THE IMPACT OF THE FINANCIAL REPORTING BILL ON REGISTERED CHARITIES

Transcription

1 5 March 2013 Jonathan Young MP Chair Commerce Select Committee Parliament Buildings Wellington Dear Mr Young THE IMPACT OF THE FINANCIAL REPORTING BILL ON REGISTERED CHARITIES The Commerce Committee has sought advice on the impact of the Financial Reporting Bill on registered charities. Specifically the Committee asked for the following: Evidence of the need for changes in the Bill for the charitable sector. Detailed information on the impact of the Bill on compliance costs in the charities sector, including adjustment costs and on-going costs, and costs for related groups. A report-back on views obtained from large charities such as the Salvation Army, Cancer Society and Presbyterian Support Services. Our report is attached. The reason the FR Bill includes a power for the XRB to issue accounting standards for registered charities is that there are problems with the overall standard of current reporting by registered charities. Those problems are caused by: Uncertainty within the accounting profession about what is expected for NFP reporting. Many charities comply with existing accounting standards issued by the XRB, even though there is no legislative requirement to do so. However, those standards can be difficult to apply to the NFP sector because they are designed largely with for-profit entities in mind, particularly those entities that operate in capital markets. Therefore, some accountants who prepare NFP entity financial reports struggle to understand how to apply them. Active decisions by some accountants employed or on the governing boards of charities to not comply with generally accepted accounting practice (GAAP) even where they are required to by NZICA s Code of Ethics. This can lead to financial reports that mislead users, including private and public sector funding agencies. Many volunteer treasurers not understanding the requirements of GAAP and/or not having the necessary accounting skills to even prepare simple financial statements in accordance with fundamental recognition, measurement, disclosure and presentation principles. They need some simple guidance. -

2 The main points in the attached report about costs and benefits are as follows: With one exception, we consider that the compliance costs are commensurate with the benefits that will be obtained as a result of the XRB issuing accounting standards for registered charities. The exception that may face disproportionately high compliance costs relates to charities towards the lower end of the proposed Tier 3 of financial reporting (i.e. towards the $40,000 payments end of the $40,000 to $2 million band that defines Tier 3). This is because the Tier 3 standard is accruals-based and requires more skill to prepare than some of those charities are likely to have access to. Increasing the $40,000 amount in clause 45 of the FR Bill would manage any such compliance problem because more charities would then be eligible for the very simple Tier 4 cash reporting standard. Charities additional costs and benefits depend on what they are currently doing and which of the four tiers of NFP reporting they will move to under the new system. There are very diverse starting points across the 25,000-odd registered charities and there is no simple way to categorise them. We have not attempted to quantify the costs and benefits because we do not think that they can be reliably estimated without commissioning a complex and detailed study. The adjustment costs for the great majority of large charities and most medium charities will generally be low in proportion to their size for the following reasons: o o o Many are already preparing in accordance with generally accepted accounting practice (GAAP), or something close to it. Compliance with the new NFP standards will not require large amounts of up-skilling. The changes will generally only require minor modifications to existing electronic accounting systems. Some of the adjustment costs will be incurred even if the provisions empowering the XRB to make standards for registered charities were to be taken out of the FR Bill. This is because in the absence of NFP sector standards many large and medium charities that are currently preparing in accordance with the current standards that are designed for for-profit entities will choose to switch to the new suite of public sector standards that will be issued by the XRB later this year. They will make this change because the public sector standards are more appropriate than for-profit standards to the NFP sector. The most significant costs will be incurred by some large charities that are only reporting at the branch level at present. Branch level reporting is appropriate where the branches are autonomous. However, the national office should incorporate branch information into a set of consolidated financial statements if the national office controls the branches. That could involve significant one-off systems-related costs. However, it is very important to make this change because national offices that exercise control over branches but are not consolidating are providing an incomplete picture. The 95% of charities that will report in accordance with one of the two simple format reporting standards (i.e. Tier 3 and Tier 4) will incur one-off costs of moving from whatever it is they are currently doing. However, there will be significant benefits: o o o preparation will be easier for volunteers because they will be able to use simple templates external users of the financial statements will obtain much more useful information, particularly in a new statement of service performance charities will have access to much better financial and non-financial information that can contribute to the governing board s strategy and governance activities.

