New standard on income recognition for not-for-profit entities

Just prior to Christmas, the Australian Accounting Standards Board (AASB) issued its long awaited standard on income recognition for not-for-profit entities (NFPs), AASB 1058 Income of Not-for-Profit Entities.

‘Financial reporting for not-for-profit entities will now more closely reflect economic reality. Revenue from grants and donations will be recognised where any associated performance obligation to provide goods or services is satisfied, and not immediately upon receipt as usually occurs with current standards.’

Extract from AASB Media Release, 20 December 2016

Together with the new revenue standard, AASB 15 Revenue from Contracts with Customers, AASB 1058 is meant to simplify and clarify income recognition for NFPs, and supersedes all current income recognition requirements for private sector NFPs, and most of the requirements for public sector NFPs currently contained in AASB 1004 Contributions.

The requirements of the standard must be applied to each transaction based on its substance rather than its legal form, or any random description given to it (e.g. grant or donation).

What types of income does AASB 1058 apply to?

The objective of the standard is to establish principles for recognising income:

  • On transactions where the consideration to acquire an asset is significantly less than fair value principally to enable a NFP to further its objectives, and
  • For the receipt of volunteer services.

This means that AASB 1058 does not deal with situations where either consideration is not significantly less than fair value, or it is significantly less than fair value but the difference is not principally to enable the NFP to further its objectives.

Scope exceptions

AASB 1058 will apply to transactions where the consideration to acquire an asset is significantly less than fair value principally to enable a NFP to further its objectives, and the receipt of volunteer services, except for:

  • Share-based payment transactions (AASB 2 Share-based Payment)
  • Business combinations (AASB 3 Business Combinations)
  • Insurance contracts (AASB 4 Insurance Contracts, AASB 1023 General Insurance Contracts and AASB 1038 Life Insurance Contracts)
  • Licences outside the scope of AASB 15 Revenue from Contracts with Customers
  • Income taxes (AASB 112 Income Taxes)
  • Restructure or administrative arrangements within the scope of AASB 1004 Contributions.

How to recognise and measure an asset received

We need to apply the relevant Australian Accounting Standards  when recognising an asset as a grant/donation (AASB 1058, paragraph 8). For example, if the NFP receives:

  • Cash - recognise as a financial asset under AASB 9 Financial Instruments
  • Leased assets – recognise a right-of-use asset under AASB 16 Leases
  • Property, plant and equipment (PPE) - recognise under AASB 116 Property, Plant and Equipment, and
  • Intangible assets – recognise under AASB 138 Intangible Assets.

Changes have been made to the relevant standards so that the asset is recognised at fair value.

This means that ‘peppercorn leases’ (where lease payments are made at below-market rates), will need to be recognised as right-of-use assets at fair value in the statement of financial position.

Recognising the ‘credit entry’

AASB 1058, paragraph 9 requires that the credit entry is recognised in accordance with other Australian Accounting Standards if / when it meets the criteria to be recognised in accordance with these standards. For example, the credit entry could be recognised as:

  • Contribution by owners (AASB 1004)
  • Revenue or contract liability (AASB 15)
  • Lease liability (AASB 16)
  • Financial instrument (AASB 9)
  • Provision (AASB 137 Provisions, Contingent Liabilities and Contingent Assets).

Application of judgement is required to determine which ‘bucket’ the credit entry belongs to.

Generally, any excess of the carrying amount of the asset (paragraph 8) over amounts recognised under paragraph 9 are recognised as income immediately in profit or loss. The exception is when financial assets (e.g. cash) are received to acquire or construct a recognisable non-financial asset (e.g. PPE) to be controlled by the entity.

Additional guidance is available for applying AASB 15 to not-for-profit entities

Appendix F has been added to AASB 15 by AASB 2016-8 Amendments to Australian Accounting Standards – Australian Implementation Guidance for Not-for-Profit Entities and includes implementation guidance on identifying contracts with a customer in a not-for-profit context.
In determining whether AASB 15 should be applied to grants:

  • There must be a contract with a customer to provide goods or services. These need not be provided to the customer directly, but instead can be provided to third party beneficiaries on the customer’s behalf
  • The contract must create enforceable rights and obligations, and
  • The contract must include promises to deliver goods and services that are ‘sufficiently specific’, which requires judgement.

