Not-for-profit entities sometimes need to make corrections to prior-year financial statements so that net assets are appropriately classified in financial statements.
There has been some inconsistency in practice in addressing the circumstance where changes in classifications within net assets in the prior period need to be made.
Prior-period statements are often presented for comparative purposes with current-year financial statements. The apparent confusion relates to whether the changes within net assets should be considered by focusing on net assets in the aggregate or by individual net asset class.
Depending on how not-for-profit entities have addressed this particular issue, financial statements sometimes have reflected the net asset changes as being error corrections and, in other circumstances, the statements have reflected the changes simply as being reclassifications.
To clarify how this financial reporting issue needs to be addressed, the AICPA released some Technical Practice Aid guidance that can be found in TIS Section 6140.23, Changing Net Asset Classifications Reported in a Prior Year.
The Technical Practice Aid guidance refers to the authoritative literature in reaching the conclusion that the appropriate approach in evaluating this particular circumstance would be to focus on individual net asset classes, rather than net assets in the aggregate.
As a reminder, pursuant to the guidance in the FASB Accounting Standards Codification (FASB ASC) Topic 250, Accounting Changes and Error Corrections, errors in previously issued financial statements include those related to measurement, presentation or disclosure in the financial statements resulting from mathematical errors, mistakes in the application of accounting principles generally accepted in the United States (U.S. GAAP), or oversight or misuse of facts that existed at the time the financial statements were prepared.
Additionally, a change from an accounting principle that is not considered to be generally accepted to one that is generally accepted would be considered an error correction.
Not-for-profit entities need to consider individual net asset classes rather than net assets in the aggregate when determining whether correction of classifications in previously issued statements constitute errors in those statements.
The pertinent guidance here actually falls within FASB ASC 958, Not-for-Profit Entities. That guidance contains the clear stipulation that usefulness of information provided in the financial statements is improved significantly if certain basic financial information is classified in a comparable manner from period to period.
In developing the authoritative accounting guidance that addresses this particular financial reporting issue, the FASB concluded that, in assessing the financial position or performance of not-for-profit entities, it is important to avoid focusing attention almost exclusively on net assets, the change in net assets, total assets or other highly simplified and aggregated amounts.
As an example, using the guidance in FASB Concepts Statement No. 6, Elements of Financial Statements, since donor-imposed restrictions affect the types and level of service not-for-profit entities can provide when the entities have maintained certain classes of assets may be more significant than whether they have maintained net assets in the aggregate.
Reclassification of net assets – i.e., simultaneously increasing one net asset class and decreasing another asset class – needs to be made when any of the following circumstances exist:
- Not-for-profit entities fulfill purposes for which net assets were restricted.
- Donor-imposed restrictions expire with the passage of time or with the death of a split-interest agreement beneficiary, if the net assets are not otherwise restricted.
- Donors withdraw, or court actions remove, previously imposed restrictions.
- Donors impose restrictions on otherwise unrestricted net assets.
To illustrate the last item, donors may make restricted contributions that are conditioned on not-for-profit entities restricting stated amounts of unrestricted net assets. Restrictions that are not reversible without consent of donors result in reclassification of unrestricted net assets to restricted net assets.
Essentially, it is important for not-for-profit entities to carefully evaluate classifications within individual net asset classes in efforts to avoid having to correct prior-period financial statements that are presented for comparative purposes.
While many circumstances exist for which reclassifications between net asset classes would be appropriate, any restatements due to inappropriate classifications within net asset classes would not be reflected as reclassifications in the financial statements. Rather, those types of situations result in error corrections being reflected in the statements.