Eric Hummer, Partner
In this 2nd part of my series on enhancing not-for-profit (NFP) annual and financial reporting, I focus on financial disclosures and upcoming significant changes in accounting standards that could have a significant impact on how NFPs account for and recognise revenue, leases and available-for-sale financial assets (i.e. investments).
The nature and extent of financial statements disclosures are often guided by generic templates with limited relevance to the operations of the NFP. Areas that are often relevant to NFP’s that can often be improved include the following:
- Economic dependence
Any NFP in receipt of grants should consider the impact on their financial performance and position if recurring grant arrangements are discontinued. This is particularly relevant where multi-year arrangements are due to expire prior to the next annual financial reporting cycle. If the NFP’s financial performance and/or financial position would be adversely affected, appropriate economic dependency disclosures should be made by way of a note to the financial statements.
- Related party disclosures
When general purpose financial reports are prepared, compliance is required with AASB 124 Related Party Disclosures. At a minimum, key management personnel remuneration must be disclosed in total where the NFP pays salaries or wages. In regards to related-party transactions, a generic note will not meet the full disclosure requirement of the standard. For related-party transactions, the nature, amount and balances outstanding by related-party category are required to be disclosed.
- Inventories for distribution
NFPs should consider the extent to which they receive and/or hold inventories for distribution at nil or nominal cost. If material, an appropriate accounting policy should be developed and appropriate disclosures are required in the NFP’s financial report.
- Estimates and accounting policy judgements
NFPs often need to improve the quality and completeness of disclosures in relation to estimation uncertainty and significant judgements made when applying accounting standards. This is a consistent area of risk and focus for regulators and auditors alike. A generic note is not recommended. The estimates and judgements should be specific to the NFP.
The disclosure requirements are principles based and should include all information necessary for stakeholders to understand the significant estimates and judgements made and their effect on the financial statements. This would usually include details of key assumptions made and reasons for judgements (such as reference to expert opinions or other external data sources that have been relied upon). Where key assumptions or judgements have changed that have a significant impact on reported financial disclosures, this should also be disclosed including the reasons for the change.
In addition to current financial reporting requirements, NFP’s should be aware of impending changes to three accounting standards that may have a significant impact on their financial reporting in future years in relation to revenue recognition, leases and investments.
AASB 16 Leases has now been released with an effective date of 1 January 2019 (i.e. reporting periods ending 31 December 2019 onwards). This standard removes the distinction between operating and finance leases and requires all leases to be recorded on the balance sheet (statement of financial position). There are two exceptions to this principle, being short-term leases and leases of low-value assets. NFP entities should undertake an early analysis of the effect of bringing operating lease liabilities onto the balance sheet and the associated impact on funding or bank covenants where relevant.
- Revenue recognition and contributions
AASB 15 Revenue from Contracts with Customers has introduced a five-step process for revenue recognition effective from 1 January 2018 (i.e. reporting periods ended 31 December 2018 onwards).
In addition, AASB 1058 Income of Not-for-Profit Entities was issued on 12 January 2017 replacing AASB 1004 Contributions. The new AASB 1058 will work in conjunction with AASB 15 to ensure NFP revenue recognition requirements more closely reflect the economic reality of NFP transactions. The new standard requires revenue from grants and donations to be recognised when any associated performance obligation to provide goods or services is satisfied, and not immediately upon receipt as currently occurs. More assets will also be recorded on the balance sheet under the new requirements, including leases with significantly below-market terms and conditions. AASB 1058 applies for financial reporting periods beginning on or after 1 January 2019 with early adoption permitted, only where AASB 15 is also applied.
NFPs should review the requirements of this standard to understand the implications for their current revenue (including contributions) recognition policies and contracts under which they operate.
- Available for sale financial assets and the new AASB 9 Financial Instruments
NFPs should consider whether they want to adopt the new AASB 9 Financial Instruments before its official application date to financial years commencing on or after 1 January 2018 (i.e. reporting periods ended 31 December 2018 onwards). The new standard changes accounting for investments that aren’t held for trading. If these investments meet certain conditions, the movements in fair value (both upwards and downwards) are accounted for through ‘other comprehensive income’ and not the profit or loss. This would protect NFPs from significant market downturns impacting the profit or loss.
All aspects and changes required under AASB 9 should be considered prior to deciding whether to early adopt this standard.
Assessing the likely financial impacts of these impending changes is something that all NFPs should be conscious of as the initial implementation of the revised requirements may require:
- disclosures of expected impacts prior to the accounting standard being initially applied;
- the restatement of comparative figures;
- the determination of future operating results (especially where the basis of recognition of revenues is impacted).
In the next blog of this series I will focus on areas where NFPs can enhance NFP annual reporting beyond the financial domain including the use of visualisation techniques and reporting on strategy, performance, sustainability and an NFPs greatest asset, people. See you then!