Non-Profit Blog

The Evolving Role of CFOs in Driving ESG Initiatives

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According to BDO Middle Market CFO Outlook Survey, 64% of chief financial officers (CFOs) believe environmental, social and governance (ESG) adoption will improve their organization’s long-term financial performance. However, for sustainability initiatives to succeed, ESG needs to be a cross-functional collaboration. Finance leaders must play a leading role in advancing their organization’s ESG strategy as they have access to large amounts of organizational data and influence over budget and business strategy. CFOs must lead efforts to identify, measure and report ESG factors, integrate ESG risks into overall enterprise risk management, and collaborate with risk leaders to address both strategy and oversight around issues like climate, workplace matters, and reputation.

CFOs must also navigate new metrics as ESG reporting will soon escalate from best practice to a regulatory mandate for certain entities. Organizations with international operations may already face sustainability reporting requirements. Once the SEC finalizes its proposed climate change disclosures, publicly traded U.S. companies will be required to disclose the impact of material climate risks on their business, operations, value chain and strategy, and greenhouse gas emissions data. Private entities and nonprofit organizations can use this as a basis to look at what may become a focus area of their stakeholders and determine whether to voluntarily adopt ESG reporting. CFOs must collaborate with the organization’s sustainability leader to assess the significance of ESG risks and determine stakeholder materiality, nonfinancial ESG priorities, industry-specific standards and disclosure of best practices.

Finally, CFOs need to embed ESG into their own decision-making processes, drive accountability and take the lead in transforming ESG strategy from vague values to tangible action. CFOs must ensure that ESG initiatives are implemented with an eye on the bottom line by striking a balance between targeted, socially responsible cost- reduction initiatives and smart spending to fuel sustainable growth. History has shown that organizations with sustainable business models generally grow faster than those without them, and sustainable business model innovation is quickly becoming necessary to attract and retain ESG-conscious stakeholders.

© 2023 BDO USA, LLP. All rights reserved. www.bdo.com

The IRS Weighs in on Nonprofit NIL Collectives

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The IRS on June 9, 2023, released generic legal advice memorandum AM 2023-004, which addresses whether developing paid name, image, and likeness (NIL) opportunities for collegiate student-athletes furthers an exempt purpose under Internal Revenue Code Section 501(c)(3).

The memorandum concludes that many 501(c)(3) organizations developing these opportunities for student-athletes are not tax-exempt because the private benefits they provide to student-athletes are not incidental, either qualitatively or quantitatively, to any exempt purpose furthered by that activity.

In 2021, the NCAA adopted an interim NIL policy permitting student-athletes to be compensated for the use of their NIL without impacting their NCAA eligibility. Under the interim policy, student-athletes may receive compensation for NIL activities subject to certain limitations.

The interim policy prohibits NIL agreements without a quid pro quo (i.e., compensation for work not performed) and agreements in which compensation is contingent on enrollment at a particular school or athletic participation or achievement. In addition, state laws and university-specific NIL policies may impose additional requirements or limitations on student-athlete NIL activities.

Since the interim policy was adopted, many organizations, generally referred to as “NIL collectives,” have been established by boosters and fans of one or more of a university’s athletic programs to develop, fund or otherwise facilitate NIL deals for student-athletes. NIL collectives generally operate independently of the affiliated university, and some are formed as nonprofit entities under state law and have applied for and received recognition of tax exemption under Section 501(c)(3) using Forms 1023 and 1023-EZ.

In general, a nonprofit NIL collective pools contributions, identifies and partners with local and regional charities to develop paid NIL opportunities for student-athletes of the university, and pays compensation to the student-athletes in exchange for their NIL in a manner consistent with NCAA regulations, university policies, and state and local laws. The paid NIL opportunities typically include promoting the collective or a partner charity through a video or social media post, attending a fundraising event, autographing memorabilia for the collective or a partner charity to sell, or participating in or leading a sports camp.

The issue considered in the IRS memorandum is whether an organization that develops paid NIL opportunities furthers an exempt purpose under Section 501(c)(3).

Section 501(c)(3) provides exemption for organizations organized and operated exclusively for one or more of the exempt purposes set forth in 501(c)(3). The regulations provide that an organization is not operated exclusively for exempt purposes unless it serves public and not private interests.2 When an organization serves both public and private interests, the private benefit must be clearly incidental to the overriding public interest.

Unlike the prohibition against private inurement to insiders, which is absolute, private benefit to non-insiders will not preclude an organization from exemption under Section 501(c) (3) if the private benefit is incidental in both a qualitative and quantitative sense. To be qualitatively incidental, the private benefit must be a byproduct of the exempt activity or a necessary collateral result to the accomplishment of the exempt purpose. To be quantitatively incidental, the private benefit must be insubstantial in amount when compared to the overall public benefit conferred by the activity.

Applying these principles to nonprofit NIL collectives, the IRS states in the memorandum that the benefit to private interests will, in most cases, be more than incidental, both qualitatively and quantitatively. The IRS found that the private benefit received by the student-athletes was not qualitatively incidental for numerous reasons. The memorandum notes that the compensation received by the student-athletes is not a byproduct — but rather a fundamental part — of a nonprofit NIL collective’s activities, and that in many circumstances the compensation for NIL activities is the very justification for the organization’s existence. It further noted that the benefits received by the student-athletes extend beyond compensation by relieving the student-athletes of the transaction and compliance costs they would otherwise incur to participate in an NIL deal (e.g., identifying and vetting partner charities, negotiating the terms of the NIL deal and ensuring compliance with state NIL laws).

The IRS also found that the private benefit to student-athletes is not quantitatively incidental because the private benefit received by the student-athletes was not insubstantial when compared to the overall public benefit conferred by the activity. The memorandum noted that many NIL collectives pay, or intend to pay, all funds to student athletes after payment of administrative and other expenses, with some promising to pay 80% or even 100% of all contributions to student-athletes, which by any measure could not be considered incidental.

The IRS Office of Chief Counsel concluded that many organizations that develop paid NIL opportunities for student athletes are not tax-exempt as described in Section 501(c)(3) because the private benefits they provide to the student-athletes are not incidental — either qualitatively or quantitatively — to any exempt purpose furthered by that activity.

© 2023 BDO USA, LLP. All rights reserved. www.bdo.com

How Can AI Technology Create Value in Higher Education?

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Incredible advances in technology in recent years have enabled organizations to connect with and serve stakeholders in new and increasingly efficient ways. This includes leveraging artificial intelligence (AI) and chatbot technologies to revolutionize higher education operations, offering many benefits to institutions and their various stakeholders.

In the past few years, we have seen higher education institutions hone their competitive edge by harnessing AI capabilities to increase efficiencies, make data-driven decisions, improve student support, create personalized learning experiences and increase inclusivity in learning. Below, we explore areas where higher education institutions have taken advantage of such technology and the associated benefits.

AI Can Improve Operational Efficiency

The education programs that define colleges and universities would not be possible without sizable and complex back-office structures, the magnitude of which is hard to grasp without intimate knowledge of university operations. From recruitment to research services, human resources to legal, and finance to facilities, there are numerous behind-the-scenes processes in place to ensure faculty and students have a positive, seamless experience. Administrative processes, especially those lacking automation and modernization, can be fraught with inefficiencies, delays and human errors that have the potential to negatively impact the college’s financials and faculty and student experiences.

