Not-for-Profit Reporting Series: Presentation of Investment Return and Expenses

A recently released standard focuses on providing greater transparency to not-for-profit financial statements and notes regarding liquidity, financial performance, and cash flow. Ultimately, Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities, enhances a not-for-profit entity’s ability to tell its financial story.

In a series of articles on the new standard, we’re taking an in-depth look at the changes it requires. Although it won’t take effect until fiscal years beginning after December 15, 2017, early adoption is permitted, so it’s a good idea to assess how this will affect your organization in the future and how it might benefit today.

These new requirements are designed to enhance the usefulness of the GAAP-based financial statements that not-for-profits provide to donors, grantors, creditors, and other stakeholders. In this part of the series, we’ll cover changes to the presentation of investment return and expenses.   

The Current Standard

There’s a lack of consistency in the presentation of investment return and expenses on the statement of activities. Not-for-profits are also required to disclose investment expenses on the face or in the notes of financial statements. This leads to a lack of comparability between organizations. 

Additionally, investment return presented in the reconciliation of an endowment’s beginning and ending balances is separated into the following:

  • Investment income—interest, dividends, and rent, for example
  • Net appreciation or depreciation of investments

What the Standard Changes

Not-for-profits will now present investment return net of related investment expenses, which will include both external and direct internal investment expenses, on the statement of activities. The net presentation of investment return will also require expenses to be included in the net asset categories in which investment return is reported—for example, net assets with or without donor restrictions. Direct internal investment expenses are those produced in the direct conduct or supervision of activities that generate investment return, such as:

  • Employee costs. These include salaries, benefits, travel, and other costs for personnel responsible for developing and executing investment strategy.
  • Costs related to internal investment management. These include expenses generated in the supervision, selection, and monitoring of investment management firms.

Requiring an organization to report its investment return net of external and direct internal investment expenses provides a more comparable measure of investment return across all organizations, regardless of how the investment activities are administered, monitored, and managed.

Under the new standard, organizations will also no longer be required to disclose gross investment income and related expenses in the footnotes. This eliminates the difficulties and cost of identifying embedded fees as well as the resulting inconsistencies in reported investment expenses.

Not-for profits may present the net investment return from portfolios that are managed differently or derived from different sources as separately labeled line items on the statement of activities. Here are some examples:

  • Net investment return generated from operating cash may be presented separately from the return generated from an organization’s endowment.
  • An entity may present the net investment return appropriated for spending separately from the return exceeding the amount appropriated for spending, if appropriately labeled.

Endowment Reporting

ASU 2016-14 specifically discusses required disclosures for endowment funds. A reconciliation of the beginning and ending balances of the not-for-profit’s endowment will now include investment return shown as net of investment income (in other words, interest and dividends), net appreciation or depreciation, and direct internal and external investment expenses. 

Because donor stipulations and laws vary, organizations must assess the relevant facts, circumstances, and laws for their endowment gifts to determine the correct classification of endowment funds within the not-for-profit financial reporting model (see FASB Accounting Standards Codification® Subsection 958-205-45-2). This evaluation should include a determination of whether some or all of the investment return on an endowment is available for spending. If a donor or law imposes a restriction on an investment return, that return will be reported within net assets with donor restrictions until appropriated for expenditure.

When to Implement

Early adoption is permitted before the standard’s effective date of fiscal years beginning after December 15, 2017. It’ll also become effective for interim periods within fiscal years beginning after December 15, 2018.

Not-for-profits should apply the amendments retrospectively to their financial statements. However, when presenting comparative financial statements, entities can elect to omit certain information for periods before the year of adoption. This includes analysis of expenses by both functional and natural classifications as well as disclosures of liquidity and resource availability.

In the year the amendment is first applied, an organization must disclose the nature of reclassifications, restatements, and their effects—if any—on the changes in net asset classes for each year presented.

Start Preparing Now

Not-for-profits can prepare for this change by conducting preliminary discussions on how to best tell their financial story. Those that don’t elect early adoption should consider updating their financial statement presentation instead, using various illustrative examples. It’s best to take the time now to speak with those responsible for governance and the board of directors to determine the optimal presentation of an organization’s financial statements.

We're Here to Help

We’ll continue to provide insight through this series of articles on the new standard. To learn more about ASU 2016-14 and how general changes coming to not-for-profit financial statement requirements may affect your organization, contact your Moss Adams not-for-profit professional.