Not-for-profits – the Cinderella of the accounting world

There is arguably a yawning gap in the international accounting world. The International Accounting Standards Board (IASB) has developed a growing global consensus around international financial reporting standards (IFRS) designed to meet the needs of global capital markets, the for-profits sector.

The International Public Sector Accounting Standards Board (IPSASB) has developed high quality international public sector accounting standards (IPSAS) for government bodies based in part on IFRS with additional standards for public sector specific issues.

Neither IASB nor IPSASB lay claim to not-for-profits. Arguably overshadowed by these twin sisters, IFRS and IPSAS, not-for-profits are the hidden Cinderella. Whether this matters depends upon the answer to two questions which I posed when speaking in ACCA's seminar theatre at Accountex last week: What’s unique about not-for-profit accounting and is the not-for-profits sector of a size that really matters?

What’s unique about not-for-profit accounting?

There are five key areas of difference:

• Not-for-profits seek to further a social purpose and one expression of this social purpose is liability-seeking behaviour. The most obvious is giving money and resources away to communities or beneficiaries in the form of grants and gifts. Other expressions are social enterprise activities involving the marginalised, those with poor skills or significant physical or learning impediments, in socially useful activities which may involve the relatively unproductive economic use of assets. This means that commitments (or promises) have a greater significance and a boundary needs to be drawn between what is recognised as a liability and what is not;
  
  
• Not-for-profits enjoy a range of sources of income and one of the most significant, especially for charities, are gifts of money and resources. The recognition of income from such non-exchange transactions is key and involves establishing a boundary to identify at what point gifts and promises become income;
  
  
• Another expression of social purpose is holding and using assets other than for cash flows. Whether this is the operation of hospices free to those in need, homeless shelters or the provision of facilities at or below cost, the use of economically valuable assets for non-cash flow purposes is a unique feature. This raises the issue about how to value these assets and on what basis they can be said to become impaired;
  
  
• Public expectations of not-for-profits differ from those of for-profits or government. Not-for-profits may have a membership or they may not. Many countries recognise their social value by providing tax breaks and funding in addition to or in support of public giving. Not-for-profits therefore have a broad group of interested stakeholders seeking transparency and accountability for the use of their money;
  
  
• Not-for-profits have in most, but not all forms, no owner and no equity class. Even with member owned mutuals restrictions on the disposal of a member interest prevent the free trading of that interest. The importance of distributable profit to pay dividends is arguably of little relevance, if any. Much of for-profit accounting is concerned with identifying items that are charged to profit (comprehensive income) and items handled outside of profit (other comprehensive income). Not-for-profit accounting is more concerned with identifying what restrictions as to purpose, use, or distribution of the residual interest (or fund balances) apply in and at the end of the accounting period.

This list is not exhaustive; for more information please refer to the technical papers presented at the July 2012 Charity Finance Group seminar. 

Is the sector of a size that matters?

Much attention has been focused in the media on how the construction sector has been doing in the UK and whether activity is rising, indicating a return to prosperity. A sector of a similar size has gone little noticed for its economic contribution. The National Council for Voluntary Organisations (NCVO) estimates in its UK Civil Society Almanac 2014 that the not-for-profit sector has an income of £181bn and employs 2.3m people (8% of the workforce). The sector is similar in size to the construction sector.

The Consultative Committee of Accountancy Bodies commissioned pioneering international research on whether there is demand for an international accounting standard for not-for-profits. The overwhelming answer was a clear yes, especially from those based in Africa and Asia. Visit the CCAB website to view that research.

The UK leads the way

The UK-Irish Generally Accepted Accounting Practice effective from 1 January 2015 includes a new Financial Reporting Standard applicable in the UK and Republic of Ireland (FRS 102) based on IFRS for Small and Medium-sized Enterprises.

The Financial Reporting Council has recognised the importance of not-for-profits (termed public benefit entities or PBEs) with sector specific issues addressed for the first time in a UK standard. In this respect the FRC leads the way and may be a forerunner of things to come.

Perhaps one day yet the Cinderella sector will meet her prince in an international not-for-profits standard.