There are multiple use cases for how AI has helped colleges and universities increase efficiency and decrease costs related to back-office functions. These include:

Improving Recruitment and Retention Efforts

College recruitment and enrollment efforts can be costly, challenging and inefficient. To address these inefficiencies, many colleges and universities are leveraging AI to generate models that target potential students based on specific criteria and demographic characteristics. These solutions allow schools to identify, collect and analyze relevant data to isolate and recruit students with the highest likelihood of attending, which has helped schools save countless hours and dollars related to analyzing data and contacting prospective students with little to no chance of matriculating. As a result, schools have increased enrollment (or at least the related yield) and decreased recruiting costs.

Similarly, using AI chatbots has been shown to help significantly decrease “summer melt,” which is when students admitted to a school fail to matriculate for the upcoming year. Studies show that the need to jump through administrative hoops is an important driver of such decisions for newly admitted students.

In recent years, some institutions have utilized AI chatbots to reduce the melt. After introducing a chatbot in 2016, one such institution saw a 22% decrease in summer melt by 2020. The university partnered with a student engagement platform to develop and implement a smart text messaging capability available 24/7 to answer questions regarding admissions and enrollment, financial aid applications, placement exams and class registration. The chatbot even reaches out to students via text when they have not completed tasks by certain dates.

Identifying and Targeting Key Donors

Higher education institutions can automate and optimize their fundraising practices to engage alumni and donors more effectively. By studying donor history and preferences, AI algorithms can predict the likelihood of future giving. These predictions can then be used to group donors and tailor communication and fundraising strategies accordingly.

In addition, AI can segment prospects or donor data based on similarities such as geography, age, major in college, graduation year and other factors. This can help customize fundraising strategies to better engage and retain donors. Higher education institutions can also tap into AI language generation models such as ChatGPT to generate emails, thank you or stewardship letters, fundraising ideas and proposals.

Improving Facilities Operations Through Data-Driven Decisions

Big data is also adding value by helping universities make decisions that optimize costs. At one university, a water irrigation program coordinator reduced the time spent managing sprinkler systems from eight hours to only 30 minutes daily. Moreover, this university saves $1 million each year from decreasing water usage from 176 million gallons to 35 million. How was this achieved? None other than AI: the university invested in an automated water landscaping system that processes data and decides how to manage the campus’s water irrigation. With the help of AI, the water irrigation program coordinator and his team can “identify problems and make changes very quickly.”

Predictive Analytics Can Offer Tailored Student Support and Communications

With the decline in college enrollment and graduation, it is imperative that schools think of innovative ways to support and retain their students. AI has great potential to improve the student experience. And while AI chatbots will never completely replace person-to-person interaction, they can do wonders to fill the gap. AI’s capabilities can provide individualized support to students, identify those who are at risk and make for a more inclusive environment.

Personalizing Learning Experiences

One of the most promising aspects of AI in higher education is its potential to customize learning for each student. By analyzing data on individual learning styles, preferences and progress, AI can tailor educational content to create individualized educational experiences for all students.

A college-level AI teaching assistant named Jill Watson demonstrates this unique capacity. In an online course, Knowledge-Based Artificial Intelligence, Professor Ashok Goel used Jill to respond to about 100,000 questions that students posted on the class forum. By doing so, Jill helped the professor achieve “personal attention at scale,” reaching more students than would have been feasible with only human aid.

Another institution is also taking advantage of AI technology to create a personalized learning experience. This school partnered with IBM Research to build a virtual environment in which students can learn and practice Mandarin. With the computational architecture in place, the school launched the course, “AI-Assisted Immersive Chinese.” In the digitized language immersion experience, students learn Chinese by interacting with computer-generated characters and receiving feedback from them.

These projects demonstrate the future of education, one in which students can have deeper understanding of material and greater satisfaction with learning outcomes. The possibilities are endless.

Identifying At-Risk Students

A public research university is using behavioral intelligence and predictive AI – with a 10-year dataset of student records – to improve student retention, provide support and predict performance outcomes. In one instance, a student realigned his academic goals after a computer program notified his academic advisor that the student’s B-average GPA was not likely to sustain him in the school’s Nursing Program. So, his advisor helped him shift toward another major of interest in which he would stay on track to graduate.

This university has even developed and implemented engagement campaigns supported via text messaging. These campaigns target students to remind and encourage them to participate in academic activities and instruction that may add to their academic success, non-classroom activities of potential interest and administrative processes and deadlines that could impact their education.

Making Learning Accessible and Inclusive

AI and chatbots provide higher education institutions with the opportunity to enhance their accessibility and inclusivity. AI-powered tools can serve students with various needs by providing additional support: speech-to-text, text-to-speech, visual representations and many other adaptive technologies.

At another public research university, students can receive assistive technology resources to make learning more accessible. The Student Disability Resource Center’s Assistive Technology Lab offers various tools to assist students with disabilities ranging from hearing or visual impairments to learning challenges. This includes note taking and recording apps, speech-to-text tools, and text-to-speech technologies. The center also works with instructors to create an inclusive learning environment, such as guidance on using “Blackboard Ally,” which creates alternative versions of content to make it more accessible according to the way each student learns.

Conclusion

As AI technologies continue to evolve, educational institutions need to acknowledge, understand and, as they see fit, leverage the capabilities of AI and chatbots to improve the student experience. By doing so, schools can create more efficient, engaging and inclusive learning environments, position themselves at the forefront of educational innovation and better prepare students for the future. Investing in students’ educational experiences is an investment in the future.

© 2023 BDO USA, LLP. All rights reserved. www.bdo.com

How Nonprofits and Local Governments Can Leverage Sustainability Tax Credits

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When examining the availability of tax credits, organizations in the nonprofit and local government space typically disregard the opportunity as inapplicable to their organizations. To tax-exempt entities, the concept of leveraging credits to lower their tax burden may seem at odds with their tax status. However, to help build a more sustainable and equitable future, the federal government has made some tax credits available to these organizations to facilitate their work. As community-leading organizations, exempt entities have historically been the primary drivers of economic and sustainable development. Therefore, it only makes sense for the funding to be made available to those most familiar with it.

A Historic Moment

On Aug. 16, 2022, President Biden signed the Inflation Reduction Act (IRA) into law, representing the largest investment in climate action in American history. It is estimated that the IRA’s provisions will help reduce carbon emissions throughout the country by 40%. Facilitating the work of both for-profit and community-leading organizations, the ultimate goal is to mitigate the effects of climate change across the country.

Through the IRA, Section 6417 was added to the Internal Revenue Code (IRC). The section provides for a monetization of applicable tax credits, referred to as “elective pay” in the IRC and commonly known as “direct pay.” Direct pay allows tax-exempt entities to claim some tax credits, which can be treated as a refundable payment against federal income taxes, effectively providing a dollar-for-dollar cash grant in the amount of the tax credit.

Nonprofits, state and local governments, Indian tribal governments, Alaska Native Corporations and rural electrical cooperatives have each been identified as entities eligible to receive this benefit. Direct pay has created a powerful funding mechanism for organizations seeking to finance sustainability projects.

