Changes to Nonprofit Investment Accounting and Reporting under FASB ASU 2016-01
In January 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-01, “Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.” The amendments in this ASU address certain aspects of recognition, measurement, presentation and disclosure of financial instruments. The amendments in this update are applicable to all entities that hold financial assets or owe financial liabilities, including not-for-profit entities (NFPs). While there are several provisions within the ASU, the following is intended to specifically discuss what we believe to be the most relevant for NFPs.
First, it is important to understand how an equity security is defined within ASU 2016-01. The guidance in this ASU is generally applicable to investments in equity securities and other ownership interests in an entity, including investments in partnerships, unincorporated joint ventures and limited liability companies. An equity security is defined within the ASU as “any security representing an ownership interest in an entity (for example, common, preferred, or other capital stock) or the right to acquire (for example, warrants, rights, forward purchase contracts, and call options) or dispose of (for example, put options and forward sale contracts) an ownership interest in an entity at fixed or determinable prices.” The guidance does not apply to derivative instruments, equity method investments, investments in consolidated subsidiaries or investments held by a financial interrelated entity. Investments measured at net asset value (NAV) are discussed further below.
Certain NFPs, primarily healthcare entities, may designate a portion of their investment portfolio as ‘available-for-sale’ (AFS), ‘trading’ or ‘held-to-maturity’ (for debt securities). Currently, changes in the fair value of debt and equity securities classified as trading securities are included within an operating measure (in the case of an NFP business-oriented healthcare entity, this would be the performance indicator), while the changes in fair value of AFS and held to maturity debt and equity securities may be reported outside the operating measure, as changes in net assets without donor restrictions (unless restricted by donor stipulation or by law).
The most significant provision of this ASU impacts those NFPs that designate their investment in equity securities as AFS. Entities are no longer allowed to classify equity securities as trading or AFS. Further, changes in fair value of equity securities (within the scope of the guidance) must be recognized within an operating measure. This is a significant change from current accounting rules, which provide for recognizing the changes in fair value outside the operating measure, as previously discussed. The ASU does not, however, change the guidance for classifying and measuring investments in debt securities (i.e. changes in the fair value of debt securities can continue to be excluded from an operating measure, unless the debt security is deemed a trading debt security).
The other significant provision in the ASU is the application of the cost method to certain equity investments that do not have readily determinable fair values. The fair value measurement of certain equity securities may be difficult to obtain because of the nature of the investment. Previously, these investments were generally allowed to be reported at cost. Under the new ASU, the cost method of accounting is no longer allowed. Such investments are required to be reported at their estimated fair value. However, the guidance does provide for a measurement alternative. Under this measurement alternative, NFPs may choose to measure the investment at cost, less impairment, adjusted for observable price changes in orderly transactions for the identical or similar investments of the same issuer. If this measurement alternative is not elected, equity securities without readily determinable fair values must be reported at their estimated fair value, just like other equity securities. Each investment must have a separate election made for the measurement alternative, and this has to be reassessed at each reporting period to ensure the investment still qualifies for the alternative. The new guidance also simplifies the impairment analysis for each equity security without a readily determinable fair value that uses the measurement alternative by requiring a qualitative assessment to identify impairment.
It is important to note that the measurement alternative only applies to equity securities that do not have readily determinable fair values and that do not qualify for the existing practical expedient in Accounting Standards Codification (ASC) 820 to estimate fair value using the NAV per share (or its equivalent). For example, many NFPs own investments structured as limited liability companies, limited partnerships, institutional trusts, common and collective trusts, or similar equity instruments. These are commonly referred to as “alternative investments.” Alternative investments typically provide their investors with a NAV per share (or its equivalent, such as member units or an ownership interest in partners’ capital to which a proportionate share of net assets is attributed). While each alternative investment must be carefully reviewed to determine the appropriate method of accounting, many qualify for the practical expedient to estimate fair value using their NAV under ASC 820. Therefore, these alternative investments are generally excluded from the measurement alternative as ASC 820 continues to apply.
Another important item to note is that ASC 321, Investments – Equity Securities, which is the new subtopic resulting from this ASU, uses the term ‘equity securities’ to include equity instruments that do not meet the definition of a security. Thus, ownership interests in all entities, including general partnerships, limited liability companies, limited liability partnerships, joint ventures, and so forth, are within the scope of ASC 321, unless they are consolidated subsidiaries or accounted for using the equity method.
The ASU also revises certain disclosure requirements. Most notable to NFPs are the following requirements:
- presenting financial assets and financial liabilities separately, grouped by measurement category and form of financial asset (that is, securities or loan and receivables) on the statement of financial position or in the accompanying notes to the financial statements;
- for equity securities without readily determinable fair values for which the measurement alternative is applied, disclosure of the carrying value, impairment adjustments and qualitative/quantitative information over observable price change adjustments; and
- elimination of the requirement to disclose the fair values of financial instruments measured at amortized cost (for entities other than public business entities). Examples include notes receivable and debt.
For public business entities, the amendments in this ASU are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. For all other entities, including most NFP organizations, the amendments are effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. Early adoption is permitted by entities other than public business entities as of the fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Also, the provision exempting nonpublic entities from the requirement to disclose fair values of financial instruments can be early adopted.
The amendments in the ASU should be recorded as a cumulative-effect adjustment to the statement of financial position as of the beginning of the fiscal year in which the guidance is adopted. The amendments related to equity securities without readily determinable fair values (including disclosure requirements) should be applied prospectively to all investments that exist as of the date of adoption.
In summary, depending on the makeup and classification of the securities held by your organization, this new ASU could have some impact, particularly to business-oriented healthcare organizations that report a performance indicator. Debt covenant requirements could also be impacted in some cases. The above highlights the more significant impact to NFPs, but there are other provisions within ASU 2016-01 that may also impact your organization. Please refer to the detail of the full ASU, which can be found at the FASB website.
If you have any questions regarding ASU 2016-01, please contact Tiffany Cavanaugh or your BNN advisor at 800.244.7444.
Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, investment, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.