash flow statement more understandable and usable by the primary users.


Net asset classification

The board is proposing to replace the current requirement to present on the face of the statement of financial position the amount for each of three classes of net assets (unrestricted, temporarily restricted, and permanently restricted) with the amount for two classes of net assets (net assets with donor restrictions and net assets without donor restrictions). The board believes the existing three-class presentation creates complexity in financial reporting, especially considering the impact of changes in laws that allow organizations, within the bounds of prudence, to spend from a permanently restricted endowment even when the amount of endowment net assets has fallen below the original amount of the endowed gift (i.e., it is underwater).

The proposed ASU retains the current requirements to provide information about the nature and amounts of different types of donor-imposed restrictions, underscoring the importance of information about how those restrictions affect the use of resources. Financial statement preparers may present this disaggregated information on the face of the statement of financial position or in the notes.

The board also decided to revise how underwater donor-restricted endowment funds are classified. Existing GAAP requires the disaggregation of amounts by which an endowment fund has fallen below its original gift, and the presentation of such amounts with unrestricted net assets. The board believes the legal ability of NFPs to continue to spend from underwater endowments makes the classification of such underwater amounts as unrestricted confusing, and thus, the proposed ASU would require classification of underwater amounts in net assets with donor restrictions.

To provide better information about the degree to which the funds are underwater and their potential effect on an NFP’s liquidity, the proposed ASU also requires disclosure of the aggregate amount by which funds are underwater, the original gift amount (or amount required to be maintained by the donor or law), and any governing board policy or decisions to spend, or not spend, from such funds.

Replacing the existing three classes of net assets with just two classes should make the net asset position of an NFP more understandable, promote greater awareness of the availability of net assets for current and future operational purposes, and help to streamline the presentation of the changes in net assets in the statement of activities.

Statement of activities

Considering the proposed changes to net asset classification, the proposed ASU requires a corresponding change to the statement of activities, that is, a requirement to present changes to each of the two classes of net assets as well as the amount of the total change in net assets. Additionally, the proposal requires the presentation of two measures of operating activities associated with changes in net assets without donor restrictions within the statement of activities.

The first measure of operations is a subtotal of operating revenues, support, expenses, and gains and losses that excludes amounts that are unavailable as a result of donor-imposed restrictions. The board believes this subtotal should reflect amounts that are available to, and used for, carrying out an NFP’s purpose for existence in the current fiscal year. The board believes this presentation best reflects the operating performance of an organization without regard to how that organization finances its operations through debt or investing activities, both of which would be presented outside of the operating measure. It also improves the comparability of reporting among NFPs, especially among NFPs with similar missions or operational structures.

Additionally, recognizing that many NFPs manage their operations under multiyear business plans through the establishment of quasi-endowment or reserve funds, the proposal requires separate presentation of transfers to and from such funds that have been authorized by a governing board or its designees. This requirement significantly improves the transparency of decisions made by an NFP’s board (or its designees).

The second required operating subtotal then reflects the amount of the first subtotal plus or minus the impact of operating transfers authorized by the governing board or its designee. The board believes this presentation has the advantage of clearly presenting to financial statement users a perspective on operational performance that is not readily discernible in an operating measure that only reflects revenue and expense of a single fiscal period. In other words, it allows an NFP to “tell its story” in terms of amounts that are available to support the NFP’s mission and how those amounts are being managed to support the mission in the current and future periods. Yet, unlike today’s reporting model, it does so in a transparent way that creates better comparability across entities.

The board also believes presenting investment income/loss and interest expense separate from the operating measures will result in greater visibility as to the impact of investing and financing activities, and greater comparability of NFPs’ financial statements.

In addition to requiring intermediate measures of operating performance, the proposed standard requires all NFPs (rather than just voluntary health and welfare entities) to provide information about their operating expenses by both nature (such as salaries, rent, and office supplies) and function (categories include program, general and administrative, and fundraising). This information can be provided on the face of the statement of activities, as a separate statement, or in the notes to the financial statements, supplemented with enhanced disclosures about the methods used to allocate costs among functions. As NFPs already report this information on IRS Form 990, Return of Organization Exempt From Income Tax, this requirement creates a clear line of sight between their GAAP financial statements and Form 990. This requirement acknowledges the fact that many users believe this information is useful in assessing how an NFP uses its resources and its stewardship for the resources entrusted to it.

