Video transcript: Financial reporting update: Public benefit entities
Brett Story, Associate Director Technical
Hello, I’m Brett Story, Associate Director Technical at Audit New Zealand. Welcome to this 2020 financial reporting update video for public benefit entities.
The main focus of the presentation today is providing an overview of the differences arising from new group accounting standards, PBE IPSAS 35 to 38 that take effect this year. I will cover some key differences in relation to assessing control, joint arrangement classifications, and disclosures.
I will also cover:
- the transition timeframes for the revised financial instrument standards PBE IFRS 9 and PBE IPSAS 41.
- the International Public Sector Accounting Standards Board’s (or IPSASB) exposure drafts on revenue and expenses ED70-72; and
- highlight how the new for-profit leases standard, NZ IFRS 16, may result in consolidation adjustments.
PBE IPSAS 35 introduces a new definition of control and new guidance in applying the concepts of power and benefits. These are important concepts as they determine whether you need to consolidate an entity into your group financial statements.
Under PBE IPSAS 35, an entity controls another when the entity is exposed, or has rights, to variable benefits from its involvement with the other entity and has the ability to affect the nature or amount of these benefits through its power over the entity.
While these concepts of power and benefits are not new, the new control definition and guidance can result in entities being assessed as controlled when they were previously assessed as not controlled under the previous control standards.
In terms of benefits, the benefits test is broader compared to PBE IPSAS 6. For example:
- PBE IPSAS 6 referred to entitlement to benefits, which had sometimes been problematic to interpret. PBE IPSAS 35 only requires “exposure” to benefits which is broader than entitlement.
- PBE IPSAS 6 included the complementary benefits test in respect of non-financial benefits where 3 criteria needed to be met. These criteria no longer exist. PBE IPSAS 35 discusses that non-financial benefits can occur when the activities of another entity are congruent with the objectives of the entity and support the entity in achieving its objectives. Non-financial benefits can also occur when two entities have complementary objectives.
In terms of power, PBE IPSAS 35 introduces the concept of a special relationship. The following suggests that the entity has more than a passive interest in the other entity and, in combination with other rights, may indicate power through a special relationship:
- Firstly, the relationship between the entity and the other entity’s operations is one of dependence. For example, the entity funds a significant portion of the other entity’s operations or provides critical services, technology, supplies or raw materials.
- Secondly, a significant portion of the other entity’s activities either involve or are conducted on behalf of the entity.
- Thirdly, the entity’s exposure, or rights, to benefits from its involvement with the other entity is disproportionately greater than its voting rights.
PBE IPSAS 35 continues to have an autopilot concept, which is now referred to as pre-determination.
Entities sometimes establish special purpose vehicles, such as trusts, to undertake specified activities. When the establishing entity does not appoint a majority of the governance appointments, special consideration needs to be given as to whether the entity has predetermined the activities of the potential controlled entity and ensured that the benefits flow to them.
For example, a district health board instructed its legal firm to establish a trust on the DHBs behalf with the objects of undertaking fundraising activities and distributing grants to the DHB.
The DHB only has rights to appoint 2 out of the 7 trustees.
The DHB designed the trust deed such that no changes could be made to its objects. In this simplified example, the DHB controls and will consolidate the trust because it has predetermined the activities of the trust and ensured that the benefits from its activities flow to it.
When assessing whether control arises from the pre-determination can sometimes be an area that requires significant judgement.
From our experience to date with the new standard, we expect entities currently consolidated into the group will continue to be controlled and consolidated under PBE IPSAS 35.
We have seen a number of cases where our clients have assessed they now control an entity under the new standard and will be consolidated for the first time. We see the main risk on transition to the new standard is for those entities previously assessed as not controlled that may now be assessed as controlled.
The transition has also highlighted situations where potential controlled entities have not been previously assessed for control so a control assessment may need to be completed for the first-time for some entities.
Now on to key changes for joint arrangements, which is when 1 or more parties jointly control an activity.
Under the previous standard, there were 3 types of joint arrangements:
- jointly controlled entities;
- jointly controlled operations; and
- jointly controlled assets.
Under PBE IPSAS 37 there are now only 2 types of joint arrangements:
- joint ventures; and
- joint operations.
A joint arrangement not structured through a separate vehicle will always be a joint operation. However, if the arrangement is structured through a separate vehicle, such as a company, whether that arrangement is a joint venture or joint operation will now depend on the venturers rights to the assets and liabilities of the arrangement.
If the venturer has a right only to the net assets of the entity, that will be a joint venture.
If the venturer has rights to the assets and obligations for the liabilities of the arrangement, then that will be a joint operation.
For arrangements structured through a separate vehicle, the standard includes a number of considerations to assess whether in substance the venturer has rights to the assets and liabilities of the arrangement.
An example of this is where a company is established to produce an output to the joint venture parties and only those parties purchase all that output. In this simplified case, the arrangement will be a joint operation because the venturers in substance have the rights to the service potential of the company’s assets and obligations to fund the company’s liabilities. Under the previous standard, this arrangement would have been a jointly controlled entity.
