international financial reporting standards and charities

INTERNATIONAL FINANCIAL REPORTING STANDARDS AND CHARITIES A review of the potential impact of recent proposals | Spring 2010

1487_CFGD IFRS Report_v4_FINAL.indd 1

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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 Charity SORP 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 IFRS for SMEs 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.


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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 IFRS for SMEs 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 IFRS for SMEs 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 IFRS for SMEs 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 IFRS for SMEs 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 IFRS for SMEs and: • the Charity SORP • the other SORPs covering housing and the HE/FE sectors • UK GAAP and 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: • • • • • • • • • •

Much of the Charity SORP addresses the contents of the annual report. The IFRS for SMEs 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 IFRS for SMEs 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 IFRS for SMEs 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: UK GAAP and Charity SORP

Issue

IFRS for SMEs

Columnar presentation

Might be less prevalent

Required in SOFA

Note of historical cost profits and losses

Not required

Required

Finance costs

Presented as a separate line item

Charities do not usually present as a separate line item

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.


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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:

Issue

IFRS for SMEs

Presentation of changes in funds / reserves

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.

Accounting policies, estimates and errors This is the sort of minor issue which it is difficult to see a public benefit standard changing.

UK GAAP and Charity SORP In the Charities SORP it forms part of the SOFA.

Issue

IFRS for SMEs

Error found relating to prior periods

Adjust by means of a prior year adjustment if the error is material

UK GAAP and Charity SORP Adjust by means of a prior year adjustment if the error is fundamental

Financial Instruments 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 IFRS for SMEs:

Statement of Cash Flows The changes here are mainly presentational:

Issue

IFRS for SMEs

UK GAAP and Charity SORP

Cash flow from endowment income

Presented as operating cash flows

Presented as financing cash flows

Definition of cash

Includes cash equivalents, ie available in 3 months without penalty

Only includes cash available on demand without penalty

Presentation of cash flows from operating activities

Presented on the face of the cash flow statement

Reconciliation of net operating income to cash flow from operating activities is usually presented in the notes

Notes to the Financial Statements 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 IFRS for SMEs is notably less than those contained in FRSs and SSAPs.

• • • • •

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”:

IFRS for SMEs

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

FRS 4 deals broadly with the accounting for debt. Accounting for other financial instruments determined by convention only

Disclosure

Some

None

Consolidated and Separate Financial Statements There are no sized based exemptions for the preparation of consolidated accounts under the IFRS for SMEs.


Issue

Investments in Associates, and Investments in Joint ventures The treatment of associates changes under the IFRS for SMEs. 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 IFRS for SMEs for not-for-profit entities.


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Investment Property

Intangible assets

The IFRS for SMEs 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 IFRS for SMEs. 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.

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.


Issue

IFRS for SMEs

Changes in fair value

Recognised in the income statement (top half of statement of comprehensive income)

Recognised in bottom half of SOFA

Properties rented to other group entities

Accounted for as investment property in individual accounts and property, plant and equipment in group accounts

Accounted for as tangible fixed assets in both individual and group accounts

Account separately for gross value of property interest and obligations payable on the head lease

Usually account for just the net leasehold interest

Leasehold investment property

Property, Plant and Equipment Potentially some of these changes are the most significant, both in terms of breadth of application and impact. The IFRS for SMEs is silent on heritage assets.

Issue

IFRS for SMEs


Measurement

Asset revaluations not permitted

Revaluations permitted

Borrowing costs

Capitalisation not permitted

Choice of capitalising or expensing

Mixed use property

Account for owneroccupied and investment portions separately

Split accounting permitted, or alternatively account for entire property based on the predominance of use

Donated assets

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)

Recognised at current value on date of donation

Disclosure

No concept of a “heritage asset” or disclosures about fair value

FRS 30 ‘Heritage assets’ to be complied with for periods starting on or after 1 April 2010


Business combinations and goodwill The IFRS for SMEs 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 IFRS for SMEs, it is likely that more intangibles (such as brand values) would be recognised than would when applying the purchase method under UK GAAP. The IFRS for SMEs 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. UK GAAP and Charity SORP

Issue

IFRS for SMEs

Method of accounting

Merger accounting not permitted

Merger accounting permitted if certain criteria are met

Intangibles identified on a business combination

To be initially recognised at fair value separately from goodwill and amortised thereafter

Intangible assets rarely recognised separately from goodwill on a business combination

Negative goodwill

Credited immediately to income statement in full

Negative goodwill deferred in balance sheet and released to income statement over appropriate periods

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Leases

Government Grants

Lease accounting is likely to be a detailed area for consideration, although the impact on the balance sheet will vary.

