Call to fix “outdated” charities financial framework

The study by the Centre for Public Value at the University of Western Australia, Allocating Charities’ Financial Reporting Requirements Using Tiers: Australian Perspectives, found increasing sector concern at reporting obligations that are arbitrarily allocated using a three-tiered system of large, medium and small charities based on their income levels.

Under Australian regulations, the larger a charity’s financial turnover, the greater the complexity of information required and so the more complex the reporting requirements.

The research team, led by Han Wen and also including Centre director Professor David Gilchrist, Prerana Agrawal and Lyndie Bayne, found that key challenges under the current system included resource constraints, a lack of auditors with specific experience and the necessity for charity-specific accounting standards.

“Our data suggests that [financial report] preparers perceive the current tiered reporting requirements as insufficient, particularly for small and medium-sized charities,” the research paper found.

The federal government increased reporting thresholds in 2022 with a view to reducing the compliance requirements of thousands of charities in response to a review of the Act governing the Australian Charities and Not-for-profits Commission (ACNC).

However, the report revealed that stakeholders are demanding more detailed information, current accounting standards are seen as unsuitable, and irrelevant disclosures reduce the relevance of reports.

Increasing demands from funders and donors for more transparency and evidence of impact was also playing a role.

“It is noted that stakeholders demand more than mere financial data, emphasising the importance of incorporating both financial and non-financial performance indicators,” the report said.

As a result, many charities are adopting strategies such as creating audited reports and social impact statements to meet these demands, even though they come with added financial costs.

“Charities are balancing the costs of compliance with the benefits of aligning with stakeholder expectations,” the report found.

“This study highlights a trend among charities towards demonstrating social impact, thereby emphasising the imperative for more comprehensive and accessible reporting formats.”

The report found that although transparent reporting engenders trust, the associated expenses may impede complete disclosure. This means charities are striving to ensure that the satisfaction of stakeholders justifies the financial costs.

“Accountability in financial reporting necessitates addressing the needs of stakeholders. The prevailing emphasis on financial outcomes, contrasted with the stakeholders’ demand for insights into non-financial performance, highlights a disconnect in accountability practices.”

The report found that effective financial reporting should integrate both quantitative and qualitative data to bolster accountability.

“This imperative may motivate charities to develop supplementary reports, such as infographics and social impact statements, and to foster transparency [and] trust by adherence to ethical standards.

“Moreover, this trend illuminates the ongoing efforts undertaken to adapt financial reports for enhanced accessibility and a wider audience appeal.”

The study also unearthed concerns about the metrics used to determine charity size under the current tiered system, which subsequently affect financial obligations.

“Preparers [of financial reports] often prefer using revenue as a metric for its simplicity,” the paper found.

“Nonetheless, relying solely on revenue is insufficient; adopting a multi-criteria approach would provide a more comprehensive understanding of a charity’s size and operational scope.”

The paper acknowledged existing research that underscored the influence of revenue volatility on the sustainability of charities and said applying consistent criteria could lead to more stable categorisations of charities.

“However, this method could potentially complicate the classification process, introducing the risk of confusion and misinterpretation,” it said.

Benefits of the current system

Despite concerns over the current three-tiered financial reporting system, the report found it had some advantages, with evidence from larger charities indicating it aligned well with stakeholder expectations and enhanced funding security.

“Furthermore, the simplicity and consistency of the three-tier structure are favoured by preparers, as it streamlines and simplifies financial reporting and regulatory compliance.

“This system is designed to reduce misunderstandings and fluctuations in categorisation which accounts for its popularity among charities seeking more efficient reporting methods.”

Professor Gilchrist said there is always a balance between meeting accountability requirements and the application of not-for-profit resources where they do most good.

“We haven't got the balance right yet."

Gilchrist said the use of tiers to allocate reporting obligations to charities is easiest but not necessarily effective.

"Getting the reporting balance right is critical as over-reporting does not necessarily mean stakeholders have more information but it does necessarily mean administrative costs increase," he said.

"This is a real problem for Australia's not-for-profits and charities as funders do not recognise the costs associated with reporting and auditing."

Gilchrist said reduced reporting may well actually increase usability and reduce administration and auditing costs"

"Financial literacy is a critical consideration here - getting the accounting standards right is only one element in the equation. Ensuring understanding is the other."

The paper comes as the Australian Accounting Standards Board (AASB) calls for submissions commenting on draft proposals designed to simplify Australia’s NFP financial reporting framework.

The Board said that under the current framework, many NFPs that are similar in size and structure are producing financial reports that apply different reporting requirements.

It has proposed simplifying the NFP reporting framework by removing the self-assessment component from the Reporting Entity concept (exposure draft 334).

If the proposal is adopted, NFPs required to prepare financial statements in accordance with Australian Accounting Standards will no longer be able to prepare special purpose financial statements (SPFS) and will instead need to prepare general purpose financial statements (GPFS).

In an update on the proposed changes published on its website, accountancy firm Moore Australia said many NFPs prepare an SPFS even when reporting to regulators such as the Australian Charities and Not-for-Profits Commission (ACNC).

It said the AASB proposals would bring NFPs’ Australian Accounting Standards compliance requirements into line with those of for-profit organisations.

The AASB has also proposed the introduction of a single Tier 3 accounting standard for smaller entities such as charities, incorporated associations, trusts and co-operatives (exposure draft 335).

If adopted, Tier 3 reporting entities would produce a set of financial statements that would include:

• financial position
• profit or loss and other comprehensive income
• changes in equity (required only in particular circumstances)
• cash flows
• notes to the financial statements.

It is hoped the new simplified standard would be easier to understand for people who don’t have a background in financial reporting, such as volunteers at small NFPs, who are often required to help prepare financial reports.

The Board said NFPs contribute more than $156 billion to the Australian economy annually and their financial reports provide vital information to a wide range of stakeholders including donors, funders, and volunteers.

“The accounting standards set by the Australian Accounting Standards Board ensure stakeholders can have confidence in the information being provided and that financial reports are consistent and comparable,” the Board said on its website.

“Under the current framework, many NFP entities that are similar in size and structure are producing financial reports that apply different reporting requirements. This creates a number of issues including a lack of consistency and reduced comparability between reporting entities.”

“Our proposal to introduce a single accounting standard for Tier 3 NFP entities recognises that Tier 1 and Tier 2 reporting requirements may not present a proportionate cost/benefit for smaller NFP entities that may be affected by the proposals in ED 334.”

The Board said it had conducted widespread consultation within the sector on the proposals and that any changes would take up to three years to implement.

The deadline for providing submissions to the AASB consultation is February 28.