3 Higher compliance costs and higher benefits tend to go hand-in-hand. Charities that fall well short of acceptable standards of financial reporting at present will face higher one-off adjustment and on-going costs in complying with the standards. However, the users of those financial statements will also obtain larger benefits because the improvement in quality of reporting will be commensurately higher. We consulted with the Association of NGOs of Aotearoa (ANGOA) and the External Reporting Board (XRB) in preparing this report. We consulted with ANGOA because it is uniquely placed among not-for-profit (NFP) sector organisations to provide informed views for two reasons: It has a broad perspective because it is an umbrella organisation for 91 NFP sector national, regional and local umbrella NFP organisations. ANGOA also facilitates NGO networking and shares information about issues of common concern, with a particular emphasis on strengthening relationships across the sector and between the sector and government. ANGOA has taken an active interest in NFP financial reporting issues in recent years and has organised and participated in seminars and workshops around the country to promote informed debate and encourage submissions on discussion papers issued by MED/MBIE and the XRB. We consulted with the XRB because the financial reporting strategy and standards that it issues will have a significant impact on the costs and benefits of the charities-related proposals in the FR Bill. The XRB broadly agrees with the attached analysis of the advantages and disadvantages of the charities-related changes and the summary appearing above. Yours sincerely Melanie Porter Manager, Corporate Law Commercial and Consumer Environment

4 Financial Reporting Bill: MBIE Officials Report on the impact on charities Consultation on the charities proposals 1. There has been extensive consultation with the not-for-profit sector on the proposals relating to charities. In September 2009, the Ministry of Economic Development and the Accounting Standards Review Board (ASRB the XRB s predecessor) simultaneously released discussion papers about several issues, including charities-related proposals. 2. The MED paper outlined the proposal to empower the ASRB/XRB to set standards for registered charities. It proposed that registered charities with operating expenditure of less than $20,000 be eligible to report on a cash basis (That amount was increased to $40,000 in the FR Bill see clauses 45 and 77). 3. The ASRB s discussion paper outlined tentative proposals for the standards it would set if the law changes in the MED discussion paper were to be implemented. The main proposal was to replace the current approach of having the same standards for all reporting entities with three different classes of standards: one each for for-profit entities, public sector entities and NFP entities. The proposals for NFP public benefit entities (PBE) were as follows: a. Tier 1: NFP PBE standards building on International Public Sector Accounting Standards (IPSAS) b. Tier 2: Differential PBE standards, requiring considerably fewer disclosures than the Tier 1 standards c. Tier 3: Simple format reporting, with Tier 3a being accrual reporting and Tier 3b being cash reporting. 4. Following the release of the two discussion papers, ANGOA and the Not-for-profit Special Interest Group of NZICA organised 13 workshops throughout the country. As noted on the first page of ANGOA s submission to the Commerce Committee, the workshops were intended to encourage organisations in the community sector to make submissions on the discussion papers and to provide information and views from the sector, which were incorporated into submissions by ANGOA. 5. The ASRB further elaborated on its proposed multi-standards approach in a position paper and two follow-up consultation papers in September 2011 by making the following two changes to the proposals outlined in the 2009 discussion paper: a. It proposed a multi-standards approach comprising one group of standards for forprofit entities and another group for all public benefit entities or PBEs (i.e. public sector entities and NFP entities). b. It re-designated the proposed Tiers 3a and 3b as Tiers 3 and The ASRB ran seminars in Auckland, Hamilton, Wellington and Christchurch to outline the proposals and encourage submissions. The key theme in submissions from the two PBE sectors (i.e. public entities and NFP entities) was to support the move to the multistandards approach. There was general concern that IFRS do not fit with PBE financial statements users needs. Those sectors wanted standards that are more relevant. 7. The XRB finalised the multi-standards approach within its financial reporting strategy in March 2012 and it was approved by the Minister of Commerce under s 34A of the FR Act 1993 on 2 April 2012.

5 8. In December 2012, the XRB released exposure drafts for the proposed NFP PBE simple format accrual and cash standards. Submissions close in June The XRB, ANGOA and the Department of Internal Affairs Charities Group (DIA Charities) have jointly organised a road show of 26 seminars in 16 centres from March to May. 1 There were 1,528 registrations as at 25 February and the XRB is expecting that the final total will be close to 2,000. The XRB is also placing a podcast on its website in March and will finalise the series with a webinar on 14 May. Evidence of the need for the changes in the Bill to reporting for the charitable sector 9. All registered charities are required to attach financial statements to the annual returns they file with DIA Charities. There is no legislative requirement to comply with accounting standards issued by the XRB, although many charities do so for other reasons such as wanting to demonstrate their good governance and transparency to funders. There is evidence of three types of problems: a. Uncertainty among accountants about how the current accounting standards, which have been designed for use by for-profit entities, apply to the NFP sector b. Consequential decisions by some chartered accountants in response to that uncertainty to not comply with GAAP c. Volunteer treasurers either lacking the required accounting skills or actively not complying with GAAP A. Uncertainty among accountants 10. When the decision was made in New Zealand in 2002 to adopt IFRS, the future focus and content of IFRS was uncertain. The International Accounting Standards Board (IASB), which issues IFRS s, was in its infancy it had come into existence on 1 January Subsequently, the IASB has clarified that its focus is on developing accounting standards for application by for-profit entities, particularly those being financed through capital markets. Table 1: Conceptual problems with applying IFRSs to PBEs Fundamental premise of IFRS Entities have an over-riding profit-seeking objective Transactions are invariably exchange in nature Transactions take place in markets for goods and services Asset values are largely arrived at by referring to future cash flows The main users are investors and analysts Applicability to PBEs PBEs have an overall objective of providing goods or services for community or social benefit Many transactions are non-exchange in nature Markets often do not exist and some PBEs hold many specialised assets Asset valuation needs to take account of the nature and purpose of the entity The main users are taxpayers, donors and funders 1 MBIE is also presenting at 20 of those 26 seminars on a discussion paper released on 21 February 2013 called Auditing and Assurance for Large & Medium Registered Charities Concrete Proposals. Submissions close on Friday 17 May.