Appendix F also includes examples to illustrate these principles.

Will grant income be recognised immediately?

Not necessarily. If the grant is a result of a contract with a customer with enforceable rights, and obligations that are ‘sufficiently specific’, revenue would be recognised in accordance with AASB 15 rather than AASB 1058 (e.g. the grant received by a business to provide a training programme to long-term unemployed would be accounted for in accordance with AASB 15). This may result in more cases of income deferral than we currently see under AASB 1004.

Alternatively, in some cases income  will be deferred, with the ‘credit entry’  being recognised as a liability, contribution by owners, a lease liability, or a provision. Refer to Recognising the ‘credit entry’ for more details.

What if an NFP receives cash/financial assets to purchase or construct PPE (non-financial asset)?

If an NFP receives cash or a financial asset to acquire or construct a non-financial asset (PPE) that the NFP will control, the NFP recognises a liability for the difference between the initial carrying amount of the financial asset received (cash) and the amount recognised under AASB 1058, paragraph 9, being the NFP’s obligation to acquire or construct the non-financial asset.

This liability is then recognised as income as or when the entity satisfies its obligation to purchase or construct the non-financial asset.

Example

Sports NFP receives $1 million cash grant on 30 June 2016 to build a gymnasium for communal use.

By 30 June 2017, it had spent $800,000 on construction and a survey indicated that the gymnasium was 80% complete. Construction was completed three months later on 30 September 2017.

On 30 June 2016, applying AASB 1058, the journal entry would be:

Dr Cash   $1 million  
Cr Liability     $1 million 

The liability represents the NFP’s obligation to acquire or construct the non-financial asset.

On 30 June 2017, the journal entry would be:

Dr Liability   $800,000  
Cr Income     $800,000
Dr PPE in progress   $800,000  
Cr Cash     $800,000

On 30 September 2017, the journal entry would be:

Dr Liability   $200,000  
Cr Income     $200,000
Dr PPE in progress   $200,000  
Cr Cash     $200,000

If the grant is spent on an item that does not result in a recognisable asset (e.g. amount does not qualify for recognition as an asset under Australian Accounting Standards, so would be expensed immediately), then the ‘credit entry’, $1 million, is recognised as income, and not as a liability. An example of this could be a grant for research where the expenditure does not qualify for recognition as an asset under AASB 138 Intangible Assets.

How to account for volunteer services

Local governments, government departments, general government sectors (GGSs) and whole of governments must recognise volunteer services if:

  • The services would have been purchased had they not been provided voluntarily, and
  • Their fair value can be reliably measured.

If the fair value of volunteer services received can be reliably measured, other non-government NFPs can choose to recognise these free services as an asset (if relevant asset recognition criteria are met), or as an expense, with an equivalent amount of income.

When does the new standard apply?

AASB 1058 applies to annual reporting periods beginning on or after 1 January 2019.  Early adoption of  this standard is permitted if the entity also applies AASB 15 to the same period. It should be noted that as part of these amendments, AASB 2016-7 Amendments to Australian Accounting Standards – Deferral of AASB 15 for Not-for-Profit Entities also defers the application of AASB 15 by NFPs to 1 January 2019.

Transition

The ‘date of initial application’ is the beginning of the first annual period in which the entity first applies this standard.

AASB 1058 is to be applied either:

  • Retrospectively with adjustments to comparatives in accordance with AASB 108 Accounting Polices, Changes in Accounting Estimates and Errors (full retrospective restatement) or
  • Retrospectively applying the ‘cumulative catch-up’ approach, with the cumulative effect of initial adjustments recognised in retained earnings on the ‘date of initial application’, and no restatement of comparatives.

If the entity applies full retrospective restatement, it need not restate completed contracts or transactions that begin and end within the same annual period, or that are completed contracts or transactions at the beginning of the earliest comparative period (‘opening balance sheet date’), provided it applies this practical expedient  to all such contracts.

It should be noted that assets subject to ‘peppercorn leases’ will be subject to the transition requirements of AASB 16, and will therefore need to be measured at fair value in the statement of financial position on transition.