This means joint arrangements previously classified as jointly controlled entities will need to be assessed to determine whether they are a joint operation on transition to PBE IPSAS 37.
Another key change is that joint ventures must be accounted for using the equity method of accounting. Proportional consolidation is no longer permitted for such arrangements.
Previous disclosures about subsidiaries, joint ventures and associates were included in their respective standard. Under the new group standards, disclosures for these interests are now included in PBE IPSAS 38.
PBE ISAS 38 expands the disclosures of the previous standards. How this impacts entities will depend on the types of interests they have and whether they are material to the group. Some examples of expanded disclosures include:
- significant judgements that have been exercised in assessing whether you control an entity or whether a joint arrangement is a joint venture or joint operation;
- summarised financial information about the assets, liabilities, surplus or deficit and cash flows for each material subsidiary that is not 100% owned; and
- various financial statement line items for each material joint venture, such as cash and cash equivalents, current and non-current financial liabilities, and depreciation and amortisation.
When you have interests in other entities, you will need to carefully work through these new disclosures and ensure you are providing those for your material interests.
A number of PBEs, including the financial statements of government, early adopted PBE IFRS 9 Financial Instruments in their 30 June 2019 financial statements. This was to avoid mixed group accounting issues when for-profits subsidiaries adopted NZ IFRS 9.
For those entities that have not yet early adopted PBE IFRS 9, there is now only a limited window to do that, with the 31 March and 30 June 2020 balance dates being the last year you can early adopt.
PBE IFRS 9 was a New Zealand stop gap measure while the IPSASB developed their IFRS 9 equivalent financial instrument standard. That equivalent standard, IPSAS 41 has now been issued.
PBE IPSAS 41 therefore supersedes PBE IFRS 9, and PBE IPSAS 41 must be adopted for 31 March and 30 June 2023 balance dates.
PBE IPSAS 41 is largely aligned with PBE IFRS 9. This will mean in general there shouldn’t be any transition adjustments for those entities that early adopted PBE IFRS 9.
For those entities that haven’t early adopted PBE IFRS 9, adjustments could arise on transition to PBE IPSAS 41 due to the different financial asset classification rules and a new expected credit loss model for loans and receivables.
The International Accounting Standards Board has issued a package of 3 exposure drafts on revenue and expense transfers.
ED 70 addresses the accounting for revenue with performance obligations and is based on IFRS 15 Contracts with Customers. It will replace IPSAS 9.
ED 71 addresses the accounting for revenue without performance obligations. It will replace IPSAS 23.
Current revenue standards distinguish revenue based on an exchange/non-exchange distinction. In contrast, whether you apply ED 70 and ED 71 is based on a performance obligation approach.
ED71 also introduces requirements on the subsequent measurement of non-contractual receivables, such as taxes and fines. This is an area that is not presently addressed by PBE IPSAS 23 so will provide some welcome clarity on the accounting for these receivables.
There is presently no standard that addresses the accounting for transfer expenses, such as grants, which can be an area of significant expenditure for some entities in the public sector.
ED 72 proposes an accounting model that is similar to ED 70 and ED 71 based on performance obligations.
ED 72 proposes that if a transfer expense gives rise to performance obligation(s) and meets certain criteria, the transfer provider recognizes an expense when (or as) the transfer recipient satisfies the performance obligations.
If there is no performance obligation, the transfer provider recognizes an expense at the earlier of:
- a present obligation to transfer resources; or
- the transfers of the resources
If you want to have your say on these proposed new standards, you can submit your submission to the New Zealand Accounting Standards Board by 23 September and the IPSASB by 1 November 2020.
For-profit entities are applying the new leases standard NZ IFRS 16 this year. NZ IFRS 16 significantly changes lease accounting for lessees, resulting in most leases being recognised on the balance sheet as a lease liability and right of use asset. For profit lessor accounting continues to be based on the finance and operating lease model.
A number of for-profit entities in the public sector are consolidated into a PBE group. PBEs are still applying a lease standard that is based on the finance and operating lease model.
This means for-profit entities may need to make consolidation adjustments when submitting their consolidated financial information to their PBE parents to be consistent with the operating and finance lease model. Essentially they will need to unwind their NZ IFRS 16 transition adjustments for operating leases when submitting their reporting packs.
The IPSASB is continuing to work on a new lease standard based on IFRS 16. However, it is unclear when a revised PBE leases standard will be available. So these mixed group lease consolidation adjustments will continue for the foreseeable future.
If you are interested, there is a short financial reporting update video for for-profit entities available on our website that covers NZ IFRS 16 at a high level.
That concludes this short financial reporting update video. I hope you have found this useful in providing a high level overview of the new group reporting standards and some other reporting matters.
If you have any particular audit related questions that arise from application of the new group standards, then contact your auditor to discuss further in the usual manner.
Thank-you and stay safe.
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