New Consolidation Standard to affect Not for Profits

Not-for-profit organisations such as schools, churches and charities could be at risk of breaching the legislation with the introduction of a new accounting standard.

Last year the Australian Accounting Standards Board introduced a new accounting standard (AASB 10 Consolidated Financial Statements) which changes the way businesses and not-for-profits determine control over associated entities.

The new standard became mandatory for businesses in December 2013 and will now become mandatory on 31 December 2014 for not-for-profits.

However, many not-for-profit organisations are unaware of the changes, the application of which could give rise to a number of unexpected issues.

AASB 10 has been designed to establish the principles for the preparation of consolidated financial statements when an entity controls one or more other entities.  Its aim is to ensure the end users of financial statements are provided with a more comprehensive reflection of a group’s current position.

It is anticipated that a number of previously unconsolidated groups will now be expected to prepare consolidated financial statements under the new standard.

However, the standard only applies mandatorily to those entities that prepare general purpose financial statements.  Consequently, some entities may ‘choose’ to prepare the less onerous special purpose financial statements in order to avoid the complexities of consolidation even though the reporting entity concept is not designed to be a choice but based on the existence of users (see more below).

For the users of financial statements the end result could be less transparency.

Application of AASB 10

AASB 10 changes the way in which control over an entity is assessed.  The new standard considers whether an entity has power, exposure or rights to variable returns from its involvement with the investee and a link between that power and those variable returns.

This is a significant departure from the previous standard which largely considered only ownership interest as an indicator of control.

As such it is possible that previously unconsolidated entities will now require consolidation.  Some may find this problematic, and while they have been encouraged to prepare early it is expected that many entities will be caught out assuming there are no changes to the consolidated group.

Consider the following examples:

Example 1: Your Local School

A school has a building fund established to ‘hold’ monies ‘received’ from the school.  As an unincorporated entity there is no ownership interest by the school over the building fund.  Therefore, these funds have historically been left out of the consolidated picture, however, under AASB 10 ownership interest is irrelevant.

The school (via the school council) dictates how the money is to be spent and therefore the school arguably has the power to direct the relevant activities of the fund.  Assuming the other elements of the control model are present, the building fund will require consolidation.

Example 2: An Incorporated Association

An Incorporated Association has been established to raise funds for an overseas charity.  Due to the structure of the arrangement there is no ownership interest between the Association and the charity, however the Association has the ability to direct how the charity spends the funds raised.  Therefore, under AASB 10 it is likely that the Association would control the charity and would be required to consolidate the financial position and performance of the charity.

It is possible that the overseas charity may not comply with equivalents to Australian Accounting Standards or there may be deficiencies in record keeping.  As a consequence obtaining the information necessary to consolidate may be difficult.

These examples are commonplace, providing an additional financial and administrative burden on the entities involved.  As a result, we have seen instances where entities are considering their options for preparing special purpose financial statements in order to avoid the additional work required to consolidated controlled entities.

General or special purpose financial statements – a choice?

While not intended to be a ‘choice’ there is much debate around the framework provided for determining whether an entity prepares general or special purpose financial statements.

Under the Australian Accounting Standards, entities are deemed to be either reporting entities (which must comply with all applicable Australian Accounting Standards and prepare general purpose financial statements) or non-reporting entities (which typically comply with only some of the standards and prepare the less onerous special purpose financial statements.)

Whether an entity is a reporting entity is determined by its management team who must determine whether it is reasonable to expect that there are users of general purpose financial statements who depend on them to make economic decisions.  If such users exist, the entity is deemed to be a reporting entity.

Many commentators, however, believe that the reporting entity concept is flawed and that in many cases, entities which ought to be reporting entities have deemed themselves non-reporting entities in order to prepare the less onerous special purpose financial statements.

What you should do

Many entities, particularly not-for-profits, have not yet considered the changes much less performed a reassessment of consolidation conclusions.  These entities may be caught out by the changes as the time commitment required for gathering the necessary additional information to perform the retrospective restatement may be greater than expected.

If you have not yet assessed how AASB 10 will apply to your entity please contact your local William Buck advisor.