Have your say on NFP accounting – income recognition, control, related party disclosures and more

Topic

Difficulties encountered in practice

Sufficiently specific criterion and the legal interpretation of agreements

The term ‘sufficiently specific’ is unclear and there is confusion in practice about how the term should be applied. Judgement is required and this can result in contracts with similar terms and conditions being accounted for differently in practice.

While it will be clear for ‘black and white’ scenarios whether obligations in the contract are ‘sufficiently specific’, there are many ‘grey areas’ where judgement is required. For example:

Capital grants

If all of the following apply, capital grants received by NFPs in the form of a financial asset (cash) to acquire or construct a non-financial asset are deferred and recognised as income when the NFP acquires the non-financial asset, or as it constructs the non-financial asset:

• The NFP is required to use the financial asset to acquire or construct a recognisable non-financial asset to identified specifications
• The NFP is not required to transfer the non-financial asset to another party after acquisition or construction, and
• The grant occurs under an enforceable agreement.

There will be some scenarios in practice where it is clear whether there are ‘identified specifications’ for the acquired or constructed asset, but judgement is required for other scenarios as illustrated in the examples provided in ITC 50:

Difference between management accounts and statutory accounts and alternative revenue recognition models

Some NFPs are maintaining two sets of books for income recognition:

• One for internal reporting purposes (management accounts) or for donors, with revenue recognised based on the activities carried out (i.e. when the related expenses are incurred)
• Another for statutory reporting purposes based on Australian Accounting Standards.

The AASB is seeking comments on alternative approaches to recognising revenue in the NFP sector.

Principal v agent, including the appropriate recognition of financial liabilities

If a NFP is acting as principal in a grant arrangement, it recognises gross revenue and related expenses. However, if it is acting as agent because its only obligation is to transfer funds received to other entities, it recognises only the net commission as revenue.

The AASB is seeking feedback about whether NFP-specific guidance is needed to assist NFPs to determine whether they are acting as principal or agent, as well as examples where different applications in practice significantly affect the comparability of financial statements.

Examples identified in ITC 50 include:

• A university receives funding to pay out scholarships to students – here the university is acting as agent and recognises a liability for funds received
• A Foundation provides grants to Charity A. Charity A must direct the funds to other charities on a ‘best endeavours’ basis. This is Charity A’s only activity. There is diversity in practice. It is unclear whether Charity A should recognise:
  • Gross revenue for the grant received from Foundation (as principal), together with distributions to other charities as expenses, or
  • A financial liability for funds to be passed onto other charities.

Grants received in arrears

In some grant arrangements accounted for under AASB 1058 (i.e. where ‘sufficiently specific’ criteria are not met), there is diversity in the accounting for income received in arrears where work funded by the grant is performed before the funding is received. NFPs may be:

• Not recognising an asset or revenue until the funds are received
• Recognising a receivable and revenue when work is performed, or
• Recognising a contract asset and revenue as the work is performed.

The AASB is seeking views as to the appropriate accounting treatment, as well as examples where there is diversity in practice.

Termination for convenience (TFC) clauses

A TFC clause in a contract allows the grantor to terminate the agreement without showing cause, such as default or breach of the contract. There is diversity in practice, with TFC clauses being accounted for by recognising either:

• A liability for unspent funds when the grant is provided, and recognise income as funds are spent, or
• A liability only when the TFC clause is exercised by the grantor and there is a request for repayment, with income being recognised on receipt of the grant.

Accounting for research grants

The AASB has published a range of illustrative examples to AASB 15 in relation to research activities conducted by NFPs, as well as several staff FAQs. However, there is still diversity in the way research grants are accounted for by NFPs. The AASB is seeking comments and examples on practical application issues relating to accounting for research grants.

Statutory receivables

AASB 9 Financial Instruments, paragraph C4, notes that financial assets of NFPs include receivables arising from statutory requirements (e.g. rates, taxes and fines). The AASB 9 recognition and measurement requirements only apply to the initial measurement of statutory receivables, not their subsequent measurement.