Accounting for government (and other) grants in the IFRS for SMEs 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.

Issue

IFRS for SMEs


Leasehold premiums paid

Leasehold premiums paid likely to be classified as prepayment

Leasehold premiums paid generally classified as a property asset

Although not addressed, likely treatment for lease incentives is spreading over the minimum lease term

Lease incentives spread over the period to first rent review

Disclosure required of the total future minimum lease commitment

Disclosure required of the annual lease commitment

Lease incentives

Disclosure of operating lease commitments

Provisions and Contingencies 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 IFRS for SMEs as it stands generates potential problems, and sector specific guidance will be needed. UK GAAP and Charity SORP

Issue

IFRS for SMEs

Donations of nonfinancial assets

There appears to be no scope to measure assets at anything other than cost (which in the case of donated assets would be nil)

Recognised at fair value on date of donation

Legacy income subject to life interest

Potential need to discount to a present value and then accrete up over the period until receipt recognising interest income

Generally not recognised because recognition criteria not met. If recognised, unlikely to be discounted

Pro bono and volunteer services received

Not addressed

SORP requires income and expense recognised where the benefit is reasonably quantifiable and measurable


Issue

IFRS for SMEs

Matching of grant income to related expense in the income statement

All grants recognised as income in full when performance conditions have been met, which could be interpreted as the end of any clawback period

UK GAAP and Charity SORP Charity SORP similarly requires all grants to be recognised on receipt, except to the extent repayment is considered probable

Borrowing costs 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 IFRS for SMEs 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.

Issue

IFRS for SMEs

When to recognise an impairment

Criteria for measuring value are based entirely on commercial return and cash flow considerations

UK GAAP and Charity SORP Charities can look at the service potential of assets, in assessing recoverable amount

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Employee benefits

Related party disclosures

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.

The IFRS for SMEs requires more disclosure than the SORP.


Issue

IFRS for SMEs

Holiday pay accruals

Holiday pay to be recognised as an accrual or prepayment as appropriate

Holiday pay generally not accounted for

Presentation of actuarial gains and losses

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

Actuarial gains and losses recognised in the statement of total recognised gains and losses, ie the “bottom half” of SOFA

Certain simplifications to projected unit credit method of measuring defined benefit liabilities permitted on grounds of “undue cost or effort”

Projected unit credit method to be applied in full

Measurement basis for defined benefit scheme liabilities

Income tax 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 IFRS for SMEs. 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 IFRS for SMEs.

Issue

IFRS for SMEs


Disclosure of transactions with group entities

No exemption from disclosing transactions in an entity’s individual financial statements between itself and other entities within the same group

No requirement to disclose transactions between 100 per cent owned entities of a group, provided consolidated financial statements are prepared

Disclosure of donations from related parties

No exemption

Exemption given in Charity SORP

Remuneration of key management personnel

Details of key management remuneration must be disclosed

Disclosures driven by relevant legislation and regulators

Disclosures required

Name of related party does not need to be disclosed, but the nature of the relationship does

Both the name of related party and the nature of the relationship needs to be disclosed

Transition to the IFRS for SMEs When an entity transitions from UK GAAP to the IFRS for SMEs, the basic rule is that the financial statements for both the current year and comparatives are presented in accordance with the requirements of the IFRS for SMEs. In order to present a comparative statement of comprehensive income it is therefore necessary to have an IFRS for SMEs compliant balance sheet two years prior to the date of the first financial statements prepared in accordance with the IFRS for SMEs. 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 IFRS for SMEs.

Events after the end of the reporting period The debate on the treatment of designated funds might be reopened: the IFRS for SMEs is silent on specifics like fund designation.


