FASB

Article Dean Dorton

As a result of FASB’s project to enhance the usability of Not-for-Profit (NFP) entities financial statements and the associated notes to those financial statements, FASB released ASU 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities.

This update seeks to:

  • Address the complexity of the three net asset classes
  • Improve transparency in relation to liquidity issues
  • Create consistent guidelines for the presentation and disclosure of expenses
  • Simplify the statement of cash flow presentation requirements.

The current net asset classifications have been eliminated and replaced by two new classes:

Investment returns will now be presented net of expenses and the requirement to disclose those netted expenses has been eliminated. NFP entities using the direct method cash flow statements are no longer required to reconcile the direct method to the indirect method. For gifts received to acquire or build long-lived assets, entities will now be required to use the “Placed-in-Service” method to report the expiration of gift restrictions and will need to reclassify any such amounts for assets previously placed in service. The new guidelines require NFPs to present both the natural and functional classification of expenses in the same location.

Additional disclosure requirements are as follows:

  1. Disclosure of the amounts and purposes of self-imposed restrictions or limitations on assets without donor imposed restrictions.
  2. Disclosures of the composition of donor restricted net assets and how those restrictions affect their use.
  3. Qualitative information on management’s plan to meet the entity’s cash flow needs for the next twelve months as well as the availability of the assets that will be used to meet those needs.
  4. Disclosure of the methodology used to allocate expenses between program and support functions.
  5. Underwater endowment funds will now require increased disclosure requirements relating to the entity’s policies and actions taken concerning appropriation of such funds, the fair value of the funds, original gift amount to be maintained and the aggregate deficiencies of the funds, which are to be classified as part of net assets with donor restrictions.

Nonprofit organizations that will be affected include charities, foundations, colleges and universities, healthcare providers, religious organizations, trade associations, and cultural institutions, among others.

These changes will be effective for annual statements with fiscal years beginning after December 15, 2017 and for interim periods with fiscal years beginning after December 15, 2018. The amendment is to be applied on a retrospective basis; however, entities presenting comparative statements have the option to omit the increased requirements surrounding the analysis of expenses and liquidity and availability of resources for the period presented prior to adoption.

Authored by Tom Smither, Supervisor of Assurance Services.

For additional information, please contact your Dean Dorton advisor or:
Crissy Fiscus, cfiscus@deandorton.com
David Richard, drichard@deandorton.com

Article Dean Dorton

On February 25, 2016, the Financial Accounting Standards Board (FASB) issued its new lease accounting guidance in Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842).

The ASU will require organizations that lease assets to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases, unless the lease is a short term lease.

Short term leases
A short term lease is defined in the ASU as “a lease that, at the commencement date, has a lease term of 12 months or less and does not include an option to purchase the underlying asset that the lessee is reasonably certain to exercise”.  The lease term is defined as the noncancellable period for which a lessee has the right to use an underlying asset, together with all of the following:

  • Periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that option.
  • Periods covered by an option to terminate the lease if the lessee is reasonably certain not to exercise that option.
  • Periods covered by an option to extend (or not to terminate) the lease in which exercise of the option is controlled by the lessor.

For short term leases, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. If a lessee makes this election, it should recognize lease expense for such leases generally on a straight-line basis over the lease term.

Leases not considered short term
For all other leases, the lessee will be required to recognize the following at the commencement date of the lease:

  • A lease liability, which is a lessee‘s obligation to make lease payments arising from a lease, measured on a discounted basis; and
  • A right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term.

When measuring assets and liabilities arising from a lease, a lessee (and a lessor) should include payments to be made in optional periods only if the lessee is reasonably certain to exercise an option to extend the lease.  Similarly, optional payments to purchase the underlying asset should be included in the measurement of lease assets and lease liabilities only if the lessee is reasonably certain to exercise that purchase option. Reasonably certain is a high threshold. In addition, a lessee (and a lessor) should exclude most variable lease payments in measuring lease assets and lease liabilities, other than those that depend on an index or a rate or are in substance fixed payments.

Consistent with current Generally Accepted Accounting Principles (GAAP), the recognition, measurement, and presentation in the statements of income and cash flows will depend on the lease’s classification as a finance or operating lease.