What Credits are Eligible?

Not all federal tax credits are eligible for direct pay. Eligible credits are those introduced or expanded through the IRA, and which are meant to support investment in renewable energy or green technologies.

Eligible credits include the following:

  • Energy credit (Section 48)
  • Clean electricity investment credit (Section 48E)
  • Renewable electricity production credit (Section 45)
  • Clean electricity production credit (Section 45Y)
  • Commercial clean vehicle credit (Section 45W)
  • Zero-emission nuclear power production credit (Section 45U)
  • Advanced manufacturing production credit (Section 45X)
  • Clean hydrogen production credit (Section 45V)
  • Clean fuel production credit (Section 45Z)
  • Carbon oxide sequestration credit (Section 45Q)
  • Credit for alternative fuel vehicle refueling/recharging property (Section 30C)
  • Qualifying advanced energy project credit (Section 48C)

How Does it Work?

To claim the credit, applicable entities must first complete a prefiling registration process with the IRS that results in a credit registration number. The appropriate tax forms must be completed (for example, Form 3468 and Form 3800 for an energy credit) and included on an original, timely filed return (including extensions) with the direct pay election.

Organizations that already file an annual tax return would continue to file that return with the appropriate tax credit form. Organizations that do not normally file an annual information return with the IRS, would utilize a Form 990-T.

Issues for Consideration

While direct pay offers a powerful funding mechanism for sustainability projects, there are several outstanding issues that require further guidance. One such issue involves joint venture partnerships. A partnership cannot make a direct pay election, even if all partners qualify as applicable entities in their own right. Partners are also not permitted to individually claim direct pay because they are not the direct owners of the property or activities generating eligible credits. This poses a challenge for project funding, as many tax-exempt entities often collaborate with private partners who contribute expertise or capital to bring sustainability projects to fruition.

Another issue involves the treatment of qualified progress expenditures. Filers are generally allowed to claim a credit for qualifying progress expenditures incurred in tax years preceding the year a project is placed in service. This provision enables earlier benefits for multiyear projects. The proposed regulations under Section 6418 recently clarified that tax credits for qualified progress expenditures may not be transferred. However, the proposed regulations under Section 6417 notably do not include similar language. It is not clear whether this omission was a technical oversight or if the government intended to allow a direct pay election for qualified progress expenditures.

In conclusion, it is crucial for applicable entities that previously had no use for federal tax credits to now consider monetizing these credits, which can provide cash for sustainability projects. By assessing whether their investments or activities qualify for a credit eligible for direct pay, applicable entities can unlock the potential to generate funds for their sustainability initiatives.

With the IRS planning to launch the prefiling registration portal by the end of 2023, it is important for applicable entities to proactively gather the necessary documentation to support their credits. By preparing to complete the appropriate tax form with a valid registration number, entities can ensure compliance and seize the opportunity to access cash for their sustainable projects. The right collaboration can help with the process so entities receive the necessary support. Utilizing the direct pay option allows these entities to make a lasting impact by helping communities thrive every day.

© 2023 BDO USA, LLP. All rights reserved. www.bdo.com

Are Your Processes Innovative or Merely Electronic? Leverage Technology the Right Way

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Decades of innovation have transformed the finance office from a mindset of processing transactions to one of strategic financial management. But even with this advancement, nonprofit organizations are operating in an increasingly complex environment that requires them to balance routine and new tasks with a higher volume of information.

When the topic of efficiency is raised to an organization whose finance team is at capacity, it is not unusual to hear the team is already using technology and that, perhaps, no further innovation is possible. However, asking a few questions helps to uncover whether the tools they have implemented are really transforming their processes or whether they have merely replaced manual processes with electronic ones.

 

Confusing “Electronic” With “Innovative”

As a result of the pandemic, most finance offices were forced to shift to virtual operations. Understandably, many were unable to put a strategic plan in place before making this transition and simply replicated a manual workflow that layered into it an electronic component, such as email or another paperless option. Many of these workflows still exist today but present confusing workarounds for typical tasks, such as:

  • Emailing vendor invoices as message attachments, with approval indicated in the body of the email message, and then saving the email as a PDF as supporting documentation and manually entering data from the invoice for payment processing.
  • Completing time sheets via spreadsheets that then are manually reviewed, corrected and compiled for manual data entry into the payroll system for processing.
  • Using shared electronic folders for collecting scanned credit card receipts for manual reconciliation via spreadsheet at month’s end.
    What all these examples have in common is that they replace paper with an electronic file. But these modifications do not introduce any real workflow changes or innovative technology that is designed and customized to support that workflow. In fact, workflows like this can be less efficient and less effective, especially in a high-volume environment.

 

Real Innovation

There are a variety of innovative technology solutions that enhance efficiency and effectiveness for the finance team. For example, the following simple solutions can help address the situations above:

  • Utilize one of the many electronic accounts payable (AP) tools that enable electronic invoice routing based on an organization’s defined approval workflow, facilitate electronic coding that syncs to the general ledger and have a mobile app option. These tools also will facilitate electronic vendor payments without time-consuming manual data entry.
  • Implement electronic time sheets that work with your organization’s payroll processing technology, eliminating the potential for mathematical errors, facilitating tracking paid time off and syncing for payroll processing without manual entry.
  • Consider an expense management system with mobile app capability. Similar to the AP solutions, these tools allow credit card holders to take pictures of receipts and other supporting documentation, code and approve within the app, and facilitate month-end reconciliation. Expense management systems are also designed to automate employee expense reimbursements in a similar way.

Beyond electronic accounts payable, time sheets and credit card management, other common areas for innovation include:

  • Automated financial reporting—including budget versus actual, dashboards and forecasting—that reduces the need to download data to a spreadsheet for manual report creation.
  • System integrations, so that information—including development revenue, inventory balances or deposit details—is automatically updated in the general ledger and not manually entered.
  • Expense allocations that are automatically calculated based on set parameters to avoid time-consuming calculations.
  • Document routing and storage systems that are designed to circulate important items—including grant agreements, information for grant reports and vendor contracts—for internal approval and to house final versions in a central location.

When beginning to assess which tools may improve efficiency, it is helpful to focus first on the most time-consuming areas for the finance team, also keeping in mind how the team would spend time if capacity were increased. These are just a few of the most common areas for innovation, and there is certainly no shortage of technology solutions. BDO can help organizations assess finance team infrastructure needs, including opportunities for technology innovations, and help with related implementation and internal training.

© 2023 BDO USA, LLP. All rights reserved. www.bdo.com

Form 990 Review: What Nonprofit Boards Should Look For

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Many in the nonprofit world know Form 990 as the all important nonprofit tax form that details an organization’s activities and financial standing. In addition to justifying an organization’s tax-exempt status, Form 990 reveals key information that charity-rating organizations and grantmakers use when evaluating nonprofits.

The IRS does not mandate that nonprofit boards review Form 990, but due to the form’s importance, board review is a widely adopted best practice. And if the board does review the form, the IRS requires an organization to disclose its Form 990 review process. Establishing a consistent board review process helps organizations mitigate compliance risk, but also helps board members identify and address any issues that may raise a red flag to funders, donors and charity watchdogs.

