Speakers at CFG's Annual Conference 2012

1. The Proposed Financial Reporting Standard
Issues for Public Benefit Entities
Pesh Framjee
Head of Not for Profit at Crowe Clark Whitehill
Special Advisor to the Charity Finance Group (CFG)
Member of the Charity SORP Committee
Audit | Tax | Advisory

2. Three new Financial Reporting Exposure Drafts (FREDs)
 FRED 46 „Application of Financial Reporting
Requirements‟ (draft FRS 100)
 FRED 47 „Reduced Disclosure Framework‟ (draft FRS
101)
 FRED 48 „The Financial Reporting Standard
applicable in the UK and Republic of Ireland‟ (draft
FRS 102)

3. Key changes to framework proposals
 Replacing all current accounting standards with a single
FRS.
 Introduction of a reduced disclosure framework
 Retaining the financial reporting standard for smaller
entities (FRSSE).
 No tier system
 Allowing accounting treatments permitted under current
accounting standards

4. Financial Reporting Standards for Smaller Entities
An entity is small if it meets 2 of the 3 criteria:
1. Fewer than 50 employees
2. Turnover below £6.5m
3. Assets less than £3.26m
• Could be a limited change option
• Issues with the definition of turnover
• Where an item is not covered by FRSSE have to turn to the FRS
• FRSSE will be maintained and will have to be updated
• SORP will have to cover both the new FRS and the FRSSE

5. Timetable
 The exposure drafts are open for comment until 30 April 2012
 Subject to the feedback received it is expected to issue the final
standards by the end of 2012.
 The ASB is proposing that the revised proposals should take
effect from for accounting periods beginning on or after 1 January
2015 with earlier adoption permitted
 SORPs cannot be fully developed or consulted on until the FRSs
are issued
 Charity Regulations cannot be changed until SORPs in place
 Need to consider comparative information so will impact on
earlier accounting periods

6. Statement of Principles
In 2007 the ASB published
the Interpretation for Public
Benefit Entities of the
Statement of Principles for
Financial Reporting which
sets out the principles that
should underlie the
preparation and
presentation financial
statements of public benefit
entities

7. Overall
 There is much in the FRED that will be
of value to PBE‟s and the general
principles are well recognised and
strong
 Regrettably there continues to be
much scope for confusion in key areas
for PBEs
 The requirements that are PBE
specific often do not recognise
important trust and charity law
requirements and appear to conflict
with other key parts of the FRED
 Some easy fixes but your response is
really needed.

8. Areas of Concern
Major concerns (but easy fixes)
1. The recognition of restricted income
2. The recognition of grants receivable
3. The recognition of funding commitments
4. The valuation of gifts in kind
Some other areas which can be lived with

9. Income recognition – Restricted income

10. Non Exchange Transactions (PBE 34.63)
“A non-exchange transaction is a transaction
whereby an entity receives value from another
entity without directly giving approximately equal
value in exchange or gives value to another
entity without directly receiving approximately
equal value in exchange”
• Donations, legacies, donated goods and services etc
• Grants?

11. FRED 48’s definitions are the root of the problem
 Restriction: “a requirement that limits or directs the
purposes for which a resource may be used but does not
require that resource to be returned to the donor if the
resource is not used as specified”
 Performance Condition: “a requirement that specifies that
the resources is either to be used by the recipient as
specified, or if not so used, to be returned to the donor”
The derogation that states that restricted income can not
include funds that have to be returned to a donor if they are
not used as specified flies in the face of well recognised
principles of charity accounting and charity law.

12. Mixes up a restriction with a condition
“PBE34B.13 Some resources are given with performance
conditions attached which require the recipient to use the
resources for a particular purpose in order to be entitled to
retain the resources. An entity will not recognise income from
those resources until these performance conditions have been
met.”
• Purpose restrictions are not performance conditions.
• A better definition for performance condition – „a condition
that requires the provision of specified service or goods
where the entitlement to payment is conditional on the
specified good or services being provided‟
• There are other conditions that are not performance related

13. Why does this matter?
“PBE34.65 An entity shall recognise receipts of resources from non-
exchange transactions as follows:
 Transactions that do not impose specified future performance
conditions on the recipient are recognised in income when the
resources are receivable.
 Transactions that do impose specified future performance
conditions on the recipient are recognised in income only when
the performance conditions are met.
 Where resources are received before the revenue recognition
criteria are satisfied a liability is recognised.”
• Flawed definitions will change how charities account for income
• The general income recognition principles have not changed, why
should the income recognition principles for PBEs change so
dramatically?

