presentation of quasi equity in balance sheet

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ASU 2016-14: The FASB’s New NFP Standard

By: Russ Madray

October 19, 2016 View the report as a PDF On August 18, 2016, the FASB issued Accounting Standards Update (ASU) 2016-14,  Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities . The amendments in this ASU are intended to improve financial statement presentation by not-for-profit (NFP) organizations—a model that has existed for more than 20 years. The new guidance will affect substantially all NFPs, including charities, foundations, private colleges and universities, nongovernmental health care providers, cultural institutions, religious organizations, and trade associations, among others, and requires NFPs to improve their presentation and disclosures to provide more relevant information about their resources (and the changes in those resources) to their donors, grantors, creditors, and other users. There are qualitative and quantitative requirements in a number of areas, including net asset classes, investment return, expenses, liquidity and availability of resources, and presentation of operating cash flows. Practitioners and their NFP clients will need to be especially mindful of the enhanced and additional disclosures required by this ASU. Accordingly, our report will focus on these new disclosure requirements. Net Asset Classification In order to simplify the net asset classification scheme, the new guidance requires NFPs to present, on the face of the statement of financial position, the amount for each of two classes of net assets— net assets with donor restrictions  and  net assets without donor restrictions —as opposed to three. However, the guidance does retain current requirements to provide information about the nature and amounts of different types of donor-imposed restrictions, and also requires similar information about governing board designations. The disclosures are intended to highlight the importance of information about how those restrictions and designations affect the use of resources, including their liquidity. See the illustrative note disclosures at the end of this report for examples of these requirements. As part of the change to net asset classification, the amendments change how endowments that have a current fair value less than the original gift amount (or amount required to be retained by donor or by law), known as “underwater” endowments, are classified; rather than reducing unrestricted net assets for amounts by which endowment funds are underwater, those amounts will be reported within net assets with donor restrictions. The amendments also require disclosure of the aggregate amount by which the funds are underwater, the original gift amount (or amount required to be maintained by the donor or law), and any governing board policy or decisions to spend, or not spend, from such funds. See the illustrative note disclosures at the end of this report for an example of this requirement. CPEA Observation:  NFPs also now will be required to use the placed-in-service approach (without specific donor restrictions stating otherwise) to report expira¬tions of restrictions on gifts of cash or other assets to be used to acquire or construct a long-lived asset; the option to imply a time restriction and release the restriction over an asset’s useful life (the “over-time” approach) will no longer be permitted. This change is intended to improve comparability and bet¬ter reflect the economics of such transactions. Information about Liquidity In order to provide more transparency, the new guidance includes requirements aimed at improving the ability of financial statement users to assess an NFP’s available financial resources and liquidity. Specifically, the amendments require disclosure of both quantitative and qualitative information about the  availability of  and  how  the NFP manages its liquid available resources to meet cash needs for general expenditures within one year of the balance sheet date. See the illustrative note disclosures at the end of this report for examples of these requirements. CPEA Observation:  While note disclosures will still be needed, presenting a classified balance sheet may be an effective way for organizations to comply with many of the new liquidity disclosure requirements. Expense Presentation In order to make information about expenses more comparable and useful, the new guidance requires all NFPs (not just voluntary health and welfare organizations) to provide information about their operating expenses by both nature and function—on the face of the statement of activities, as a separate statement, or in the notes to the financial statements, supplemented with enhanced disclosures about the methods used to allocate costs among functions. See the illustrative note disclosures at the end of this report for an example of this requirement. Practice Note:  While a separate statement of functional expenses is not required, it may be the most effective presentation option for NFPs with more than one program. CPEA Observation:  A net presentation of investment expenses against investment return will be required on the face of the statement of activities; external and direct internal investment expenses will be netted against the investment return. A disclosure of the components of investment expense will no longer be required.  Statement of Cash Flows In a departure from the FASB’s original exposure draft, which would have required the direct method, the new guidance allows NFPs to continue to present either the direct or indirect method of reporting operating cash flows. However, the presentation or disclosure of the indirect method reconciliation is no longer required if the NFP us¬es the direct method. The FASB hopes that the removal of the reconciliation requirement will encourage more NFPs to use the direct method. Effective Date and Transition The amendments are effective for annual financial statements issued for fiscal years beginning after December 15, 2017, and for interim periods within fiscal years beginning after December 15, 2018. Application to interim financial statements is permitted but not required in the initial year of application. Early application is permitted. The amendments should be initially adopted only for an annual fiscal period or for the first interim period within the fiscal year of adoption. NFPs will apply the ASU’s guidance retrospectively. If presenting comparative financial statements, an NFP can elect to omit the following information for any periods presented before the period of adoption:

• Analysis of expenses by both natural classification and functional classification (the separate presentation of expenses by functional classification and expenses by natural classification is still required). NFPs that previously were required to present a statement of functional expenses do not have the option to omit this analysis; however, they may present the comparative period information in any of the formats permitted in this ASU, consistent with the presentation in the period of adoption.
• Disclosures about liquidity and availability of resources.

