FINANCIAL REPORTING FRAMEWORK FOR NOT-FOR-PROFIT

ENTITIES Deacon Titus Alao Soetan, FCA

1ST Deputy Vice President The Institute of Chartered Accountants of Nigeria

OUTLINE

• LEARNING OBJECTIVES

• INTRODUCTION

– GROWTH OF NFPOs

– NEED FOR ACCOUNTABILITY

– WITHOUT ACCOUNTING, THERE IS CAN NOT BE ACCOUNTABILITY

• Definition of NFPOs

• Types of NFPOs

OUTLINES

• Features of both types of NFPOs

• Stakeholders of NFPOs & their information needs

• Financial Reporting Framework

– IFRS Vs IPSAS

– Single Columnar

– Stand alone standards

LEARNING OBJECTIVES

• UNDERSTAND WHAT NFPOs ARE

• KNOW THEIR STAKEHOLDERS AND THEIR INFORMATION NEEDS

• UNDERSTAND THE THRUST OF NON-EXCHANGE TRANSACTION REPORTING

• APPRECIATE THE IMPORTANCE OF SERVICE PERFORMANCE REPORTING

INTRODUCTION

• Phenomenal growth of non-for-profit organizations(NFPOs)

• DRIVERS:

Govt’s desire to provide public goods through other means

the desire by independent private entities to provide public goods e.g., education, health, etc.

private citizens’ desire to pursue their own visions of a good society independent of government policies.

Growth of corporate social responsibility

INTRODUCTION CONTD

• Public confidence in NFPOs is gradually waning due to – poor or lack of proper financial record keeping, – Inefficiency and ineffectiveness – Misallocation/mismanagement of resources – Lack of Impact assessment reports

INTRODUCTION CONTD

• Can anything be done to restore the public confidence? • Can the NFPOs be made more efficient and responsive to the needs of the

citizens? • Can they be held accountable to their resource providers? • The affirmative answers to these questions lie in

Accounting and Accountability in NFPOs.

INTRODUCTION CONTD

• Where there is no accounting, there cannot be accountability. • Leaders of NFPOs

• owe the society a measure of accountability • Must keep reliable records and regularly give their stewardship report to their

stakeholders • Must provide impact assessment report

• Standard setters need to evolve a suitable reporting(including financial) framework that will define the nature of such stewardship reports.

Definition OF Not-For-Profit Entities

• A NFPO is “an entity without transferable ownership interests, organised and operated exclusively for social, educational, professional, religious, health, charitable or any other not-for-profit purpose. Its members, contributors and other resource providers do not, in such capacity, expect pecuniary return directly from the organization”.

DEFINITION OF NFPOs CONTD

• In line with the entity concept, NFPOs – are independent legal entities that exist for the promotion of public

good/societal advancement. – They do not have shares or shareholders in the strict sense – donations to them do not confer proprietary rights. – Any surplus arising from their activities are not generally distributed to

owners or members but are used to pursue their goals and objectives.

DEFINITION OF NFPOs CONTD

• The Nigerian Companies and Allied Matters Act (CAMA), 1990 as amended, for instance, provides that – NFPOs are registered as a “Company limited by Guarantee”

• The object clause is primarily to promote the objectives of such a company

• shareholders barred from distributing its profits among its members, as dividend or otherwise.

• Breach of the restrictive provisions is an offence according to Section 603(3) of CAMA.

• Their shareholders enjoy limited liability in the event that the NFPO is wound-up or dissolved.

TYPES OF NFPOs

• Not-for-profit organizations are basically of two types: – public sector NFPO(Community Interest Coys); and – private sector NFPO.

• Public Sector NFPO is often a creation of government and largely funded through grants, • Private Sector NFPO are owned, financed and operated by donor agencies, public spirited individuals, philanthropists, etc. • Both types exist to deliver services of peculiar nature to the society.

FEATURES OF PUBLIC SECTOR NFPOs

• Public sector NFPO is often required to enter into a contract or service agreement with the government department providing the fund and this will specify the – measures of the services to be delivered and – system of financial accountability required.

• This explains why many advocate that public sector NFPOs should use IPSAS as basis for financial reporting.

FEATURES OF PUBLIC SECTOR NFPOs CONTD

• In most cases, the government, as chief financier, exercises control over public sector NFPOs.

