Reporting of financial performance by entities in the not-for-profit (NFP) sector remains the cornerstone of regulatory oversight and the primary means of discharging accountability by sector participants. Notably, NFP reporting requirements are often imposed on a much wider population of the sector than their for-profit counterparts. In this context, there are several current and future developments impacting financial reporting by NFPs that are noteworthy. Some of these developments are already in play, while others are in development and likely to have an impact in the very near future.
The Australian financial reporting framework
The Australian Accounting Standards Board (AASB) project to overhaul the Australian financial reporting framework is a major initiative that has far-reaching implications for financial reporting across multiple sectors, including the NFP sector. The biggest change being proposed by the AASB is to remove the ability for entities to prepare Special Purpose Financial Statements (SPFS) in accordance with Australian Accounting Standards (AAS). Importantly, this change will not affect those entities that prepare financial statements that are not in accordance with AAS.
The AASB is using a phased approach to the development and implementation of its proposals. Phase one of the project relates to for-profit entities and the proposed changes are expected to come into effect from 1 July 2020. Phase two will relate to private sector NFP entities and will affect charities, incorporated associations and many other NFPs that prepare annual financial statements in accordance with AAS for statutory or other purposes. Any changes to NFP financial reporting arising from these proposals are not expected to come into force before 2021. The third and final phase will relate to public sector entities operating across all three tiers of government in Australia.
The biggest change being proposed by the AASB is to remove the ability for entities to prepare Special Purpose Financial Statements in accordance with Australian Accounting Standards.
What are the proposed changes?
The biggest change being introduced through these proposals will be to remove the ability for entities to prepare SPFS in accordance with AAS. This will mean that all NFP entities seeking to prepare financial statements in accordance with AAS will have to prepare General Purpose Financial Statements (GPFS) that comply with all applicable requirements of all AAS. For example, an entity previously preparing SPFS may have developed an accounting policy where it opted not to measure and disclose the relevant numbers for deferred tax under AASB 12 Income Taxes on the basis that there are no users of its financial statements who would require this information. Subject to materiality considerations, such an accounting policy choice will not be available when preparing GPFS.
The current AASB financial reporting framework that caters for GPFS incorporates a two-tiered model of AAS. Tier 1 AAS applies to entities with public accountability (e.g. listed companies) and no significant changes are proposed to this Tier. Tier 2 is a Reduced Disclosure Requirements (RDR) model that allows for a reduction in disclosure while retaining all recognition and measurement requirements of AAS. All NFPs are eligible to apply the Tier 2 AAS under the current model. The AASB is developing a new Tier 2 model of simplified disclosures which will also be available to all NFPs.
Although the Tier 2 model incorporates simplified disclosures, the full recognition and measurement requirements are extensive and the smallest NFPs may find it challenging to comply with these requirements when preparing financial statements. For example, a registered charity or a public company limited by guarantee with revenue of just $250k is required to prepare a statutory financial report that complies with AAS, and such small NFPs may not have the resources or ability to comply with all the recognition and measurement requirements of AAS. The AASB has acknowledged the challenges of applying the two-tiered model to all NFPs and is considering developing simpler reporting requirements that can more easily be adopted by the smaller NFPs. The cut-off point for determining which group of smaller NFPs may be eligible to apply such simpler reporting.
requirements is yet to be determined and other regulators such as the Australian Charities and Not-for-profits Commission (ACNC) and state-based regulators may play a part in making this determination.
The AASB is developing a new definition of the term ‘not-for-profit’
The not-for-profit definition
Currently all entities broadly apply the same reporting framework regardless of the sector to which they belong. Going forward, the AASB is proposing to develop a ‘fit for purpose’ framework for the NFP sector and to facilitate this, the AASB is developing a new definition of the term ‘not-for-profit’ as follows:
‘An entity whose primary objective is to provide goods or services for community or social benefit and where any equity has been provided with a view to supporting that primary objective rather than for a financial return to equity holders.’
It is possible that this proposed definition could result in some charities registered with the ACNC not meeting the definition. There is also a suggestion that some member-based clubs that exist to provide benefits to their members, such as sporting clubs, may also not meet the proposed definition. The AASB is currently considering feedback from stakeholders on these and other points raised to arrive at a suitable definition that does not give rise to unintended consequences.
The AASB recognises the importance of ensuring that not only does its NFP definition align with existing statutory and common law understanding of the term ‘not-for-profit’, but also that it does not create an unnecessary impost on the sector. For example, if an entity that previously considered itself an NFP is no longer able to meet the proposed new definition, this entity may be required to prepare its financial statements based on the proposed new Tier 2 requirements discussed above. The simpler financial reporting frameworks currently being developed by the AASB for the NFP sector would not be available to an entity that does not meet the NFP definition.
Disclosure of compliance with recognition and measurement in SPFS
While it develops a new reporting framework for NFPs, the AASB believes it is appropriate for charities who prepare and lodge SPFS with the ACNC, and public companies limited by guarantee preparing and lodging financial statements with the Australian Securities and Investments Commission (ASIC) to disclose information on the application of the recognition and measurement requirements of AAS in the preparation of those SPFS.
