Not-for-profits (NFPs) now have to consider two accounting standards to determine the accounting for their income.
This new, additional guidance in the standards is useful and should lead to more consistency in practice. However, the tough first question though is: Where to start? The new NFP income standard, AASB 1058 Income of Not-for-profit entities or the new revenue standard, AASB 15 Revenue from contracts with customers? The first step in this determination is whether or not the income arrangement is part of an enforceable contract. If the contract is enforceable then you continue the assessment of whether the performance obligations in this enforceable contract are sufficiently specific. If it is not an enforceable arrangement and/or the performance are not sufficiently specific, then income is recognised under AASB 1058, almost always immediately.
An agreement which creates consequences for not performing is an enforceable contract. The contract can be written, oral or implied by an NFP’s customary business practice. Identifying an enforceable contract is straight-forward when there is a refund obligation to the customer if specific services or goods are not provided, damages can be claimed, penalties are incurred or the customer has the right to enforce the agreed services. Even arrangements requiring the NFP to ask the donor if the funds received can be re-directed could be considered an enforceable contract.
But what if the agreement itself says it is not legally binding? Such statements are typical in Heads of Agreement, Letters of Intent or Memorandums of Understanding (MOU). If you are an NFP engaging under such contracts, this does not necessarily mean the agreement is not enforceable. Key will be if parties involved in the arrangement act based on the intent of the document. For example, an NFP enters into a MOU with the local government to provide mentoring services to indigenous high school students. The MOU states that it is not legally enforceable. As both parties rely on the MOU, which is shown by the services provided by the NFP and funding received from the local government, it is possible that an enforceable contract has been created.
On the other hand, broad statements of intent are not enforceable agreements. Consider an NFP who receives $2m of donations from a fund raising campaign where they promise to use the funding on mental health programs, but use the funding on other programs instead. If the NFP can unilaterally redirect these funds to other similar programs and there are no consequences to the NFP for using the funds on alternative programs, then this would not be considered an enforceable contract. Such donations would be recognised under the new NFP standard as income when received or receivable.
And what if there is no return obligation for funds already received, but future funding could be withheld? For example, a University is to receive a grant for heart research with no return obligation, but the arrangement indicates the University will not receive future funding if they do not use the funds in accordance with the grant terms. The ability of the grantor to withhold future funding does not mean the current contract is enforceable, as the University is not entitled to the future funding anyway (e.g. there has been no agreement between the parties).
Do not assume your contracts are enforceable. If you are yet to start assessing your contracts, as the effective date of 1 July 2019 has begun, now is the time as the considerations around whether your contracts are enforceable or not can be complex. Starting the assessment earlier provides you with an opportunity to amend your arrangements such that you are not bound to accounting outcomes that do not match the economics of your arrangements with your donors.
If you wish to discuss further, or any other aspects of the implementation of NFP income and revenue standards, please contact your KPMG adviser or the contacts on this page.
Article series about implementation issues we have seen impacting entities when embedding the new revenue standard.
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