• Some indicators of control may include – power to unilaterally appoint or remove a majority of the members of the NFPO’s

governing board, – ability to access and direct the ongoing use of the NFPO’s assets, – holding of majority of the voting shares or a golden share that has over-riding power, – power to approve business plans and budgets, – powers to remove CEO, – power to amend and approve major policies on sources of revenue, accounting policies,

personnel, compensation, collective bargaining or deployment of resources.

FEATURES OF PRIVATE SECTOR NFPOs

• Private Sector NFPO do not sign agreements with donor agencies/persons. Where signed, it is largely to meet documentation processes for funds draw down.

• They receive funds from entities and persons that share their idea of a good society.

• The stewardship report is to inform/ reassure the donors that their object clauses are being pursued.

• The framework eventually adopted by any NFPO is a function both of its activities and environment.

Information Needs of Stakeholders of NFPOs

• WHO ARE THE STAKEHOLDERS OF NFPOs? • THEY INCLUDE

– donor agencies, – philanthropists, – the public, – regulators, – the government, – internal and external customers, etc.

Information Needs of Stakeholders of NFPOs(contd)

• Most of these stakeholders provide NFPOs the resources with which they accomplish specified goals. Such resources may be in form of

– grants, – endowments, – contributions, – endowment funds without or with restrictions that may be permanent or temporary.

Information Needs of Stakeholders of NFPOs (contd)

• The information needs of these stakeholders are diverse. – A donor agency may desire to know how the funds it provided were spent – Another donor may desire to assess the impact of its donation on the set objectives. – Another may need comparative information to make decision on additional funding required or on its continued relation with the entity.

Information Needs of Stakeholders of NFPOs (contd)

• In each case, the NFPO must provide information in such a manner that its stakeholders’ needs are satisfied. • Financial statements are frequently the main source of financial information for members and others interested in the financial performance of a not-for-profit entity.

Information Needs of Stakeholders of NFPOs (contd)

• Since financial statements play an important role in demonstrating accountability for the use of resources

– managers of NFPOs, must present to their stakeholders high quality financial reporting.

• Without doubt, NFPOs will experience significant challenges in providing these.

Standards/Guidance Notes by Professional Bodies/Regulators

• Some professional bodies have prepared Guidance notes/Standards to help members improve the quality and consistency of information in NFPOs’ financial statements. • For instance, the Financial Reporting Council (FRC) of Nigeria issued in 2011 the Statement of Accounting Standards 32 titled, “Accounting by Not-For-Profit Organisations”. • Other examples include Canada, New Zealand, USA, UK, etc

Objectives of Financial Reporting

• The prime objective of financial reporting is to provide on a timely basis – Reliable & credible information to resource owners to enable them make economic decisions.

• Such stewardship report promotes accountability and trust, two critical virtues which underlie business and commercial relations.

Objectives of Financial Reporting (contd)

• Other objectives of financial reporting include – qualitative aspects of reporting. – For instance, if NFPO’s expends fund on an initiative to promote girl-child education, there should be a report of how many girls enrolled for and eventually completed formal education programmes in that locality. In other words,

• performance reporting should drive financial reporting by NFPOs.

Financial Reporting Framework for NFPOs-IFRS

• Adoption of the principles-based International Financial Reporting Standards (IFRS) financial reporting framework is now the vogue

• Use of IFRS framework is plausible since stakeholders may have cross-jurisdictional representation.

Financial Reporting Framework for NFPOs-IFRS(Contd)

• But there are challenges – Complexities of IFRS – Cost of conversion – Cost of capacity building – Compliance with IFRS must be total

Financial Reporting Framework for NFPOs-IFRS (Contd)

– IFRSs were not developed with the needs and circumstances of NFPOs in mind.

– IFRS were developed largely for “publicly accountable entities” and these exclude NFPOs

– Application of IFRS would require a NFPO to make significant judgments in selecting among the options or alternatives permitted by the IFRS GAAP hierarchy.

Financial Reporting Framework for NFPOs-IPSAS

• NFPOs and government share a common objective to provide community services, rather than to generate a profit.

• Demonstrating accountability for resources, obligations and financial affairs and how they were administered is among the stated objectives of public sector financial reporting.

