INTERNATIONAL FINANCIAL REPORTING STANDARDS AND CHARITIES A review of the potential impact of recent proposals Spring 2010
A review of the potential impact of recent proposals Spring 2010 03 IFRS FOR SMES WHAT IT MEANS FOR CHARITIES Introduction Charity accounting and reporting is facing significant change as a result of new international standards, and a debate between other sectors on public benefit accounting. This document sets out the main issues for finance directors and audit committees. The 2005 is drawn up under UK Generally Accepted Accounting Practice (UK GAAP). UK GAAP will at some stage be converted into an international framework (International financial reporting standards). IFRS were originally developed for larger commercial entities and have been adopted by quoted companies in this country for some years. A framework has now been proposed to extend the IFRS regime to more entities. The current proposal is in three tiers as follows: Quoted companies (including those with listed debt) continue under IFRS. These are referred to as publicly accountable entities. This is Tier 1. Small entities follow the FRSSE. In general terms this means that charities with income under 6.5m would not apply the new regime, but would follow the existing SORP, but taking all the FRSSE exemptions. This is Tier 3. Everything else is described as an SME (small or medium sized entity), and would have to follow either the or full IFRS. This therefore affects companies and charities who cannot apply the FRSSE. The phrase SME is a misnomer, as this regime could apply to quite large organisations as long as they are not publicly accountable. This is Tier 2. In addition it is proposed that a separate public benefit standard is developed, for organisations like charities. The exact plans for such a standard are yet to be decided.
04 International Financial Reporting Standards and Charities Where charities currently fit Charities are not legally allowed to adopt full IFRS, and so if some were deemed to be publicly accountable then a change in legislation would be needed. In any case, charities are likely to want to follow the simpler, shorter rather than full IFRS. However, the IFRS for SME is not designed for charities, hence the proposal to develop a separate standard which will address Public Benefit Entities. At time of writing it is not certain whether such a standard would: be created at all, or its timetable simply interpret the or actually change it encompass all not-for-profits, including those that are publicly accountable encompass all not-for-profit accounting issues or just cover high level issues require separate SORPs or guidance notes, of as yet uncertain authority. What is the issue now? If the is adopted on the current proposed timetable there is little time to develop a comprehensive public benefit framework and specific guidance for charities. It is possible that technically charities would have to comply with when they become UK GAAP, which charities preparing accruals accounts have to follow. It is likely that in the long term, all charities will fall under the same regime, even those currently applying the FRSSE. It is important therefore to understand what are the key and important differences between and: the the other SORPs covering housing and the HE/FE sectors full IFRS. Somehow, over the next few months, these differences will need to be addressed. Most important for charities is to understand how the existing SORP s requirements are likely to change either to comply with the IFRS for SMEs, or as a result of the three not-for-profit SORPs being under pressure to harmonise. Charities need to understand the implications on their own accounts, and be ready to influence the debate and to prepare their own systems. Our experience with commercial organisations suggests that early preparation pays huge dividends. The list below sets out the potential big issues. In practice many, maybe all, will be dealt with through the public benefit standard or new guidance from the charity regulators, but as things currently stand in the proposals: charity accounts could exclude all donated goods and services owner-occupied properties could not be revalued borrowing costs could not be capitalised all grants would be treated as income immediately unless there were unfulfilled performance conditions relating to the grant columnar fund analysis may not be possible income arising from certain legacies receivable might be recognised earlier certain financial instruments would be carried at fair value on the balance sheet more intangibles would feature on balance sheets if charities combine with one another mergers would have to be treated as takeovers related party donations would be disclosed. Much of the addresses the contents of the annual report. The does not concern itself with narrative reporting or with summary accounts or summarised financial information. This bulletin therefore highlights the financial statement differences. Inevitably the is silent on sector specifics, and guidance will need to be issued urgently on these if the ASB push forward with the proposals in its consultation for replacing UK GAAP with the IFRS for SMEs effective 31 December 2012. Otherwise there is the prospect of charities interpreting their results on a personal reading of the IFRS for SMEs