Not-for-Profits Brace for the Calm Before the Storm

November 02, 2015

The Not-For-Profit (NPO) Sector is a vital part of the Canadian community. In 2004, Statistics Canada estimated that there are over 160,000 NPOs in Canada reporting $112 Billion in revenues. NPOs have over 2 million staff and draw on 2 billion volunteer hours.

The sector is large and diverse. A significant number of NPOs have revenues below $30,000 per annum while, at the other end of the spectrum, over 20,000 NPOs report revenues of greater than $500,000 per annum. The management sophistication among these large and small NPOs is also considerable, since stakeholders may range from a small group of fundraisers, with limited resources, to the federal government. This diversity, where large NPOs account for over 80% of total revenues in this sector and where the smaller NPOs number more than 64,000 strong, poses a challenge for accounting standards setters trying to meet a wide range of financial statement user needs. Further complicating the situation is the distinction between private and public sector NPOs. Public sector NPOs (such as many universities, colleges and hospitals, depending on the province) are extensions of government, while private sector NPOs (such as service agencies, professional associations, churches, and even sports groups) are independent. Many critics argue that NPO accounting standards have not kept up with the growth of this sector. Let’s explore how we got where we are.

The “4400 Series”

For many years in Canada there were no robust, specific accounting standards for NPOs. That changed in 1996 with the introduction of For many years in Canada there were no robust, specific accounting standards for NPOs. That changed in 1996 with the introduction of the “4400 series” into the CICA Accounting Handbook. These standards, based on extensive stakeholder input, contained some unusual approaches for accounting standards. These “alternative” methods can result in drastically different financial results, especially in the
statement of operations.

At the time of the introduction of the “4400 series” public sector accounting standards were still in their infancy. The Public Sector Accounting Board (PSAB) standard setters focused on moving governments to full accrual accounting but did not have the ability to consider separate standards for public sector NPOs. As a result,
public sector NPOs were to follow the “4400 series”. This move had the advantage of providing comparability between public sector NPOs and their private sector counterparts, but was inconsistent with the accounting practices of governments, the major funders of the public sector NPOs.

Despite the problems seen with the “4400 series” the standards in use today have not been altered significantly since 1996. For the most part this was primarily due to the difficulty of enacting change. In the world of accounting standards, the past 19 years has been an eternity.

In 2010, the PSAB became serious about addressing the reporting issues for public sector NPOs. Starting in April 2012, public sector NPOs were directed to follow the PSAB standards.

As a temporary measure, they brought the “4400 series” into the PSAB standards, now renumbered the “4200 series”. (Click here to read BDO’s
Critical Knowledge Series on the “4200 series”). This set the clock running to force reconsideration of appropriate accounting standards for NPOs.

While the private sector standards were outdated and needed modernization, the public sector standards were standing still with the temporary “4200 series”. It only made sense that the private sector standard setter, the Accounting Standards Board (AcSB), considered working with the PSAB.

Many people felt, and still feel, that comparability between private and public sector NPOs is important. They feel that it would be confusing to the general public for similar organizations to follow different accounting standards.

The ACSB and PSAB Joint Task Force

Enter the creation of the “Joint Task Force” of the AcSB and PSAB. Given the responsibility to provide recommendations for the future of NPO accounting, the task force was considering if standards should be identical for private and public sector NPOs and when, if ever, differences in standards made sense.

In April 2013, the Joint Task Force issued a “Statement of Principles” (see sidebar). The adoption of the principles would have brought private and public NPO accounting standards together on most fronts. Responses from stakeholders were considerable. There was disagreement with many of proposed principles. In particular, private NPOs had concerns over revenue recognition for contributions, consolidation of controlled entities and function and object reporting. This put PSAB in a quandary because these principles were generally consistent with existing PSAB standards.

The life of the Joint Task Force was several years. With world events such as the financial crisis happening during this period, accounting standards in Canada and around the world changed significantly. It was clear that NPO standards needed major change but were the organizations just too different, too diverse? The AcSB and PSAB were heading for a divorce. The Joint Task Force had run its course.