6 11. It has become increasingly clear that the capital markets focus makes IFRS less relevant to the users of non-capital markets entities, particularly PBEs. The main conceptual problems of IFRS for both public and private sector PBEs are outlined in Table Beginning in 2008, the ASRB considered the matter in detail and concluded that these were valid concerns that needed to be addressed in the New Zealand context. The issues were addressed in the ASRB s 2009 discussion paper. Most public sector and NFP submitters agreed that change to a multi-standards approach was needed, and that users of financial statements would better be met by producing PBE standards that were based on IPSAS. 13. This change will improve charity accountability to donors and taxpayers. B. Non-compliance with GAAP 14. The main evidence of non-compliance with GAAP appears in a doctorate thesis by Rowena Sinclair. 3 It was a qualitative inquiry into the accounting methods charities in New Zealand use. Dr Sinclair conducted in-depth interviews on accounting treatments used by charities in determining their accounting policies. 15. The study targeted larger charities that employ qualified accountants to prepare their financial statements. There were 84 participants in 75 interviews. Dr Sinclair interviewed people involved in the preparation or auditing of the financial statements, managers of charities, board members of charities and experts in charities. She concluded that there are three key reasons behind the choices that charities make in accounting treatment: a. Poor knowledge of appropriate professional standards by accountants working in the charities sector b. A low level of financial literacy among the preparers and users of charities financial statements c. It is the aim of many charities to look poor as they seek to gain more funding. 16. Dr Sinclair s thesis includes numerous quotes from interviews demonstrating: a. many instances of chartered accountants not complying with GAAP, which also meant that they were not complying with NZICA s Code of Ethics. b. use of accounting recognition and measurement methods that are unquestionably incompatible with GAAP c. use of funds for general purposes when they were intended for specific purposes d. intentions to produce meaningless or confusing financial statements e. intentions to misrepresent the charity s financial position and performance to obtain funding. 17. Some examples appear in Appendix 1 of this report. 2 Adapted from a table in The Auditor-General s views on setting financial reporting standards for the public sector, June 2009, page Rowena M. S. Sinclair, Understandability and Transparency of the Financial Statements of Charities Unpublished thesis submitted to Auckland University of Technology, 2010

7 C. The problems with the status quo for volunteer treasurers 18. Most small charities rely on volunteers to prepare the financial statements that are currently required to be attached to the annual returns submitted to DIA Charities. Some charities may have someone with the accounting skills to do a good job. However, most rely on individuals with limited accounting skills and knowledge. Many volunteer treasurers do not understand the concept of accrual accounting and, even if they do, may not understand all of the requirements of GAAP insofar as they are applicable to their charity. 19. This is evidenced by a report commissioned by the Ministry of Economic Development from the School of Accounting and Commercial Law at Victoria University of Wellington 4 (the Cordery & Patel study). The study analysed the quality of financial reporting by 400 randomly selected small and medium-sized charities: 200 with expenditure of less than $40,000 and the other 200 with expenditure of between $40,000 and $2 million. 20. Cordery & Patel found that fewer than 5% of the sampled charities produced financial reports that could be classified as good or very good despite more than half of those financial statements having an unqualified independent audit or review opinion. They found very little reporting of charity-specific items, such as explanations of grants, details around the expenditure incurred in fundraising or information on volunteers and gifts-inkind. 21. Less than 60% of the sample of 400 financial statements appeared to comply with GAAP. Cordery & Patel concluded that clear rules are required to improve accountability by improving charity reporting, and increase comparability between charities. 22. Cordery & Patel did not seek to obtain information about why GAAP was not being complied with. However, much of the non-compliance was due to not making disclosures that should have been made, mis-categorisations and not presenting information in an appropriate manner. Thus, it seems likely that most of the non-compliance of the charities small and medium charities that were the subject of this study was due to a lack of understanding of GAAP or concerns about its appropriateness for NFP entities. 23. Cordery & Patel also stated that over half the sample in their research received assurance on their financial statements and 108 of these were provided by NZICA members. However, over a quarter of the assurance reports were not in the appropriate format. Costs and benefits The status quo for registered charities and the XRB s proposals for tiers of reporting for NFP PBEs 24. Until recently, the accounting standards issued by the XRB applied to all forms of reporting entity, whether for-profit or NFP, and whether private or public sector. Those standards were written from a for-profit entity perspective but included boxed text that provided for a small number of alternative treatments or concessions for PBEs. 25. The XRB has now embarked on a three-stage process of issuing standards that will eventually lead to standards that are fully designed with PBEs in mind. Stage 1 is an interim step that is described in the next paragraph. Stage 2 will implement the full set of public sector PBE standards in Stage 3 will implement the full set of NFP PBE standards in Dr Carolyn Cordery and Kapil Patel: Financial Reporting Stocktake: An Assessment of Accountability through Charities Filing on the New Zealand Charities Register, 18 March 2011.

