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Pending FASB guidance raises questions about operations

Published Date:
Feb 19, 2014

As part of a wide-ranging effort to improve how nonprofits present their financial statements, the Financial Accounting Standards Board (FASB) has put forth a tentative definition of what counts as nonprofit operations—and, in the process, has raised new questions about how organizations should talk about their assets, speaker Hilda H. Polanco said at the Foundation for Accounting Education’s 36th Annual Nonprofit Organizations Conference on Jan. 16.

Polanco, the founder and managing director of a firm that advises nonprofits, led a sessionon strategies for reporting operating results, in anticipation of changes in guidance from the FASB. The board has been deliberating on adjustments to the nonprofit financial reporting model for the past several years.

What a nonprofit includes in its operating budget can have a significant impact on how assets are treated in the financial statement. With this in mind, Polanco said, the FASB tentatively agreed in May that an operating measure would be defined along two key dimensions: whether resources are from or directed at carrying out a not-for-profit organization’s purpose for existence (mission-based), and whether these resources are available for the current period of operations, reflecting both external limitations and internal actions (availability). The definition, she said, could be incorporated into an eventual exposure draft on nonprofit accounting at the conclusion of the overall project or be a separate consideration.

However, while the definition itself might seem clear-cut, things can be more complicated than they sound, she noted. For example, she said that while certain organizations have very large endowments, only a fraction might be used for operations, and so the true size of the endowment might not immediately be apparent in the statement of activity. Furthermore, there is also the question of how much of the endowment is available for immediate use, since part of it could be tied up in investments that may take a while to become fully liquid.

Another issue, according to Polanco, is how income associated with a capital campaign will be treated.

“It remains an open question, in the new definition of operations—will there be an inclusion of assets created by the building from a capital campaign, or [will it be] a donation of assets being valued?” she said. “There’s no real answer right now in terms of which they are going with it.”

She posed, as an example, the scenario of a nonprofit receiving a building. Most organizations, she said, would simply recognize the entire building the year it goes into operation and depreciate its value over time. This, however, can lead to swings in the financial information, since the nonprofit is suddenly recognizing a huge asset. A less used option is to recognize the depreciation and income of the building over its lifetime, which has zero impact to operations; those taking this option, she said, are typically organizations that don’t want an inflated change in their net assets this year.

Say the organization, instead, used fundraising to buy the building. If the capital campaign is just starting, she said, and the organization is collecting donations in the first year of it, the monies raised would not show as being available for operations, though they would when the building is ready to be used. However, she said, there would still be the question of what exactly happens to the bottom line in response.

“Would it impact [the] operation [budget’s] bottom line? We don’t know. If it’s counted in the way most nonprofits do it today, then yes, it will affect operations, big time,” she said. “If the guidance goes in the direction of [saying] revenue and expenses are the same, it wouldn’t have an impact.… This whole idea of connecting capital to operating is going to continue to be an important one.”

Hopefully, she said, there will soon be some clarity on differentiating between capital and operating monies, especially considering that the recent trend in giving has been leaning more toward in-kind goods rather than cash donations.

Another area where it might not be so clear what does and does not fall under operations is reserve funds, though this could mainly be a function of the variability between how these funds could be managed, such as requiring repayment for funds drawn down, or requiring an interest payment. Also, she asked, what are the circumstances in which someone can consider these funds to be available to them?

“If the operating measure becomes the measure of success or evaluation, what are the areas in which we really want to be clear and make sure that the guidance is being straightforward and is not able to be easily manipulated?” she said. “We would want a guideline that really reflects what an organization intends to do and not necessarily what it thinks is a good thing in order to affect the operations [presentation].”

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