Accounting update. New income recognition proposals for Not-for-Profits. At a glance. Background reasons for issuing the ED

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1 May 2015 Acconting pdate At a glance The release of a two part ED will impact income recognition in the NFP sector The proposal will delay the recognition of some types of income by NFP entities may reslt in a better matching of income expenditre compared to crrent practice The new reqirements are proposed to apply to annal reporting periods beginning on or after 1 Janary 2017 The ED is open for comment ntil 14 Agst 2015 New income recognition proposals for Not-for-Profits The Astralian Acconting Stards Board (AASB) has released an Exposre Draft (ED) that may change when certain types of income wold be recognised by Not-for-Profit (NFP) entities. This proposal has been partially driven by a range of concerns with the crrent stard, AASB 1004 Contribtions (AASB 1004), the issance of AASB 15 Revene from Contracts with Cstomers (AASB 15). The proposal may reslt in the deferral of income in some circmstances for NFP entities. In addition, the proposal may reqire certain components in an arrangement, sch as donations, to be separated from other types of income. The ED also exps the circmstances where fair vale wold be reqired to be sed to recognise the vale of a transaction sch as when a NFP entity acqires a good or enters into a lease at a discont to fair vale. Backgrond reasons for issing the ED Drawbacks of AASB 1004 By reqiring non-reciprocal transfers of assets to be recognised as income when received by a NFP entity, AASB 1004 fails to accont for any obligations that may arise for the NFP entity to provide specific goods or services. This is a common criticism of AASB Income can potentially be recognised too early, while associated expenses may be recognised in later reporting periods when the goods or services are provided to third parties. This leads to a mismatch between income expenditre volatility in reported reslts. For example, a niversity receiving a grant related to specific services to be provided to stdents over a certain period may, nder AASB 1004, be reqired to accont for income when the grant is received, despite the niversity having obligations to provide ftre services.

2 Issance of AASB 15 Dring the development of AASB 15 (which was issed in December 2014), the AASB formed a view that this stard shold apply to all contracts NFP entities into with cstomers despite some of the contracts having been regarded as non-reciprocal transfers nder AASB AASB 15, which replaces AASB 118 Revene, AASB 111 Constrction Contracts related Interpretations, otlines the principles an entity mst apply to recognise measre revene. However, as it was written for for-profit entities in the private sector, it raises many qestions as to how to apply the principles in the NFP sector. For example, is there a contract when a donation is made dring a general fndraising drive? Who is the cstomer of a NFP entity? Is the cstomer the beneficiary of any goods or services provided by the NFP entity (which cold be an individal, a grop or the pblic at large) even if they do not directly pay for the goods or services? Or is the cstomer the party that contribted the fnds to the NFP entity for the provision of the goods services? And how do the answers to these qestions impact income recognition? A separate ED issed Given the above, in light of the AASB s deliberations on the comments received on Exposre Draft ED 180 Income from Non-exchange Transactions (Taxes Transfers), the AASB decided to isse ED 260 Income of Not-for-Profit Entities (ED 260). The ED consists of two parts: Part A AASB 2015-X Revene from Contracts with Cstomers Astralian Implementation Gidance for Not-for-Profit Entities which provides athoritative implementation gidance to assist NFP entities apply the reqirements of AASB 15 Part B Draft AASB 10XX Income of Not-for-Profit Entities - which addresses the acconting by NFP entities for inflows of assets that do not arise from contracts with cstomers, sch as donations, grants, appropriations, complsory transfers sch as taxes, rates fines (replacement stard to AASB 1004) Under the proposal, a NFP entity wold be reqired to first consider whether a transaction is a contract with a cstomer that has performance obligations. A performance obligation is a promise to transfer goods or services to another party. If this is the case, the NFP entity wold accont for the transaction nder AASB 15, inclding the Astralian Implementation Gidance (Part A of the ED). Otherwise, the transaction wold be acconted for in accordance with Part B of the ED. Contract with a cstomer with performance obligations Yes AASB 15 (Part A) No Draft AASB 10XX (Part B) Key items for consideration in the proposed stard PART A - Astralian Implementation Gidance on AASB 15 for NFP Entities One of the most significant changes proposed is the reqirement for NFP entities to se the principles of AASB 15 when acconting for revene from all of their contracts with cstomers. This incldes contracts considered to be non-reciprocal in natre. Of particlar note is the reqirement to se the concept of performance obligations as the basis for determining when a NFP entity can recognise revene in relation to grants other fnding arrangements. For sch arrangements, the proposal wold reslt in revene being recognised when the performance obligation is satisfied, regardless of whether the ltimate beneficiary of the goods or services transferred is the grantor of the fnds or another party. In contrast, where the beneficiary of the goods services is not the grantor, the crrent reqirements are often interpreted as reqiring income to be recognised when the fnds are received. Basic principles of revene recognition nder AASB 15 The core principle nder AASB 15 is that an entity recognises revene at an amont that reflects the consideration to which the entity expects to be entitled in exchange for transferring goods or services to a cstomer. The principles are applied sing the following five steps: 1. Identify the contract(s) with a cstomer 2. Identify the performance obligations in the contract 3. Determine the transaction price 4. Allocate the transaction price to the performance obligations in the contract 5. Recognise revene when (or as) the entity satisfies a performance obligation Acconting pdate: New income recognition proposals for Not-for-Profits EY May 2015 Page 2