8 26. The status quo is defined by the Stage 1 implementation which came into effect for accounting periods beginning on or after 1 December Stage 1 did not change anything in substance. What it did do was replace the existing one set of standards that included PBE boxed text with two stand-alone sets of standards: one for for-profit entities and the other for PBEs. 27. For example, under the previous set of standards there was a box in the standard relating to operating segments (NZ IFRS 8) stating that PBEs are not required to comply with the requirements of NZ IFRS 8. Under the changes implemented in December 2012: a. The for-profit NZ IFRS 8 no longer includes the PBE-related text b. There is no PBE equivalent of NZ IFRS The new status quo for PBEs from 1 December 2012 is as follows: a. Tier 1: The New Zealand equivalents of International Financial Reporting Standards for PBEs (NZ IFRS PBE) along with three New Zealand-specific standards. These standards apply mainly to public sector entities and a small number of large NFP PBEs. b. Tier 2: The Framework for Differential Reporting for PBEs (Diff Rep) Diff Rep can be used by entities that are not publicly accountable; and are closely held and/or not large. It provides a significant number of disclosure concessions from NZ IFRS PBE (e.g. a cash flow statement is not required) and a small number of measurement concessions. c. Tier 3: The set of domestic standards that applied before New Zealand adopted IFRS in 2007 (Old GAAP) Old GAAP can be used by entities that are not publicly accountable or large. Old GAAP is incomplete and outdated because it has not been maintained since The XRB will no longer permit Old GAAP to be used once the reporting requirements for small and medium companies are removed. The XRB s proposed tiers for NFP PBEs 29. The XRB s new framework, insofar as it applies to NFP PBEs, including registered charities, will be as follows from 1 April 2015: a. Tier 1: Expenses of $30 million or more NZ PBE Standards comprising IPSAS modified as appropriate for New Zealand and NFP circumstances, together with additional standards as necessary. b. Tier 2: Expenses of $2 million to $30 million PBE Standards Reduced Disclosure Regime (PBE Standards RDR). This is a new suite of standards comprising the standards applying to Tier 1 but with disclosure concessions. However, there are no recognition or measurement concessions. c. Tier 3: Payments of $40,000 to expenses of $2 million PBE Simple Format Standard Accrual (PBE SFR-A) comprising a single standard allowing reporting in accordance with a simple format approach using accrual accounting. See Appendix 2 for further information. d. Tier 4: Payments of less than $40,000 PBE Simple Format Standard Cash (PBE SFR-C) comprising a single standard allowing reporting in accordance with a simple format approach using cash accounting. See Appendix 2 for further information.

9 The costs for charities that will be in Tier 1 ($30 million-plus charities: PBE Accounting Standards) 30. There were, on 21 February 2013, 59 charities (0.2% of the 25,040 charities registered on that date) that would be required to report in accordance with the Tier 1 standards. It is likely that all of those charities will currently be required to prepare in accordance with either NZ IFRS PBE or Diff Rep for the reasons outlined below. 31. First, some are already obliged by legislation to prepare in accordance with GAAP. For example, universities and technical institutes are public entities and must, therefore, prepare in accordance with GAAP. So must charities that operate retirement villages. 32. Second, the largest charities usually choose to produce high quality financial reports. They value proper financial management and sound financial reporting because it gives them credibility with funders and in the market more broadly. This reason also applies to many Tier 2 charities. 33. Third, it is likely that the financial reports are all being prepared by chartered accountants. NZICA s Code of Ethics states that members who are involved in, or have responsibility for the preparation or presentation of general purpose financial reports should take all reasonable steps within their power to ensure that GAAP is complied with. Although Dr Sinclair provided strong evidence that some large charities actively do not comply with this obligation, we think it is likely that most if not all the non-compliers will be in the new Tier 2 (i.e. the $2 million to $30 million range), not Tier Fourth, GAAP is complied with for auditing-related reasons. Practitioners who audit general purpose financial reports express an opinion as to whether the financial report complies with GAAP. We would expect that auditors within the Big 4 and the mid-tier firms would consistently do so. 35. Some of the 59 Tier 1 charities are currently preparing in accordance with Tier 1 while others will be preparing in accordance with Tier 2. For those entities currently in Tier 1: a. There will be an up-skilling transition cost for employees preparing the financial statements to gain an understanding of the differences between the current IFRS standards and the proposed IPSAS-based standards. This cost will be very small because there are not many differences between IFRS and IPSAS at present, although the differences will increase over time. In addition, it is easy to identify the differences because the XRB has published a list. The list will be maintained. b. There may need to be electronic accounting systems changes. All of the charities in Tier 1 are likely to be using a standard electronic accounting package comprising a general ledger along with modules for accounts payable, accounts receivable and fixed assets. Some may also have modules for commitments and/or budgets. The report writers that they currently use are likely to be sufficiently flexible to be adapted to meet the new requirements. It is very unlikely that any entities moving from the current Tier 1 to the new Tier 1 would need to buy new systems, or redevelop current systems in any significant way. c. It is unlikely that there will be any significant new on-going costs for entities transferring from the current Tier 1 to the new Tier 1 as both sets of standards are of similar complexity. The only on-going costs they have to incur are those associated with issuing of new standards, or amending or withdrawing existing standards. Those costs would have been incurred anyway. 36. For the charities transferring from the current Tier 2 Diff Rep to Tier 1 PBE accounting standards:

