ACCOUNTING STANDARD FOR NOT-FOR-PROFIT ORGANIZATIONS

Presented by:Usman Tahir Farooqi, ACADirector, Advisory ServicesAnjum Asim Shahid Rahman

February 06, 2015ICAP House, Lahore

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The time has come for all evangelists to practice full financial disclosure. The world is watching how we walk and how we talk. We must have the highest standards of morality, ethics and integrity if we are to continue to have influence. (Billy Graham)

Table of Contents

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Introduction and Background

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Brief on Standard Development Process

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General Framework

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Specific Framework

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Inventories

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Tangible and Intangible Assets

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Strategic Investments

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Contribution

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Fund Accounting

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Related Party Transactions

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Introduction and Background

NPOs are organizations:►Formed for non-profit purposes

►Without transferable ownership interest, may earn profit

►Financial dispositions promote entity’s objectives

NPOs may include:►Charities / Foundations

►Welfare organizations

►Professional and trade associations

►Institutions4

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Introduction and BackgroundNeed for replacement of existing ICAP guideline for NPOs (2009 version) by a focused standard outlining bare minimum requirements to report financial information by an NPO especially for areas which are not dealt with in primary source.

It is applicable on NPOs that are registered under section 42 of the Companies Ordinance, 1984; however, others will have a recommended framework in place for adoption.

A four tier arrangement for NPOs is under consideration for adoption to determine applicable/primary financial reporting framework 5

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Introduction and Background

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Adoption of a superior set of standards is not restrained.

NPO to be classified for two consecutive years accordingly

In case of a conflict situation, primary reporting Framework shall prevail. Back

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Standard Development Process

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Accounting Standards Committee (ASC/Committee) has representation of all stakeholders

Formation of sub committee to review existing guideline and global standards

Finalization of draft for review by ASC

Approved draft was exposed to solicit comments from members

This session is for education and awareness of PCP members

Submission of draft to SECP for notification.Back

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General Framework

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► The proposed Standard for NPO follows the same conceptual framework as IRFSs, FRS-MSE and AFRS-SSE. An NPO follows the same rules of accounting as those required for all entities.

► The definitions of assets and liabilities are the same and the not-for-profit organization must also follow accrual accounting except in case non-corporate Micro NPOs.

► The revenue recognition criteria are the same as those of profit-oriented enterprises except that contributions to a not-for-profit organization are considered revenue.

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General Framework

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► Objective of financial statements

► Contents of financial statements

► Characteristics of financial statements

► Financial statements assertions

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General Framework – Objectives of FS

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► Fair presentation of financial results to provide information to the users of financial statements for decision making

► The objective is achieved through:

► Specific contents

► Qualitative characteristics (materiality, substance over form, completeness and timeliness in addition to relevance, reliability, understandability and comparability)

Underlying Assumptions

► Going concern

► Accrual basis

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General Framework – Contents of FS

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► Statement of financial position

► Statement of income and expenditure

► Statement of changes in net assets

► Statement of cash flows

► Notes to the accounts

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General Framework – Contents of FS

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► Statement of financial position► Description of assets and liabilities similar to profit oriented entities

► No shareholders equity and the difference of assets and liabilities is shown as net assets or fund balance

► May present assets / liabilities using fund accounting

► Statement of income and expenditure► Reflects net income / surplus similar to profit oriented entities ► May classify expenses by:► Nature (Salaries, rent, utilities etc.► Functions (administrative, research)► Programs (education, health)► May present activities using fund accounting Back

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General Framework – Contents of FS

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► Statement of changes in net assets

► “Total net assets” represents the organization’s residual interest in its assets after deducting its liabilities.

► The statement of changes in net assets replaces the statement of changes in retained earnings and the statement of changes in equity that is prepared by a profit-oriented entity.

► Statement of cash flows

► The statement of cash flows is the same as that shown for profit-oriented entities.

► Cash from financing activities would include contributions that are endowments or are restricted for the purchase of capital assets as well as to redeem debt financing.

