FASB Changes to Independent School Financial Statements

The wait is over! The Financial Accounting Standards Board (FASB) has released the long-awaited Accounting Standards Update No. 2016-14. Issued on August 18, 2016, this update will change the financial reporting model for all not-for-profit organizations — including independent schools.

The new standard began taking shape after the FASB formed the Not-for-Profit Advisory Committee (NAC) in 2009. The NAC recognized there was a need for improvement in not-for-profit financial reporting and has made updates that will simplify net asset classifications and improve disclosures regarding financial performance, liquidity, and cash flows.

The NAC has been working on this project since 2011. After extensive research, deliberations, discussions, outreach, and receiving more than 260 comment letters on the initial exposure draft, the FASB issued the final standard for Phase 1 of the project. Phase 2 of the project — which includes consideration about requiring a measure of operations on the statement of activities — has been deferred for further study.

The standard responds to the need for revision and improvement in several areas of independent school financial reporting, including:

• The existing three-category classification of net assets (unrestricted, temporarily restricted, and permanently restricted) will be replaced by a two-category classification (net assets with donor restrictions and net assets without donor restrictions). This revision is a simplified approach that combines the former temporarily restricted and permanently restricted net asset classifications into one category.
• Disclosures will be enhanced to clarify the nature of board-designated and donor restrictions, with an emphasis on how and when the resources can be used. Many school boards designate net assets into buckets that can include net investment in plant, operating reserve, and more. If not already in place, schools will need to have established policies that address these disclosure requirements.
• Disclosures will be enhanced to include both qualitative and quantitative information about liquidity. Qualitative disclosures include how an independent school manages its available liquid resources. Quantitative disclosures include the availability of financial assets to meet cash needs for general expenditures within one year of the balance sheet date.
• Independent schools will continue to have flexibility to decide whether to report an operating subtotal, as well as self-define what is included in or excluded from the operating measure.
• Independent schools will be required to present expenses by both natural and functional classifications in one location. The most practical approach might be to include a statement of functional expenses along with the statement of activities. This allows, for example, a school to report total instructional expenses on the statement of activities with a breakdown of the natural categories of those instructional expenses on the statement of functional expenses.
• Enhanced disclosures about the methods used to allocate costs among functional classifications will be required.
• The accounting and disclosure requirements for underwater endowments will be updated.
• Independent schools will be required to use the placed-in-service approach for reporting the expiration of restrictions on gifts of long-lived assets, thus eliminating the option to release the restrictions over the useful life of the asset. This would mean that capital campaign funds raised for a new building would be released from restrictions once the building is placed in service, not as the construction costs are incurred or over the useful life of the building.
• Investment return will be presented net of external and direct internal investment expenses on the statement of activities. The requirement to disclose investment expenses that have been netted is eliminated.
• Independent schools will continue to have the flexibility to choose between the direct and indirect method of reporting cash flows. The requirement to use the direct method for cash flows in the April 2015 exposure draft has been excluded from the final standard.

The Accounting Standard Update will take effect for fiscal years beginning in 2018. In other words, this update will affect financial statements for the years ending December 31, 2018, and June 30, 2019. Early application is permitted. For a full list of Accounting Standards Updates and final documents, please visit the FASB website.

To view a easy one sheet of the changes, click here for a Summary of Changes to Not-for-Profit Financial Statements.