  • For finance leases, a lessee is required to:
    • Recognize interest on the lease liability separately from amortization of the right-of-use asset in the statement of income.
    • Classify repayments of the principal portion of the lease liability within financing activities and payments of interest on the lease liability and variable lease payments within operating activities in the statement of cash flows
  • For operating leases, a lessee is required to:
    • Recognize a single lease cost in the statement of income (which will include both the amortization of the right-of-use asset and the “interest” element associated with the lease liability), calculated so that the cost of the lease is allocated over the lease term on a generally straight-line basis.
    • Classify all cash payments within operating activities in the statement of cash flows.

The ASU also will require disclosures to help investors and other financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases. These disclosures include qualitative and quantitative requirements, providing additional information about the amounts recorded in the financial statements.

Lessor accounting
Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model and Topic 606, Revenue from Contracts with Customers.

Sale and leaseback transactions
The new lease guidance also simplified the accounting for sale and leaseback transactions primarily because lessees must recognize lease assets and lease liabilities. Lessees will no longer be provided with a source of off-balance sheet financing.

Effective dates
Public business entities should apply the amendments in ASU 2016-02 for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Nonpublic business entities should apply the amendments for fiscal years beginning after December 15, 2019 (i.e., year ending December 31, 2020 for a calendar year entity), and interim periods within fiscal years beginning after December 15, 2020. Early application is permitted for all public business entities and all nonpublic business entities upon issuance.

Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach.

If you have any questions regarding this new standard or would like assistance in implementing the new standard, please contact your Dean Dorton advisor, or:

David Richard, Director of Assurance Services: drichard@deandorton.com
Simon Keemer, Director of Assurance Services: skeemer@deandorton.com


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Article Dean Dorton

Increased attention and scrutiny from the public, government agencies, and financial institutions have placed a greater emphasis on accountability, transparency, and risk management for colleges and universities and their foundations. One of the first steps to addressing this increased scrutiny is by developing a strong audit committee as part of your board of directors.

Audit committees can contribute through facilitating:

  • Accurate and timely financial reporting
  • Strong internal control environment
  • Compliance with laws and regulations
  • Management of operating risks

According to a 2011 Association of Governing Boards of Universities and Colleges (AGB) Survey of Higher Education Governance, 65% of the boards of independent institutions and 45% of public institutions had a separate audit committee. A 2010 AGB survey found 70% of college and university foundations had a separate audit committee. The industry has obviously recognized the need for the committee and in this newsletter we will discuss the committee’s purpose and responsibilities, who should be a member of a strong audit committee, and some best practices for effective audit committees.

Purpose and Responsibilities

The audit committee’s purpose is to provide oversight of the institution’s financial practices and standards of conduct. In the execution of this purpose, the committee has the following responsibilities:

  • Understand and provide oversight of accounting practices and the financial reporting process
    • The committees of private institutions must be aware of Financial Accounting Standards Board (FASB) regulations
    • Public institutions’ committees must be cognizant of Governmental Accounting Standards Board (GASB) standards
  • Oversee the internal audit function
    • Review the internal audit plan on an annual basis
    • Internal auditor should report their findings directly to the board
  • Selection and oversight of the external auditor
    • Review the performance of the external auditor
    • Ensure the independence of the external auditor
  • Review the financial statements
    • Review should include “management discussion and analysis”
    • Compare results with prior years
    • Analyze revenue and expense trends
  • Risk management
    • Understand the risks (operational, strategic, financial, compliance, and reputational) facing the institution
    • Assess whether those risks will prevent the institution from fulfilling its strategic objectives
  • Compliance
    • Analyze the institution’s recognition of and reporting required under federal, state and local laws as well as contractual compliance

The depth and breadth of this list is further evidence of the need for a separate audit committee as part of the board of directors. The board as a whole simply would not have the resources to adequately carry out these responsibilities, whereas the smaller audit committee is dedicated to these six main objectives.