resulting in inconsistency across the sector. Finally, the IFRS for SMEs sets out different disclosure requirements, which are not addressed in detail here as, on the whole, they are not fundamental. Below is a summary of the issues which we think are of most significance. Each section sets out the differences between the and current guidance, with our own, subjective, scoring of the significance from high (red traffic light) to low (green). The sections that follow are extracted from a more comprehensive analysis, prepared by BDO, which also looks at the other not-for-profit SORPs, and explains the background in more detail. Reference should be made to this document for more information, and in certain sections where the application is limited to a smaller group of charities. Some sections of the IRFS for SMEs are not addressed below, on the basis that there are no, or minimal, implications for charities. Statement of Financial Position This is the new name for the Balance Sheet. Beyond the name, not much changes, except that some more detail of creditors is likely to be given on the face. Statement of Comprehensive Income and Income Statement This statement is essentially the same as the SOFA, save that it does not incorporate transfers between reserves or a reconciliation to the brought forward reserves: Columnar presentation Note of historical cost profits and losses Finance costs Might be less prevalent Not required Presented as a separate line item Required in SOFA Required Charities do not usually present as a separate line item
A review of the potential impact of recent proposals Spring 2010 05 Statement of Changes in Equity and Statement of Income and Retained Earnings This is the equivalent of the reconciliation of funds presented at the foot of the SOFA along with transfers between funds: Presentation of changes in funds / reserves Statement of Cash Flows Presented separately as a primary statement except in certain circumstances where it can be appended to the single statement of comprehensive income to form a single Statement of Income and Retained Earnings. The changes here are mainly presentational: Cash flow from endowment income Definition of cash Presentation of cash flows from operating activities Notes to the Financial Statements Presented as operating cash flows Includes cash equivalents, ie available in 3 months without penalty Presented on the face of the cash flow statement In the Charities SORP it forms part of the SOFA. Presented as financing cash flows Only includes cash available on demand without penalty Reconciliation of net operating income to cash flow from operating activities is usually presented in the notes Detailed disclosures and notes are determined by the Charity Commission and/or OSCR over and above those required by the IFRS for SMEs. However, the quantity of disclosures in the is notably less than those contained in FRSs and SSAPs. Consolidated and Separate Financial Statements There are no sized based exemptions for the preparation of consolidated accounts under the. Accounting policies, estimates and errors This is the sort of minor issue which it is difficult to see a public benefit standard changing. Error found relating to prior periods Financial Instruments Adjust by means of a prior year adjustment if the error is material Adjust by means of a prior year adjustment if the error is fundamental This is potentially a significant area of impact for most charities, depending on how exactly a public benefit standard addresses it. A widely held misconception is that the accounting for financial instruments is something that only affects banks and other complex financial institutions. If you have any of the following, then the accounting could be different under the : Investments. Long-term receivables. Bad debt provisions. Derivatives, such as interest rate swaps or foreign currency contracts. Interest free loans (payable or receivable). In some circumstances, the changes might even affect aspects of contracts that are not immediately obvious. For example, contracts where the price is denominated in a foreign currency might need to account for the foreign currency element of that contract as a derivative. A term extension or prepayment feature on a fixed rate loan potentially has value that needs to be accounted for separately from the loan. Lease contracts where the rentals fluctuate by some variable other than inflation have a positive or negative value as a result of the pricing mechanism that might need to be accounted for separately from the lease payments. Such features are known as embedded derivatives : Level of detail of accounting requirements Covers many types of financial instruments setting out requirements for those to be measured at amortised cost and those to be measured at fair value Disclosure Some None FRS 4 deals broadly with the accounting for debt. Accounting for other financial instruments determined by convention only Investments in Associates, and Investments in Joint ventures The treatment of associates changes under the. As these are unusual in charities the topic is not discussed in this document. Joint ventures occur more often but are still not common. Again the treatment changes: both associates and joint ventures are dealt with at length in the separate BDO guide to for not-for-profit entities.
06 International Financial Reporting Standards and Charities Investment Property The deals with investment properties, but it does not have a specific section on investments, or programme related investments. In both cases therefore guidance needs to be taken from the nearest relevant section of the. For investments, refer to Financial Instruments, whereas for programme related investments it would appear that you would look to the underlying asset to determine the accounting treatment. The table refers only to investment properties. Changes in fair value Properties rented to other group entities Leasehold investment property Property, Plant and Equipment Recognised in the income statement (top half of statement of comprehensive income) Accounted for as investment property in individual accounts and property, plant and equipment in group accounts Account separately for gross value of property interest and obligations payable on the head lease Recognised in bottom half of SOFA Accounted for as tangible fixed assets in both individual and group accounts Usually account for just the net leasehold interest Potentially some of these changes are the most significant, both in terms of breadth of application and impact. The is silent on heritage assets. Measurement Borrowing costs Mixed use property Donated assets Disclosure Asset revaluations not permitted Capitalisation not permitted Account for owneroccupied and investment portions separately Appears to be no scope to measure property, plant and equipment at anything other than cost (which in the case of donated assets would be nil) No concept of a heritage asset or disclosures about fair value Revaluations permitted Choice of capitalising or expensing Split accounting permitted, or alternatively account for entire property based on the predominance of use Recognised at current value on date of donation FRS 30 Heritage assets to be complied with for periods starting on or after 1 April 2010 Intangible assets Few, if any charities worry about the treatment of research costs. Accounting for intangibles assets usually arises in the context of mergers: these are addressed in the next section. Business combinations and goodwill The requires all combinations (other than those under common control) to be accounted for using the purchase method. This requires one entity to be identified as the acquirer and the other the acquiree, with the acquiree s identifiable assets and liabilities subject to a fair value exercise and its income and expenditure only incorporated into the acquirer s consolidated income statement from the date of the combination. This would mark the end of merger accounting everything would have to be a takeover of one entity by another, or perhaps treated as a donation of assets. When applying the purchase method under the, it is likely that more intangibles (such as brand values) would be recognised than would when applying the purchase method under UK GAAP. The requires any negative goodwill to be recognised immediately and in full in the income statement as a gain. A greater amount of negative goodwill will probably arise on such transactions, given the need to recognise any identified intangibles on acquisitions and mergers. Method of accounting Intangibles identified on a business combination Negative goodwill Merger accounting not permitted To be initially recognised at fair value separately from goodwill and amortised thereafter Credited immediately to income statement in full Merger accounting permitted if certain criteria are met Intangible assets rarely recognised separately from goodwill on a business combination Negative goodwill deferred in balance sheet and released to income statement over appropriate periods
A review of the potential impact of recent proposals Spring 2010 07 Leases Lease accounting is likely to be a detailed area for consideration, although the impact on the balance sheet will vary. Leasehold premiums paid Lease incentives Disclosure of operating lease commitments Provisions and Contingencies Leasehold premiums paid likely to be classified as prepayment Although not addressed, likely treatment for lease incentives is spreading over the minimum lease term Disclosure required of the total future minimum lease commitment Leasehold premiums paid generally classified as a property asset Lease incentives spread over the period to first rent review Disclosure required of the annual lease commitment The only significant issue here is that disclosure in respect of contingent assets and liabilities (such as legacy income and grant income clawback respectively) might disappear because they need to be recognised in the balance sheet. Revenue This is another area where interpretation of the as it stands generates potential problems, and sector specific guidance will be needed. Donations of nonfinancial assets Legacy income subject to life interest Pro bono and volunteer services received There appears to be no scope to measure assets at