ICAS comments on detailed proposals for international financial reporting guidance for NPOs
The ICAS Charities Panel has responded to part two of a major consultation on the development of international financial reporting guidance for not-for-profit organisations (NPOs).
In its response to part two of the consultation, ICAS comments on key financial reporting matters relevant to NPOs where guidance may need to be tailored to their specific needs. The International Accounting Standards Board’s (ASB’s) International Financial Reporting Standard for Small and Medium-sized Entities (the IFRS for SMEs) forms the basis of most of the proposals in the consultation.
The ICAS response acknowledges the need for NPO specific guidance while seeking to ensure that any departures from the IFRS for SMEs are necessary and proportionate.
About part two of the consultation
Part two of the consultation considers the following financial reporting themes:
- The reporting entity.
- Accounting for incoming resources.
- Accounting of outgoing resources.
- Accounting for financial and non-financial assets.
- The presentation, content and scope of financial reports.
The themes are sub-divided into issues with at least two alternative proposals given for each issue. The ICAS approach is to support the proposals most closely aligned to the IFRS for SMEs.
The consultation paper for part two is available here.
Part one of the consultation, which closed in July, considered general financial reporting issues for NPOs, such as the scope of the planned NPO Guidance and the information needs of external stakeholders. Our commentary on part one and response is available here.
In responding to part two of the consultation, ICAS commented on the issues it judged to be of the highest priority.
- The reporting entity and control.
- Non-exchange revenue.
- Grant expenses.
- Inventory held for use or distribution.
- Presentation of financial statements (including fund accounting).
The reporting entity and control
The consultation provides commentary on identifying the reporting entity and other entities it controls. However, the commentary in the consultation paper focuses more on what constitutes control than on providing a framework for identifying the reporting entity and its boundary.
Identifying the ‘reporting entity’ is a necessary first step for accounts preparers prior to being able to identify any other entities it controls.
The Conceptual Framework for Financial Reporting issued by the IASB provides commentary on the reporting entity and its boundary. Given that the NPO Guidance will not be underpinned by its own conceptual framework and the complex structure of some NPOs, guidance on the reporting entity and its boundary will be of prime importance, in addition to providing a definition of control.
There is limited material on accounting for non-exchange transactions within the IFRS for SMEs beyond the treatment of government grants. This understandable as the IFRS for SMEs has been developed for profit orientated entities.
ICAS recommends an approach to accounting for non-exchange revenue which follows the recognition and measurement principles and the requirements on accounting for government grants in the IFRS for SMEs.
With regards to accounting for grants, ICAS believes that the same guidance should apply to government and non-government grants to ensure consistency and comparability.
It will be necessary to deal explicitly with non-performance related conditions attached to grant funding in the NPO Guidance, including time-related conditions. This will ameliorate the risk of grant income being overstated and an NPO flipflopping in and out of audit.
With regards to accounting for donations in kind, the ICAS response sets out the following key points:
- Donations in kind should only be recognised in limited circumstances on the grounds that it is not normally practical to value these reliably.
- A downside of recognising donations in kind, could be to push an NPO into an audit due to having to recognise related income.
- Robust disclosures should be required for any ‘material’ donations in kind not recognised in the financial statements. However, assessing materiality for disclosure purposes will be a challenge especially for items which do not have a monetary value placed on them.
- Income from goods donated for resale should be recognised at the point of sale.
- Consideration should be given to recognising donated goods for onward distribution at fair value at the point of receipt where the cost to the donor is known. ‘Cost to the donor’ being a proxy for fair value.
- Donated land and buildings should be recognised at fair value as it should be practical to do so. Fair value being ‘deemed cost’ where the NPO does not adopt a policy of revaluation for land and buildings.
ICAS supports guidance on accounting for grant expenses based on the concepts and pervasive principles of the IFRS for SMEs, including additional guidance on recognition, measurement and disclosure.
It is important that guidance deals with the following circumstances:
- Grant funding with no conditions attached.
- Grant funding with performance related conditions attached.
- Grant funding with non-performance related conditions attached.
It is likely that there will be conditions within funding agreements which do not prevent the recognition by the funder of grant expenses. While it will not be possible for the NPO Guidance to provide absolute clarity about whether or not a non-performance related condition is sufficient to prevent recognition, every effort should be made to set out guidance on this matter.
Funder imposed time-related conditions are likely to be a feature of multi-year grant awards. While we believe that clearly specified time-related conditions would normally prevent a grant recipient from recognising grant income relating to future reporting periods, we do not believe that the existence of a time-related condition alone is sufficient to prevent the funder from recognising a related grant expense and liability.
Inventory held for use or distribution
There are close links between accounting for non-exchange revenue and inventory held for own use or distribution, where the goods have been donated. With this in mind ICAS raised the following points on the treatment of donated goods:
- Income from donated goods held for resale should be recognised at the point of sale. Therefore, donated goods for resale should be recorded at cost at the point of receipt which is ‘nil’.
- Consideration should be given to requiring goods for onward distribution to be recognised initially at ‘fair value’ where their fair value is cost to the donor and ‘cost to the donor’ is known.
- Donated goods for own use should not be recognised in the financial statements.
Guidance on purchased inventories and the cost of own produced inventories should follow the requirements of the IFRS for SMEs.
Presentation of financial statements
The ICAS response is bookended by two issues of fundamental importance ‘identifying the reporting entity’ and the ‘presentation of financial statements’.
ICAS believes that NPO Guidance on financial statement presentation will need to be flexible so that country specific requirements can be met while still enabling NPOs to say that they have prepared their financial statements in accordance with the guidance. This includes flexibility as to how the primary statements are named.
Proposals to adopt fund accounting in the NPO Guidance are prominent and as fund accounting is applied by UK charities, this is a familiar approach to financial statement presentation. ICAS is supportive of this approach being followed in international guidance, especially in the absence of a strong case for an alternative approach.
NPOs should be required to demonstrate, by way of a note to the financial statements, how they have calculated their ‘free’ reserves. The NPO Guidance should define ‘free’ reserves in its glossary of terms.
The reporting of reserves policies and performance against reserves policies should be dealt with in NPO narrative reports as these are not financial reporting matters. This includes the reporting of any element of ‘free’ reserves set aside by management for a specific purpose.
Following this consultation there may be a further consultation on specific financial reporting matters, including accounting for legacies, heritage assets, related party transaction and foreign currency transactions.
Prior to the NPO Guidance being finalised, the IFR4NPO Initiative will publish an exposure draft for consultation. The guidance will be developed over a five-year period.
Read the ICAS Charities Panel response to the consultation here.