10 a. The up-skilling cost will be somewhat higher because there is more change to learn. The extent of the costs will depend on the nature of the charity s activities because the Diff Rep/RDR disclosure concessions are relevant to some but not others. b. More modifications of electronic report writers may be needed. However, as with the previous sub-category, it is unlikely that there will be a need to buy new systems or significantly redevelop current systems. c. There will be some on-going costs because they will be required to make more disclosures and, therefore, collect more information during the course of the year. Generally speaking, the on-going costs are unlikely to be significant. However, we do note that there are diverse starting points. 37. In addition, Tier 1 preparers will need to keep up with the changes to the PBE accounting standards. Every year, the IPSAS Board adds new standards and/or amends or withdraws existing standards. Preparers will need to keep up with the changes. This will not add a compliance burden for charities currently preparing in accordance with NZ IFRS because they have do that now. Summary on Tier To summarise, for the 59 charities in the new Tier 1: a. transition costs are likely to be very low in proportion to their total expenditure. In addition, even if the NFP PBE standards were not to be issued, some charities may incur similar transition costs because they might choose to move to public sector PBE standards b. on-going costs for those transitioning from the current Tier 1 standards will be roughly zero because the two Tier 1 sets of standards are of similar complexity c. there may be on-going costs for those transitioning from the current Tier 2 standard because the new Tier 1 requires more disclosures than the current Tier 2. However, some of the Tier 2 concessions have little relevance to charities because they relate to matters that have no relevance to charities (e.g. credit, liquidity and market risks associated with financial instruments, segment reporting and tax-related matters). The costs for charities that will be in Tier 2 ($2 million to $30 million charities: PBE Standards RDR) 39. There were, on 21 February 2013, 912 charities (3.6%) that would be required to report in accordance with the new Tier 2 PBE Standards RDR, or opt-up to Tier Chartered accountants are likely to be preparing the financial statements for the great majority of charities in this tier, so they are ethically obliged to prepare and present in accordance with GAAP. In many cases the preparation is likely to be carried out by employees of the charity while in other cases it is out-sourced to accounting firms, both mid-tier firms and small firms. This means that the NZICA ethical obligation to prepare in accordance with GAAP applies. For out-sourced work, the ethical obligation applies whether it is carried out at commercial or subsidised rates, or pro bono. 41. We think it is reasonable to assume that the mid-tier accounting firms would consistently meet this obligation. However, we think that Tier 2 and the top end of Tier 3 is where much of the GAAP non-compliance issues of the type documented by Dr Sinclair is taking place, mainly by some charity employees and volunteer treasurers. There may also be some non-compliance among some small accounting firms, particularly where the work has been carried out on a pro bono basis (see the last quote from Dr Sinclair s thesis in Appendix 1 to this report).