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15,000

3,000

68,000

Incoming resources from charitable activities

Other incoming resources

Total incoming resources

10,000

2,000

Charitable activities

Governance costs

Net incoming resources before transfers

35,150

Total comprehensive income for the period

0

0

(500)

(500)

(500)

(500)

Adjustment 1 £’000

(5,000)

(5,000)

0

0

0


0

2,500

(2,500)

2,500

2,500

0


(500)

(500)

0

(500)

(500)


100

100

(100)

(100)

0


(425)

(425)

0

(425)

75

(500)


(2,500)

(2,500)

0

(2,500)

(2,500)


Reduces revenue and expenditure for estimated value of pro bono services received Removes revaluation gains and losses on owner-occupied property Recognises gains and losses on equity investments in profit and loss Net movement on grant income where performance conditions for receipt not met Net reduced pension cost arising from taking advantage of simplified projected unit credit method on grounds of undue cost or effort Net movement arising on recognition of legacy income with reserved life interest at fair value with imputed interest accretion Recognition of donated items of property, plant and equipment during the year at nil cost Separate presentation of finance costs (including unwinding of discounted liabilities such as pensions) 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

135,150

Total funds carried forward

Adjustment 1 Adjustment 2 Adjustment 3 Adjustment 4 Adjustment 5 Adjustment 6 Adjustment 7 Adjustment 8 Adjustment 9

100,000

Total funds brought forward

RECONCILIATION OF FUNDS

(350)

(2,500)

Gains/(losses) on investment assets

Actuarial gains/losses on defined benefit pension schemes

5,000

33,000

Gains on revaluation of fixed assets for charity’s own use

OTHER COMPREHENSIVE INCOME

Net income for the period

0

35,000

33,000

Total resources expended

GROSS TRANSFERS BETWEEN FUNDS

3,000

Other resources expended

Finance costs

20,000

Costs of generating funds

RESOURCES EXPENDED

50,000

Incoming resources from generated funds

INCOMING RESOURCES

As reported under UK GAAP £’000

Reconciliation of hypothetical charity SOFA to statement of comprehensive income

0

0

0

(1,000)

1,000

0


5,000

5,000

(5,000)

(5,000)

0


31,825

(350)

0

0

32,175

31,900

(600)

1,000

2,000

9,500

20,000

64,075

2,075

15,000

47,000

As reported under IFRS for SME £’000


APPENDIX 1

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Adjustment 1 Adjustment 2 Adjustment 3 Adjustment 4 Adjustment 5 Adjustment 6 Adjustment 7 Adjustment 8

0

0

(1,750)

(1,750)

(1,750)

1,275

1,275

1,275

(1,000)

(275)


5,000

5,000


5,000

3,000

8,475 (20,000) 6,525 (5,000)

0

1,500

250


56,525 20,000 (6,525) 100,000

(5,000)

100

4,900

(5,000)


2,000

0

100,000

(5,000)


10,000 20,000

(3,250) (6,525)

(30,000) 28,000 2,000 2,500 6,275

(6,500) 2,000 4,000 500 750 250

3,250 6,525

4,775 139,775 30,000

750 500 2,500 25 7,500 11,275 6,500

135,000

100,000 25,000 10,000


Reanlaysis of liabilities Removal of revaluation reserve to recognise carrying value at deemed cost and elimination of pension reserve Presenting lease premiums as a prepayment of rent Recognises liability in respect of grant income where all conditions for receipt not yet met Recognises reduction to defined benefit pension liability arising from taking advantage of simplified projected unit credit method on grounds of undue cost or effort Adjustment to recognise all legacies with reserved life interest at fair value Adjustment to recognise non-financial assets donated since date of transition at cost of nil Recognition of impairment loss due to inability to measure recoverable amount of assets by reference to its service potential

PROVISIONS DEFINED BENEFIT PENSION SCHEME LIABILITY TOTAL ASSETS LESS TOTAL LIABILITIES FUNDS Endowment Funds Restricted income funds Unrestricted income funds Net accumulated surplus Revaluation reserve Pension reserve

NET CURRENT ASSETS TOTAL ASSETS LESS CURRENT LIABILITIES LONG-TERM FINANCIAL LIABILITIES Bank loans Other long-term liabilities Provisions Employee benefits

CURRENT LIABILITIES Bank loans and overdrafts Short term creditors Other short-term financial liabilities Provisions Employee benefits

CURRENT ASSETS Stocks and WIP [Inventory] Investments Other financial assets including debtors Prepayments Cash at bank and in hand

LONG-TERM ASSETS Tangible Assets Financial assets Investment property Prepayments

As reported under UK GAAP £’000

Reconciliation of hypothetical charity balance sheet to statement of financial position

(2,500)

(2,500)

(2,500)

(2,500)


(25,000)

(25,000)

(25,000)

(25,000)


72,025

40,025

12,000 20,000

72,025

28,000 3,500 2,500 5,275 39,275

2,000 4,250 500 750 (25) 7,475

750 500 2,500 125 7,500 11,375

62,500 30,000 10,000 4,900 107,400

As reported under IFRS for SME £’000


APPENDIX 2

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