The Joint Task Force issued a “Statement of Principles” that outlined 15 recommended principles. These principles fell into 4 main areas:

  • Revenue recognition
  • Long-lived assets
  • Controlled and related entities
  • Financial statement presentation

There were 4 principles related to revenue recognition. These applied to private sector NPOs and public sector NPOs alike:

  •   Recognize a contribution as a receivable when there is control of the contribution (or control could be exercised if necessary) and when the amount to be received can be reasonably estimated.
  • Recognize a contribution as revenue when the contribution is received or receivable (as above) except when, and to the extent, the contribution gives rise to an obligation that meets the definition of a liability.
  • When a contribution’s stipulations give rise to an obligation that meets the definition of a liability, an equivalent amount of revenue should be recognized as the liability is settled.
  • A choice to recognize contributions of materials and services at fair value when a fair value can be reasonably estimated.
  • For long-lived assets there were some differences between private and public sector NPO accounting:
  • Existing subtle differences for capitalization criteria between private and public sector NPOs was not changed. But harmonization of asset write-down policy was recommended.
  • Partial write-downs of assets could be made when service capability diminished.
  • Intangible assets remained an area of significant difference.
  • Intangibles exist in private sector NPOs but do not meet the definition of an asset in the public sector.
  • Elimination of the “size test” which would mean that, subject to materiality, all NPOs would capitalize and amortize their long-lived assets.
  • Complicated areas such as collections and historical treasures would continue to have different accounting treatment in the private and public sector.

The recommendations contained significant change for private sector NPOs on accounting for controlled and related entities. The “4400 series” allows for private sector NPOs to account for controlled entities that are themselves NPOs by either consolidating them or providing financial statement note disclosure. The Joint Task Force recommended consolidation only. Recommendation for financial statement presentation, included suggestion that the format remain different between the private sector and public sector. In particular, private sector NPOs would not have to follow the “net debt” model used in the public sector. Further:

  • Expense by object information already required by public sector standards should also apply to private sector NPOs.
  • Fundraising and general support expenses would be a functional area for reporting purposes.
  • Required disclosure for all NPOs should include expense allocation details.

Not-for-Profit Advisory Committee

In May 2015, the AcSB approved the creation of a standing committee known as the “Not-for-Profit Advisory Committee” to act in an advisory capacity, assisting with improving private sector NPO standards and providing advice on implementation issues. With Committee member volunteer applications currently open, we will be well into 2016 before we see the direction of the Committee

It is expected that PSAB will monitor the happenings of the Not-for-Profit Advisory Committee, but there is a pressing need for change that they cannot ignore. As the standards are aging rapidly and, in many cases, becoming out of step with other accounting frameworks, once the new Not-for-Profit Advisory Committee gets its feet under it, we will likely see several changes coming down the pipe.

The introduction of the “4200 series” of standards for public sector NPOs was clearly a stopgap measure. Action is needed because of the inconsistency with other PSAB standards. Moreover, use of the “4200 series” was optional and some jurisdictions did not allow government NPOs to use them. As a result, we are likely to see consistency with the new PSAB standards, many of which may arrive faster than those expected for private sector NPOs.

Some lament the “divorce” of the AcSB and PSAB will result in a lack of harmonization of NPO standards. It may become difficult to compare financial reporting of private and public sector NPOs even if they operate in the same business line. Over the long term there may be external forces that will bring the private and public sector NPO standards into closer alignment. We will have to watch to see if that does indeed happen.

Hang on to your hats! It is going to be an exhilarating ride over the next few years.

We are truly in the calm before the storm. It will be important to watch for Statement of Principles and Exposure Drafts from the AcSB and PSAB, which will allow you to have your say on any proposed changes. Ensure that the NPO you are connected with has resources, either on staff or available through your external accountants or auditors, that are keeping up with the changes and experienced at implementation.

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