3 Identifying whether a contract with a cstomer exists The following table otlines some of the factors that need to be considered in determining whether a NFP entity has a contract with a cstomer. Factor to consider Enforceable agreement Contract Cstomer Explanation The term contract refers to an agreement with another party that creates enforceable rights obligations. Under the ED, an agreement with a NFP entity may be enforceable throgh legal or eqivalent means if, for example: The cstomer or another a party has a right to enforce specific performance Or A mechanism (sch as a Ministerial directive) exists to provide a party with the legal athority to reqire the transfer or otherwise provide compensation for non-performance Compensation for failing to provide the promised goods or services cold take the form of a retrn of consideration provided, or a sfficiently severe penalty payment. While it is common for fnding agreements to inclde retrn obligations, it is also common for sch retrn obligations not to be enforced so raises the qestion as to whether this wold render a contract non-enforceable. The ED states that a contract wold still be enforceable despite a lack of history of enforcement despite the cstomer s intention to enforce. Enforceability does not depend on a party s intention to enforce, bt rather on the party s capacity to enforce. Contracts do not need to be written, bt can be oral or implied by the NFP entity s cstomary bsiness practices in performing or condcting its activities. A cstomer is the party that promises consideration in exchange for goods or services for which it obtains all, or sbstantially all of the benefits from those goods or services. However, for some contracts in the private sector for most contracts in the NFP sector, the cstomer may direct that the goods services be provided to third party beneficiaries (inclding individals or the commnity at large) on its behalf. Therefore, the fact that the cstomer is not also the direct recipient or beneficiary of the goods or services transferred does not mean that the arrangement is otside the scope of AASB 15. This contrasts to the crrent reqirements whereby sch arrangements might be considered nonreciprocal hence wold fall otside the scope of AASB 118 within the scope of AASB Identifying whether a performance obligation exists Once an entity has identified a contract, it wold then assess the goods or services it has promised to transfer to the cstomer to determine if, how many, performance obligations exist in the contract. If a performance obligation(s) is identified, then revene will be recognised only when the performance obligation is satisfied by transferring the promised goods services to the cstomer. For a performance obligation to exist in respect of a NFP entity, the promise to transfer a good or service mst be sfficiently specific to be able to determine when the obligation is satisfied. In determining whether the promise is sfficiently specific, jdgment wold be reqired taking into accont any conditions specified regarding the promised goods or services, inclding the following conditions (ED 260 IG13): The natre or type of goods or services The cost or vale of the goods or services The qantity of the goods or services the period over which goods or services mst be transferred A promise to transfer goods or services over a particlar time period does not, of itself, meet the sfficiently specific criterion. Accordingly, a condition for a grant to be sed by a NFP entity dring a particlar year to provide nspecified goods or services wold not, of itself, meet the sfficiently specific criterion. Similarly, the existence of an acqittal process of itself wold not give rise to a performance obligation. If a NFP entity either: Promises goods or services, bt not as part of an enforceable arrangement Or Makes promises that are not stiplated in sfficient detail to be able to determine when they are satisfied Acconting pdate: New income recognition proposals for Not-for-Profits EY May 2015 Page 3

4 then any inflows related to that arrangement wold not give rise to revene from a contract with a cstomer, wold not be in scope of AASB 15. Instead, sch inflows wold be acconted for in accordance with draft AASB 10XX. How we see it A NFP entity will need to consider its fnding arrangements assess whether they fall within the scope of AASB 15 or draft AASB 10XX, or both. This will reqire determining whether each arrangement is enforceable incldes promises that are sfficiently specific to qalify as performance obligations. This assessment will involve analysing arrangements at a level of detail previosly not reqired. Donations In sitations where a cstomer enters into a contract with a NFP entity with an intention to both provide a contribtion obtain goods or services from the NFP entity, the contract may inclde a donation. The donation represents the consideration that is not attribtable to the goods or services promised in the contract. Donation components wold be reqired to be acconted for in accordance with draft AASB 10XX, that is, they wold be recognised as income when the entity recognises the inflow of donated resorces. Determining whether a contract with a cstomer incldes a donation wold reqire a two part qalitative assessment: Assessment Description reqired 1. Did the Factors to consider in determining cstomer intend to whether a cstomer intended to make a make a donation? donation cold inclde, for