As part of the consultation undertaken in relation to its standard-setting frameworks in 2017, the Australian Accounting Standards Board (AASB) asked for specific feedback regarding the definition of a ‘not-for-profit entity’, and whether there was sufficient guidance on how to distinguish entities as for-profit (FP) entities and not-for-profit (NFP) entities.
The majority of respondents supported retaining the term ‘not-for-profit entity’, but requested more guidance from the AASB in determining whether an entity is a FP or NFP entity under the accounting standards. Respondents also supported using the New Zealand Accounting Standards Board’s (NZASB’s) updated definition of ‘public benefit entity’ (PBE) because it gives greater focus on what a NFP is, rather than what it is not (see definitions below).
In June 2019, the AASB released Exposure Draft (ED) 291 Not-For-Profit Entity Definition and Guidance which proposes to amend the definition of ‘not-for-profit entity’ in Australian Accounting Standards. The ED is open for comment until 9 September 2019. Interested parties are encouraged to make submissions to the ED.
Why is the change to the definition important?
The classification of an entity as a FP or NFP entity determines which accounting standards and related accounting policies are applied to the financial reporting of the entity. At present, Australian Accounting Standards incorporate unique financial reporting requirements and exemptions for NFP entities which differ from those adopted by FP entities. This means that the recognition, measurement, presentation and disclosure requirements may change if the classification of an entity changes from NFP to FP, or vice versa.
The distinction between a FP entity and a NFP entity would become even more significant if the AASB develops a separate NFP entity financial reporting framework with simplified recognition and measurement requirements and different reporting tiers for NFP entities.
What is the proposed change to the definition?
The current definition of a NFP entity as defined in Australian Accounting Standards is:
An entity whose principal objective is not the generation of profit. A not-for-profit entity can be a single entity or a group of entities comprising the parent entity and each of the entities that it controls.
The revised definition for a NFP entity being proposed by the ED is:
An entity whose primary objective is to provide goods or services for community or social benefit and where any equity has been provided with a view to supporting that primary objective rather than for a beneficial return to equity holders.
The proposed definition comprises two interdependent parts:
- the primary objective to provide goods or services for community or social benefit; and
- the provision of equity to support that primary objective rather than for a financial return to equity holders.
Both parts of the definition need to be assessed in combination in determining an entity’s classification. Assessing one of the parts alone is unlikely to be sufficient in determining whether an entity is a NFP or FP entity.
How do you determine whether your entity is a NFP entity?
In many cases, it will be obvious whether an entity meets the definition of a NFP entity. For example, most charities registered under the Australian Charities and Not-for-profits Commission Act 2012 are likely to meet the definition of a NFP entity.
In other cases, determining the primary objective of an entity may be challenging, especially where the entity has multiple objectives and such objectives are not ranked. To identify an organisation’s primary objective (i.e. why the entity exists and what it intends to achieve), it will be necessary to assess the substance of the entity’s purpose. Professional judgement may be required and the organisation’s constitution may require amendment to ensure classification as FP or NFP can be supported.
The ED provides several indicators which should be considered when determining if an entity meets the new definition of a NFP entity. Substance over form and professional judgment will be required when assessing whether an entity is a NFP entity. The indicators listed in the ED are:
- the stated entity objectives;
- the nature of the benefits, including the quantum of expected financial benefits;
- the primary beneficiaries of the benefits;
- the nature of any equity interest;
- the purpose and use of assets; and
- the nature of funding.
The ED provides comprehensive guidance on each of the above indicators which will often need to be considered in combination with each other in determining if an entity meets the definition of a NFP entity.
How should entities prepare?
It would be prudent for entities to assess the application of the proposed change to the definition of a NFP entity to their circumstances sooner rather than later. A suggested approach would be:
- entities currently classified as NFP entities should assess and understand why they are classified as such and identify the NFP reliefs they are currently entitled to under Australian Accounting Standards;
- position papers should be prepared which document the assessment as a NFP or FP entity using the indicators and related guidance in the ED.
If it is concluded that the classification of the entity or group will change, entities should:
- consider and document the material impacts on their financial reports;
- consider the amendments to their accounting policies which may be required.
Position papers should be presented to Audit Committees or Boards, so they are across the changes and any potential material impacts.
NFP entities should carefully consider the application of the proposed definition change. Those organisations that are currently considered to be NFP entities may need to apply considerable judgement and professional interpretation to ensure any possible reclassification to a FP entity is identified early.