Improving the presentation of operating cash flows

To further enhance the reporting of an NFP’s operating performance, the board is proposing two fundamental changes to the statement of cash flows. First, the board is proposing the use of the direct method of reporting cash flows from operating activities (see “Direct-Method Transition Would Require Prompt Attention“). Second, the board is proposing to realign the reporting of several items among operating, financing, and investing categories so that the reporting of those items is more consistent with how the items are reported in the statement of activities (see “Recategorizing on Statement of Cash Flows”).

Two primary reasons the board decided to propose the use of the direct method are:

  • The direct cash flow method is more understandable by the average user of financial statements and thus more useful than the indirect method, and
  • The cost of implementing the change to the direct cash flow method is not expected to involve significant implementation or ongoing costs, based partially on the experience of public universities and other NFPs that already report under the direct method.

In addition to requiring the use of the direct method of cash flows, the proposal reflects the realignment of specific line items to improve the consistency of the operating measures reported in the statement of activities and operating cash flows.

While the majority of FASB members believe the reclassifications improve the alignment of the statement of cash flows to the statement of activities, a number of NAC members, as well as a minority of board members, oppose this aspect of the proposal in that it appears to them to be “getting ahead” of business enterprises (e.g., the board has not yet proposed similar reclassifications for business enterprises).

Improved information about liquidity

At the initial meetings with NAC, members noted shortcomings of the information NFPs provide to users regarding exposure to liquidity risk. Other NFP stakeholders also have noted shortcomings.

The prevalence of donor-imposed restrictions and the lack of clarity about how those restrictions affect the availability of assets to fund current operations frequently make the assessment of liquidity difficult in the NFP environment.

FASB considered alternatives to improve the information that would be useful to the assessment of an NFP’s liquidity risk. In doing so, however, the board was challenged to avoid requiring the reporting of forward-looking information, which some stakeholders believe goes beyond the boundary of FASB’s financial reporting standards.

Despite these challenges, the proposal includes some requirements that are expected to improve a financial statement user’s ability to assess an NFP’s liquidity position. Specifically, the proposal requires the disclosure of quantitative and qualitative information about the liquidity of assets and near-term demands for cash as of the reporting date, including (1) the amount of financial assets at the end of the period; (2) the amount that, because of restrictions or other limitations on their use, is not available to meet cash needs in the near term; (3) the amount of financial liabilities that require cash in the near term; and (4) the way an organization manages its liquidity, including the time horizon it uses in the management of liquidity as well as any other sources of cash (such as lines of credit) during that time horizon.

This information, along with the disclosures previously described about underwater endowment funds and the changes to net asset classification, should significantly improve users’ ability to assess NFPs’ liquidity risk.


The board is seeking public comment on the proposed ASU. Comments can be emailed to by Aug. 20. Members of FASB and FASB staff members working on the project also have participated in various forums to solicit feedback, including conferences and meetings sponsored by state societies of CPAs, NFP industry conferences, meetings with executives of large national CPA firms specializing in the audits of NFPs, and national meetings sponsored by the AICPA, United Way Worldwide, and the National Association of College and University Business Officers (NACUBO). Additionally, FASB will continue to meet with NAC and hold round tables to discuss constituents’ reactions to the proposed ASU, after which redeliberations of the proposal will begin. While predicting the timing of the issuance of a final ASU is speculative, the goal of the project team is to issue a final standard in 2016.

© Copyright 2015 by Financial Accounting Foundation, Norwalk, Conn.

Editor’s note:

Larry Smith is a member of FASB, and Ken Euwema is a member of FASB’s Not-for-Profit Advisory Committee.

About the authors

Larry Smith ( is serving his second five-year term as a FASB member. Ken Euwema ( is vice president and controller of United Way Worldwide in Alexandria, Va., and is in his second three-year term as a member of FASB’s Not-for-Profit Advisory Committee.

To comment on this article or to suggest an idea for another article, contact Ken Tysiac, editorial director, at or 919-402-2112.


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