example: 2. Is the donation separately identifiable from the other goods services promised in the contract? whether the goods or services are promised as part of a fndraising event held by the NFP entity, whether amonts received are identified as tax dedctible (either wholly or partially), whether amonts received are sbstantially in excess of the stalone selling prices for any goods or services that the NFP entity is promising to transfer to the cstomer. All of the following criteria mst be met for a donation to be separately identifiable: Evidence that part of the consideration received does not relate to promised goods services. An example of this may be Assessment reqired Description an entity selling a one-year online sbscription to its charitable magazine, asking cstomers to donate an additional volntary amont. The entity s entitlement to retain the donation is not conditional on the entity transferring a good or service to the cstomer (donor). For example, the consideration in the example above may fail to meet this condition if the entity offers a fll refnd of the sbscription the donation in the event it does not pblish 12 monthly isses of its magazine. The amont of the donation component can be measred reliably. Another example of the qalitative assessment that might be reqired nder the proposal is a charity dinner fnd raising event. This is where the ticket price is above the fair vale of the meal provided. From the cstomer s perspective, they may be prchasing a meal a networking opportnity, as well as making a donation. This sitation wold need to be assessed nder the above criteria. If the donation component meets the above criteria, the donation income wold be recognised when the fnds are received, while the component relating to the performance obligation for the dinner wold be recognised as revene when the performance obligation is satisfied, for example when the event occrs the meal is provided. If the donation fails to meet the above criteria, it wold not be acconted for separately all of the consideration promised in the contract wold be recognised as revene when the NFP entity satisfies its performance obligation by holding the charity event providing the dinner. Donations which are not part of a contract with a cstomer wold also be acconted for in accordance with draft AASB 10XX. This incldes donations implicit in peppercorn (or below market) leases (see below) assets acqired by NFP entities at a discont to their fair vale. Peppercorn leases To ensre that donation components are appropriately identified, the ED incorporates conseqential amendments to other stards which will lead to changes in income recognition. For example, it is common in the NFP sector for leases to be entered into at peppercorn or below market rates. Acconting pdate: New income recognition proposals for Not-for-Profits EY May 2015 Page 4

5 Under crrent reqirements, if a NFP entity is granted a below-market lease that is classified as a finance lease, AASB 117 reqires the NFP entity to measre the lease asset liability at the present vale of the minimm lease payments. This acconting both nderstates the lease asset fails to recognise the donation component. To address this, the ED proposes to amend AASB 117 sch that NFP entities wold be reqired to measre the lease asset at the fair vale of the leased property at inception of the lease. Conseqently, the difference between the present vale of the peppercorn lease rental the fair vale of the lease asset wold be recognised as donation income. Similar amendments have been proposed for other non-financial assets that are acqired for an amont that is less than fair vale. How we see it The reqirement to componentise contracts into a revene component a donation component poses practical challenges for NFP entities. NFP entities will need to reassess their lease contracts the acqisition of other non-financial assets, assess fair vale of those assets recognise any implied donation amont as income immediately. This will impact a NFP entity s reslts both initially on an ongoing basis (for example, de to higher depreciation expense on leased assets). PART B Draft AASB 10XX Income of NFP Entities Overview Part B of the ED sets ot the reqirements for NFP entities when acconting for income which does not fall within the scope of AASB 15. Under the ED, sch transfers of assets inclde, bt are not limited to, the following: Volntary transfers, sch as: Donations, inclding identifiable donation components of contracts with cstomers Other transactions with donation elements, sch as where the fair vale of the asset acqired by the NFP entity significantly exceeds the consideration paid Grants in relation to which specific performance obligations have not been identified Appropriations to government department agencies Complsory transfers sch as taxes, rates fines. For these items, the draft AASB 10XX carries forward the crrent acconting treatment nder AASB 1004, the timing of the recognition of income is determined by an assessment of when control of the fnds passes to the NFP entity (volntary transfers) or when the entity has an enforceable right to receive fnds (complsory transfers). Therefore, volntary transfers wold sally be recognised on receipt of fnds, complsory transfers wold sally be recognised when the nderlying taxable event occrs. Volnteer services AASB 1004 crrently reqires certain NFP entities in the pblic sector to recognise as income the fair vale of services provided by volnteers if the fair vale of those services can be reliably determined the services wold have been prchased if they had not been donated. In Part B, the AASB proposed to carry forward those reqirements virtally namended. In a change from AASB 1004, the ED also proposes an explicit election for all NFP entities, whether pblic or private, to recognise as income the fair vale volnteer services received if the fair vale of those services can be measred reliably. Contribtions by