New Accounting Rules Can Lower Your Nonprofit’s Overhead
Originally published by Techsoup at https://blog.techsoup.org on August 7, 2020.
We don’t often get excited about accounting, but there is some great news for nonprofits about how to expense cloud computing costs that will lower reported annual operating expenses. Back in 2018, the Financial Accounting Standards Board (FASB) issued updated accounting standards for costs related to cloud computing services and other big technology expenses. These changes go into effect for nonprofit organizations with fiscal years starting after December 15, 2020.
For nonprofits starting their next fiscal years after December 15, we thought you’d welcome the news that the revised rules can help you significantly reduce your reported overhead expenses when making investments in cloud technologies. Doing so is extremely important to donors, grantmakers, and charity rating services like the Better Business Bureau Wise Giving Alliance, Charity Navigator, and Charity Watch.
In August of 2018, the FASB issued an Accounting Standards Update, number 2018–15, for cloud computing-related expenses. The new standard means that nonprofits will no longer have to characterize their tech investments to move to the cloud as operating expenses but instead can characterize them as capital expenditures to be spread over a period of years. This can significantly lower overhead costs in a given year because nonprofits don’t have to expense those costs all at once.
How It Has Been up to Now
Before this new standard, most IT expenses counted as operating expenses, except for those that could be amortized over several years such as hardware equipment costs (such as servers) and perpetual software licenses. How technology costs could be accounted for was dictated by the type of technology expense. Here are some examples of the different types of technology costs and how they have been accounted for up to now:
Required to be expensed in the year they were incurred:
- Technology implementation: One-time implementation, customization, and testing costs for new technology (not including hardware or software licensing expenses).
- Training: One-time staff training costs on how to use new systems or technologies.
- Service contracts: Any ongoing services for hosting, support, maintenance, and the like.
- Hosted software as a service (SaaS): Costs for cloud licenses where the software is hosted and you pay monthly or annually on subscription (examples include Office 365, Zoom, G Suite, and Salesforce)
Can be amortized over time (usually over several years):
- Software perpetual licenses: These are the traditional on-premises (or installed) software licenses that you purchase once and use until you decide to upgrade to a new license.
- Hardware: Costs for computers, servers, and so on.
Specifically, requiring that technology implementation and training costs be expensed in the year they have incurred increases a nonprofit’s management and general overhead expenses for that year. For nonprofits seeking to keep their reported overhead costs low, these accounting requirements have effectively disincentivized modern technology adoption. And as a result, nonprofits are now broadly underinvested in critical infrastructure that has become more and more essential to how charities deliver impact.
In 2017, Independent Sector and TechSoup partnered through the Tech for Common Good initiative to submit recommendations to the FASB to amend the Generally Accepted Accounting Principles (GAAP). This effort was successful, and the FASB changed the accounting rules for cloud-based monthly subscriptions. FASB Chairman Russell Golden said in a news release that “existing U.S. GAAP resulted in unnecessary complexity and needed to be updated to reflect emerging transactions in cloud computing arrangements that are service contracts.”
With these new changes set to go into effect in December of this year, nonprofits stand to benefit through the additional financial accounting flexibility that this new guidance allows.
What the Changes Mean for Your Accounting
These changes mean two things:
- Nonprofits will now be able to record cloud migration and implementation costs as capital expenditures, allowing them to keep their overhead low in the year that these technology investments are made.
- Ongoing service or software subscription costs will generally continue to be declared in the year that they are incurred. However an annual lump sum payment for these can be expensed out over the year.
Capital expenditures are considered to be long-term investments. Money spent now that will provide “future economic benefit” beyond the current fiscal year, and therefore those expenses can be recognized over several years rather than just in the year they were incurred. Under ASU 2018–15, nonprofits will be able to recognize expenses associated with implementing and training staff on cloud-based, or “hosted” services, as long-term assets and amortize them over time.
Here are some examples of what may now be capitalized over time:*
- Service fees to develop or customize cloud-based software for your organization
- Service fees to implement and migrate existing data to cloud systems
- Service fees to test cloud-based software to make sure it works for you
- IT hardware costs (these have long been capitalized expenses)
* Always check with your accountant to confirm that you are accounting for your technology expenses correctly. TechSoup does not claim expertise in this area.
Being able to expense these costs over time in your accounting avoids reporting big IT overhead costs in a single year in the Management and General section on your Form 990 for any particular year. Do keep in mind that software costs and amortization expenses can be allocated across multiple functions (program service, management and general, or fundraising). It is not mandated that expenses of this nature be 100 percent allocated to management and general.
This update may be especially useful if your organization has been putting off modernizing your IT because of the impact it would have on your reported operating expenses. ASU 2018–15 will become effective for fiscal years beginning after December 15, 2020.
Ongoing service or subscription costs for technology are generally unaffected by this rule change as they are usually billed on a monthly, quarterly, or annual basis. So while our understanding is that you can smooth these costs out over 12 months (if you are paying quarterly or annually), the overall impact of these expenses on your annual costs will not change. Examples of ongoing service and subscription costs include
- Online storage costs
- Online backup and archiving costs
- Datacenter costs
- Cloud-based subscription software licenses
Helping Break the Nonprofit Starvation Cycle
Charities have long struggled with the famous nonprofit starvation cycle. It is the dilemma that organizations face in building robust infrastructure — including effective data management, communications, program delivery, security, and financial systems — to successfully deliver on their missions.
There is an increasing awareness that organizations cannot deliver on their missions effectively without the infrastructure and skills to do so, and that overhead costs can come down faster with appropriate technologies driving up efficiency. However, many funders persistently prefer to fund charities with low overhead, and so this accounting change will help nonprofits manage that issue.
TechSoup is proud to have worked with our community and Independent Sector to help accounting standards align with reality and lower overhead concerns so that organizations may feel more free to make strategic, necessary investments in cloud technology and the benefits it can bring.
About the Authors
Jim Lynch is a senior writer for TechSoup
Stacey Bergman is a certified public accountant and partner with YH Advisors, a Huntington Beach, California, accounting firm specializing in tax-exempt organizations. She has extensive experience working with nonprofits in the preparation of their internal financials, getting ready for financial audits, and preparing income tax returns.
- Digital Transformation: What It Means for Your Nonprofit and How to Get Started
- TechSoup’s Accounting Product Donations and Discounts for Nonprofits
- Accounting products in TechSoup Boost
- TechSoup’s Blog Content on Accounting
- TechSoup’s Articles and How-tos on Accounting
- TechSoup’s Blog Content on Cloud Computing
- TechSoup’s Articles and How-tos on Cloud Computing
- Office 365 Support Services for Nonprofits
- Office 365 Bootcamp for Nonprofits course
- Fundraising for Nonprofits course track
Originally published at https://blog.techsoup.org on August 7, 2020.