Practice Note:  Advise your NFP clients to discuss the new guidance with their board. Boards count on financial statements and should be a part of the process for managing implementation. What’s Next? A future Phase 2 of the FASB’s NFP project is slated to address additional issues, including:

• Whether to require intermediate measure(s) in the financial statements
• Whether and how to define such measure(s) and what items should be included
• Alignment of measures of operations in the statement of activities with measures of operations in the statement of cash flows

There is currently no expected timeframe for the completion of the second phase.  Illustrative Note Disclosures These illustrative note disclosures, adapted from ASU 2016-14, provide examples of the following requirements from the ASU:

Note A – Net Assets with Donor Restrictions

Net assets with donor restrictions are restricted for the following purposes or periods.

Subject to expenditure for specified purpose:

Note B – Governing Board Designations Metropolis Community Foundation’s governing board has designated, from net assets without donor restrictions of $92,600, net assets for the following purposes as of June 30, 2017. 

Note C – Underwater Endowments From time to time, the fair value of assets associated with individual donor-restricted endowment funds may fall below the level that the donor or the Uniform Prudent Management of Institutional Funds Act (UPMIFA) requires Metropolis Hospital to retain as a fund of perpetual duration. Deficiencies of this nature exist in 3 donor-restricted endowment funds, which together have an original gift value of $3,500, a current fair value of $3,300, and a deficiency of $200 as of June 30, 2017. These deficiencies resulted from unfavorable market fluctuations that occurred shortly after the investment of new contributions for donor-restricted endowment funds and continued appropriation for certain programs that was deemed prudent by the Board of Trustees.  Metropolis Hospital has a policy that permits spending from underwater endowment funds depending on the degree to which the fund is underwater, unless otherwise precluded by donor intent or relevant laws and regulations. The governing board appropriated for expenditure $75 from underwater endowment funds during the year, which represents 3 percent of the 12-quarter moving average, not the 5 percent it generally draws from its endowment. Note D – Availability of Financial Assets The following reflects Metropolis Museum’s financial assets as of the balance sheet date, reduced by amounts not available for general use because of contractual or donor-imposed restrictions within one year of the balance sheet date. Amounts not available include amounts set aside for long-term investing in the quasi-endowment that could be drawn upon if the governing board approves that action. However, amounts already appropriated from either the donor-restricted endowment or quasi-endowment for general expenditure within one year of the balance sheet date have not been subtracted as unavailable.

Metropolis Museum is substantially supported by restricted contributions. Because a donor’s restriction requires resources to be used in a particular manner or in a future period, Metropolis Museum must maintain sufficient resources to meet those responsibilities to its donors. Thus, financial assets may not be available for general expenditure within one year. As part of Metropolis Museum’s liquidity management, it has a policy to structure its financial assets to be available as its general expenditures, liabilities, and other obligations come due. In addition, Metropolis Museum invests cash in excess of daily requirements in short-term investments. Occasionally, the board designates a portion of any operating surplus to its liquidity reserve, which was $1,300 as of June 30, 2017. There is a fund established by the governing board that may be drawn upon in the event of financial distress or an immediate liquidity need resulting from events outside the typical life cycle of converting financial assets to cash or settling financial liabilities. In the event of an unanticipated liquidity need, Metropolis Museum also could draw upon $10,000 of available lines of credit (as further discussed in Note X) or its quasi-endowment fund.  Note E – Availability of Financial Assets Metropolis Foundation financial assets available within one year of the balance sheet date for general expenditure are as follows.