11 42. Most of the $2 million to $30 million charities that do prepare in accordance with GAAP are likely to be preparing in accordance with Diff Rep or Old GAAP at present. 43. For those currently using Diff Rep, there are not many differences between the two Tier 2 systems and the one-off and on-going compliance costs will be low. The main implications are as follows: a. Diff Rep does not require a cash flow statement to be prepared, but PBE Standards RDR does. This new obligation is not onerous because it does not involve collecting any information that would not otherwise be collected. b. There are fewer disclosures in total under PBE Standards RDR than Diff Rep. Generally speaking, the compliance savings are likely to be insignificant because the net reduction in the number of disclosures is small. However, there may be exceptions because it will depend on the nature and number of PBE concessions that they are currently taking and how many they will take in future. c. Diff Rep has a small number of measurement concessions but PBE Standards RDR has none. However, the up-skilling cost is likely to be negligible because the main concession (using Inland Revenue depreciation rates) does not apply to registered charities. 44. Almost all of the rest of the $2 million to $30 million charities that comply with GAAP are likely to be using Old GAAP. As noted earlier, Old GAAP is the set of standards that applied in New Zealand before IFRS s were adopted, and it has not been maintained since Old GAAP was never intended to be anything more than a transition, pending the removal of general purpose financial reporting obligations for non-large nonissuer companies. The XRB stated in its March 2012 strategy that it will withdraw Old GAAP. Thus, even if the charities-related reporting requirements in the FR Bill were to be taken out, those charities that are currently using Old GAAP will need to transition to something else. 45. It is very difficult to generalise about the compliance costs for charities that are in the $2 million to $30 million range but do not comply with current GAAP because there is a big difference in the sophistication of charities at the top and bottom ends of the range. That said, it is likely that the great majority would keep proper accounting records, which means that the transition costs will usually be small and the on-going costs close to zero. 46. It is possible that a very small number of charities towards the bottom end of the $2 million to $30 million range are cash reporting at present. They will need to make a significant investment in up-skilling and systems change because they will either not be preparing statements of financial performance and financial position or, if they are, it will not be in accordance with anything like what will be expected under RDR. Our view is that the increased compliance is fully justified because cash reporting is wholly inadequate for any entity of this size, whether for-profit or not. Diff Rep-related transitional costs 47. The XRB has already decided that Diff Rep will be withdrawn. Therefore, nothing in the FR Bill has any impact on costs and benefits associated with entities that will transition from Diff Rep to PBE Standards RDR.

12 Summary on Tier To summarise, for the 971 charities in the new Tier 2: a. The compliance for those that are not complying with GAAP at present will range from close to zero for those that already have good accounting records-keeping systems through to being significant for the minority whose existing record-keeping systems and financial reports are wholly inadequate. b. The other costs and benefits relate to decisions already made by the XRB to withdraw Diff Rep and Old GAAP, and are not affected by the content of the FR Bill. The costs for charities that will be in Tier 3 ($40,000 to $2 million: PBE SFR- A) 49. There were, on 21 February 2013, 10,286 charities (41%) that would be required to prepare in accordance with Tier 3 or opt-up to a higher tier. 50. It is very difficult to generalise about Tier 3 because it is, by far, the most diverse tier: a. As discussed in relation to Tier 2, $2 million charities are likely: i. To have their financial reports prepared by chartered accountants ii. To be operating standard accounting packages systems b. $40,000 charities will mostly have: i. Their financial reports prepared by volunteer treasurers, many of whom will have limited accounting skills ii. Unsophisticated accounting systems, such as manual accounting records or involve the use of spreadsheets that are part of the standard software on the computer c. Tier 3 will include charities that use cloud computing (e.g. Xero) or off-the-shelf desktop software packages (e.g. MYOB). 51. Most charities that account in the cloud will incur no additional cost. The main provider, Xero, is planning to incorporate the two simple format reporting standards into its remote server systems because it will help the company retain existing clients and attract new ones. MYOB also now offers accounting in the cloud products. 52. The impact on charities using off-the-shelf accounting software is likely to vary depending on the age of the package they currently have. It is possible that those with newer software may be eligible for automatic updates at no additional cost. However, those with older packages may find that they will need to start accounting in the cloud (at an annual cost of $500-$700 a year) or buy a modern simple product at a one-off cost of $400 or $500. The proportion of the total that could be attributed to the FR Bill reforms depends on how much sooner the charity upgraded than it would otherwise have done. It would be reasonable to attribute the full cost if the charity upgraded several years earlier. However, only a proportion of the total cost should be attributed to the FR Bill if the purchase was brought forward by, say, one or two years. 53. The impact on charities that use spreadsheets for their accounting records keeping and financial statement preparation is likely to be variable. The costs will be insignificant for those already preparing reasonably good accrual-based financial reports. However, they will be more significant for charities that are producing poor accrual statements at present.

