Accounting for revenue in the not-for-profit and public sectors is a complex task that requires a deep understanding of the underpinning accounting standards.
At a glance
- Australia’s not-for-profit sector comprises more than 600,000 registered organisations that generate annual revenue of over A$146 billion.
- Income recognition within the sector is a complex task, since there is often a mismatch between when cash is received and when it is recognised as revenue in the accounts and then spent and recognised as an expense.
- Determining when certain forms of income need to be recognised requires an in-depth understanding of two accounting standards: AASB 15 and AASB 1058.
By Gary Anders
Australia’s not-for-profit (NFP) sector is large and diverse, with more than 600,000 registered organisations generating in excess of A$146 billion in annual revenue.
A large amount of income comes from grants provided by governments, trusts and foundations, private philanthropists and, in many cases, members of the general public making small donations.
This is where things can get quite complicated from an accounting perspective, especially when it comes to determining the timing of when certain forms of income need to be recognised.
To do this effectively requires a detailed understanding of two accounting standards from the Australian Accounting Standards Board (AASB) – AASB 15 Revenue from Contracts with Customers and AASB 1058 Income of Not-for-profit Entities.
It is also important to understand the distinction between revenue and income.
While “revenue” is generally defined as income arising in the course of an entity’s ordinary activities, “income” includes not only revenue, but also other increases in economic benefits received (including grants and donations) other than contributions from owners.
The AASB 15 and AASB 1058 accounting standards work in tandem, with both standards becoming effective from the start of 2019.
AASB 15 is the default standard across both the for-profit private and NFP/public sectors for recognising revenue based on the satisfaction of performance obligations required by an enforceable contract that is “sufficiently specific”. The standard also includes specific guidance on applying the requirements to NFPs.
AASB 1058 has been designed more specifically around the unique needs of NFP and public sector entities, effectively taking over from its predecessor, AASB 1004 Contributions.
Under the new revenue/income recognition model, an NFP needs to consider whether AASB 15 applies to a transaction that gives rise to income based on whether the performance obligations arising from the transaction are “sufficiently specific” and “enforceable”. When AASB 15 does not apply, the NFP generally applies the requirements of AASB 1058.
The issues with income recognition
“The challenge that has arisen in the past two or three years in applying these two new standards is that you’re getting some odd outcomes for grant-related income recognition,” says Ram Subramanian, CPA Australia’s senior manager – reporting policy.
“Some grants can involve receiving a sum of money without specific conditions on how it is used. Others involve money provided under a formal contract that specifies how and when the money is spent. The question turns around the recognition timing of grant income.
“Sometimes, when an NFP receives a large sum of grant money, the accounting rules might require recognition of all the money received as income in the year of receipt.
“This could cause challenges for the NFP, as readers of its financial statements might assume that the entity has had a very good year when, in fact, the money recognised as income in that year is to be allocated for use in future years.”
Mismatches in revenue recognition
David Hardidge FCPA, director – technical and treasury products at the Queensland Audit Office, says there is often a mismatch between when the cash is received, when it is recognised as revenue in the accounts and when it is spent and recognised as an expense, which can be over several financial years.
“Not-for-profits want a break-even or a sustainable result that’s not swings and roundabouts,” Hardidge says. “They don’t want to book a big profit from upfront revenue recognition in one year, and then apply expenses in the next financial year.
“People thought the new revenue standards would improve that, but they really haven’t worked out, I think, as a lot of people had hoped.”
Hardidge says there are two key terms in the standards that are important in trying to get to a deferred revenue position and essentially match revenue with activities.
“One term is ‘performance obligation’. It’s very hard to learn how to apply this term, performance obligation, for grants where you may have to do something with the money you have received. It’s not as simple as the words might seem, and there’s a lot of requirements and guidance in the standards on it.
“So, unless someone’s explained it to you, or you’ve read a summary, you’re really going to struggle to work it out yourself.” Hardidge says this can be a problem for NFPs that may not have accountants who have read and understood AASB 15 and AASB 1058.
"Not-for-profits want a break-even or a sustainable result that's not swings and roundabouts. They don't want to book a big profit from upfront revenue recognition in one year, and then apply expenses in the next financial year. David Hardidge FCPA, Queensland Audit Office
“They don’t necessarily have the staff who can spend time reading 100-page standards.
“If you have a performance obligation, you can possibly defer revenue. If you don’t have a performance obligation, you’re in AASB 1058, but the 1058 standard also has rules on capital grants.
“If you’ve got a capital grant to build an asset, it goes back to AASB 15 to work out how much of the capital asset that you’ve built to work out how much revenue you have to recognise.
“This is a further complication, and another part of the complication, if you have a performance obligation, is a term called ‘sufficiently specific’.
“Your grant agreement needs to be sufficiently specific for you to be able to work out how much revenue to defer. The AASB wasn’t sufficiently specific in explaining what ‘sufficiently specific’ was.
“It applies in a very technical context, and there’s often lots of discussion and debate in relation to whether a grant has a performance obligation and if it is ‘sufficiently specific’.”
Understanding the standards
Andrew Marks FCPA, a director at accounting firm William Buck in Melbourne, has extensive experience in dealing with government grants to the NFP sector and ensuring clients are accounting for the revenue per the accounting standards.