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General Framework – Qualitative characteristics

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► Understandability

► Relevance

► Timeliness

► Materiality

► Reliability

► Substance over form

► Completeness

► ComparabilityBack

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Specific FrameworkOnly applicable for NPOs

No requirement in primary sources and other reporting frameworks

Specific accounting and disclosure requirements:

Inventories

Tangible/intangible assets

Strategic investments

Contribution

Fund accounting

Related party transactions15

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An NPO is not required to record materials or services that are donated to it.

An NPO can only recognize materials or services if:

Fair value can be reasonably estimated

Materials/services are used in the normal course of the organization’s operations and would otherwise have been purchased (6.15).

If the NPO records the inventory, it measures it at fair value at the date of the contribution

Inventories held for distribution at no charge / nominal charge are recognized at lower of cost and replacement cost

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Inventories

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Examples

An NPO has received inventory item as donation. The original cost of that item is Rs.10,000 and the current market price is Rs.120,000

The NPO intends to distribute the above item free of cost. The carrying value is Rs. 9,000 and current purchase price is Rs.8,000

An NPO regularly receives services of various volunteers to run its business

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Inventories

Tangible Capital and Intangible Assets

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NPOs follow the same criteria as profit-oriented companies with respect to the recognition and measurement of tangible capital assets and intangibles;

Capitalized at cost and then depreciated /amortized over their useful life,

In the case of land or an intangible that has a infinite life, at cost

If the capital asset is contributed, or if the organization purchases the asset at an amount significantly below fair value, cost is considered to be the fair value at the date of the contribution.

If in the rare circumstance that the fair value cannot be determined, the capital asset is recorded at a nominal value.

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Tangible Capital and Intangible Assets

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If micro entity’s average annual revenues for the current and preceding period are less than Rs. 10 million, it is not required to capitalize and depreciate its capital assets (Section 8.1).

These “Micro NPOs” may be more interested in cash flows, and as such, they are allowed to immediately expense these costs, or to capitalize these assets and not depreciate them.

If the NPO subsequently has revenues more than Rs. 10 million, it must begin to capitalize and depreciate assets going forward.

If the revenues then fall below Rs. 10 million again, the organization still continues to capitalize and depreciate assets. The exemption is lost forever and is no longer available to it.

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Tangible Capital and Intangible Assets

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Collections are defined as works of art and historical treasures that have cultural, aesthetic, or historical value that is worth preserving perpetually.

The difficult aspect in presenting these collections is valuation. These items are usually received as a contribution and as such the organization does not have the benefit of an arm’s length transaction to determine fair value.

Standard for NPOs allows a not-for-profit organization not to record any cost for these collections. The organization decides whether the benefit to be derived from the fair value outweighs the cost to determine the fair value (10.4).

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Section 4: Strategic Investments

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The NPO is required to follow the IRFSs, IFRS-SME, AFRS-SSE with respect to the accounting and reporting its strategic investments.

NPOs may invest in profit-oriented entities, other not-for-profit entities, or may have other economic interests. The proposed Accounting Standard for NPOs defines an economic interest as an organization:

that holds resources that must be used to produce revenue or provide services for the reporting organization, or for whose liabilities the reporting organization is responsible (11.1).

there is a presumption that control exists if the organization has the right to appoint the majority of the other entity’s board of directors.

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Contributions

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Contributions are revenue from primary sources (donations / grants), may be in the form of cash or in kind

Recognized as revenue or deferred grant, examples include:

An NPO has received donation of Rs.10 million from an international donor with no restrictions. The amount is placed in a bank and profit of Rs.500,000 was earned during the year

An NPO has received donation of Rs.10 million from an international donor which has to be spent in 3 years

A motor vehicle has been donated to an NPO for flood relief work

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Contributions

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A contribution receivable should be recognized as an asset if it meets both of the following two criteria:

The amount to be received can be reasonably estimated.

Ultimate collection is reasonably assured.