The AASB is proposing that charities and other affected NFPs should disclose whether they have or have not complied with the recognition and measurement requirements of AAS in SPFS, and if no assessment has been made of compliance or non-compliance, this fact should be disclosed. Where there is known non-compliance with the recognition and measurement requirements of AAS, an indication of the non-compliance should be disclosed. The ACNC has expressed support for these proposals on the grounds of transparency. If these proposals are implemented, they are expected to be short-term disclosures that will be removed when a new financial reporting framework is established and the ability to prepare SPFS is removed.
New Accounting Standards
Four major new accounting standards come into effect in 2018 and 2019 which bring in significant new accounting requirements. Affected NFPs should already be well advanced in analysing and understanding the new requirements and ensuring adequate resourcing to implement these changes. A summary of the accounting changes being brought in through these new accounting standards follows:
AASB 9 Financial Instruments came into effect from 1 January 2018 and brings in new classification and measurement requirements for financial instruments. One of the most significant changes introduced through AASB 9 is the requirement to write down financial assets based on expected credit losses that may arise in the future. Whilst this change will affect loans and other debt instruments issued by an organisation, it will also affect trade and other receivables.
Changes have been introduced to the classification of financial instruments as well. Many NFPs fund their operations through the income earned from investments in listed or unlisted securities. Such investments can no longer be carried at cost. Instead, they will have to be measured at fair value, with any gains or losses recognised through profit or loss, and in some cases through other comprehensive income. The requirements in this area are complex and NFPs should seek external professional advice if there is no in-house expertise on the topic.
Revenue and income recognition
AASB 15 Revenue from Contracts with Customers and AASB 1058 Income of Not-for-profit Entities both came into effect for NFPs from 1 January 2019. The two standards bring in new recognition requirements and guidance for exchange-based transactions relating to revenue arising from the provision of goods and/or services, and non-exchange based income transactions that can include grants, donations and volunteer services.
The new standards introduce improved income recognition criteria for grants and other similar income received by NFPs, removing some of the previous confusion around deferral of grant income to future periods. Under the new requirements, an NFP may be able to defer grant income for recognition in future periods if it is able to determine whether the grant contract gives to rise to an ‘enforceable’ and ‘sufficiently specific’ arrangement. ‘Enforceability’ of the contract would normally be established if there are obligations to return unspent grant funds. A grant contract needs to have ‘sufficiently specific’ terms, which broadly means that the terms are specific enough to enable identification of the performance obligations relating to goods and/or services are being provided, and to what extent such performance obligations have been completed. Grant contracts that meet these conditions would be accounted for under AASB 15, whilst those that do not meet these conditions will be accounted for under AASB 1058.
AASB 16 Leases also came into effect for NFPs from 1 January 2019. The distinction between operating leases and finance leases is no longer made by lessees when applying AASB 16. Most leases will need to be capitalised in the balance sheet, represented by a lease liability and a new ‘right of use’ asset. The lease liability will be written down by the interest charge and repayments over the lease term, whilst the right of use asset will be amortised over the same lease term.
One specific issue affecting NFPs arising from AASB 16 and AASB 1058 discussed above is the accounting for peppercorn leases. The term ‘peppercorn lease’ is generally used to describe a lease that has nil or nominal lease payments. Peppercorn lease arrangements are a common feature in the NFP private-sector where philanthropic minded asset owners provide significantly discounted access to leased property and other assets to assist NFP entities further their not-for-profit objectives.
Since the issuance of AASB 1058 in December 2016, many affected entities have had difficulties in determining the fair value of right of use assets arising under peppercorn leases. Recognising these difficulties, in December 2018, the Australian Accounting Standards Board (AASB) issued an amending standard1 that provides a temporary exemption for not-for-profit (NFP) entities from the requirement to fair-value the right of use assets arising from peppercorn lease contracts. The exemption is optional, allowing entities to measure and recognise right of use assets arising from peppercorn leases at fair value if they choose to do so or at cost (based on actual payments). The AASB will decide on whether to make the temporary exemption permanent at a later date.
In addition to financial reporting changes being brought about through AASB pronouncements discussed above, NFPs should also keep abreast of other regulatory changes that could have an impact on financial reporting.
One notable area of change could arise through the ACNC independent review recommendations made in 2018 which include recommendations relating to financial reporting requirements under the ACNC legislation. For example, enhanced related party disclosures in financial statements is one of the recommendations being made. It is understood that a government response to the recommendations is currently being developed, and this is likely to be issued early next year.
There is a clear need for NFPs to keep abreast of the ever-changing financial reporting landscape, and professional associations have a role to play in disseminating information on key changes as they arise. On this note, CPA Australia has recently updated and published the ‘Charities — a guide to financial reporting and assurance requirements’ to assist charities navigate the complex statutory financial reporting requirements.