“I think one of the major issues is that a lot of NFP organisations don’t necessarily know the ins and outs of the accounting standards, which is completely understandable,” he explains. “And they like to match the revenue in the same period as they actually spend the money.
“While I completely understand that they want to do it that way, that’s not how the standard works, and you’ve got to take other factors into account.
“That’s probably one of the main challenges we face when undertaking the audit of NFP organisations – making sure that, if they do want to book income in advance, that they’re meeting the requirements under AASB 15.
“AASB 15 allows revenue to be deferred if certain conditions are met. If they don’t meet the conditions of AASB 15, they have to go to AASB 1058, which, other than in very limited circumstances, requires revenue to be recognised upfront.”
Marks says, generally speaking, NFP organisations like to progressively recognise revenue if it is part of a multi-year funding agreement. His job as an auditor is to make sure they are recognising it in accordance with AASB 15 and AASB 1058.
“The wording of the funding agreement is really critical. There has to be a contract, but the tricky part is that the contract has to articulate specifically the performance obligations that have to be adhered to,” he says.
“When those performance obligations are met, then you can recognise the income progressively. The key is the wording of the funding agreement and whether it has these performance obligations specifically outlined, as opposed to really being just general in nature.
“If it’s a poorly worded funding agreement, and we can’t see these performance obligations outlined, then we have to go to AASB 1058, and that then has to be recognised straight away as revenue.”
Marks believes the new standards are a lot fairer than the previously used AASB 1004, but both grant providers and recipients need to ensure obligations are properly documented and explained in funding agreements.
“It’s probably one of the biggest issues in the not-for-profit sector when they’re doing their financial statements,” he says.
Complications in government contracts
Michelle Harrison CPA, principal adviser, accounting and financial management with the South Australian Department of Treasury and Finance, says about threequarters of the state government’s income is sourced from grants or taxes, which are almost exclusively accounted for under AASB 1058.
The state also generates income from charges for goods and services, and most of this is comprised of revenue from contracts with customers.
“We have seen application of AASB 15 largely restricted to fees for goods and services, as well as licences issued by the government,” Harrison says.
“At times, it has been challenging to distinguish whether income should be accounted for under AASB 1058 or AASB 15. Similar to experiences in the private sector, a clear understanding of the detail within individual contracts or agreements is needed to understand when to account for income.”
Harrison points out that perhaps more relevant to the public and NFP sectors is the need for particular reflection on the fundamental nature of the agreements.
“Some of the areas that have taken particular thought to resolve have involved consideration of whether a party providing consideration is a ‘customer’ or not,” she says. “It is not always immediately apparent whether an arrangement is to provide goods or services to a customer, or whether requirements in an agreement for particular services are ultimately reflective of broader responsibilities of the recipient.
“The challenges for governments in implementing the new standards stem not only from analysis of transactions with non-government parties, but also in considering how to account for transactions between government entities.
“Monies appropriated from the consolidated funds of the government are treated as AASB 1058 income by recipient government entities. Other agreements may be formed between government entities that result in a contract with a customer for accounting purposes.”
Harrison says one of the challenges her government department has faced was determining which government entity was the party to an enforceable agreement.
“For example, the Commonwealth Government provides grant funding for infrastructure programs that may then take a number of years to carry out,” she says. “Like other governments, the South Australian Government recognised significant liabilities upon implementing AASB 1058 in respect of funding already received for such capital projects, which were yet to be completed.
“It took particular consideration to determine which entity within the government should report related AASB 1058 liabilities.
“We concluded that, for accounting purposes, it is Treasury and Finance that represents the State Crown as having the enforceable agreement with the Commonwealth to develop the infrastructure.”
Grey areas in research grants
The recognition of income from research grants provided to universities and for medical research institutes provides a unique set of challenges, says CPA Australia’s reporting policy adviser, Ram Subramanian.
“Unfortunately, just ‘doing research’ is not considered provision of goods and services, because an entity is spending money on research, but may or may not come up with a tangible output,” he says. “They may not publish a paper out of it. The grant provider appreciates that, sometimes, research goes nowhere.”
Robin Donohue, director of corporate finance with Deakin University, says that, for 95 per cent of Deakin’s income, there has been no difficulty in working out which accounting standards apply.
However, difficulties have arisen when it comes to the application of different types of research income based on the type of research being undertaken.
Donohue says the accounting standards are not easily applicable to their research, and the consistency of interpretation is still being debated a number of years following their coming into force.
“Last year, in conjunction with the AASB, the Victorian Auditor General’s Office and Victorian universities, there were a number of virtual workshops where we discussed the differences of opinion and the application of the wording within the standards.”
A discussion point was the use of termination for convenience clauses in contracts where a grantor may rescind a contract at any time and require any unspent monies to be returned.
“So, that meant that the practical differences between AASB 15 and AASB 1058 with terminations for convenience essentially give you the same outcome,” Donohue says.
“It then doesn’t matter, in a way, which standard you assess them under. You might have differences in disclosures in your financial statements in relation to them, but it will have the same profit effect.”
Yet, views on the use termination of convenience clauses are far from uniform, with some technical experts questioning the validity of their application for income recognition purposes.
This is a sure sign that the book on the applications of AASB 15 and AASB 1058 is far from closed.