Recent nonprofit financial reporting standards updates will result in several changes to external financial statements that church financial leaders should understand.
Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) 2016-14 is intended to improve information in nonprofits’ external financial statements and notes about financial performance, cash flows, liquidity, and availability. The ASU is in effect starting for churches and other nonprofits with a December 31, 2018 year-end audit, review, or compilation.
External financial statements are used to provide information to outside parties such as banks, church extension funds, and other lending institutions. Financial statements prepared under Generally Accepted Accounting Principles (GAAP) must include “footnote disclosures” that explain policies, background details, facts, or additional numerical summaries about totals in the statements. ASU 2016-14 includes the addition of specific liquidity disclosures to the footnotes of the external financial statements (we covered this in detail in Part 1 and Part 2 of our recent XPastor article series).
Church management and board members have consistently asked four questions about one of these changes, a new amount called “financial assets available to meet cash needs for general expenditures within one year” (I’ve shortened this to “financial assets available” in this article).
Even if they don’t ask, I include the answers to these questions in our church clients’ final audit or review exit presentation. It’s important for every church financial leader (including elders or board members, audit/finance committee members and senior management) to ask and understand the answers to these four key questions.
1. What are “financial assets available”?
Here is a sample liquidity disclosure under ASU 2016-14 as it may appear in your church’s external financial statements:
The table ends with the total financial assets available. But what are they?
In most cases, especially for churches, financial assets available represent the undesignated operating cash of the church. Undesignated operating cash is the amount of cash available less unrestricted funds set aside by the board, and less funds held for donor-imposed restrictions. Essentially, they are resources available for your church to spend as needed in its day-to-day operations.
If your church does not have board-designated funds for operating reserves, this represents your operating reserves. If you do have board-designated funds for operating reserves, this amount needs to be added back to determine the church’s total operating reserves.
2. How do financial assets available relate to the unrestricted – undesignated net assets?
This is a very important question because the two amounts may not be not the same. This total does not replace unrestricted (now known as “without donor restrictions” under ASU 2016-14) – undesignated net assets (we’ve shortened this to “undesignated net assets” in this article). Over the years, I’ve emphasized how important it is for church boards to manage their undesignated net assets, and that has not changed. Undesignated net assets are the result of achieving positive change in net assets (known as “net income” in the for profit world) in the unrestricted (without donor restrictions) column of the statement of activities over the life of the church.
In business terms, this is the net income accumulated in retained earnings that result from earning money in the day-to-day operations of the church, so that the church has adequate cash flows to maintain its ministries. These accumulated earnings serve the same purpose, whether you call them “retained earnings” as in a for-profit entity or “undesignated net assets” as in a not-for-profit. They are reserves that will help fund the general operations of the church during the following year.
Undesignated net assets are key to the life of the church and must be closely monitored, especially when the church does not have adequate board-designated funds set aside for operating reserves. Many churches I work with set aside enough operating reserves to cover 8 to 12 or more weeks of operating expenditures.
To demonstrate the difference between the two amounts (and how they relate), I provide the boards I work with a statement of Operating Assets, Liabilities and Net Assets during the exit conference (this statement is not part of the audited or reviewed financial statements because it only represents the operating portion of the church’s financial information).
Another way to look at this is to think of the external financial statement as a pizza. The statement of Operating Assets, Liabilities and Net Assets only represents one slice of the pizza, but it’s a very important slice. Let’s look at some examples:
In Scenario 1, the church increased its balances of accounts payable, accrued payroll, and accrued expenses, which had the effect of increasing operating liabilities. The offset was a corresponding increase to financial assets available. If you don’t pay accounts payable or other accrued expenses, you aren’t spending cash and operating cash increases.
In Scenario 2, the church prepaid several expenses—thereby increasing prepaid expenses—without considering the impact on their operating cash. By doing this, they lowered the financial assets available by the same amount that they increased prepaid expenses.
Now let’s look at a few more scenarios:
In Scenario 3, the church drew down an additional $130,000 on its operating line of credit (LOC), which increased operating liabilities and financial assets available. This also makes sense as a draw of cash on the LOC would provide additional operating cash (and also the corresponding liability).
In Scenario 4, the church’s school, which is part of the church’s financial statements, accelerated billings for the following fiscal year. This increased cash received and the corresponding deferred revenue liability. It would not have been a factor if the school was not part of the church’s financial statements.
Note that even though all these examples had the same net assets without donor restrictions — undesignated balance, each is reporting a different financial assets available amount.
However, the most fiscally responsible way to increase this amount over the long term is as follows: