Saturday, 25 May 2013

15. NZ’s proposed new accounting standards for registered charities

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Most registered charities in NZ are not currently required by law to meet any particular standard of financial reporting.   They simply have to complete the financial question in the annual regulator return and attach financial statements that do not need to follow any accounting standards.  From a charity’s perspective this is a good thing – it means the treasurer can be very inexperienced and still prepare simple financial reports which are accepted by the regulator.  From a user point of view, it means the quality of financial information varies considerably between charities, so financial performance is difficult to assess and charity financial information cannot easily be compared.

However, significant changes are on the horizon.   From 1 April 2015 it is proposed that all registered charities will have to prepare accounts which meet accounting standards set by the NZ accounting standard setting body.  Failure to do so could result in fines for the charitable entity and every officer of the charity not exceeding $50,000.

What are the proposed changes, what’s good and bad about them, and will small charities cope?

Summary

For accounting purposes, registered charities will be split into four tiers:

Tier
Entities
Standards
1
- Publicly accountable
- Expenses > $30m
Full PBE (Public Benefit Entity) standards
2
Expenses < $30m
PBE standards (Reduced Disclosure Regime)
3
Expenses < $2m
Simple format reporting standard (accrual)
4
Operating payments < $40k
Simple format reporting standard (cash)


The changes summarised in this blog discuss the proposed changes for charities in tiers 3 and 4 – which apparently make up 96% of all registered charities in NZ (39% and 57% respectively).  The changes are outlined in Exposure Drafts issued in December 2012, with feedback due by 28 June 2013.  They include links to templates and guidance notes.  In total, the proposals are outlined in 286 pages – so as you can imagine the devil is in the detail.

Analysis

On the surface, the proposals seem like a good approach.  They will put NZ ahead of Australia, and light years ahead of the current NZ approach, with clearer and mandatory accounting rules for all registered charities.  Financial information reported to the regulator will be more detailed, more consistent and more reliable.

It is excellent to see that related party transactions, the nature of fundraising activities and restricted purpose funds, all appear to be required to be disclosed by Tier 3 and Tier 4 charities.  These are three areas which are important to understand when reviewing any charity’s financial information.

There are eight specific reporting proposals which I specifically would like to comment on:

1. Reporting burden for small charities in Tier 4 and the lower end of Tier 3 

The level of reporting appears to be potentially onerous in comparison to what is currently provided in question 25 of the annual regulator return, particularly by Tier 4 charities with operating expenditure below $40,000.  For example, many may not be familiar with providing a statement of service performance, a statement of resources and commitments, or even notes to financial statements.  Even the smaller Tier 3 charities may struggle with providing a statement of accounting policies and a statement of cash flows. Although, as a user of the information, I am supportive of having this level of information available, will it create a challenging reporting burden for small charities and can this be alleviated in some way?  If not, what will the consequences be?

2. Lack of detail for grouped and consolidated charities

The exposure draft notes that it is only applicable to single entities and does not address charity groups or consolidation issues.  That is quite a major omission, especially in light of the specific grouping provisions in the Charities Act 2005, which do not require controlled charities to consolidate but leave consolidation decisions entirely at the discretion of the charities (subject to approval from the regulator).  The Act also enables charities to group on a basis other than control which means charitable group membership and totals are likely to be inconsistent with the group membership and totals calculated under accounting standards using the control test.   The omission from the exposure draft is also problematic if, as the exposure draft suggests, the criteria of size shall be applied to consolidated totals.  So it will be important to see how the grouping and consolidation issues will be addressed as soon as possible.   

3. Income from government grants and public donations

I would like to see receipts separately identify government grants and public donations.  This information is valuable because it tells users how much public funds have been made available to the charity.  It is reasonable to assume that such charities will be subject to an increased level of accountability to the public. 

4. Grants and donations paid by a charity

I would also like to see “grants and donations paid” be mandatorily disclosed in all cases, and that they be distinguished between payments made in NZ and payments made overseas.  This is important for the regulator, the Inland Revenue and the general public who would all want to know the extent of financial resources NZ charities are sending within NZ and overseas.

5. Volunteer and paid staff details

I was disappointed that Tier 4 charities do not have to quantify their volunteers and paid staff, which is something they already do for the regulator and gives a valuable insight into their pool of human resources.  I notice that even the UK regulator is making this information mandatory from 2013.

6. Commercial activity disclosed as a method used to raise funds

I would like to see the description of the methods used to raise funds specifically include a description of any commercial activities undertaken.  The example could include a scenario such as the following: “The charity operates a paint manufacturing business in order to raise funds which will be used for charitable purposes”. 

I believe users should be able to clearly identify commercial activities being conducted by a charity, particularly commercial activities that are unrelated to the charitable activities. Commercial activities may be a concern for users for several reasons: the officers of the charity may not be skilled to run commercial operations and therefore governance should be strengthened if commercial activities exist; the commercial operations may expose the charity to business risks and accumulated reserves may need to be diverted from funding charitable activities to propping-up failing business activity; commercial activities could make the charity particularly susceptible to providing private benefits to officers and related parties through business transactions; or the charity may get so involved in unrelated commercial activities that its charitable activities become secondary or virtually non-existent.  

7. Transitional provisions

The first performance report does not require comparative information and pre-existing assets only need to be recorded if they are significant and have values that are readily obtainable.  I believe this should only apply to new charities who have not already reported their financial information to the charities regulator.

8. For the purposes of the NFP tier criteria, should the definition of expenses include or exclude grants made?

I believe the definition of expenses for the NFP tier criteria should exclude grants made.  It is common for constitutional documents to refer to the percentage of surplus that should be distributed by way of grants and donations.  To include grants and donations in as operating expenses is inconsistent with this approach.

In many instances charity officers will have significant discretion over the amount of grants to make.  It would not be helpful if a charity’s officers felt compelled to reduce the amount of their charity’s grant payments because of pressure to avoid moving the charity into a larger tier for accounting purposes (and/or a higher audit/review threshold).  This problem will be avoided if grants are excluded from the definition of expenses.

As an aside, I do not support NZ’s novel approach to categorise charities by operating expenditure as opposed to revenue.  An operating expenditure criterion is not consistent with any international charity regulator approach and it will reduce the ability to compare NZ charities with charities in other jurisdictions.  It will also impose additional costs on charities which are already familiar with using revenue as a threshold measure (for GST, for example) but will now also have to monitor and forecast operating expenditure for threshold purposes. 

Conclusion

My overall conclusion is that the proposals are a huge improvement from the status quo, if you look at them through the lense of a general user.  If changes can be made to accommodate the above issues they would be even better.  However if I was a non-accountant treasurer of a small charity, this new level of detail – and the penalties that come with them – may be alarming.    I suspect that finding a volunteer treasurer for a small charity is going to be a lot more difficult from 1 April 2015.


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The detail: Future proposals

In July 2012 a new Financial Reporting Bill was introduced into Parliament by Commerce Minister Craig Foss.  The Bill, once enacted, will repeal the Financial Reporting Act 1993 and is expected to apply from 1 April 2015.

The Bill amends the Charities Act 2005 to require the annual return of a charitable entity to be accompanied by financial statements. For registered charities in Tiers 1 and 2, the financial statements must comply with GAAP. In the case of other registered charities in Tiers 3 and 4, compliance with a non-GAAP standard (which will set a lower tier of financial reporting) is sufficient.  The proposed change effectively gives the accounting standards as issued by the External Reporting Board (XRB) force of law.

The tiers have been defined as follows:

Tier
Entities
Standards
1
- Publicly accountable
- Expenses > $30m
Full PBE (Public Benefit Entity) standards
2
Expenses < $30m
PBE standards (Reduced Disclosure Regime)
3
Expenses < $2m
Simple format reporting standard (accrual)
4
Operating payments < $40k
Simple format reporting standard (cash)



There is also a new section 42B in the Charities Act which provides for an offence of knowingly failing to comply with financial reporting standards. The charitable entity and every officer of the charity may be liable under this offence, which has a penalty of a fine not exceeding $50,000.

Exposure Draft Documents

The XRB says it recognises that NFPs “may have limited access to professional accounting expertise”, and have therefore “written the standards for Tiers 3 and 4 in relatively simple language where possible”.

Below are the links to the Exposure Drafts issued in December 2012 (with feedback due by 28 June 2013).  They include links to templates and guidance notes.  In total, the proposals are outlined in 286 pages.

In summary, for tier 4 registered charities with expenses < $40k (simple format reporting – cash) charities must prepare a performance report which has five sections (two less than Tier 3 entities): entity information, a statement of service performance, a statement of receipts and payments, a statement of resources and commitments (which is similar to a balance sheet) and notes to the financial statements.

For tier 3 registered charities with expenses < $2m (simple format reporting – accrual) charities must prepare a performance report which has seven sections (two more than Tier 4): entity information, a statement of service performance, an income statement, a balance sheet, a statement of cash flows (not required for Tier 4), a statement of accounting policies (not required for Tier 4) and notes to the financial statements.

ED XRB A1 (FP Entities + PS PBEs + NFPs Update) The proposed third revision to Standard XRB A1 issued by the XRB Board to give effect to the new Accounting Standards Framework (69 pages).


Tier 3 Accrual Accounting Standard (70 pages).
Tier 4 Cash Accounting Standard (39 pages).


Tier 3

Optional Template for ED PBE SFR-A (NFP) - PDF Version (23 pages)
Guidance Notes Accompanying the Optional Template for ED PBE SFR-A (NFP) (42 pages)
Tier 4

Optional Template for ED PBE SFR-C (NFP) - PDF Version (14 pages)
Guidance Notes Accompanying the Optional Template for ED PBE SFR-C (NFP) (29 pages)


There are 18 specific consultation questions:

Tier 3

1. Do you consider that the proposed structure will provide appropriate information for users of the Performance Report?
2. Do you consider that the proposals relating to the Statement of Service Performance are practicable?
3. Do you agree that grants, donations and fundraising revenue should be recorded as an asset and revenue when the cash is received (even when there are conditions attached to the donation or grant).
4. Do you agree that significant donated assets should be recorded at a current value?
5. Do you agree with the other simplifications proposed?
6. Do you agree that entities should be permitted to opt up to a Tier 2 PBE standard for a specific type of transaction?
7. Are there any transactions that are not addressed in the ED that are relatively common for Tier 3 and should be addressed?
8. Do you consider that the requirements for the proposed Statement of Cash Flows has been adequately simplified?
9. Do you consider that the proposed transitional provisions are practical?
10. Do you have any comments on the draft template and guidance notes?
11. Are there any other comments you wish to make?

Tier 4

1. Do you consider that the proposed structure will provide appropriate information for users of the Performance Report?
2. Do you consider that the proposals relating to the Statement of Service Performance are practicable?
3. Do you agree with the proposals for the presentation of receipts, payments, resources and commitments?
4. Are there any relatively common transactions for Tier 4 not-for-profit entities that are not addressed which should be?
5. Is there any further information that should be required so as to enable users to better understand the financial statements?
6. Do you consider the proposed transitional provisions are practical?
7. Do you consider that the draft Template and associated Guidance Notes would be useful?

3 comments:

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CharityWatchNZ said...

Thanks for your comments Jyoti. I'm in the middle of writing my next blog at the moment - for sports charities - so I'm still playing with the charities register data!

It was good to read this particular blog about accounting standards again. Now, almost a year later, the Financial Reporting Bill has become the Financial Reporting Act 2013. One of the major changes has been in the Tier 4 operating payment threshold, which increased from $40,000 to $125,000 (refer to section 46 of the Act). That should make things a lot easier for many more small charities!

Regards

Stu Donaldson