Charities and not-for-profits are created with a specific purpose in mind. These organisations use their funding to advance their purpose, which benefit millions of lives daily.
Like any other entity, running these charities results in inevitable costs. These costs take valuable funds away from their core purpose. The obvious costs include administration and employee costs, but there is also the cost to comply with reporting obligations.
To keep overheads to a minimum, it is not uncommon for some to take advantage of offers from organisations or local councils to provide them with premises on a lease that is significantly below market terms and conditions. These leases enable charities to keep their costs down and are referred to as peppercorn leases. Peppercorn leases are generally leases with a nil or nominal lease payment, however, they also include lease payments that are more than nominal but significantly below market value.
In 2016 the Australian Accounting Standards Board (AASB) issued two new accounting standards, AASB 16 Leases and AASB 1058 Income of Not-for-Profit Entities. Both of these new accounting standards have an effective date for all not-for-profit entities, with an annual reporting period beginning on or after 1 January 2019.
The application of these new standards requires not-for-profit entities to measure right-of-use assets at initial recognition at fair value in respect of any peppercorn leases. This is a significant change in accounting treatment for these peppercorn leases which will have a significant impact on not-for-profit entities.
As a practical example, while preparing the impact of this new standard, one of our not-for-profit clients realised that they had in excess of 70 peppercorn leases. This meant that they had to go through a process of reviewing and classifying each of the lease agreements, and assessing the fair value in accordance with the accounting standards to determine the impact of the new accounting standard, AASB 16.
During December 2018, the AASB issued Accounting Standard AASB 2018-8 Amendements to Australia Accounting Standards – Right-of-Use Assets of Not-for-Profit Entities. The ED provides an option for not-for-profit entities to measure right-of-use assets at initial recognition for peppercorn leases either at cost, in accordance with AASB 16 paragraphs 23-25, or at fair value, in accordance with AASB 16 paragraph Aus25.1 (to be amended).
In accordance with the changes to the measurement, the standard also proposes additional disclosure requirements in the financial statements. This will ensure users understand the effect on the financial position, financial performance and cash flows of the entity arising from peppercorn leases, when the entity elects to measure the right-of-use asset at initial measurement at cost, rather than at fair value.
The cost saving benefit of this standard for clients will be significant. Organisations can avoid obtaining valuations to determine the fair value when they adopt AASB 16. The money saved from this can go towards their core purpose.
The financial reporting threshold for not-for-profit sector entities may be revised as a result of ACNC Legislative Review recommendations. This ED will pre-empt entities at the lower level of the reporting threshold, who might not be required to apply AASB 1058 and AASB 16 in future, from incurring costs in measuring right-of-use assets at initial recognition at fair value in the interim period.