ICAS’ Charities Panel has responded to part 1 of a major consultation on the development of international financial reporting guidance for not-for profit organisations (NPOs).
ICAS broadly welcomes plans to base international financial reporting guidance for NPOs on the IASB’s International Financial Reporting Standard for Small and Medium-sized Entities (the IFRS for SMEs).
Nevertheless, the ICAS response makes recommendations ICAS believes are necessary to place the planned guidance on a firm footing and to ensure that it is proportionate to the needs of NPOs operating in challenging environments.
About part 1 of the consultation
Part 1 of the consultation considers the following general matters:
- Scope of the planned guidance
- Information needs of external stakeholders
- Basis of the planned guidance
Part 2 of the consultation, which closes in September, considers NPO-specific financial reporting issues. It sets out how key specific issues have been identified, provides a description of the nature of each issue and criteria for prioritising issues to be considered for inclusion in the guidance.
About the IFR4NPO’s Initiative
The consultation is being conducted by the International Financial Reporting for NPOs (IFR4NPOs) Initiative.
The Initiative has been established to develop the world’s first internationally applicable financial reporting guidance for NPOs. Its purpose is to improve the clarity and consistency of NPO annual reports and financial statements, resulting in greater credibility and trust in the not-for-profit sector globally.
The Initiative arose from a project supported by the UK’s Consultative Committee of Accountancy Bodies (CCAB) back in 2014.
Scope of the planned guidance
A ‘board characteristics’ approach is proposed for the guidance which ICAS supports. This approach lends itself to jurisdictions that do not have a legal framework for NPOs, including charities, therefore eliminating a potential barrier to applying the guidance.
ICAS recommends that the broad characteristics approach is extended to enable entities, such as trade unions, which are for private benefit (i.e. which do not have exclusively public benefit objectives) to apply the guidance. For such an approach to work, we have also recommended that the broad characteristics approach specifies that the guidance should not apply to entities permitted by their founding documents to distribute surpluses to individuals or to commercial profit distributing entities.
The information needs of external stakeholders
The consultation paper explores the information needs for external stakeholders with reference to accountability and decision-making. A strong emphasis is placed on decision-making which goes beyond the reference to economic decision-making in the objectives set for financial statements prepared in accordance with the IFRS for SMEs.
ICAS has challenged the emphasis placed on NPO financial reports (i.e. the annual report and financial statements together) being useful for decision-making. ICAS also has a preference for referring to ‘stewardship’ than solely to ‘accountability’. Stewardship encompasses both management’s accountability for past actions and its responsibility for the future sustainability of the entity.
It is important that the objectives of annual reports and financial statements are considered separately in the first instance, given the need for accruals-based financial statements, prepared under the IFRS for SMEs, to present fairly the financial position, performance and cash flows of an entity. There is no equivalent concept which applies to annual reports.
Combined objectives for financial reports are feasible given that the boards of premium listed UK companies are required to make a statement that the annual report and financial statements, taken together, are ‘fair balanced and understandable’. The concept of ‘fair, balanced and understandable’ may be helpful in thinking about the combined objectives of NPO financial reports.
Basis of the planned guidance
The consultation paper proposes that the NPO guidance on the preparation of financial statements needs to be based primarily on an international rather than a jurisdictional-level framework. It examines the extent to which the three existing international frameworks would allow the project objectives to be met.
The three international frameworks referred to in the consultation paper are International Financial Reporting Standards (IFRS), the IFRS for SMEs and International Public Sector Accounting Standards (IPSAS).
ICAS supports this approach to the preparation of the guidance, including using the IFRS for SMEs as the starting point. Care will need to be taken to ensure that the guidance on the preparation of NPO financial statements provides a coherent framework given that three different, albeit similar frameworks, will be drawn on.
In addition, the ICAS response highlights the following additional key risks which need to be considered in developing the guidance:
- Undue specialisation – The guidance should only depart from the IFRS for SMEs where departure is clearly justifiable.
- Failure to define the ‘reporting entity’ with sufficient clarity – The consultation paper refers briefly to the ‘reporting entity’ but further commentary will be needed within the final guidance. Identifying the ‘reporting entity’ is a fundamental issue for financial reporting. Individual reporting entities can exist within a group structure while still being self-governing for financial reporting purposes. Also, NPOs may have local branches which are constitutionally part of a parent entity and are therefore not separate entities for financial reporting purposes.
- Not providing appropriate concessions for smaller or less complex NPOs – This could limit the number of NPOs with the capacity to implement the guidance. Concessions could be offered by developing a tiered approach with core requirements for all NPOs based on a paired down version of the IFRS for SMEs. Additional requirements, drawing further on the requirements of the IFRS for SMEs, could be placed on ‘larger’ and/ or more complex entities, with the largest and/ or most complex entities applying the full guidance.
Read the ICAS response to the consultation here.