Over the last twelve months we have seen many NFPs struggle with applying the revised income and revenue recognition accounting standards as part of their financial reporting processes. Further, we have seen the board members of these NFPs having difficulty in understanding how the resulting outcome of applying these standards is logical and consistent with the underlying objectives and mission of the NFPs.
The accounting standards in question are AASB 1058 Income of Not-for-profit Entities and AASB 15 Revenue from Contracts with Customers. The difficulties arise in circumstances where the funding by the other party (usually a government body) is received up-front in advance of any expenditure being made. For an operational type grant (in contrast to a capital grant) the only way to defer up-front monies received is for the grant agreement to be accounted for under AASB 15 or sometimes the monies received under the agreement could be considered a financial liability. Deferral means the amount is recognised as a liability and only taken to the income statement as money is expended or performance obligations are satisfied.
Deferral of monies received under AASB 15 is possible when:
- There is an enforceable agreement between the parties; and
- The agreement includes a promise by the NFP to transfer services (or goods) that are sufficiently specific for the entity to determine when the obligation is satisfied.
The key areas of confusion are underlined above. Firstly, sometimes it is difficult to determine whether a transfer of services exists between the NFP and the customer (ie often the government) or a third party as directed by the customer. Secondly, the term ‘sufficiently specific’ is not well understood and whilst examples are provided in the standard on this concept, every NFP is different, the agreements are different and do not fit into the model examples very well.
Deferral of monies received as a financial liability under AASB 9 Financial Instruments may be possible where the contract between the parties contains a termination for convenience clause and that clause is assessed to have substance. However, this treatment is not widely accepted, and this can create uncertainty and confusion.
The resulting outcome of applying these accounting standards is not generally consistent with the matching of income and expenditure that NFPs tend to prefer, since matching reduces the volatility in the income statement. The uncertainty and confusion created has led to inconsistent application of the standards, increased costs by both NFP preparers, their accountants and auditors in reviewing the detail in agreements with government, leading to frustration and sometimes illogical outcomes. These standards were supposed to address the difficulties in the application of the old AASB 1004 Contributions and instead have created their own problems.
Points to consider
To assist you in assessing each contract with government (or those with other parties) where income is received up-front we recommend you consider the following matters in order to assess whether the funds relating to operational grants can be deferred or not:
- Some contracts contain a termination for convenience clause, which means the contract can be terminated by either party or just one party without cause (i.e. for no particular reason). These clauses are often contained in the standard terms and conditions which accompany the specific grant contract.
- For each contract it is important to identify the services (or goods) to be provided and who the services (or goods) are to be provided to.
- When considering whether the performance obligations are ‘sufficiently specific’, where the contract does not contain this level of detail, look for evidence of ‘sufficiently specific’ in documents linked to the contract, such as tender or proposal documents, annual activity statements or budgets that must be approved by the funding provider, detailed project plans with milestones, detailed key performance indicators, etc.
- The assessment of contracts and the resulting outcome will involve applying judgement to the principals outlined in the accounting standard. It is important that this judgement is documented and reviewed by the board so that it can be consistently applied from year to year, or adapted when circumstances change. This judgement when significant should also be disclosed in the financial statements.
On the horizon
In response to stakeholder feedback on the application of these standards, the AASB decided in June to commence a narrow-scope short term project exploring the issues further. A number of issues were discussed at the September 2021 AASB meeting and further issues will be discussed at the November 2021 AASB meeting. Included in those issues are the matters discussed above including the ‘sufficiently specific criterion’, ‘principles of the standards’, ‘scope of AASB 15’, ‘enforceable criteria’, ‘documentation’ and ‘termination of convenience clauses’.
In addition to those narrow scope areas that the AASB will review in the short-term, the AASB has also indicated it will commence a post implementation review of AASB 15 and AASB 1058 next year.
If you have any feedback on how you have been impacted in the implementation of these standards as well as ongoing issues, please do not hesitate to contact us so we can feed it into the consultation processes at the time.