Metropolis Foundation’s endowment funds consist of donor-restricted endowments and a quasi-endowment. Income from donor-restricted endowments is restricted for specific purposes and, therefore, is not available for general expenditure. As described in Note Y, the quasi-endowment has a spending rate of 5 percent. $1.65 million of appropriations from the quasi-endowment will be available within the next 12 months.  As part of Metropolis Foundation’s liquidity management, it has a policy to structure its financial assets to be available as its general expenditures, liabilities, and other obligations come due. In addition, Metropolis Foundation invests cash in excess of daily requirements in short-term investments. To help manage unanticipated liquidity needs, Metropolis Foundation has committed lines of credit in the amount of $20 million, which it could draw upon. Additionally, Metropolis Foundation has a quasi-endowment of $33 million. Although Metropolis Foundation does not intend to spend from its quasi-endowment other than amounts appropriated for general expenditure as part of its annual budget approval and appropriation process, amounts from its quasi-endowment could be made available if necessary. However, both the quasi-endowment and donor-restricted endowments contain investments with lock-up provisions that would reduce the total investments that could be made available (see Note X for disclosures about investments).  Note F – Expenses by Nature and Function The table below presents expenses by both their nature and their function for fiscal year 2017. 

The financial statements report certain categories of expenses that are attributable to more than one program or supporting function. Therefore, these expenses require allocation on a reasonable basis that is consistently applied. The expenses that are allocated include depreciation, interest, and office and occupancy, which are allocated on a square-footage basis, as well as salaries and benefits, which are allocated on the basis of estimates of time and effort. The CPEA provides non-authoritative guidance on accounting, auditing, attestation, and SSARS standards. Official AICPA positions are determined through certain specific committee procedures, due process and extensive deliberation. The views expressed by CPEA staff in this report are expressed for the purposes of providing member services and other purposes, but not for the purposes of providing accounting services or practicing public accounting. The CPEA makes no warranties or representations concerning the accuracy of any reports issued.

Copyright © 2016 by American Institute of Certified Public Accountants, Inc. New York, NY 10036-8775. All rights reserved. For information about the procedure for requesting permission to make copies of any part of this work, please e-mail  [email protected] with your request. Otherwise, requests should be written and mailed to the Center for Plain English Accounting, AICPA, 220 Leigh Farm Road, Durham, NC 27707-8110.

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Balance Sheets 101: What Goes On a Balance Sheet?

• 09 Jun 2016

A balance sheet is one of the primary statements used to determine the net worth of a company and get a quick overview of its financial health. The ability to read and understand a balance sheet is a crucial skill for anyone involved in business, but it’s one that many people lack.

What Is a Balance Sheet?

A balance sheet provides a snapshot of a company’s financial performance at a given point in time. This financial statement is used both internally and externally to determine the so-called “book value” of the company, or its overall worth.

Balance sheets are typically prepared and distributed monthly or quarterly depending on the governing laws and company policies. Additionally, the balance sheet may be prepared according to GAAP or IFRS standards based on the region in which the company is located.

The balance sheet is just a more detailed version of the fundamental accounting equation—also known as the balance sheet formula—which includes assets , liabilities , and shareholders’ equity .

The Balance Sheet Equation

Balance sheets are typically organized according to the following formula:

Assets = Liabilities + Owners’ Equity

The formula can also be rearranged like so:

Owners’ Equity = Assets - Liabilities or Liabilities = Assets - Owners’ Equity

A balance sheet must always balance; therefore, this equation should always be true.

You’ve probably heard at least some of these terms before. But what do they actually mean and include? Let’s break it down. Below, we’ll explore what exactly goes on a balance sheet.

What Goes on a Balance Sheet?

The assets are the operational side of the company. Basically, a list of what the company owns . Everything listed is an item that the company has control over and can use to run the business.

The left side of the balance sheet is the business itself, including the buildings, inventory for sale, and cash from selling goods. If you were to take a clipboard and record everything you found in a company, you would end up with a list that looks remarkably like the left side of the balance sheet. The assets are what allow the company to run.

Assets can be further categorized as either current assets or fixed (non-current) assets. Some of the most common current assets include:

• Cash and cash equivalents
• Accounts receivable
• Short-term marketable securities

Common fixed or non-current assets include:

• Property and equipment
• Long-term marketable securities
• Intangible assets such as patents, licenses, and goodwill

Assets will typically be presented as individual line items, such as the examples above. Then, current and fixed assets are subtotaled and finally totaled together.

2. Liabilities

Liabilities and equity make up the right side of the balance sheet and cover the financial side of the company. This is a list of what the company owes. With liabilities, this is obvious—you owe loans to a bank, or repayment of bonds to holders of debt. The interest rates are fixed and the amounts owed are clear. Liabilities are listed at the top of the balance sheet because, in case of bankruptcy, they are paid back first before any other funds are given out.

