ASB: FRED 45, financial reporting standard for public benefit entities

Comments from ACCA to the Accounting Standards Board, July 2011.

ACCA is pleased to have this opportunity to comment on the above exposure draft which was considered by ACCA’s Charities Panel which is a group of members who work for or with charities. Their views are primarily addressing the issues from the charity perspective rather than from other public benefit entities (PBEs).

Overall comments

We appreciate the recognition of the different financial reporting issues and perspectives of PBEs as opposed to profit-seeking entities that this FRED brings.

On the other hand as this only deals with differences it brings a new layer of regulation to go with the new FRSME and the SORPs. Most charities have essentially used the SORP as their principal guidance on the preparation of accounts and the trustees’ report and this has worked well. We hope that this will be able to continue, which we would see by the SORP incorporating the guidance material from this FRED. We will be writing to the Charity Commission to encourage them to approach the revised SORP in this way.

We would prefer that some other term than ‘public benefit’ is used for this standard as the term has a more specific meaning in the definition of a charity under the law.

Responses to ASB’s specific questions

Q1. Definition of a PBE

We agree with the definition and the guidance in the appendix. However we would note that the position of social enterprises may be difficult to determine in some cases given that they may deliver a mixture of public and private benefit. ASB should consider whether there is any further guidance they can give in these cases.

In this context we would prefer that the definition in 1.3 when it refers to a financial return to equity providers includes the word “primarily” which is included in 1A.1

Q2. Effective date

We agree that the effective date should be co-ordinated with that of the FRSME and that early adoption for those governed by SORPs should not be allowed. This is on the assumption that the effective date allows time for the SORPs to incorporate the final version of this standard. We believe there should be a gap of 18 months minimum between the publication of any of the SORP, this standard, the FRSME and the effective date.

Q3. Concessionary loans

We agree that PBEs should not be required to impute a market rate of interest in the accounting for soft loans at reduced or zero rates of interest. Charities could only legally provide concessionary loans in furthering their public benefit objectives. However we are not clear when the standard treatment from the FRSME would be appropriate. In our view therefore the right treatment is that in paragraphs 2.4 to 2.11 and this should be required for PBEs with no option. Optional treatments are inherently undesirable in accounting standards and so should be avoided whenever possible. If the option is retained then the current text should be clearer as to whether this is an across-the-board choice or a loan-by-loan option.

We are not clear whether the basis of impairment of concessionary loans is  appropriate. Paragraph 2.6 is measuring impairment (following the definitions of impairment loss and fair value less cost to sell in FRED45) by comparing carrying amount against fair value less costs to sell. This does not seem a very practical method for concessionary loans as there will rarely be any market activity to reach the fair value. It would also seem to lead to an immediate write down of all of the concessionary loans as they are by definition at below market value.

Alternatively are PBEs meant to refer back to 11.21 to 11.26 of the FRSME which includes the impairment triggers? It would be better if there was a clear reference if this was meant to be the case. There would need to be guidance for concessionary loans on the effective interest rate to use in paragraph 11.25(a).

Q4. Property held for social provision

We agree with the proposals here.

Q5. Combinations to be treated as a gift

We agree with the guidance and think that this will appropriately cover the great bulk of combinations between PBEs.

Guidance and disclosures are equally needed for the donor entity as the receiving one.

Q6. Merger accounting

Merger accounting will be abolished under the FRSME. There seems little justification given in this FRED as to why ASB are retaining it for PBEs, other than this has been the approach in the US and Australia.

We are not in favour of the restatement of the past as if the merger had always had happened. So we endorse the ‘pro forma’ title that would be needed on the comparative figures, but in the current period there are to some extent similar ‘pro forma’ figures because the combination is accounted from an arbitrary date, namely the beginning of the accounting period.

Given that merger accounting is a defunct concept outside the PBE sector, we would prefer to have ‘fresh start’ accounting to be applied for the relatively few cases that are not combinations by way of gift.

On the disclosures this section should have an exclusion for immaterial combinations from 4.7(c) in particular. Either in this standard or in the SORPs there should be a disclosure of the objectives of the combined entities and whether this creates new activities or new restrictions on the activities of the PBE. 