Form 990 should include detailed information about the significant programs the organization conducts, how much revenue it generates and where it is spending money. It’s also important to note that prominent foundations and other philanthropic institutions look for a detailed Form 990 during their grantmaking due diligence, and making sure this information is accurate, up-to-date, and readily available can help board members secure larger donations.

 

Enhancing Accuracy and Addressing Compliance Concerns

Most nonprofit boards see reviewing Form 990 as a part of their fiduciary responsibility to the organizations they serve. Given this responsibility, legal and financial professionals who have the skills to understand the information reported in the return and flag compliance concerns can provide a great deal of value as nonprofit board members. When reviewing Form 990, here are some issues the board should look for:

  • Compensation issues: If the IRS determines nonprofit executives are unreasonably compensated, executives may be liable to pay an excise tax and return the excess benefit. Board members who approve the excessive compensation may also be liable for an excise tax. Beyond the IRS, funders and donors may also want to understand how executive compensation is determined as they make funding decisions.
  • Cost allocation: In part IX of Form 990, nonprofits are required to allocate their expenses between program service activities, management and general expenses, and fundraising. The IRS requires that the process for cost allocation is reasonable under the circumstances and that the allocation process is documented thoroughly. Additionally, charity watchdogs and funders and donors will analyze what percentage of overall funding is going toward program activities to help determine their funding decisions.
  • Transaction and loan ethics: The IRS is interested in transactions that may involve “interested persons” such as directors and officers and others with substantial influence in the organization. These transactions are disclosed in Schedule L of the return and should be “at fair market value and arm’s length” as it pertains to the nonprofit. Board members should review Form 990 for these transactions in order to confirm that they meet the arm’s length and fair market value standard. In addition to transactions, loans made by an organization to an interested person could raise a red flag. The IRS will look for these loans to carry commercially reasonable terms and carry an interest rate and security as a bank loan would.

If organizations cannot demonstrate that transactions and loans “are at fair market value and arm’s length,” the organization and individuals involved could be subjected to excise tax penalties. If these transactions and loans are particularly egregious, they could jeopardize the organization’s tax-exempt status.

As nonprofits face increasing demands for transparency, a formalized board review process for Form 990 can help organizations put their best foot forward with the IRS, the public and donors.

 

Creating a Powerful Narrative to Support Your Mission

Form 990 is an important component of an organization’s ability to navigate increasing scrutiny and pursue funding opportunities. By applying their knowledge and experience to the reporting process, board members can help the nonprofits they serve maintain compliance with IRS regulations as well as reinforce the organization’s commitment to its mission in the eyes of donors and the public. Finally, a detailed Form 990 arms the organization with the information it needs to communicate its story, highlights the impact of its work, and makes a compelling case to donors, grantmakers and the public at large.

© 2023 BDO USA, LLP. All rights reserved. www.bdo.com

Cash Benefits for Supporting ESG – New Markets Tax Credit

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With an increasing focus on environmental, social and governance (ESG) issues, some organizations are seeking ways to fund various ESG initiatives. Tax credits and incentives have played an important role in subsidizing ESG initiatives, with the Inflation Reduction Act significantly enhancing their impact on environmental investments. However, the often-overlooked social aspect of ESG can also be supported by tax credits and incentives.

The social dimension of ESG focuses on an organization’s relationship with society, including the well-being of employees and the communities the organizations operate in. One mechanism that organizations can utilize to fund initiatives supporting local communities is the New Markets Tax Credit (NMTC)

 

What is the NMTC?
The NMTC is a federal program established in 2000 to incentivize investment in low-income communities. Codified under Internal Revenue Code Section 45D, the program has been continuously extended through legislative packages. The latest extension provides a $5 billion annual allocation through 2025.

The CDFI Fund, an agency of the U.S. Treasury, administers the program through certified community development entities (CDEs). CDEs use the NMTC allocation to generate a 39% tax credit, which can be monetized by tax credit investors.

Using tax credit equity, the CDEs fund projects in low-income communities, often through loans with flexible features such as below-market interest rates and principal forgiveness.

CDEs help the CDFI Fund allocate funds nationwide, carefully selecting projects that have a significant impact on low-income communities. These projects commonly focus on creating jobs, developing the workforce, providing goods and services to the community, improving healthcare and other community benefits.

The NMTC program requires annual reporting of community outcomes generated by each project, making it an effective tool to support the “S” in ESG initiatives.

 

Nonprofits and the NMTC
Nonprofit organizations receive a significant portion of NMTC funding each year. The social mission of nonprofits aligns well with the NMTC program’s goal of community development, particularly for underserved populations. NMTC funds often serve as a valuable source of funding for nonprofits to supplement their capital campaigns and other fundraising efforts.

However, nonprofits face challenges in utilizing the leveraged structure commonly used for NMTC funding. In a leveraged structure, tax credit investors create an investment fund that combines their tax credit equity with other financing sources to provide project funding. One challenge nonprofit organizations face is that the leveraged structure typically requires two taxable entities. To address this, many nonprofits establish supporting organizations to facilitate NMTC transactions. Additionally, securing upfront funding sources can create time-value pressure on cash flow, especially for nonprofits that finance their projects over time.

To illustrate how NMTCs can support a project, consider a nonprofit health clinic that aims to expand its facility and acquire equipment to enhance services for disadvantaged individuals in an eligible low-income census tract. The total project cost is $10 million and, despite receiving donations and other funding sources, the clinic can raise only $7.5 million. The clinic can bridge the financing gap through an NMTC loan, which is funded by the tax equity generated from the CDE’s NMTC allocation, enabling the project to move forward. An additional advantage is that the NMTC loan principal is often forgiven after a seven-year term, resulting in a permanent cash benefit to the organization.

 

© 2023 BDO USA, LLP. All rights reserved. www.bdo.com

Nonprofits Pivot from Survival to Resilience: BDO 2023 Nonprofit Standards Benchmarking Survey

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The BDO 2023 Nonprofit Standards Benchmarking Survey of more than 250 nonprofits highlights a crucial shift in the nonprofit sector towards strategic resilience, marking a departure from the reliance on recent federal funding. Data from our annual survey reveals that in response to economic uncertainties, nonprofits are prioritizing digital transformation (42%), cost reduction (38%), and seeking new funding sources (36%) as their top concerns for the next 12 months. Despite a decrease in revenue for 44% of surveyed nonprofits in the latest fiscal year, 69% anticipate an increase in the coming year.

The nonprofit industry has continually turned crisis into opportunity, and this year is no different. While less than half (44%) of surveyed nonprofits saw increased revenue in their most recent fiscal year, 69% anticipate revenue will increase in the next fiscal year. Nearly all (99%) surveyed organizations say they have expanded or shifted their mission scope in the past 12 months, with more than half doing so to address emerging needs among the populations they serve. Organizations are also focused on efficiency and strengthening bottom lines, identifying digital transformation, cost reduction and finding new revenue and funding sources as their highest priorities over the next 12 months.

Even in the face of economic uncertainty, nonprofits are showcasing their determination amid a decline in giving and higher costs. Investment in technology is a priority in the coming year. More than half (59%) of nonprofits plan to increase their technology spending in the next 12 months, and 57% plan to select and/or implement a new enterprise resource planning (ERP) system within the same time frame.

