The new FASB Accounting Standards Update (ASU) 2016-14 is bringing on several changes for nonprofit financial reporting and disclosures that will go into effect for fiscal years beginning after December 15, 2017. One of those changes involves the reporting of expenses.
ASU 2016-14 will require that functional expenses be reported as part of the basic financial statements or footnotes for all nonprofits. Operating expenses must be shown by both their nature and function. “Functional” classification refers to identifiers such as program, management and general, and fundraising. Expenses must then be further segregated into their “natural” classification, which is referring to groupings such as salaries, rent, depreciation and supplies. Nonoperating expenses are not required to be shown by function if the nonprofit is distinguishing between operating and nonoperating activity. The new ASU has also given better guidance about which expenses are management and general.
In addition to reporting the functional expenses, nonprofits will be required to disclose the allocation methodology behind those expenses. If allocations are being done based on a time study or square footage, for example, that will now need to be documented in a footnote describing the basis used for each natural expense line.
The last ASU 2016-14 change related to expenses addressing the treatment of investment expense. Currently, nonprofits have the option of netting investment expenses with related investment income, and disclosure of the fee amount is required. The new ASU will require that direct investment fees be netted with related investment income. Therefore, investment fees will no longer be included in the functional expense reporting. These investment fees should only include expenses that relate directly to generating investment return. The amount of netted expense and components of investment return will no longer need to be disclosed.
Overall, the expense changes discussed are meant to make information more useful to those using the financial statements, such as donors, grantors, and others. The changes help make users aware of what expenses are fixed and which are being allocated. The changes also ensure investment fees are more comparable between nonprofits by including internal and/or external investment fees within the investment income.
The best way to prepare for the upcoming expense-related changes is to ensure the nonprofit has a functional expense allocation methodology that is rational and can be adequately supported. Determining direct internal and/or external investment expenses is another proactive step in preparing for the new ASU.