anything other than cost (which in the case of donated assets would be nil) Potential need to discount to a present value and then accrete up over the period until receipt recognising interest income Not addressed Recognised at fair value on date of donation Generally not recognised because recognition criteria not met. If recognised, unlikely to be discounted SORP requires income and expense recognised where the benefit is reasonably quantifiable and measurable Government Grants Accounting for government (and other) grants in the is unlikely to present a change for charities, but this will present a big change for housing associations and education institutions. The fall out from that debate may well yet affect charities. Entities other than charities tend to distinguish between grants received in relation to capital and revenue expenditure, releasing the former to income as the related asset is depreciated. Matching of grant income to related expense in the income statement Borrowing costs All grants recognised as income in full when performance conditions have been met, which could be interpreted as the end of any clawback period similarly requires all grants to be recognised on receipt, except to the extent repayment is considered probable Like grant accounting, this topic is more significant for the housing sector than charities. Whereas interest can be capitalised within the cost of certain assets under UK GAAP, under the all interest costs are expensed immediately Impairment of assets Charities hold some specialist assets held for non commercial reasons: the SORP does not permit those to be written off just because they have no commercial return. When to recognise an impairment Criteria for measuring value are based entirely on commercial return and cash flow considerations Charities can look at the service potential of assets, in assessing recoverable amount
08 International Financial Reporting Standards and Charities Employee benefits There are two issues here. Whilst holiday pay would not normally create a material adjustment, charities may opt for a simpler approach to defined benefit pension scheme accounting. Income tax Holiday pay accruals Presentation of actuarial gains and losses Measurement basis for defined benefit scheme liabilities Holiday pay to be recognised as an accrual or prepayment as appropriate Accounting choice as to whether actuarial gains and losses on defined benefit pension schemes are recognised as an item of other comprehensive income or in the income statement Certain simplifications to projected unit credit method of measuring defined benefit liabilities permitted on grounds of undue cost or effort Holiday pay generally not accounted for Actuarial gains and losses recognised in the statement of total recognised gains and losses, ie the bottom half of SOFA Projected unit credit method to be applied in full The difference is probably purely technical: the result is likely to be the same. It is usually irrelevant in charities. There is however a tax risk that subsidiary profits might be stranded on a prior year adjustment arising from first time adoption of. Foreign Currency This change would only affect charities with overseas consolidated entities. The exchange gains and losses arising on consolidation need to be kept in a separate reserve under the. Related party disclosures The requires more disclosure than the SORP. Disclosure of transactions with group entities Disclosure of donations from related parties Remuneration of key management personnel Disclosures required Transition to the No exemption from disclosing transactions in an entity s individual financial statements between itself and other entities within the same group No exemption Details of key management remuneration must be disclosed Name of related party does not need to be disclosed, but the nature of the relationship does No requirement to disclose transactions between 100 per cent owned entities of a group, provided consolidated financial statements are prepared Exemption given in Disclosures driven by relevant legislation and regulators Both the name of related party and the nature of the relationship needs to be disclosed When an entity transitions from UK GAAP to the, the basic rule is that the financial statements for both the current year and comparatives are presented in accordance with the requirements of the. In order to present a comparative statement of comprehensive income it is therefore necessary to have an compliant balance sheet two years prior to the date of the first financial statements prepared in accordance with the. Certain reliefs are given from full retrospective application in preparation of the transition balance sheet. Appendices 1 and 2 show reconciliations of a hypothetical charity s SOFA and balance sheet from UK GAAP to the. Events after the end of the reporting period The debate on the treatment of designated funds might be reopened: the is silent on specifics like fund designation.