The report also delves into increased donor scrutiny surrounding ESG topics. Just over half (51%) of nonprofits say funders and donors have asked for more information on ESG strategy in the past 12 months, while 42% said they are seeing an increase in requests for information on environmental impact and reduction strategies.

Now in its seventh year, Nonprofit Standards examines emerging challenges and opportunities facing nonprofit leaders, offering data-backed insights they can use to further their missions and sustain their organizations into the future. The survey includes an overview of the nonprofit sector as well as breakout reports for health and human services organizations, higher education institutions, grantmakers and their recipients, public charities, international nongovernmental organizations (INGOs) and organizations with more than $75 million in revenue.

How does your organization compare to peers? Benchmark yourself.

© 2023 BDO USA, LLP. All rights reserved. www.bdo.com

Do You Know Who Is Watching?

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The chorus of a popular ’80s song says, “I always feel like somebody’s watching me.” Not-for-profit entities (NFP) have their financial information available on a variety of platforms including, but not limited to, the NFP’s website, the public inspection copy of its Form 990, and perhaps on its state attorney general’s website, if the NFP solicits donations from the public. This public exposure of financial information might have NFPs feeling like somebody’s watching them, and they would be correct!

Potential and existing donors look at an NFP’s financials to understand how the entity is doing overall and how donations are spent on program services before committing to donate. Watchdog organizations also review and assess this information. A watchdog organization is typically a nonprofit group that monitors the activities of governments, industry or other organizations and alerts the public when actions that go against the public interest are detected. It is important that management and those charged with governance understand the watchdog organizations, the rating platforms and the methodologies behind those ratings. There are many of these organizations, but this article will focus on three prevalent organizations: Charity Navigator, Candid and the Better Business Bureau Wise Giving Alliance.

These three watchdog organizations have an enrollment process for nonprofits. Once the application is approved, the nonprofit may provide pertinent information that will be used by the watchdog organization to provide information to the public.

Charity Navigator
Charity Navigator’s mission is to make impactful giving easier for all by providing free access to data, tools and resources to guide philanthropic decision-making. Charity Navigator’s methodology involves ratings, curating lists and providing alerts.

Ratings

Charity Navigator focuses on two objectives in its approach to ratings: helping others and celebrating the work of charities. The types of charities assessed by this watchdog organization are 501(c)(3) tax-exempt organizations, which are U.S.-based organizations commonly referred to as public charities.

Eligible charities receive a zero- to four-star rating determined by the weighted sum of the organization’s individual beacon scores. Charity Navigator’s Encompass Rating SystemTM provides a comprehensive analysis of charity performance across four key domains, referred to as “beacons.” The beacons are as follows:

  • Impact and Results – determines if a nonprofit is making good use of resources to address the issues it aims to solve.
  • Accountability & Finance – evaluates a nonprofit’s accountability and transparency as well as its general financial health, and includes measures of stability, efficiency, and governance.
  • Leadership & Adaptability – evaluates the nonprofit’s leadership practice and ability to respond to change.
  • Culture & Community – evaluates the nonprofit’s overall culture and its connectedness to the constituents and community it serves.

Charity Navigator established this more encompassing rating system to fairly assess nonprofits across domains that influence organizational performance and success. By expanding the assessment beyond financial metrics, donors are provided with a more holistic understanding of nonprofit performance.

To be eligible for an overall rating, organizations must have an Impact & Results score and/or an Accountability & Finance score. Nonprofits that do not or are unable to earn an Impact & Results or Accountability & Finance score at the time of application can still earn scores for Culture & Community and Leadership & Adaptability. Charity Navigator’s rating system is not established to be all or nothing. It is designed to provide potential donors with as much meaningful information about the organization as is available.

The breakdown of the ratings is outlined below:

Rating Score Assessment Description

  • 4 star, 90+, Great Exceeds or meets best practices and industry standards across almost all areas. Likely to be a highly-effective charity.
  • 3 star, 75-89, Good Exceeds or meets best practices and industry standards across some areas.
  • 2 star, 60-74, Needs improvement Meets or nearly meets industry standards in a few areas and underperforms most charities.
  • 1 star, 50-59, Poor Fails to meet industry standards in most areas and underperforms almost all charities.
  • 0 star, <50, Very poor Performs below industry standards and well underperforms nearly all charities.

Curated Lists

In order to help donors navigate their giving, Charity Navigator compiles lists of charities divided into three distinct categories:

  • Where To Give Now – aims to respond to donors’ and media’s existing interest in certain trending topics. The charity needs to have a three or four-star rating, have clear and concentrated efforts responding to the issue as described on its website, and if facing a specific crisis, allows donors to designate their donations to the crisis-specific efforts.
  • Popular Charities – highlights some curated groups of ratings and is often a popular area of interest for donors. These are the most searched for, visited, and supported on Charity Navigator.
  • Best Charities – aims to highlight exciting giving opportunities that donors may not be aware exist. To be included, a charity needs to have a three- or four-star rating and has to run a particularly impactful program based on specific criteria.

Alerts
When a charity is reported to engage or confirmed to have engaged in misconduct or questionable practices, Charity Navigator posts an alert on the charity’s profile page to raise awareness and help inform donor’s giving. In issuing an alert, Charity Navigator’s Alert Issuance Committee considers the following:

  • Credibility (based on a media outlet that Charity Navigator deems reliable) and timeliness of information
  • Nature, scope, and seriousness of the allegations or convictions
  • Whether or not the allegations have been proven
  • Other factors on a case-by-case basis

Charity Navigator has the following four levels of alerts:

  • Review Before Proceeding – this alert is given if matters of concern relating to the organization have been reported, but to Charity Navigator’s knowledge, no legal proceeding has commenced, or the matter is not of a legal nature.
  • Proceed with Caution – this alert is given if a credible media outlet has reported that a government agency or a private third-party has filed charges or brought a claim as part of a pending legal proceeding, alleging that the organization or its managers have engaged in illegal conduct, including but not limited to financial wrongdoing, discrimination, or violation of data security laws.
  • Proceed with Increased Caution – this alert is given if a credible media outlet has reported that the organization is engaged in bankruptcy proceedings or the organization has been found, through a legal proceeding, to have engaged, or have managers who have engaged, in illegal conduct including, but not limited, to financial wrongdoing, discrimination, or violation of data security laws.
  • Giving Not Recommended – this alert is given if the organization lacks 501(c)(3) status or a credible media outlet has reported that the organization has engaged, or have managers who have engaged, in substantial fraud or misrepresentation relating to the organization’s charitable purposes or activities, as determined through a legal proceeding.

Candid
Candid, a nonprofit that provides comprehensive data and insights about the social sector, was formed with the 2019 merger of GuideStar and Foundation Center. GuideStar was a public charity that collected, organized and presented information about every IRS-registered nonprofit organization. The Foundation Center collected and communicated information on U.S. philanthropy, conducted research on trends in the field and provided education and training on the grant-seeking process. Candid continues to operate both of these arms.

Candid’s mission is to find where the money nonprofits spend comes from, where it goes and why it matters. To fulfill this mission, Candid works with nonprofits to identify funders who support the organization’s work by listing their information in its Foundation Directory. On the flip side, funders use GuideStar to verify and research nonprofits aligned with their focus.

