28 September 2022
For those who prepare and audit financial statements for “small” (under $2m expenditure) charities and other not-for-profits, there are some important changes coming up. We have made a summary with some commentary about how we think this will impact the sector.
In New Zealand, these smaller entities are very common – there are about 30,000 of them including some soon to be included in this reporting under the Incorporated Societies Act 2022.
The Tier 3 standard continues to be accrual-based, and Tier 4 is a cash-based alternative for smaller entities (under $140k expenditure). This article focuses on Tier 3, which tends to be used much more than the cash-based standard even for many smaller entities as it is much more like traditional reporting. We will look briefly at the Tier 4 proposals at the end.
When the standard was introduced there were no NZ reporting or auditing standards for Service Performance Information (SPI). Now we have PBE FRS 48 for Tier 1 and 2 entities, and NZ AS-1 for the audit of Service Performance Information across all the tiers.
In a way, the proposed changes in Tier 3 are simply following the direction set by PBE FRS 48 and NZ AS-1. The terms Outcome and Output were always confusing, so these are being replaced with more descriptive terminology as per PBE FRS 48. Entity Information is no longer a prescribed report, although the information is still expected to be included somewhere.
There is also some helpful guidance provided about what to report as SPI, and how to report it. Reporting must be:
- Relevant and faithfully represented
- Timely and comparable
As such, any changes in reporting from the prior year must be explained, so there is consistency in reporting.
In our opinion, these changes are welcome and it makes sense to align SPI reporting with the other standards, as it should be more efficient for preparers and auditors, and more understandable to users.
From an audit perspective, NZ AS-1 is a complex standard that feels like overkill for auditors of smaller entities. Perhaps when the NZ version of the LCE auditing standard is released there may be something size-appropriate for auditing SPI.
Changes to standard revenue and expenditure categories
A common criticism of reporting under the existing Tier 3 standard is that the reporting categories are so broad as to be almost meaningless in some cases. The proposed changes split some of the categories into smaller classifications. For instance,
- Commercial activities are split out;
- Grants for capital projects are split from other grants;
- Government funding is split from non-governmental funding;
- Donations are now clearly differentiated from membership fees and subscriptions;
- Employee remuneration (apparently including those paid as contractors) is to be split out from volunteer and other employee expenses.
Preparers of performance reports will be able to tweak the names of the categories, but will not be allowed to add additional categories as before. This is probably for aggregation and analysis purposes.
We think these changes generally make sense. They should make the statement of financial performance more meaningful and reduce the need for extensive notes breaking down the categories.
Revenue recognition changes
The existing standard is fairly inflexible in matching revenue from grants and other bequests and gifts with the use of that money. Donations with a use or return condition are recognised as the condition is fulfilled. Any income without such a condition is currently recognised in the period it was received.
Under the new proposals, if there is a clear expectation of when funds are to be used in terms of an agreed expectation from the grantor, the revenue may be recognised as or when the conditions are satisfied.
This seems like a clear, common-sense response, more in line with the commonly accepted matching principle of accrual accounting.
Alternative measurement for assets
Under the current standard, if fixed assets are revalued, the Tier 2 standard must be used. The proposal is to allow revaluation based on say, RV (rateable value) for land and buildings, or valuation by an independent qualified valuer. Changes are to be made straight to a revaluation reserve. The whole class of assets must be revalued. Once a revaluation is made there must be consistency going forward, with no changing back to other methods, and revaluation updates made on a regular schedule. Depreciation must still be calculated on revalued assets.
The rules are to be applied to assets that do not require significant judgement or complex estimates. Investment property may also be included as their own category under fixed assets and revalued in the same way. It is proposed that financial assets (shares etc.) be measured at their current value, with changes in value put through the statement of financial performance.
This all seems sensible and familiar to us, and simple enough for preparers and auditors.
Including a note on accumulated funds
At present, there are no requirements to disclose any details of accumulated funds. The proposal is that for transparency there be a note that discloses objectives and policies for managing accumulated funds, and any plans for applying accumulated funds to meet the entity objectives. The proposal is for this to be a high-level informational view and not a binding commitment.
We can see some advantages to this disclosure. First, it will make entities think about why they have significant reserves (if in fact, they do) and perhaps how they could be better using these to meet their objectives. If they view their reserves as investments, are they making the best use of their capital? Could they be meeting their objectives in more efficient ways with a redeployment of their equity?
On the other hand, many charities certainly don’t have excess cash or investments and their equity simply represents assets such as land and buildings that are essential to their service delivery. Having to make up a nice story to put into a note in these cases seems like a pointless exercise. This could also be difficult to audit.
Simplification to the statement of cash flows
Cash flow statements are typically a headache for both preparers of financial statements and auditors. Accounting software often struggles and the results are hard to audit and hard for users to understand.
The proposal is that the categories in the statement of cash flows match the categories in the statement of financial performance. It seems to be that the statement of cash flows is to be essentially a statement of receipts and payments.
We think this is a brilliant idea. It will be easier to prepare (just based on the cash report in Xero say), easier to audit, and probably more useful to users.
Change of name
The new standard is to be called Reporting Requirements for Tier 3 Not-For-Profit Entities. This is a welcome improvement from the old tongue twister.
Tier 4 proposed changes
There are a couple of changes proposed for Tier 4. These reflect the changes in categories proposed for Tier 3, some simplified requirements for really small entities (under $10k expenditure), changing the language around outcomes and outputs, removing the need for a statement of resources and commitment and replacing this with a note, and changing the name of Statement of Receipts and Payments to Statement of Cash Received and Cash Paid.
In general, these changes seem fairly trivial. The only comment I have is that the name change to Statement of Cash Received and Cash Paid could actually be confusing. Most non-accountants think of cash as the paper money we get out of ATMs, as opposed to direct payments and EFTPOS. A backwards and unnecessary step in my opinion. Perhaps Statement of Money Received and Money Paid would be clearer?
It seems as if the drafters of the proposed changes to the Tier 3 and 4 standards have taken time to test the wind well. They have listened to users, preparers and auditors alike and come up with a sensible result. Of course, there will always be details to iron out in the execution, and the submissions (ending 30 September) may encourage further changes. Overall we rate the proposals at a solid 9/10.
See the XRB page for links to the consultation documents and drafts.