Financial Reporting Framework for NFPOs-IPSAS

• NFPOs can use IPSAS as basis for financial reporting. • However, a key difference between governments and NFPOs is

the source of their revenues and their ability to raise them. • A NFPO’s ability to raise revenue rests on its fundraising ability,

whereas govts enjoy the power to tax.

Financial Reporting Framework for NFPOs-IPSAS

• In both cases, stakeholders expect accountability for resources provided.

• The selected reporting Standards for NFPOs need to be based on a framework that focuses on accounting for non-exchange transactions.

• For Financiers of NFPOs, No Direct Personal Benefit Is Expected!

Proposal For Stand-Alone Standards For NFPOs

• The Canadian Accounting Standards Board and Public Sector Accounting Board considered the idea of developing new stand-alone accounting standards for NFPOs.

• The Boards reflected on the implications of:

– user needs and comprehension;

Proposal For Stand-Alone Standards For NFPOs(contd)

– the requirements to teach and learn another set of GAAP standards;

– costs of developing and maintaining a stand-alone approach; and

– the likelihood that such standards, if developed, might not be much different from current standards.

Proposal For Stand-Alone Standards For NFPOs

• Although the two Boards have tentatively rejected developing a set of stand-alone standards, the AcSB has tentatively concluded that NFPOs – should be able to adopt the standards presently being developed for

profit-oriented private enterprises which are IFRSs-oriented.

Proposal For Stand-Alone Standards For NFPOs(Contd)

• The IFRS will be supplemented by specific guidance dealing with the unique circumstances of NFPOs and will also conform to the conceptual framework and other private enterprise standards.

• Based on its experience and the feedback received, the AcSB believe in the current approach of applying NFPOs standards that are substantially similar to those for profit-oriented enterprises.

Simple Columnar Accounting

• NFPOs may adopt the simple columnar Revenue and Expenditure framework • Funds are created by legal, contractual or voluntary action. • Each activity will be self accounting Fund • Net positions from all Funds could be consolidated.

Simple Columnar Accounting (contd)

• Under Simple Columnar system, revenues and expenses, are usually disclosed at their gross amounts.

• However NFPOs may sometimes recognize the net amount of certain revenues and related expenses in the statement of activities. E.g., revenues and expenses relating to fund raising events and cost recovery arrangements.

Simple Columnar Accounting (contd)

• Information about gross revenues and expenses is generally necessary for users to understand fully the entity’s operations. • Since the thrust of NFPO is not profit, there is great need for performance reporting which should address its output, outcomes and impact.

Statement of Service Performance

• NFPOs’ Financial reports should indicate clearly what it – has done (its outputs), – what it has achieved (its outcomes), and – what difference it has made (its impacts).

• The inclusion of measures of output, outcome and impact will improve completeness of reporting by showing to the reader what the NFPO achieved rather than what it spent.

Statement of service performance

• Generating a surplus is not generally a key objective for NFPOs. • NFPOs often provide goods and services to constituents free of charge and seek resources from people and organisations that do not expect economic benefits in exchange.

• NFPOs require information on service performance in order to assess how well they have achieved their objectives with the resources available, and to demonstrate accountability to those who provide funds to the entity.

Statement of Service Performance(contd)

• The statement of service performance presents non-financial information on what an entity set out to achieve compared to what it did achieve. • A statement of service performance shows:

„ desired outcomes; „ an explanation of the rationale on which the entity has based its selection of activities; and „ a comparison of planned outputs to actual outputs using performance measures.

Statement of Service Performance(contd)

• A NFPO’s objectives are not primarily about increasing net worth. • Service performance reporting is more important • To be able to prepare an acceptable service performance reports, an entity needs to consider some key questions such as:

„ what are the entity’s products and services;

Statement of Service Performance(contd)

„ who is the entity providing these products and services to; „ what is the entity trying to achieve; „ what processes does the entity use to produce its goods and

services; „ what type and level of information do users want; and „ what are the key performance messages that the entity wants

to communicate?

Financial Reporting by NFPOs in Nigeria

• The objectives of financial reporting for NFPOs are to demonstrate accountability and provide useful information needed by a diverse users to make economic decisions. • The leadership of NFPOs has responsibility not only for the presentational faithfulness of their financial statements but also must present financial reports in a logical, clear and understandable manner.

Financial Reporting by NFPOs in Nigeria (contd)

The financial statements of a NFPO as stated in Nigeria’s Statement of Accounting Standards (SAS) 32 should typically include: „ Statement of Accounting Policies; „ Statement of Financial Position; „ Statement of Activities; „ Statement of Changes in Net Assets; „ Statement of Cash Flow; and „ Notes on the Accounts.

Financial Reporting by NFPOs in Nigeria(contd)

• Statement of Accounting Policies • A NFPO must clearly articulate and disclose, as integral part of

its financial statements, all its significant accounting policies used in the preparation of its financial statements.

• Such policies should preferably be disclosed under one caption than under each item of the financial statement.

Financial Reporting by NFPOs in Nigeria(contd)

• Statement of Financial Position – The primary purpose of a statement of financial position is to present the organisation’s economic resources, obligations and net assets as at the reporting date.

– This statement together with other statements and notes, provide useful information necessary for assessing whether the organisation will continue to provide services, achieve its objectives and meet its obligations.

Financial Reporting by NFPOs in Nigeria(contd)

• The financial position shall present the following information: „ Net assets invested in capital assets „ Net assets subject to restrictions requiring that they be maintained permanently as endowments „ Other restricted net assets „ Unrestricted net assets and „ Total net assets

Financial Reporting by NFPOs in Nigeria(contd)

• Statement of Activities – The primary purpose of a statement of activities is to communicate information about changes in the organization’s economic resources and obligations for the period.

– This statement provides information about the cost of the organisation’s service delivery activities for the period and the extent to which these expenses were financed or funded by contributors.

Financial Reporting by NFPOs in Nigeria(contd)

• The Statement of changes in net assets presents changes in the following for the period

„ Net assets invested in capital assets „ Net assets subject to restrictions requiring that

they be maintained permanently as endowments „ Other restricted net assets „ Unrestricted net assets „ Total net assets.

„ The statement of changes in assets is also referred to as the statement of changes in fund balances when the organisation uses fund accounting in its financial statements.

Financial Reporting by NFPOs in Nigeria(contd)

• Total net assets represent the organisation’s residual interest in its assets after deducting its liabilities.

• The net assets balance therefore provides information about the net resources the organisation has available for carrying out its service delivery activities in the future.

Financial Reporting by NFPOs in Nigeria(contd)

• Statement of Cash Flow • The objective of the statement of cash flow is to provide information about the sources and uses of cash by the organization in carrying out its operating, financing and investing activities for the period. • The statement assists financial statement users in assessing the organisation’s ability to generate cash from internal and external sources to meet its obligations.

Financial Reporting by NFPOs in Nigeria(contd)

• Notes on the Accounts There must be notes to the financial statements of NFPOs and

these should provide other useful and explanatory notes to the accounts.

Financial Reporting by NFPOs in Nigeria(contd)

Separation of charity and commercial activities A number of commercial entities that are operated as

“subsidiaries” or “divisions” under charities and other NFPOs in Nigeria, often want to claim exemption on their income, on the ground that the totality of the “group” outfits are charity activities.

Financial Reporting by NFPOs in Nigeria(contd)

• This is based on the argument that they are engaged in the “advancement of an object of general public utility” and classified as a company limited by guarantee as provided for in Section 26 of the Companies and Allied Matter Act (CAMA), 1990.

Financial Reporting by NFPOs in Nigeria(contd)

• Many professionals believe that the income of these business subsidiaries should be subject to income tax and should be rightly so reported, accounted and disclosed.

• This will, however, require NFPOs to separate the accounts of their business subsidiaries, where applicable, to satisfy the requirements of different regulatory authorities.

conclusion

• Financial accountability is best demonstrated by general purpose financial statements prepared in accordance with GAAP.

• irrespective of the financial reporting framework eventually selected, the resultant financial information will only be useful if is relevant and represents faithfully what it purports to represent.

• The usefulness of financial information is enhanced if it is comparable, verifiable, timely and understandable.

Conclusion

• Irrespective of the financial reporting framework selected, qualitative characteristics of relevance and faithful representation apply equally to financial information in general purpose financial reports as well as to financial information provided in other ways.

• For NFPOs, service performance reports hold the key to their financial viability and going concern.

• They must be encouraged to produce this qualitative report in line with best practices.