  • Foundation Directory
    Candid’s Foundation Directory gives nonprofits access to information allowing them to be smart and strategic with funding requests. Nonprofits can choose from either the Essential plan or the Professional plan. The Foundation Directory allows nonprofits to enter a phrase for what it is looking for and, based on that phrase, a results page is produced that includes Grantmakers, Grants, and Recipients. Grantmaker profiles provide a powerful summary overview of the funder’s work along with all the pertinent details nonprofits need to find and approach great prospects.
  • Tools for Funders
    Candid offers various tools funders can use to research the operations and financials of nonprofits. In order for this information to be available, nonprofits must have an account with Candid. Once the nonprofit’s profile is approved, the nonprofit can tell its story through its profile. The Candid platform is driven by each nonprofit and the information they decide to showcase. Using the profiles created by the nonprofits, Candid provides the following tools for funders:

    • GuideStar Pro – Funders use Candid’s nonprofit profiles for research, due diligence, and, increasingly, as part of the grant application process. Search for information on more than 1.8 million nonprofits, including mission, vision, values, programs, leadership, staff and board demographics, and finances.
    • Charity Check– Validate nonprofits’ status and ensure compliance with Charity Check, which is compliant with all IRS requirements. Get alerts on nonprofit status changes and monitor organizations. Funders can quickly understand key elements of a nonprofit’s operations through Candid’s Seals of Transparency which is part of the Charity Check. The levels of seals are as follows:
      • Bronze Seal – this is awarded to a nonprofit with a profile that includes its mission and contract details, donation information, and leadership information.
      • Silver Seal – this is awarded to a nonprofit with a profile that includes the information at the bronze seal level and additional information regarding program information, grantmaker status and brand details (website, social media, logo).
      • Gold Seal – this is awarded to a nonprofit with a profile that includes the information at the silver seal level and its audited financial report or basic financial information, and its Board Chair names along with leadership demographics.
      • Platinum Seal – this is awarded to a nonprofit with a profile that includes the information at the gold seal level and includes its strategic plan or strategy and goal highlights, and at least one metric demonstrating its progress and results.
  • Data Integration and Partnerships – Candid provides comprehensive social sector data through its Application Programming Interfaces and custom data services. Candid also partners directly with organizations that share value of transparency.
  • Improve Your Community Foundation’s Performance – Council on Foundations Insights helps members assess and improve their community foundation’s organizational performance through peer benchmarking. Candid also creates connections to others in the field who are interested in sharing knowledge and increasing impact.
    For more information, please visit Candid

Better Business Bureau Wise Giving Alliance
The Better Business Bureau (BBB) Wise Giving Alliance (WGA) is a standards-based charity evaluator that seeks to verify the trustworthiness of charities publicly soliciting donations. The BBB WGA helps charities build trust and donors give wisely.

The BBB WGA’s foundation is the BBB Charity Standards, 20 standards addressing four themes. Following are the four themes and an overview of each theme and its corresponding standards. For each of the 20 standards noted below, the BBB WGA assigns a finding of (1) standard is met, (2) standard is not met, or (3) unable to verify.

  • Governance and Oversight – The governing board has the ultimate oversight authority for any charitable organization. The standards noted here seek to ensure that the volunteer board is active, independent, and free of self-dealing. To meet these standards, the nonprofit will have:
    • Board Oversight
    • Board Size – Minimum of five voting members
    • Board Meetings
    • Board Compensation
    • Conflict of Interest Policy
  • Measuring Effectiveness – The effectiveness of a nonprofit in achieving its mission is of the utmost importance. It’s key that potential donors know that when they give to a nonprofit, their money is going to have an impact. This is why a section of the BBB WGA’s standards require that nonprofits set defined, measurable goals and objectives, put a process in place to evaluate the success and impact of its programming, and report on the nonprofit’s progress. To satisfy the requirements the nonprofit must have the following:
    • Effectiveness Policy
    • Effectiveness Report
  • Finances – While the BBB WGA believes that a nonprofit’s finances only tell part of the story of how they are performing, the finances can identify nonprofits that may be demonstrating poor financial management and/or questionable accounting practices. The finance standards seek to ensure that the nonprofit is financially transparent and spends its funds in accordance with its mission and donor expectations. If the nonprofit has the following they must be provided:
    • Program Expenses – at least 65% of total expenses are on program
    • Fundraising Expenses – no more than 35% of contributions on fundraising
    • Accumulating Funds
    • Audit Report
      • Audit report if gross income exceeds $1 million
      • A review by a certified public accountant is gross income is less than $1 million
      • Internally produced financial statements if gross income is less than $250,000
    • Accurate Expense Reporting
    • Detailed Expense Breakdown
    • Budget Plan

There are cases where an organization that does not meet the first three standards under finance may provide evidence to demonstrate that its use of funds is reasonable and complies with the standards we have established – and we consider them accordingly.

  • Solicitations and Informational Materials – A fundraising appeal is often the only contact a donor has with a nonprofit and may be the sole impetus for giving. This section of the standards seeks to ensure that a nonprofit’s representations to the public are accurate, complete and respectful. If the nonprofit has the following they must be provided:
    • Accurate Materials
    • Annual Report
    • Website Disclosures
    • Donor Privacy
    • Cause Marketing Disclosures
    • Complaints Records

The BBB WGA also provides a list of charities in alphabetical order. Donors may locate a nonprofit on this list and pull up the charity review published by BBB WGA. The report provides information on the nonprofit, including the finding on each of the 20 standards, including the purpose and programs of the nonprofit, information on governance and staff, fundraising, tax status and financial information.

Finally, the BBB WGA provides “Tips for Donors.” This includes publications to help the donor in its charity donation decisions. While it’s ultimately the donor’s decision, the BBB WGA recommends donors avoid or be extremely cautious when contributing to nondisclosure charities. Charities that do not provide BBB WGA with any of the requested information needed to complete a charity evaluation are called “nondisclosure charities.” While this could be benign, some of these charities could also be hiding something by choosing not to disclose.

For more information, please visit Better Business Bureau Wise Giving Alliance

While nonprofits may feel like someone is always watching with so much exposure to their financial information, watchdog groups, including Charity Navigator, Candid, and the BBB Wise Giving Alliance are working to help donors and nonprofits. Nonprofits should see watchdog organizations as another outlet to provide access to their mission and provide a holistic understanding of the operations of the nonprofit.

© 2023 BDO USA, LLP. All rights reserved. www.bdo.com

CECL for Nonprofits Is Here – Helping You Prepare

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Nonprofits have endured the challenges of adopting several new accounting standards over the last several years.  Now, after a lengthy deferral period, the Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) 2016-13, Financial Instruments – Credit Losses (Topic 326):  Measurement of Credit Losses on Financial Instruments), commonly referred to as CECL or “Current Expected Credit Losses,” is upon us.  Subsequent ASUs were issued related to CECL, which are all codified in the Accounting Standards Codification (ASC) Topic 326.

A Brief Background on CECL

What Items Are Impacted by CECL?