Composition and Structure

According to the Association of Governing Boards of Universities and Colleges (AGB), an audit committee generally has three to six members, but the exact number is dictated by the size of the organization. These members should serve staggered, multi-year terms (often three years) to promote continuity. Each member should have a general understanding of business and finance and be knowledgeable about key compliance issues and risks facing the institution. All members should also be independent of the institution. The institutions financial management team may attend meetings, but their role should be limited to that of a staff or support role. Ideally, the committee should include at least one member that is considered a financial expert. A financial expert should possess the following attributes:

  • Understand financial statements and accounting principles
  • Ability to apply these principles in relation to the review of accounting estimates, reserves, and accruals
  • Experience in the preparation and review of the financial statements
  • Understand internal controls and audit committee functions

Best Practices

Below is a list of audit committee best practices as outlined by the AGB:

  • Meet two to four times annually
  • Meet with the president, CFO, and internal auditor annually
  • Remain current with emerging accounting principles and practices
  • Review president’s expenses
  • Ensure management takes responsibility for the financial statements
  • Report to the board the following:
    • Technical issues uncovered
    • Legal environment, including any pending lawsuits
    • Compliance with regulations and contracts
    • Tax law changes that would affect the institution

Top Questions for the External Auditor, According to the AGB

  • How does the institution’s financial health compare to last year?
  • Did the auditor issue an “unmodified” opinion?
  • Were any internal control issues identified?
  • Were there any significant changes in accounting policies for this audit?
  • How comfortable is the auditor with management’s estimates?
  • Is there any evidence of fraud at the institution?
  • Were there any findings issued under a management letter?
  • Has any other auditing work been performed for the institution during the current year?
  • Are there any issues with management which the committee should be made aware?

 

Article written by Tom Smither, Supervisor of Assurance Services

Citations

Staisloff, Richard. “The Audit Committee”. AGB Effective Committee Series. 2011

Article Dean Dorton

Part 1 of 2

In February 2015 the Governmental Accounting Standards Board (GASB) issued GASB Statement 72, Fair Value Measurement and Application.  The Statement is designed to bring more clarity to areas of uncertainty related to fair value measures – including direction on how to apply fair value when market values cannot be obtained and where management judgments are necessary.

The goal of the changes required by GASB 72 is to improve the consistency and comparability in how governments measure and apply fair value and disclose information about those measurements.  The purpose for the additional disclosures about the assets and liabilities measured at fair value is to help financial statement users make better informed decisions about the potential effect of those measurements.

The Statement is very similar to FASB Accounting Standards Codification Topic 820, Fair Value Measurement, but is not identical; therefore governments should ensure that they are specifically following the requirements of Statement 72.

Fair Value Defined

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  The Statement makes it clear that fair value is an exit price.  The definition is consistent with the definition of fair value as stated in FASB Accounting Standards Codification Topic 820, Fair Value Measurement.

The Statement extends the application of fair value reporting to most investments and defines an investment as a security or other asset that a government holds primarily for the purpose of income or profit.

Major provisions of Statement 72

The Statement describes how fair value should be defined and measured, what assets and liabilities should be measured at fair value and what information about fair value should be reported in the notes to the financial statements.

Measurement
Statement 72 requires governments to measure fair value in a manner consistent with one of three approaches:

  1. Market approach – measure fair value using prices and relevant market information
  2. Cost Approach – measure fair value using an amount that would be required to replace the asset and its service capacity
  3. Income approach – measure fair value by converting future amounts, such as future cash flows, in a single current amount

Measuring fair value also requires the government to collect information regarding the inputs that were used to measure fair value.  Statement 72 uses the fair value hierarchy which is also used in FASB Topic 820, Fair Value Measurement.  The hierarchy includes 3 levels of inputs based on the reliability and objectivity of the information:

Level 1 – inputs are quotes prices in active markets for assets or liabilities identical to the ones being measured
Level 2 – inputs are inputs that are observable for similar assets or liabilities
Level 3 – inputs are unobservable inputs for example, management’s assumption of the default rate among underlying mortgages of a mortgage-backed security

Application
Statement 72 requires that most investments be measured at fair value.  Certain exceptions remain, such as:

  • Investments in certain external investment pools
  • Money market investments
  • Investments in life insurance contracts
  • Common stock meeting the criteria for the equity method
  • Unallocated insurance contracts
  • Synthetic guaranteed investment contracts

If a government has investments in alternative investments that calculate the net asset value (NAV) and the investment does not have a readily determinable fair value, the government would be permitted to report a fair value of those investments based on the NAV per share.