There are two methods to account for contributions: the deferral method or the restricted fund method.

Using the deferral method of accounting, expenses are recorded in the period in which they occur and restricted contributions are then brought into income to match against those expenses.

If the expenses will only be incurred in a future period, the contribution is shown as a deferred liability until such point as the expenses are incurred.

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Contributions

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Externally restricted resources would be presented as deferred contributions.

Internally restricted resources are determined by the entity, for instance an amount to be invested in capital assets, and the contribution is deferred to offset against the related asset.

This is sometimes referred to as an “appropriation.”

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Contributions – Restricted Fund Method

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Under the restricted fund method, the organization classifies its restricted operations by fund and recognizes the contributions immediately as revenue of that particular fund.

When using the restricted fund method, the organization will have at least a general fund, which is composed of non-restricted contributions, and an endowment fund. Any other funds that it uses must be restricted by an external source, e.g. capital assets fund.

It is up to the not-for-profit organization to decide how many restricted funds it wants to report.

Any restricted funds that do not have a separate fund are reported using the deferral method through the general fund.

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Section : Fund Accounting

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Funds

Unrestricted funds

Restricted funds

Internal restrictions

External restrictions

General fund

Endowment fund

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A not-for-profit organization may choose to disaggregate, or separate, its assets and liabilities by the activity that they belong to and/or to disaggregate the operating activities by the nature of the activity.

One way to clearly reflect the results of various different activities is to keep each activity in a separate fund.

This is just like to setting up multiple different sets of statements, one set for each activity. Each fund would then be added together to present the overall financial statements of the organization.

When all the funds are added together, the inter-fund transfers are in effect eliminated as they are inter-entity. The inter-fund transfers are not considered revenue or expenses of the entity and as such are reflected only in the statement of changes in net assets.

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Fund Accounting

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A restricted fund is a segregation of funds that are externally or internally restricted for a particular purpose.

This restriction may be imposed externally by the donors, by the legal requirements of the not-for-profit organization, or by the creditors.

Alternatively, the not-for-profit organization can internally restrict contributions for the purpose that it deems appropriate (also called designated funds). This restriction usually requires the approval of the board of directors or governing body.

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Restricted Fund

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An endowment fund is a type of restricted fund where, even though funds are collected, the principal is not allowed to be spent.

The not-for-profit organization is only permitted to use the growth in the funds for selected purposes.

Many not-for-profit organizations may have a great deal of assets but they are “cash poor.” This may be a result of the endowment funds not earning a sufficient return to manage operations.

Endowment funds can be the best way to ensure the long-term viability of the not-for-profit organization. As the endowment grows, the annual allocation to income will also increase (the organization must determine the best possible way to maximize the return on those investments and limit the risk of loss or cash shortage).

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Endowment Fund

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A capital asset fund is another type of restricted fund, which is used for the acquisition and maintenance of capital assets.

The above are types of funds that any given not-for-profit organization may select. The NPO is not required to disaggregate based on these funds nor is it restricted to only these types of funds. It is up to the not-for-profit organization to determine the best way to convey information to the user.

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Capital Asset Fund

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Identified as related parties based on relevant accounting framework

Similar considerations for control, joint control and significant influence

Economic interest

Entity holds resources for the benefit of other entity

Entity responsible for the liabilities of other entity

An NPO has obtained a long term financing from a bank. XYZ (which is also a minor donor of the NPO), has provided an unconditional guarantee to the bank for the above loan

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Related party transactions

Conclusion

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Private not-for-profit organizations are required to follow proposed standard for NPOs, and it must also adopt IFRSs, FRS-ME or FRS-SE (as applicable) for all issues not covered in proposed standard for NPOs.

All not-for-profit organizations should apply similar accounting treatments to like transactions when the needs of the users are aligned.

Revenue recognition criteria mirror those of profit-oriented entities except for contributions.

A not-for-profit organization may disaggregate its financial statements into funds based on its legal, contractual, or voluntary actions.

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End of Presentation

Thank you…

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