The extent of CECL applicability depends upon the financial assets held by each organization.   Generally, financial assets measured at amortized cost, like trade receivables, cash equivalents, contract assets that result from revenue transactions or other income, loan/notes receivable, loans to officers and employees, financing receivables and program-related investments, are required to be assessed under the CECL model.  Financial assets that are measured at fair value, equity method investments, and related party loans and receivables between entities under common control, are not.  Contributions and pledge receivables (receivables associated with revenue recorded under FASB ASC Topic 958-605) are not in the scope of CECL.  

What is Changing with CECL?

Prior to CECL, organizations utilized an incurred loss model.  The incurred loss model is largely based on historical losses whereby a loss is recognized only after a loss event has occurred or is probable.  In other words, an allowance for doubtful accounts was recorded based primarily on past experience.  Under CECL, however, entities will estimate credit losses over the entire “contractual term” of the instrument from the date of initial recognition of that instrument through the end of its term.  Now, instead of an allowance for doubtful accounts, organizations will have an allowance for credit losses. 

CECL’s objective is to provide financial statement users with an estimate of the  amount the entity expects to collect on these assets.   The CECL model removes the threshold of “probable” and requires recognition of credit losses when such losses are “expected.”  That is, even though a credit loss event may not have occurred yet, lifetime losses would still be recorded on Day One (i.e., origination or purchase of the asset) under CECL based on the expected future losses.

What Are the Elements of CECL?In order to implement CECL appropriately, organizations must follow the model outlined by CECL, which allows for management judgment throughout each step. The importance of management’s documentation of those judgments and estimates is key to the implementation and continued compliance with this standard. The graphic below provides an outline of each of the elements of CECL. 

Components of CECL Model

Historical Loss Information

Segments or pools are created based on common characteristics. A combination of both internal and external information, including macroeconomic variables, are used to establish a relationship between historical losses and other variables.

Current Conditions

To reflect current asset-specific risk characteristics, adjustments to the historical data will need to be considered. These adjustments are usually done through a combination of both qualitative and quantitative factors.

Reasonable & Supportable Forecasts

The forecast period to project expected credit losses should be reasonable and supportable. Document the rationale and provide evidence supporting the reliability and accuracy of economic scenarios and forecasts.

Revision to History

Entities are to revert to historical loss information when unable to make reasonable and supportable forecasts. The reversion method applied must be well documented and is not a policy election.

Expected Credit Loss

The results should represent the current expected credit loss over the remaining contractual term of the financial asset or group of financial assets.

 

Historical Loss Information

Generally, historical credit loss experience of financial assets with similar risk characteristics provides a basis for an organization’s assessment of credit losses according to ASC 326-20-30-8.  While organizations are accustomed to gathering historic loss information, ASC 326-20 introduces the concept of portfolio segmentation or pooling, which is likely new for most nonprofit organizations.  CECL requires management to measure expected credit losses on a collective (pool) basis when similar risk characteristics exist.  When similar risk characteristics do not exist, CECL requires management to measure each financial asset with different risk characteristics individually. Management should document the rationale for the selection of each pool. Management is also required to revisit the pools when information arises that suggests a particular financial asset or assets may no longer exhibit similar risk characteristics. ASC 326-20-55-5 provides a list of potential risk characteristics an organization may consider when identifying pools. The list is not meant to be all inclusive, and management may identify other risk characteristics to develop pools of financial assets.  Management should document the rationale for the selection of each pool.

  • Internal or external (third-party) credit score or credit ratings
  • Risk ratings or classification
  • Loan purpose 
  • Collateral type
  • Size
  • Effective interest rate
  • Term 
  • Geographical location
  • Industry of the borrower
  • Vintage 
  • Historical or expected credit loss patterns 
  • Reasonable and supportable forecast periods

To illustrate the concept of pooling and the CECL model, let’s walk through an example of what this analysis might look like for a nonprofit organization with membership dues that are recorded as revenue under ASC Topic 606. We will continue with this example as we discuss each of the elements of the CECL model.

Facts of the Example:

ABC NFP provides services to their members. The members are homogeneous and have the same risk characteristics. Members are given payment terms of 90 days. ABC NFP has tracked historical loss information for its membership dues receivable and compiled the following historical credit loss percentages:

Historical Loss Percentage Aging Category
0.3% Current
8% 1 – 30 days past due
26% 31 – 60 days past due
58% 61 – 90 days past due
82% More than 90 days past due

 

In the example above, because the members have similar risk characteristics that management considers homogenous, a single pool of all members was used by ABC NFP to analyze the accounts receivable balance associated with membership dues. There could be instances where organizations may pool members based on type of member (i.e., large corporate members versus individual members) or by geographic location of members (i.e., international members versus members based in the United States), just to name a couple of examples. The method is based on management’s judgment and the rationale for the pooling method should be documented.

The example above outlines historical loss percentages in an aging model that the organization is using as the basis for its CECL analysis. The historical loss percentage is another estimate within the model that management must determine and document. Management might choose to use a specific historic period to calculate the percentages. For example, assuming the makeup of members has not changed since the inception of the organization, management may choose to use historical loss information from the inception of the membership program. Or perhaps management may choose to use an average of the prior five or 10 years, excluding the years impacted by the COVID-19 pandemic due to the effect on its members.  The important point is that the standard does not prescribe a “right” or “wrong” method.  Instead, management must make these determinations and document the rationale for the method chosen.

Current Conditions

Once the historical loss information is determined, management must evaluate if any adjustments are needed to make the information current. The standard indicates that an organization should not solely rely on past events to estimate expected credit losses. The standard goes on to describe that, when an organization uses historical loss information, it shall consider the need to adjust historical information to reflect the extent to which management expects current conditions and reasonable forecasts to differ from the conditions that existed for the period over which historical information was evaluated. For example, are payment terms for the current period different than the historical period used in the analysis?  In our ABC NFP example for membership dues, the organization would need to consider the current make-up of the types of members and their “creditworthiness” compared to the creditworthiness of the types of members included in the historical analysis.  Another factor ABC NFP may consider is the payment terms. Perhaps historical payment terms were 90 days, and in the current year, ABC NFP changed the payment terms to 120 days.  In this case, ABC NFP would need to determine how the impact of the change in payment terms affects their historical analysis. Perhaps ABC NFP would need to add another aging category to the historical analysis determination to capture the change in payment terms.  

Reasonable and Supportable Forecasts

The next phase in the CECL model is for organizations to determine the reasonable and supportable forecast period and the related forecasts made in order to estimate credit losses. This is not an optional element of the standard – an organization must develop estimates for reasonable and supportable forecasts and document the rationale for the forecasts made as well as the period(s) being forecasted. These judgments are inherently subjective and complex and may result in a high degree of estimation uncertainty. The adjustments to historical loss information may be qualitative in nature and should reflect changes related to relevant data (such as changes in unemployment rates, property values, commodity values, delinquency or other factors that are associated with credit losses on the financial asset or in the group of financial assets). This is yet another reason it is imperative for organizations to document their rationale for all of the judgments and estimates being used to develop the expected credit losses.

Let us continue with our example for ABC NFP and introduce a few more facts:

  • ABC NFP believes that the historical loss information is a reasonable basis to determine expected credit losses for membership dues receivables held at the reporting date because the risk characteristics of its current members and its current credit practices have not changed significantly over time.Why is this fact pattern important for the CECL model?