14. Repayment possible if income not used as specified
 FRED says this will not be restricted income and will
therefore not be accounted for when receivable
 Income recognition needs to be deferred and a liability set
up if income has already been received
• Almost all income received by a charity has the possibility
albeit remote of it being repaid
• The receipt of restricted income does not really affect the
liabilities unless it is probable that the income is to be returned.
• Unspent restricted income increases the net assets of a charity
and the concept of trying to set up a matching liability on the
basis that it may in rare circumstances require repayment
could be seen as an artificial measure to reduce the stated net
assets.

15. Income recognition – Grants

16. What distinguishes a grant from a donation?
“24.1 This section specifies the accounting for all grants by
government and others. A government grant is assistance by
government in the form of a transfer of resources to an entity
in return for past or future compliance with specified
conditions relating to the operating activities of the entity.”
• There has long been a view that there is no discernible
distinction between a grant and a donation
• Some may call gifts from a corporate body or a charitable trust
grants whilst others call them donations
• However, the definition above would imply that a grant must be
a conditional donation – unless government grants are to be
defined differently to other grants
• This itself, appears to be incorrect as many grants are pure gifts
and are unconditional

17. Grant recognition - Performance model (24.5B)
a) A grant that does not impose specified future performance
conditions on the recipient is recognised in income when
the grant proceeds are receivable.
b) A grant that imposes specified future performance
conditions on the recipient is recognised in income only
when the performance conditions are met.
c) Grants received before the revenue recognition criteria are
satisfied are recognised as a liability.
This will only work if the problems with the definitions of
restrictions and performance conditions are sorted out

18. Grant recognition – Accruals model (revenue)
 24.5D Grants relating to revenue shall be recognised in
income on a systematic basis over the periods in which the
entity recognises the related costs for which the grant is
intended to compensate.
• Consider a charity that receives a grant for its work in Africa –
24.5D would mean that it does not recognise the income until it
has recognised the related costs.
• In the meantime it has to treat the income as a liability but in fact
this does not meet the definition of a liability.
• Does it also have to do this with a donation?
• Most income would not be recognised under the normal income
recognition rules but would be deferred
• Impact on cost ratios

19. Grant recognition – Accruals model (grants for assets)
“24.5F:Grants relating to assets shall be recognised in the
income on a systematic basis over the expected useful life of
the asset”
• The proposals mean that if a charity was left a building that
it would be using it would be required to recognise the
income when the gift was received.
• However if it was gifted the money to buy the building the
income could be deferred over many years.
• What about mixed funding?
• The creation of a liability to match the asset would mean
that no fund (general, restricted or permanent) would be
identified against it
• Impact on cost ratios

20. Grant or donation
What about a capital appeal to build a new hospice? When
should the income be recognised?
 When the income is received?
 When the hospice is built or
 over the useful life of the hospice?
What happens when the asset is part funded by government
grant and individual donations (eg Great Ormond Street
Hospital)

21. Interim solution
 ASB recognises inconsistencies
 The principle based approach originally recommended
would have been in line with Charity SORP
 Now awaiting a research project
Hope that the SORP will not have to change its
recommended treatment

22. Funding commitments

23. Funding Commitments
“34.56 When applying these paragraphs, the requirements of
Section 2 Concepts and pervasive principles‟ and Section 21
(Provisions) shall also be taken into consideration.”
• There is a strong body of opinion that funding
commitments should be accounted for under the
general rules for accounting for liabilities and that a
special section which appears to depart from this is
not warranted.
• Sector specific SORPs can provide additional
guidance where needed.