13 54. The costs will be larger again for some charities that would be required to move from cash to accrual reporting. It is likely that many spreadsheet-using cash reporting charities will need to make changes to the spreadsheet if they are required to move to accrual reporting. This should be within the capability of most of those charities. However, it may present challenges for any charities whose workbook was set up by a computer-literate volunteer who is no longer a member of the charity. 55. The major potential cost for charities at the low end of the Tier 3 band is not having access to the necessary expertise to prepare anything other cash-based financial reports. For example, there is potential for Tier 3 charities towards the $40,000 end of the Tier 3 band to lose volunteer treasurers: a. Who do not understand accrual accounting Although the XRB has reduced the risks by attaching a template to the standard, along with explanatory notes, we still expect that some volunteers would not have the understanding to comply. b. Who are not computer-literate This is most likely to be a significant issue for charities whose treasurer has retired from the workforce. Retiree availability problems with should diminish over time as electronic accounting packages continue to become easier to use and as the proportion of retirees who are computer-literate increases. 56. The changes may also absorb more time for the members of the governing board for some Tier 3 charities for the following reasons: a. A major feature of the two simple format reporting standards is to require charities to tell their story in words, not just in dollars. As noted in Appendix 2, the standards will require charities to state why they exist, what they achieved, what they did and when they did it. Very few charities provide any information of this type in their annual reports at present, so there will be more to report on. That said, many volunteers are passionate about the work of the charity and we consider that most Tier 3 and 4 charities do think about these matters. They will need to document those thoughts for annual reporting purposes. b. It will increase the quality of financial information available to the board. We consider that some boards will take the opportunity to use that information for improved governance purposes. 57. The XRB considers that that there will only be a need to amend the Tier 3 standard periodically, perhaps once every five years. Therefore, the cost of keeping up with the changes will be negligible. 58. To summarise, there are many different starting points within Tier 3 because it is the most diverse of the four tiers: a $40,000 charity and a $2 million charity do not have much in common. It is very difficult to generalise about the compliance issues for this Tier. Summary on Tier Perhaps the most important conclusion that might be drawn in relation to Tier 3 is that the costs are disproportionately high for charities towards the bottom end of the tier. Those costs could be significantly reduced by substantially increasing the $40,000 criterion in clause 45 of the FR Bill. This would have the effect of transferring a significant number of charities from Tier 3 accrual reporting to the much simpler Tier 4 cash reporting (see below). 60.

14 The costs for charities that will be in Tier 4 (i.e. less than $40,000: PBE SFR-C) 61. There were, on 21 February 2013, 13,783 charities (55%) that would be required to prepare in accordance with the Tier 4 simple format cash standard or to opt up to a higher tier of reporting. 62. As with Tier 3, it is likely that charities in this group use a variety of approaches to accounting records keeping and financial statement preparation. However: a. The ratio of Tier 4 charities using simple spreadsheets and keeping manual records is likely to be higher. b. A small number of Tier 4 charities attach copies of bank statements to their annual return to DIA Charities, not financial statements. 63. It should be well within the capacity of the great majority of small charities to prepare financial statements in accordance with the Tier 4 cash standard because: a. Cash reporting only requires the treasurer to keep a cash book, whether in manual or electronic form, and add up the totals at the end of the financial year for each item that needs to be disclosed. b. Although the Tier 4 standard requires major assets and liabilities to be identified, it does not involve any difficult calculations. For example, a charity that: i. Owns a photocopier that was donated to it will need to list the asset, but it will not need to estimate a dollar value or do any depreciation calculations. ii. Has a bank loan will only need to identify the bank, the amount owed and the repayment date or dates. c. The XRB template and guidance material is clear and simple. The template, which is in a fill-in-the-box format, will make preparation easier for the non-technical preparer. It has the potential to reduce compliance costs because it removes uncertainty. 64. As with Tier 3: a. The new requirement to tell the story of the charity in words, not just dollar amounts will absorb more governing board members time for some charities. b. The Tier 4 standard will only be amended very occasionally. Summary on Tier To summarise on Tier 4, as with Tier 3, there will generally be an inverse relationship between the quality of what the charity is producing now and the compliance costs. Tier 4 charities that are doing good cash or accrual financial statements now will face the least cost. At the other extreme, those lodging bank statements will have to improve markedly or consider deregistering. The benefits of the changes in the FR Bill relating to charities 66. The proposals to require the XRB to issue accounting standard for registered charities are aimed at achieving the following benefits: a. To make GAAP clearer and more relevant to the NFP sector. This will improve the standard of reporting, thereby improving transparency, accountability and comparability.

15 b. The clarity associated with having sector-specific accounting standards will remove uncertainty for accountants who are unsure what they are required to do to comply with GAAP. In addition, accounting standards issued by the XRB are legally binding. c. To address the volunteer preparer uncertainty problem. We consider that the great majority of volunteers would aim to do what is expected of them if only they knew what it was. The two simple format standards, and the voluntary template and the template guidance notes will not be a panacea but they should make a significant difference. d. To improve entity credibility because good reporting is an indicator that it is a well-run entity. e. To improve charities governance and performance. Boards of large entities, whether for-profit or NFP, typically require management to prepare sophisticated management reports that include such things as forecast cash flows and variance analysis that highlights major difference between forecasted and actual performance. Most registered charities do not have the resources to do this. The annual financial reports are probably the most useful financial information that will be available to them.