owners The AASB is also seeking views on whether a pblic-sector specific definition of contribtions by owners is still necessary in Astralian Acconting Stards also whether AASB Interpretation 1038 Contribtions by Owners Made to Wholly-Owned Pblic Sector Entities shold be withdrawn or retained. The ED explains that concerns have been raised that the crrent definition of contribtions by owners in AASB 1004 is too narrow becase it reqires NFP entities to determine whether the contribtor had specifically designated the transfer as a contribtion by an owner before classifying it as sch. As a reslt, in some cases, the definition has reqired NFP entities to classify as income items which are in sbstance contribtions by owners. The AASB is proposing to address this concern by not inclding a pblic-sector specific definition of contribtions by owners in the draft stard. That proposal wold ensre consistency with other Astralian Acconting Stards applicable to for-profit entities, which do not define contribtions by owners (eqity contribtions). The ED notes that this change wold be expected to reslt in fewer instances of transfers by owners being classified as income. Transition The proposed stard is intended to be applicable to reporting periods beginning on or after 1 Janary Early adoption is permitted, provided AASB 15 is also early adopted. Acconting pdate: New income recognition proposals for Not-for-Profits EY May 2015 Page 5

6 It shold be noted that the IASB has recently proposed a one year deferral of the application date of IFRS 15 (the international eqivalent of AASB 15). In light of this, the AASB is also considering a similar deferral to AASB 15. If this deferral is adopted by the IASB AASB, this cold possibly lead to a deferral of the proposal nder this ED. On transition, NFP entities wold be reqired to apply the stard sing one of two methods: Fll retrospective approach: retrospectively to each prior reporting period presented Or Modified retrospective approach: retrospectively with the cmlative effect recognised as an adjstment to the opening retained earnings at the date of initial application (i.e., start of the reporting period in which the entity first applies the stard). Next steps The ED is available for comment ntil 14 Agst 2015, with an intention to release the final Stard in the first half of EY will be responding to this ED. If yo wold like any assistance in ndersting the potential implications of this ED or in responding to the ED please contact yor EY adviser. To discss frther please contact yor EY adviser or one of the Assrance Leaders below: National Michael Wright Oceania Managing Partner Assrance Tel: Tracey Waring Astralian IFRS Leader Tel: EY EY Assrance Tax Tax Transactions Advisory Abot EY Abot EY EY is a global leader in assrance, tax, transaction EY is a global leader advisory in assrance, services. The tax, insights transaction qality services advisory we deliver services. help bild The insights trst confidence qality services in the we capital deliver markets help bild in trst economies confidence the world in the over. capital We develop markets in otsting economies leaders the world who over. team We to develop deliver on or promises otsting to all leaders of or stakeholders. who team to deliver In so doing, on or we promises play a critical to all of role or in stakeholders. bilding a better In so working doing, world we play for a or critical people, role for in or bilding clients a better for working or commnities. world for or people, for or clients for or EY commnities. refers to the global organisation may refer to EY one refers or more to the of global the member organisation firms of may & refer Yong to one Global or more of the each member of which firms is of a separate & legal Yong entity. Global & Yong each Global of which is a separate a UK company legal entity. limited by & garantee, Yong Global does not provide a UK services company to limited clients. by For garantee, more information does not abot provide or services organisation, to clients. please For more visit ey.com. information abot or organisation, please visit ey.com & Yong, Astralia. All Rights 2015 Reserved. & Yong, Astralia. SCORE All Rights NO <<Please Reserved. insert nmber here>> This SCORE commnication NO AU provides general information which is crrent at the time of prodction. The information contained in this commnication does not constitte advice shold not be relied This on commnication as sch. Professional provides advice general shold information be soght which prior is to crrent any at action the time being of prodction. taken in reliance The information on any of the contained information. this & Yong commnication disclaims does all responsibility not constitte advice liability (inclding, shold not withot be limitation, relied for as sch. any direct Professional or indirect advice or conseqential shold be soght costs, prior loss tor damage any action or loss being of profits) taken in arising reliance from on anything of the done information. omitted to be & done Yong by disclaims any party all in responsibility reliance, whether wholly liability or (inclding, partially, withot on any limitation, of the information. any direct Any or party indirect that or relies conseqential the information costs, loss or does damage so at its or own loss of risk. profits) Liability arising limited from by anything a scheme done approved or omitted to nder be done Professional by any party Stards in reliance, Legislation. whether wholly or partially, on any of the information. Any party that relies on the information does so at its own risk. Liability limited by a scheme approved nder Professional Stards Legislation. ey.com ey.com Adelaide Mark Phelps Tel: Canberra Ben Tansley Tel: Perth Darren Lewsen Tel: Brisbane Alison de Groot Tel: Melborne Rodney Piltz Tel: Sydney John Robinson Tel: Acconting pdate: New income recognition proposals for Not-for-Profits EY May 2015 Page 6