The AASB is seeking views on the subsequent measurement of statutory receivables, as well as whether the requirement to initially measure statutory receivables at fair value adds a considerable workload for preparers and auditors.

Topic

Difficulties encountered in practice

Control and consolidation of NFP entities – Application of the control model

Appendix E to AASB 10 Consolidated Financial Statements contains NFP-specific guidance for assessing whether an NFP has control over another entity. Common examples of relationships where an NFP needs to assess control include:

• A school establishing a foundation to raise funds for future projects
• A religious organisation establishing an auxiliary organisation to undertake activities that share common values with the religious organisation but are not related to the religious organisation’s main activities.

NFP stakeholders have raised the following concerns with the AASB regarding the application of the ‘control’ model:

• Having to consolidate entities they do not believe they have genuine control over, particularly where there are no shared liabilities or other financial impacts
• Consolidated financial statements may not be appropriate where the parent entity’s financial position and performance are obscured by the subsidiary
• Consolidation may be difficult due to the inability to obtain the required information.

The AASB is seeking examples where difficulties may be encountered in practice identifying and consolidating controlled entities.

Control and consolidation of NFP entities – Identifying variable returns

There are challenges identifying variable returns in the NFP sector because the implementation guidance contained in Appendix E is too broad. Clarity is needed as to whether, for example, fulfilling a mission element of a religious organisation is a variable return, even though there are no rights to distribution of assets.

The AASB is seeking examples where NFPs are experiencing difficulty identifying variable returns in practice.

Control and consolidation of NFP entities – Customary business practices

NFPs are unsure what effect, if any, customary business practices have on assessing control. For example, School ABC establishes Old School ABC Association that conducts fundraising. It historically distributes the fundraising proceeds to School ABC but is not obliged to do so. It is permitted to distribute proceeds to any NFP.

Control and consolidation of NFP entities – Assessing control without an equity interest

Some NFPs are experiencing difficulties assessing if they have power over other entities in which they do not have an equity interest. For example, companies limited by guarantee are often prohibited by their constitution from distributing any surplus to members, and instead must distribute to another NFP with similar objectives.

NFPs are unsure whether the ability to direct distributions on winding up give rise to power and exposure to variable returns. That is, is this a protective or substantive right?

The AASB is seeking feedback on how NFPs are applying these requirements in practice.

Control and consolidation of NFP entities – Principal v agent (public sector entities)

Investments in the public sector are often not financial, and returns are often in the form of policy outcomes rather than financial outcomes.  Public sector stakeholders have sought clarification from the AASB as to when an entity is acting as principal or agent as there can be inconsistent conclusions in similar situations.

The AASB is seeking comments as to how stakeholders distinguish whether they are acting as principal or agent.

Definition of a ‘structured entity’ for NFP entities

A ‘structed entity’ is an entity designed so that voting rights or similar rights are not the dominant factor in deciding who controls the entity, such as when voting rights relate to administrative tasks only and the relevant activities are directed by means of contractual arrangements.

Voting rights may not be the dominant factor in deciding whether an NFP controls another entity. Therefore, applying the structed entity definition could result in many NFPs being classified as ‘structured entities’.

While the AASB is not aware of any implementation issues, they are nevertheless seeking feedback about the application of the structed entity requirements in practice.

Related party disclosures by NFP public sector entities

For annual periods beginning on or after 1 July 2016, NFP public sector entities are required to include related party disclosures in their financial statements.

The AASB is aware that there are challenges identifying all related parties and difficulties ensuring complete representations are received, including obtaining information about close family members. Obtaining this information raises data privacy and audit issues.

The AASB is seeking feedback on these requirements.

Basis of preparation for special purpose financial statements (Disclosures about compliance with Australian Accounting Standards)

Private sector NFPs preparing special purpose financial statements that are required to apply AASB 1054 Australian Additional Disclosures must disclose information about their extent of compliance with the recognition and measurement requirements of Australian Accounting Standards, including consolidation and equity accounting where they have identified interests in subsidiaries, associates and joint ventures. These disclosures are not required for public sector NFPs.

The AASB is seeking feedback regarding these disclosures.