16 Appendix 1: Examples of quotations included in Chapter 6 of Rowena Sinclair s thesis Understandability and Transparency of the Financial Statements of Charities I ve never [put] anything [in the financial statements] that s been donated. It [the restricted fund] goes into the general fund; it doesn t go into a special account or anything. I presented my IRFS accounts to the [XXX]. And they decided not to consolidate This is a quarter million dollar business. But the bottom line is we are all legally independent entities. So the fact that collectively we look financially viable has got nothing to do with anything. The accountant they work with, he doesn t want the accounts presented in the way that actually is most useful for [the charity]. They ll rename them [charitable trusts] with totally different names that aren t related to the original [charity] name and the only way that you might track that actually going down is by doing searches to find a commonality of directors. We re either very financial or considerably in deficit. Twelve month contracts do not coincide with our financial year so we ve been paid out for a portion of the 6 months that we ve not yet earned. When our bank account gets big, we move it off and then we bring it back. It actually has a Trust as well which you don t see in those accounts down there. If you ve got too much money [the funders] tend to turn you down. If, however, you ve got a Trust, you can sit on some of your funds across there and you can apply the funding with legally not showing the full amount of funding that you have available to you. Part of the problem is not so much the fact that they ve paid someone but the fact that they haven t paid someone and that someone is doing it [preparing charities financial statements] largely pro bono and therefore they re taking a pro bono attitude to it

17 Appendix 2: Descriptions of the simple format PBE standards for Tier 3 (accrual) and Tier 4 (cash) The simple format sets in the exposure drafts are single, standalone standards and each of them includes three sections: The standard, which will be compulsory A template, which will be voluntary Template guidance notes Tables 2 and 3 outline the proposed requirements in each draft standard. The differences between the cash and accrual standards appear in bold in Table 3. Table 2: The Tier 4 cash standard (PSFR-C) Entity information Sections of the report Statements of service performance - Outcomes (goals) - Outputs (services) Statement of receipts & payments - Payments (money out) - Receipts (money in) Statement of resources and commitments - Resources - Commitments Notes - Preparation basis - Additional information Who are we? Why do we exist? Description What did we achieve? What did we do? When did we do it? What did it cost? How was it funded? What do we own? What do we owe? What do we need to be able to continue? i.e. cash accounting Related party transactions & events after balance date

18 Table 3: The Tier 3 accrual standard (PSFR-A) Entity information Sections of the report Statements of service performance - Outcomes (goals) - Outputs (services) Statement of financial performance Statement of financial position Statement of cash flows Notes - Statement of accounting policies - Additional information Who are we? Why do we exist? Description What did we achieve? What do we do? When did we do it? Revenue, expenses & surplus/deficit Assets, liabilities & accumulated funds Cash received and paid out Preparation basis Related party transactions & events after balance date

19 Note for file Salvation Army (Peter Bain) The Salvation Army in New Zealand operates as a trust. It has national headquarters and four divisional headquarters. The national headquarters has been preparing consolidated financial statements incorporating all New Zealand divisional headquarters and activities since the New Zealand adoption of IFRS in Prior to that, the financial statements were prepared at the divisional level. Total revenue in the latest financial year was $138 million. About $7 million came from donations. The Army s financial statements are prepared in accordance with GAAP using the Framework for Differential Reporting, which is Tier 2 of the current reporting system. It takes advantage of all the PBE concessions. It prepares in accordance with GAAP because the staff who do the work are members of NZICA. In addition they have contractual obligations to a small number of funding agencies, both public and private, to prepare financial statements in accordance with GAAP. Mr Bain stated that does not think that there is a large audience among the donating public for financial reports. He said that 90% of people give because they intrinsically believe in the charity. Mr Bain also stated that GAAP accounts were the best surrogate for financial reporting. The Salvation Army will be in Tier 1 of the XRB s financial reporting framework for PBEs. That change will not require any fundamental changes to their current records-keeping system, which is an off-the-shelf system that is customisable. There will be three compliance cost implications, none of which are significant. First, there will be a need to be a step-up in expertise and additional information gathering for the purposes of valuing the following assets: Family store stock, because it is all donated Legacy assets, because it is difficult to estimate the expected cash flows of assets that will not be transferred to the Army until after the person has passed away. Second, it will be necessary to prepare a cash flow statement, because that is not required at present under the Framework for Differential Reporting Third, it will be necessary to start preparing a statement of service performance. Mr Bain said that reporting should be more about how the dollar is spent, so there is merit in this change. He also stated that some of the specific requirements of the current IFRS-based standards haven t always applied to the Salvation Army very well. He said that there was a bit of a question mark about whether the replacement Tier 1 (PBE not-for-profit) standards will be better than the current standards because the XRB has not yet released exposure drafts. Mr Bain stated that he has not looked at the equivalent exposure drafts for Tier 1 (PBE public sector) standards. However, he did state that the move to PBE standards is a step in the right direction because it will mean that they will get more of a voice than at present. Looking at the overall picture rather than just from a Salvation Army perspective, Mr Bain stated that the current financial reporting regime was not helpful to the sector, because there is such a wide range of reporting practices. The lack of consistency does not add to the sector s credibility and that there are some benefits in moving towards consistency.