The most controversial area of not-for-profit (NFP) accounting for many years has been the requirements relating to grant accounting. At best it is confusing; at worst it results in inconsistent and nonsensical outcomes. The standard often results in income being recognised up-front, with no concept of matching income and expenditure, even for grants that cover more than one reporting period.
The new standard AASB 1058 Income of not-for-profit entities, issued by the Australian Accounting Standards Board in December 2016, simplifies these requirements by allowing NFPs to defer the recording of income until associated performance obligations have been met. Therefore, no performance obligations mean that income is recognised when it is controlled (usually upon receipt).
This new standard will bring financial reporting for NFPs closer to economic reality, reflecting the underlying grant requirements. It should be less confusing to stakeholders that may currently see significant surpluses one year and significant deficits in subsequent years based on when grant funds are received.
However, at times there will still be upfront recognition of grant income, bequests or donations where the NFP has no performance obligation or liability associated with the monies received. An understanding of these arrangements and contracts will be critical in applying the standard appropriately.
The standard does not apply until periods commencing 1 January 2019, but can be applied earlier voluntarily.
The standard, combined with the new revenue standard and the new leasing standard also commencing from 1 January 2019, will result in the biggest changes to NFP accounting that we have seen this century.
What else has changed in revenue recognition?
The general revenue requirements where NFPs have contracts with customers have also changed significantly. This change AASB 15 Revenue from contracts with customers applies a five step model to determine the amount of revenue to recognise and in which reporting period.
The principle of the updated standard is that an entity recognises revenue as performance obligations are satisfied and this will require a thorough understanding of all revenue contracts with customers.
Significant transitional relief is provided with this standard and NFPs get a one-year extension to apply it (compared to the for-profit application date).
Further, Australian-specific guidance has been added to AASB 15 which includes illustrative examples for NFP entities and an implementation guide (necessary as AASB 15 also applies to for-profit entities and is written in language for this purpose).
Has anything else changed?
More assets will be recorded on the balance sheet under the new requirements. Currently only assets acquired by NFP entities at nil or a nominal amount must be recorded at fair value. This will be extended to cover all assets where the NFP pays significantly less than fair value. The changes in the standard are intended to help entities identify and manage their resources and provide users with a better understanding of the entity’s dependence on donated assets.
Of note is that the new leasing standard AASB 16 Leases will bring most leases on balance sheet including operating leases and peppercorn lease arrangements that many NFPs are party to. Peppercorn leases are leases entered into significantly below market rate. This new standard will mean that the difference between the fair value of the asset and the liability will be recognised immediately in the income statement. For peppercorn leases this could result in some large one-off income items that need explanation to stakeholders.
How should directors approach these changes?
Directors should ask management the following questions:
- How are we preparing for these new standards?
- When will we understand the impacts on the financial statements?
- Is it best to adopt the changes earlier than the application date?
- How will this be communicated to stakeholders?
- Will any processes or systems require changing?
- Who is accountable for managing this process?