New charity financial reporting and audit requirements | An opportunity for alignment?

The biggest change in financial reporting in 20 years, and for many charities; the biggest change to their financial reporting ever, has recently been legislated. We look at the opportunities this presents for the entities themselves as well as for funders and stakeholders.

Background

The financial reporting reform enacted in 2013 has heralded the most significant change ever in the financial reporting requirements imposed on charities in New Zealand’s history. For most charities the law changes have also clarified whether or not independent assurance over these financial statements is required by law.

While a natural reaction of many charities will be to look at these changes as a compliance burden and just making their lives harder – this initial reaction while understandable is perhaps a little misguided. In fact the changes present charities with some potentially very beneficial opportunities – if they recognise these and proactively set out to take advantage of them.

The 'why' of the changes

Before looking at the implications and opportunities of the changes it is, as with most things in life, very useful to understand the rationale or key reasons that led to the changes – “The why”.

I realise that my next statement may surprise some in the sector, especially the more cynical, but my heartfelt belief is that New Zealand charities have actually been very well served by New Zealand accounting standard setters and Government legislators in recent times. This is because the recent changes have been strongly influenced by some people who really understand the charity/NFP sector, some of its key challenges, and really care to make it sustainably better for all.

Hence some of the key drivers behind the recent changes include:

Recognition that charities/NFPs have some unique features that simply don’t apply to For-Profit entities. As such, unique accounting standards are needed to accommodate these. For example; For-Profit entities don’t have to deal with how to account for donations and other forms of non-exchange revenue. Nor with things like heritage assets for which it is nonsensical to value in the same way you would a commercial asset.

An understanding that the annual operating surplus or deficit is not necessarily a key metric of a charity or NFP entity’s success. While an important hygiene factor of any sustainable organisation the reality is that other information such as service performance information is actually often far more important and relevant to stakeholders.

Recognition that charities are different sizes and hence should be allowed to follow size appropriate accounting standards. This is largely to achieve the principle that the cost of compliance does not outweigh the benefits from compliance.

An appreciation that the key interested stakeholders for many charities and NFPs will be external parties such as the donating general public, funders, & service recipients to name a few. Critically these groups of information users often have very limited or no ability to be able to require financial information relevant to them for decision making.

Also very relevant to “the why” is the fact that charities by virtue of their income tax exempt status granted by the Government are receiving a subsidy from the general public. As such there is a logical expectation that charities should be financially transparent and obliged to report in a way that provides meaningful information to the public.

What's changed - in a nutshell

For the first time ever for many charities, they are now required by law to follow accounting standards set by the accounting standard setter; the XRB (External Reporting Board). While it may come as a surprise to many; most charities and NFPs in New Zealand have not previously had any financial reporting requirements imposed by law. Instead most have been able to report pretty much as they wanted to

There is also now a requirement by law for registered charities over a certain size to obtain independent assurance over their annual financial statements. This starts at an independent review and graduates to the requirement for a full audit for larger charities.

To understand “the what” of these changes in more detail we refer you to an earlier article on our website; Adopting New Accounting Standards For Charities 2015 http://rsmhayes.co.nz/adopting-new-accounting-standards-charities-2015/

And what about other non-charity not-for-profit entities?

At present the recently legislated financial reporting reforms only apply by law to registered charities and public sector entities. This totals in the region of 30,000 entities. Incorporated societies make up a large proportion of the remaining non-charity NFPs in New Zealand. It is proposed as part of the current reform of the Incorporated Societies legislation that all incorporated societies in future be required to follow the same accounting standards as registered charities. This makes good logical sense in that the nature of these is similar to charities and as such they face many of the same accounting issues. Also of relevance is the fact that as of 1 April 2015 the old reporting standards that most entities previously tried to follow were removed from issue. Hence there is nothing else “official” for non-charity NFPs to follow. Due to this last reason we fully expect the XRB standards for charities to become the de-facto accounting standards for NFP entities that may not be required by law to follow them as these will become the most generally understood and hence most acceptable.

Some opportunities for charities/NFP entities

Ensure your entity information and description of why your organisation exists in your annual performance report is comprehensive and can hence be easily included in funding applications so that funders do not need to request additional supporting material.

Ensure your service performance information is aligned with your strategic plan (i.e. what you are setting out to achieve over the medium term) and ideally is just an annual aggregation of the key performance indicators (KPIs) that your governing body and management have been using to monitor your charity/NFPs progress towards its goals over the year. Of course you will also need to ensure your data collection systems are sufficiently robust to support your reported non-financial results.

Assessing and using accounting software that has been designed to comply with the XRB reporting standards for reporting efficiency. (Note: We understand the Xero software is being developed in this regard and would hope that other accounting software providers also see the opportunity this presents).

The requirement to clearly articulate why a charity exists and what it is trying to achieve in the performance report, may indeed provide the opportunity, and in some cases dare I say “need” for some robust reflection at a governance level about the answer to these fundamental questions.

Some opportunities for funders

Align your financial reporting requirements of entities applying to you for funding to the XRB standards i.e. specify compliance with the XRB standards. (Note: we are aware that some leading philanthropic funding bodies such as Foundation North have already changed their policies to only accept funding applications from charities and NFPs who have adopted the relevant XRB accounting standards. We understand they have done this due to comfort that these standards are appropriate for the sector, have been developed by an expert independent body, have the force of law, and that adopting common standards will assist with conformity of reporting and hence make comparison and assessment of an entity’s performance and financial position easier).

Understand the entity description and service performance information now required by financial reporting standards and ensure wherever possible that you are not requesting similar or duplicate information in another part of your funding application process.

Align your requirements for independent assurance over financial statements with the statutory minimum levels.

This last point is perhaps the most contentious in that many funders rely on independent assurance, and specifically an audit of financial statements, of entities applying for funding. The independent assurance levels set in legislation have been set on a cost vs benefit basis. However different opinions exist as to these bright-line levels. They start with a review or an audit being required if the entity has annual operating expenditure over $500,000, and a mandatory audit being required if annual operating expenditure is over $1m. Also relevant is that the independent assurance or audit engagement must be carried out in full accordance with the XRB’s assurance and audit standards, and by a statutory auditor. This last fact will raise the quality of audits being performed but is also likely to have the impact of raising the cost. This fact was taken into account by Government when setting the assurance threshold levels.

Some funders I have spoken to are nervous that these levels may be too high for their funding application comfort. This is an interesting conundrum as smaller charity/NFP entities bemoan the relative high cost of independent assurance compared to the amounts they are applying for. Just to add to the conundrum; auditors also commonly bemoan the disproportionate cost challenges of auditing smaller entities, but from the point of view of the increased difficulties they usually experience in auditing small poorly resourced charities.

Perhaps the answer to this conundrum is increased education and assistance provided by funders to help smaller charities/NFPs to be able to adopt and comply with the XRB accounting standards rather than a requirement for these to be audited if they are below the statutory independent assurance levels.

Summary

Human nature sadly means that most change is initially seen as a threat. However early consideration of mandatory changes can present positive opportunities for those with open minds and the will to embrace the future. The recent financial reporting changes for charities and NFPs provide an opportunity for improved and more aligned reporting to stakeholders. It is our hope that this more informative, consistent, and hopefully more efficient stakeholder reporting will ultimately benefit the causes for which charity and NFP organisations exist.

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Authors

Craig Fisher
Consultant