Q7. Service potential and value in use

We agree that an impairment measurement based on service potential is needed for PBEs because so many of their assets are not held for the generation of cash flows, but in fulfilling their public benefit objective.

The FRED provides little guidance in depth on this issue. In this case the SORPs should fill the gap.

The main guidance is that depreciated replacement cost (DRC) may be a suitable measure. This does not seem helpful as it is unlikely to be applicable in most cases. The main issue is most often about the extent that an activity will continue and whether there is a demand for it, rather than whether there might be a cheaper alternative way to provide it which is what DRC is really measuring.

Q8. Funding commitments

This section is based on the notion of recognised and unrecognised commitments, but it lacks a definition of a commitment. It is not clear whether this is the same as the FRSME’s term ‘obligation’. The definition is particularly important in deciding for which unrecognised commitments the disclosures in paragraphs 6.5 and 6.6 are required.

The scope of this section applies only to funding commitments and it is not clear why it should not be extended to other sorts of commitment, for example directly to individual beneficiaries rather than being restricted to funding entities.

We are content with the recognition criteria in paragraph 6.2.

The measurement of commitments, particularly perhaps the unrecognised ones, can be very difficult and subjective. For example some animal charities may commit themselves to meeting any future vet bills and the estimation of how long animals may live, how much veterinary treatment they will need and what it will cost are subject to significant uncertainties.

In determining the present value of recognised commitments, we do not find the definition on page 48 ‘in the normal course of business’ to help much, particularly for charities.

Q9. Recognition of incoming resources from non-exchange transactions

Paragraph 7.5 seems either contradictory or superfluous when compared to 7.4 (b). If there are performance conditions to be met then the incoming resource would not be recognised until they were fulfilled. So why is the separate requirement needed about repayment at some future date? What this section is missing is the concept of restricted funds, income and assets. Under this concept performance criteria as such can be met, but there may nevertheless be potential repayment or return conditions attaching to assets received (as in the example in paragraphs 7B.3).

The reference in 7.4(c) should be to the above criteria not “revenue recognition criteria”.

Q10. Clarity of guidance on recognition

Despite the guidance in 7A.3 we think that the recognition of donated goods at charity shops and the like on receipt, is difficult and will not provide very useful information to users.

The recognition of donated services will be problematic for PBEs. Paragraph 7A.10 requires them to distinguish services provided as part of a trade or profession from services provided by volunteers. In our experience this is difficult to do and the FRED would be better not to recognize donated services at all, but to deal with the issue by way of disclosure.

Q11. Heritage assets

We do not agree with these proposals and would include only a disclosure requirement for heritage assets for PBEs.

The treatment of heritage assets proposed is unsatisfactory in a number of ways

  • It includes an accounting option which is inherently undesirable in accounting standards
  • The historical cost measurement may in many cases be incomplete and inconsistent, treating earlier acquisitions one way and later ones another
  • The revaluation method looks very impractical in the great majority of cases and particularly subjective when there is little market activity and given that most heritage assets are unusual and rare and so far from fungible.
  • We particularly do not support this as an amendment of the FRSME which we consider should be based as closely as possible on the IFRS for SMEs and would not support this sort of UK specific amendment
  • The FRSME only allows for revaluation of property when it is held as an investment and we see no reason to make an exception to this for heritage assets

Q12. Future issues

We have noted above that the issues of restricted funds need to be considered before section 7 can be finalised. Fresh start accounting in our view would be preferable to merger accounting in Section 4. Otherwise we agree with the issues noted here and have no further items to add.

Q13. Definition of control

The issue is adequately dealt with in the FRSME and needs no elaboration in this FRED.

Q14. Application to the FRSSE

We see in principle no reason why the requirements set out here should not apply to smaller PBEs.

As we have stated to the ASB in our responses to their various consultations on the future of UK GAAP, we do not think that the FRSSE should be retained other than for a limited life as part of easing the transition of UK reporting to IFRS. For small entities the FRSME should include suitable disclosure reductions and derogations for cash flow statements and consolidated accounts.

In that context the SORP if it incorporates most of this standard will also then apply its principles to charities applying the FRSSE (which will be the great majority).