24. Can have a liability even where there is no enforceability
“2.20 An essential characteristic of a liability is that the entity
has a present obligation to act or perform in a particular way.
The obligation may be either a legal obligation or a
constructive obligation.”
• “An entity may be commercially obliged to adopt a
certain course of action that is in its long term best
interests in the widest sense even if no third party can
legally enforce that course
• In these circumstances the accounting should reflect
the substance over the form.” (FRS 5)

25. Recognition of funding commitments
“34.57 An entity shall recognise a liability, where it has made a
commitment that it will provide resources to another party, if,
and only if:
(a) the obligation (which may be constructive) is such that the
entity cannot realistically withdraw from it; and
(b) the entitlement of the other party to the resources does not
depend on the satisfaction of performance conditions.”
• Need to get the definition of a performance condition
right
• Should make a distinction between events within and
outside the control of the reporting entity

26. Form over substance?
“34A.2 A promise to provide cash conditional on the
receipt of future income does not give rise to a liability as
the entity cannot be required to fulfil it if the future
income is not received.”
Should not lose sight of the fundamental definition of a
liability as set out in the FRED – need to consider:
• Substance over form
• The concept of a constructive obligation
• More compelling criteria to define a liability rather than
the inclusion or such a clause
• The probability of the transfer of economic benefit

27. Is the focus on availability of funds correct?
• Despite such general caveats it is in fact usually highly
probable that there will be an out flow of funds.
Therefore the definition of a liability is met.
• The substance of the transaction is often the same
regardless of such caveats
• Charities strongly expect to have the necessary
funding and to make the payment.
• Therefore the charity SORP specifically mentions that
a condition that states that payments are dependant of
future funding does not prevent the recognition of a
liability.

28. Operational realities
“21.6: The condition in paragraph 21.4(a) (obligation at the
reporting date as a result of a past event) means that the entity
has no realistic alternative to settling the obligation. This can
happen when the entity has a legal obligation that can be
enforced by law or when the entity has a constructive obligation
because the past event (which may be an action of the entity)
has created valid expectations in other parties that the entity
will discharge the obligation.”
• The existing framework provides the flexibility for
charities to focus on their operational realities
• Many charities do not account for multi year grants
on the basis of their operating practice.
• Why should such an availability of funding clause
define the accounting?

29. Gifts in kind and fair value

30. Measured at Fair Value
 Fair Value - “The amount for which an asset could be exchanged, a
liability settled, or an equity instrument granted could be exchanged
between knowledgeable, willing parties in an arm‟s length
transaction.”
 PBE34B.15: „Paragraph PBE34.71 requires resources received to
be measured at their fair value. These fair values are usually the
price that the entity would have to pay on the open market for an
equivalent item.‟
• ASB considered and rejected the “service potential” approach
• Unhelpful references to “cost to donor” – rejected in SORP 2005
• SORP focuses “value to the charity.” (SORP: 130)

31. Valuation of gifts in kind
 The ASB discussed whether: “using a fair value would overstate the
value of a donation where the entity is unable to exploit fully an asset and
the equivalent service potential could be derived from a lower value
asset.
 They recognised that: “Being able to achieve the same service
potential from a lower value asset might suggest that the value of the
donated asset should be at the lower value.”
 They concluded that: “Donated assets should be valued at their fair
value. This reflects that the circumstances described above would rarely
occur. In many cases, an entity would be able to sell the donated asset
and if appropriate, purchase a cheaper asset with the equivalent service
potential”.

32. Do these situations “rarely occur”
• In reality these situations are common when gifts in
kind are received
• In most cases where donors provide a gift in kind for
use or distribution by a PBE, the PBE is not usually
able or expected to convert it into cash.
• Consider donated office space, assets for
distribution, donated professional services etc
• It is important that the „fair value‟ reflects the price
that the PBE would pay for the equivalent service
potential.

33. Gifts in kind - goods
FRED 48 FRED 48 SORP SORP
Recognition Measurement Recognition Measurement
Gifts for When Estimated When sold Value realised
resale received (but resale value treated as
can use cost v less costs of income
benefit) sale
Gifts for own When At fair value When Value to the
use received (open market received charity
value)
Gifts for When At fair value When Value to the
distribution received distributed charity

34. Any further clarification
Pesh Framjee
Head of Non Profits
Crowe Clark Whitehill
St Bride‟s House
Salisbury Square
London EC4Y 8EH
UK
nonproftis@crowecw.co.uk
Pesh.framjee@crowecw.co.uk