A review of the potential impact of recent proposals Spring 2010 09 APPENDIX 1 Reconciliation of hypothetical charity SOFA to statement of comprehensive income As reported under UK GAAP 1 2 3 4 5 6 7 8 9 As reported under IFRS for SME INCOMING RESOURCES Incoming resources from generated funds 50,000 (500) (2,500) 47,000 Incoming resources from charitable activities 15,000 15,000 Other incoming resources 3,000 (500) (500) 75 2,075 Total incoming resources 68,000 (500) 0 0 (500) 0 (425) (2,500) 0 0 64,075 RESOURCES EXPENDED Costs of generating funds 20,000 20,000 Charitable activities 10,000 (500) 9,500 Governance costs 2,000 2,000 Finance costs 1,000 1,000 Other resources expended 3,000 2,500 (100) (1,000) (5,000) (600) Total resources expended 35,000 (500) 0 2,500 0 (100) 0 0 0 (5,000) 31,900 Net incoming resources before transfers 33,000 GROSS TRANSFERS BETWEEN FUNDS 0 Net income for the period 33,000 0 0 (2,500) (500) 100 (425) (2,500) 0 5,000 32,175 OTHER COMPREHENSIVE INCOME Gains on revaluation of fixed assets for charity s own use 5,000 (5,000) 0 Gains/(losses) on investment assets (2,500) 2,500 0 Actuarial gains/losses on defined benefit pension schemes (350) (350) Total comprehensive income for the period 35,150 0 (5,000) 0 (500) 100 (425) (2,500) 0 5,000 31,825 RECONCILIATION OF FUNDS Total funds brought forward 100,000 Total funds carried forward 135,150 1 Reduces revenue and expenditure for estimated value of pro bono services received 2 Removes revaluation gains and losses on owner-occupied property 3 Recognises gains and losses on equity investments in profit and loss 4 Net movement on grant income where performance conditions for receipt not met 5 Net reduced pension cost arising from taking advantage of simplified projected unit credit method on grounds of undue cost or effort 6 Net movement arising on recognition of legacy income with reserved life interest at fair value with imputed interest accretion 7 Recognition of donated items of property, plant and equipment during the year at nil cost 8 Separate presentation of finance costs (including unwinding of discounted liabilities such as pensions) 9 Net gain in period from adjustments to opening and closing assets arising from inability to carry out an impairment review that takes account of service potential
10 International Financial Reporting Standards and Charities APPENDIX 2 Reconciliation of hypothetical charity balance sheet to statement of financial position LONG-TERM ASSETS As reported under UK GAAP 1 2 3 4 5 6 7 8 As reported under IFRS for SME Tangible Assets 100,000 (5,000) (5,000) (2,500) (25,000) 62,500 Financial assets 25,000 5,000 30,000 Investment property 10,000 10,000 Prepayments 4,900 4,900 CURRENT ASSETS 135,000 107,400 Stocks and WIP [Inventory] 750 750 Investments 500 500 Other financial assets including debtors 2,500 2,500 Prepayments 25 100 125 Cash at bank and in hand 7,500 7,500 CURRENT LIABILITIES 6,500 (6,500) 11,275 11,375 Bank loans and overdrafts 2,000 2,000 Short term creditors 4,000 250 4,250 Other short-term financial liabilities 500 500 Provisions 750 750 Employee benefits 250 (275) (25) NET CURRENT ASSETS 4,775 TOTAL ASSETS LESS CURRENT LIABILITIES 139,775 LONG-TERM FINANCIAL LIABILITIES 30,000 (30,000) Bank loans 28,000 28,000 Other long-term liabilities 2,000 1,500 3,500 Provisions 2,500 2,500 Employee benefits 6,275 (1,000) 5,275 PROVISIONS 3,250 (3,250) DEFINED BENEFIT PENSION SCHEME LIABILITY 6,525 (6,525) TOTAL ASSETS LESS TOTAL LIABILITIES 100,000 0 (5,000) 0 (1,750) 1,275 5,000 (2,500) (25,000) 72,025 FUNDS Endowment Funds 10,000 2,000 12,000 Restricted income funds 20,000 20,000 Unrestricted income funds Net accumulated surplus 56,525 8,475 (1,750) 1,275 3,000 (2,500) (25,000) 40,025 Revaluation reserve 20,000 (20,000) Pension reserve (6,525) 6,525 100,000 0 (5,000) 0 (1,750) 1,275 5,000 (2,500) (25,000) 72,025 7,475 39,275 1 Reanlaysis of liabilities 2 Removal of revaluation reserve to recognise carrying value at deemed cost and elimination of pension reserve 3 Presenting lease premiums as a prepayment of rent 4 Recognises liability in respect of grant income where all conditions for receipt not yet met 5 Recognises reduction to defined benefit pension liability arising from taking advantage of simplified projected unit credit method on grounds of undue cost or effort 6 to recognise all legacies with reserved life interest at fair value 7 to recognise non-financial assets donated since date of transition at cost of nil 8 Recognition of impairment loss due to inability to measure recoverable amount of assets by reference to its service potential
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