Similar to assets, liabilities are categorized as current and non-current liabilities. Common current liabilities include:

• Accounts payable
• Salaries and wages payable
• Deferred revenue
• Commercial paper
• Accrued expenses
• Short-term debt

Non-current liabilities include:

• Long-term debt
• Long-term lease obligations

Liabilities are presented as line items, subtotaled, and totaled on the balance sheet.

Below liabilities on the balance sheet is equity, or the amount owed to the owners of the company. Since they own the company, this amount is intuitively based on the accounting equation—whatever assets are left over after the liabilities have been accounted for must be owned by the owners, by equity. These are listed at the bottom of the balance sheet because the owners are paid back after all liabilities have been paid.

Unlike liabilities, equity is not a fixed amount with a fixed interest rate. Any time the value of assets change—perhaps you receive more in cash from a sale than the value of the inventory you sold, or you were forced to write down a truck that was involved in a collision and no longer works—the value of equity changes.

Because the value of liabilities is constant, all changes to assets must be reflected with a change in equity. This is also why all revenue and expense accounts are equity accounts, because they represent changes to the value of assets.

Common line items in the equity section of the balance sheet include:

• Common stock
• Preferred stock
• Treasury stock
• Retained earnings

Together, these line items make up total shareholders’ equity.

To recap, you’ll find the assets (what’s owned) on the left of the balance sheet, liabilities (what’s owed) and equity (the owners’ share) on the right, and the two sides remain balanced by adjusting the value of equity.

The Language of Business

It’s commonly held that accounting is the language of business. Understanding and analyzing key financial statements like the balance sheet , income statement, and cash flow statement is critical to painting a clear picture of a business’s past, present, and future performance. Knowing what goes into preparing these documents can also be insightful.

On a more granular level, the fundamentals of financial accounting can shed light on the performance of individual departments, teams, and projects. Whether you’re looking to understand your company’s balance sheet or create one yourself, the information you’ll glean from doing so can help you make better business decisions in the long run.

Want to learn more about what’s behind the numbers on financial statements? Explore our eight-week online course Financial Accounting —one of our online finance and accounting courses —to learn the key financial concepts you need to understand business performance and potential.

(This post was updated on January 31, 2023. It was originally published on June 9, 2016.)

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AAOIFI issues exposure drafts on “Quasi-equity (including Investment Accounts)” and “Off-Balance-Sheet Assets Under Management”

The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) Accounting Board (AAB / the board) has officially issued exposure drafts on “Quasi-equity (including Investment Accounts)” and “Off-Balance-Sheet Assets Under Management”. The proposed standards intend to improve upon and together supersede FAS 27 “Investment Accounts”.

The objective of the exposure draft on “Quasi-equity (including Investment Accounts)” is to establish the principles of financial reporting related to instruments classified as quasi-equity, such as investment accounts and similar instruments invested with the Islamic financial institution (the institution). Quasi-equity is an element of financial statements of an institution in line with the “AAOIFI Conceptual Framework for Financial Reporting” (the conceptual framework). The proposed standard provides the overall criteria for on-balance-sheet accounting for participatory investment instruments and quasi-equity, as well as, pooling, recognition, derecognition, measurement, presentation and disclosure for quasi-equity.

The proposed standard on “Off-balance-sheet Assets Under Management” aims to establish the principles of financial reporting related to off-balance-sheet assets under management in line with the conceptual framework. The proposed standard encompasses the aspects related to recognition, derecognition, measurement, selection and adoption of accounting policies etc., related to off-balance-sheet assets under management, as well as, certain specific aspects of financial reporting e.g., impairment and onerous commitments by the institution.

On this occasion, Mr Hamad Al Oqab, chairman of the AAB, stated that; “In view of the unique business model of Islamic financial institutions, as an outcome of the revision of FAS 27 “Investment Accounts”, the board decided to issue in its place two distinct standards addressing the financial reporting for instruments classified as quasi-equity and off-balance-sheet assets under management. The proposed standard intent to provide the users and preparers of financial statements with the required guidance and clarification of qualification criteria for on and off-balance-sheet accounting as per AAOIFI’s financial reporting framework. He further added: “With the issuance of the exposure drafts, the board has completed the initial stage of the revision of FAS 27 “Investment Accounts””.

To obtain industry feedback, a series of public hearings for the exposure drafts is scheduled to be held during 2023.

The exposure draft on “Quasi-equity (including Investment Accounts)” can be accessed by CLICKING HERE

The exposure drafts on “Off-Balance-Sheet Assets Under Management” can be accessed by CLICKING HERE

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