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Comments from ACCA
December 2005

The ACCA is pleased to have this opportunity to comment on the above exposure draft. The document was considered by ACCA’s Financial Reporting Committee and by its Charities Panel. I am writing to give you their views.

In August 2003 we wrote to you with our reaction to previous proposals on this subject. Those comments were principally written from the perspective of the public sector. The proposals have not changed significantly since then and our comments therefore continue to stand in that regard. In this letter we are principally giving reactions from the charitable sector, representing the bulk of the private not-for-profit activity in the UK.

The major observation, however, that is common to both these sets of comments is that ASB should recognise that the needs of users of the financial statements of public benefit entities are different from those of the private profit-oriented sector. The adaptation of the defining class proposed in this exposure draft, essentially from investors to funders, is not adequate and is unrealistic.

In the public sector the range of users is potentially very wide and we consider that a multi-stakeholder model would be best suited to this case. If a single defining class of user is to be identified for this sector then this should be the electorate.

In the charitable sector financial reporting to both funders and to beneficiaries are equally important and therefore the needs of both must be met as a minimum.

Having accepted that the users of the financial statements are different for public benefit entities, we do not think it likely that this would imply the need to create an entirely different set of accounting standards. The qualitative characteristics, definitions of elements and recognition criteria are all likely to remain substantially the same. Indeed this seems the broad conclusion of this interpretation and one with which we largely agree. The main effect of the acceptance of a wider range of users would be the need for the financial statements to provide a wider range of information and main statements.

In the case of the public sector such further statements might include:

• a budget out-turn
• inter-period resource flows
• key performance indicators of efficiency and effectiveness

In the case of charities these might include information concerning:

• significant donations/grants made
• designations or earmarking of funds to projects.

Responses to ASB’s questions raised for comment

As noted above the responses that follow primarily are in the context of charities, complementing the responses given in 2003 which were in relation to the public sector.

Question (a) Liabilities and commitments to provide public benefits

(i) We agree that performance related grants are analogous to contracts. We note that paragraph 4.39 appears to be changing the definition compared to its current explanation in the SORP.

(ii) For other sorts of grant the draft interpretation uses an approach based on the executory contract approach. While this may be helpful to some extent, we note that the current version of the charities SORP does not use this analysis but considers the in-substance ability of the grantor to avoid the obligation. The SORP’s approach seems more in line with the definition of liabilities (as compared to equity for instance) more generally in financial reporting standards. The executory contract model assumes that “non-performance” on one side would in effect terminate the obligations of the other. The concept of performance by the recipient may not be as straightforward in these cases compared to a contract and therefore the grantor should also have to consider the extent of unavoidable commitment in determining the liability. We note that the concept of what constitutes the extent of performance appears to be hard to pin down even in contracts, when it is has been tackled for example in the case of revenue recognition.

Question (b) Commitments to spend in furtherance of an entity’s objectives that constitute liabilities

We do not have an example of such a case.

Question (c) Assets subject to restrictions

Yes. Restrictions over assets should be disclosed.

Question (d) Designations

While we agree that designations are not items to be recognised in the income statement nor to affect the net assets on the balance sheet, we consider that designations or earmarking of unrestricted funds should continue to be disclosed, including in a prominent way on the balance sheet of a charity.

Designations often relate to important matters for many charities reflecting their proper governance. Designations of funds may be an important part of a transparent explanation and discharge of the obligation to consider the reserves policy of the charity. The matters for which designations may be needed may arise for example:

• to cover possible redundancy or other employee related obligations not covered by grant-funding
• the requirement for the long-term maintenance of listed buildings
• to provide for the cost of dilapidations on completion of a lease
• to recognise the funds tied up in tangible fixed assets required for the charity to provide services
• other moral obligations created by the receipt of unrestricted donations or grants or by the otherwise unrecognised commitment to make grants

We also note that ASB in this question seems to be putting forward the notion that recognition depends on there being a transaction. We would disagree with this notion, and note that some significant value changes in assets are recognised in the financial statements where there is no transaction.

Question (e) Business combinations

We agree that most combinations in the charity sector are in effect acquisitions of one charity by the other, even if they are often presented as mergers. We agree with the exclusion of entities under common control and with the treatment of gifts of businesses in Paragraph 8.15.

Question (f) Capital contributions

We do not think that capital contributions will apply to charities, as the residual interest belongs to the potential beneficiaries.

Question (g) Resources from controlling party

We agree with such disclosures.

Question (h) Capital grants

We disagree with this requirement for a mandatory impairment test in these circumstances for two reasons
• The concept of impairment is a very difficult one to apply to non-profit generating assets or businesses. Both the Charities SORP and this document accept that service potential will be a key measure in such cases in place of the commercial measure of value in use. Service potential is not well explained in either this document or the SORP.
• We see no reason to presume that service potential would have been diminished in most cases because the asset was acquired with the help of a grant.
This automatic test should therefore be restricted to any income generating assets.

Question (i) Repayment clauses

We agree that the existence of a repayment clause in a capital grant should not be an inevitable barrier to its recognition as a gain.

Question (j) Voluntary gifts

We agree with this basis for the recognition of gifts of services.

Other observations

Defining class of user

The draft interpretation rephrases the defining class of user of the financial statements as funders and providers of finance. This does not seem an adequate basis for charities. Reporting to the donors and other sources of funds should be an important aspect of financial reporting by charities, but of equal importance should be the beneficiaries and potential beneficiaries. In a commercial entity those who have provided the funds to the enterprise are also those to whom the rewards flow and in particular equity investors provide the risk capital and own the residual interest. For charities the position is entirely different. Those who have funded the charity are not those to whom the benefits flow or those who are entitled to the residual interest. Accounting standards for the charity sector should be designed to satisfy the needs of both these user groups, and not one in priority to the other.

The disclosure of designations of funds is a case (see Question (d) above) where information relevant to the needs of potential beneficiaries is being ignored in favour of the funders’ model.

Onerous contracts

We have noted above our view that the explanation of value in use for impairment of non-income generating assets is inadequately dealt with in this document. In a similar way the concept of an onerous contract is introduced with no further explanation of how this is to be determined for non-profit making entities.

Management

The use of the term “management” in this document, notably in Appendix 1, should be reconsidered. In charities an important distinction is made between management and the trustees, and this relates to the distinction between governance and management.

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