Statement 72 would require a change in how governments place a value on donated capital assets, donated works of art and historical treasures, and capital assets received in service concession arrangements. Going forward those assets will be measured at acquisition value (an entry price) – the price that would be paid to acquire an asset with equivalent service potential in an orderly market transaction at the acquisition date – rather than at fair value (an exit price).

Disclosure
The Statement requires disclosures to be made about the fair value measurements, including the level of the fair value hierarchy, and a discussion of the valuation techniques used .  Governments should organize these disclosures by type of assets or liability reported at fair value.  It also requires additional disclosures regarding investments in certain entities that calculate net asset value per share.

Effective Date
The requirements of Statement 72 are effective for periods beginning after June 15, 2015.

Coming Up
Part 2 of this email series will feature a sample financial statement disclosure for the requirements of GASB Statement No. 72.

For more information regarding GASB Statement No. 72, please contact Crissy Fiscus at cfiscus@deandorton.com or 859.425.7631 or Simon Keemer at skeemer@deandorton.com or 502.566.1036.

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Article Dean Dorton

Inventory (Topic 300): Simplifying the Measurement of Inventory

In July, the Financial Accounting Standards Board (FASB) issued ASU 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory, which requires entities to measure inventories at the lower of cost and net realizable value.  The amendment is expected to increase comparability and reduce costs.  ASU 2015-11 applies to all inventory measured using first-in, first out (FIFO) and average cost, but does not apply to inventories accounted for under last-in, first-out (LIFO) or the retail inventory method.  Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.

The FASB has issued this update as part of its Simplification Initiative which is intended to “identify, evaluate, and improve areas of generally accepted accounting principles (GAAP) for which cost and complexity can be reduced while maintaining or improving the usefulness of the information provided to users of financial statements.”

Except for public entities, the ASU is effective for periods beginning after December 15, 2016, including interim periods within fiscal years beginning after December 15, 2017.  The amendment is effective for periods beginning after December 15, 2016, including interim periods within those fiscal years for public entities.  Early adoption is permitted, and the ASU should be applied prospectively as of the beginning of an interim or annual reporting period.

ASU 2015-11

Dean Dorton would be happy to discuss implications for your business.  For more information, please contact Lance Mann at lmann@deandorton.com.


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Article Dean Dorton

The Financial Accounting Standards Board (FASB) has developed guidance that it believes will improve the information provided in financial statements and disclosures for non-for-profit entities. The proposed guidance is Accounting Standards Update 2015-230 Presentation of Financial Statements of Not-for-Profit Entities and Health Care Entities. The proposed changes could have a major impact on the following reporting areas:

  • Net Asset Classification
    • The net asset classifications (permanently restricted, temporarily restricted, and unrestricted) would be replaced with only two net assets classes (net assets with donor restrictions and net assets without donor restrictions).
  • Statement of Activities
    • Expenses would be required to be reported by both their nature and function either on the face of the statement of activities or disclosed in the footnotes. Investment expenses would be netted with investment income to allow users to identify the net profit from the entity’s portfolio.
  • Cash Flows
    • The direct method of reporting cash flows for operating activities would be required in addition to changing the classification of certain cash flows.
  • Liquidity
    • Required disclosures of quantitative and qualitative information on liquidity of assets including the amount of financial assets at the end of each period, limited or restricted for use assets, and how the organization manages its liquidity.

The changes in these areas will provide donors and the public with more information about the organizations and how they spend and invest donor money. However, there are concerns are that the cost and results of implementation will outweigh the benefits of the changes. Some criticisms the proposal has received are that the changes will create too much of a divide between not-for-profit and for-profit accounting and therefore, will make it difficult for the end users of financial statements, and will create more reconciliation differences between IRS Form 990 and the financial statements.

Comments were due to FASB by August 20, 2015. FASB will hold a roundtable on September 21, 2015 to further discuss these changes.

For further information, read the Exposure Draft or FASB In Focus.