    This particular fact pattern is demonstrating that there are no adjustments necessary for the “current conditions” element of the CECL model. Current practices, for purposes of this example, are not different than historical practices; therefore, management documented in their CECL analysis that no adjustments for current conditions are necessary.

 

  • However, ABC NFP has determined that the reasonable and supportable forecasted economic conditions have improved. The unemployment rate has decreased as of the most recent reporting period, and ABC NFP expects the unemployment rate to continue to decrease over the next 90 days.Why is this fact pattern important for the CECL model?

    Management is required to consider reasonable and supportable forecasts. In this particular example, management has chosen to use the unemployment rate as their means to forecast over the contractual period. For purposes of this example, let’s assume the members are individuals and the contractual period is 90-days, which is equivalent to the payment terms. The use of unemployment data as a way to forecast expected credit losses is a reasonable and supportable forecast because members are individuals. As the unemployment rate declines, more individuals are employed and would, in theory, be able to pay for their membership dues. In management’s view, there is enough economic data available to allow them to expect the unemployment rate will continue to decline. An organization needs to document these conclusions and sources of economic data as part of their CECL analysis.

 

  • ABC NFP estimates the effect of the decrease in the unemployment rate will impact the loss rate by a 10% decrease in each aging bucket. Management’s estimate was developed based on its knowledge of past experience for which there were similar improvements in the economy.Why is this fact pattern important for the CECL model?

    The reasonable and supportable forecasts element of the model requires an organization to quantify the forecasts to include in the calculation of expected credit losses. In the example, ABC NFP determined that the loss rate would decrease by 10%. ABC NFP may have calculated the 10% by looking back to prior years when the unemployment rate was low and comparing the overall uncollectible accounts to a set of years when unemployment was high. On a percentage basis, that calculation yielded an approximate 10% difference in uncollectible accounts. The rationale for this method and the calculations that support the 10% loss rate decrease need to be documented as part of the CECL analysis.

Reversion to History

An organization should revert to historical loss information that is reflective of the contractual term of the financial asset or group of financial assets, adjusted for prepayments, for periods beyond which the organization can make reasonable and supportable forecasts of economic conditions.  Reversion to history does not mean an organization can skip the current conditions and reasonable and supportable forecast elements of the CECL model and immediately revert to history.  The key takeaway when considering reversion to history is the period beyond which reasonable and supportable forecasts can be obtained or determined. Generally, we believe organizations should be able to forecast at least one year from the contractual starting period of the financial asset, if not more.  This is, again, a judgment management must make and document as part of its CECL analysis.  In following with our ongoing example of ABC NFP and its membership dues receivables, the contractual term of the membership dues is 90 days.   Management has determined it can reasonably forecast a 90-day period, so no reversion to history was necessary in this example.

In contrast, let’s consider a different example for an organization that has a 15-year note receivable.  That organization may determine it can reasonably forecast three years; so, for the remaining 12 years, the organization will utilize a reversion to historical loss information to estimate the expected credit losses.

Entities are to revert to historical loss information when they are unable to make reasonable and supportable forecasts over the contractual term, adjusted for prepayments.   The reversion technique applied must be well documented and may not be a policy election.  Therefore, the organization must separately evaluate each pool of assets when determining which reversion technique is most appropriate.  

Examples of reversion techniques that might be used are immediate reversion and straight-line reversion.   Immediate reversion is accomplished by reverting to the full historical loss rate at the point that forecasts are no longer reasonable and supportable, whereas straight-line reversion is accomplished by adjusting the reasonable and supportable forecasted loss rate in increments to revert back to the historical loss rate and will require judgment as to the length of time over which the straight-line period should be. Other reversion techniques may be used as long as they are rationale and systematic.  

Expected Credit Loss

The final element of the CECL model is calculation of the expected credit loss. The standard does not prescribe a specific methodology for measuring the allowance for expected credit losses. For example, an organization may use discounted cash flow methods, loss-rate methods, roll-rate methods, probability-of-default methods or methods that utilize an aging schedule, just to name a few. Organizations need to document the rationale for the selection of the calculation method as well as the calculations themselves.

Zero Loss

Now that we have made our way through the basics of the CECL model, there’s another principle of the standard that’s worth mentioning.  It is not uncommon for an organization to deem receivables or other financial assets to be fully realizable.  Based on this, organizations may want to simply not record any expected credit losses for certain financial assets. Unfortunately, the CECL model does not allow us to jump directly to the conclusion of zero loss without walking through the model. An organization’s estimate of expected credit losses shall include a measure of the expected risk of credit loss even if that risk is remote, regardless of the method applied to estimate credit losses. An organization is not required to measure expected credit losses on a financial asset (or group of financial assets) in which historical credit loss information adjusted for current conditions and reasonable and supportable forecasts results in an expectation that nonpayment of the amortized cost basis is zero.

In other words, a remote risk of loss does not mean there is zero loss, so we would expect there to be some estimated expected credit loss, albeit potentially a minimal amount. If an organization performs the assessment based on the CECL requirements, and, after documenting the history, current conditions, and reasonable and supportable forecasts, determines the estimated loss is zero, the organization has sufficiently proven no estimated expected credit loss is required.

Adoption Date and Adoption Options

CECL is effective for nonprofit entities for fiscal years beginning after Dec. 15, 2022. Thus, the standard is effective beginning with Dec. 31, 2023 year-ends. 

The standard requires organizations to adopt on a modified retrospective basis through a cumulative-effect adjustment to net assets as of the beginning of the first reporting period in which the guidance is effective.  So, in the year of adoption of CECL, organizations will need to complete their credit loss analysis twice – once as of the date of adoption and once at the end of the fiscal year. For example, an organization that has a Dec. 31 fiscal year-end will need to perform its CECL analysis as of Jan. 1, 2023, and again as of Dec. 31, 2023. On Jan. 1, 2023, the organization will increase or decrease net assets without donor restrictions for the adjustment made to either increase or decrease the allowance for doubtful accounts. The historical allowance for doubtful accounts is renamed allowance for expected credit losses. In years subsequent to  adoption, organizations will be required to reassess their CECL analysis as of the end of their reporting period. 

Will My Footnote Disclosures Be Impacted by CECL?

Yes. There are significant new CECL-related disclosure requirements that could be rather voluminous depending upon the composition of an organization’s financial assets measured at amortized cost that are impacted by CECL. Organizations will need to disclose a description of the method used to develop expected credit losses, a description of the accounting policies and methodology to estimate the allowance for credit losses, a discussion of the relevant risk characteristics for each segment of the portfolio, among other items. In order to ensure the organization has met all of the disclosure requirements, ask your auditors for a copy of the disclosure checklist or utilize the ASU to assist you early on in the financial statement preparation process.

A Documentation Exercise

For organizations with significant financial assets measured at amortized cost, the implementation of CECL, along with the ongoing requirements of the standard will take time. While your financial statements may not have a material change in the amount previously recorded as the allowance for doubtful accounts, and now recorded under the expected credit loss model, the documentation associated with the estimates and judgments to arrive at the expected credit loss balance is necessary to demonstrate compliance with this new standard.  

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© 2023 BDO USA, LLP. All rights reserved. www.bdo.com

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