When can Tier 3 entities apply Tier 2 standards for certain transactions?
Posted on 18 October 2016
Note: This blog deals with technical issues and you may like to seek professional advice if any of these scenarios apply to you
The Tier 3 standard is pretty handy. You are eligible to be in this tier if your operating expenses are below $2 million, or, you may have opted up from Tier 4 because you prefer to use accrual accounting. The standard is written clearly, and there are defined parameters within which to report, so if you have some familiarity with accounting concepts it’s relatively straightforward.
There are a couple of areas, however, where you might be required to, or choose to opt up to the Tier 2 standard* for certain transactions. The Tier 3 standard allows you to adopt certain Tier 2 standards without having to comply with the Tier 2 requirements in their entirety**.
The most common reasons you would have for applying a Tier 2 standard are:
- Revaluation of property, plant and equipment
- Revaluation of investments
I’ll go through each one in detail. This is a somewhat complex area, so if you think these apply to you, we would recommend seeking professional advice.
Under the new reporting standards, you are required to think about whether your charity “controls” for financial reporting purposes, other entities (whether these are charities or not). If your charity controls other entities, then you must prepare a consolidated Performance Report for the controlling charity, and the Tier 3 standard requires the consolidation to be prepared in accordance with PBE IPSAS 6***.
Control is defined in PBE IPSAS 6 (NFP): Consolidated and Separate Financial Statements (Not-for-Profit) as “the power to govern the financial and operating policies of another entity so as to benefit from its activities”.
This means that the overall format of the Performance Report will follow that prescribed under Tier 3, but the way you consolidate will be following the Tier 2 standard. PBE IPSAS 6 and Explanatory Guides EG A7 and EG A8 have a lot of guidance to help you determine whether your charity does control other entities so it’s worth having a read if you are not sure. These can be found on the XRB website(external link).
Key concepts for PBE IPSAS 6 in a Tier 3 context:
- You only need to present “Group” figures rather than “Parent and Group”
- You do not need to present comparatives in the first year of applying the new reporting standards
- The Statement of Service Performance also needs to be consolidated
- You need to disclose in the accounting policies of your Performance Report that you have adopted the Tier 2 standard for the purposes of consolidation
Revaluation of property, plant and equipment
Some charities hold a lot of property, and in particular, land and buildings. In the past, the charity may have recorded the value of those properties in their financial statements at the current market value. Under the Tier 3 standard if you purchased the land or buildings, then you must record that asset at the cost price. If you want to also disclose the market value, you can do so in the notes.
Under Tier 3, if you want to revalue the assets then you must apply the revaluation guidance in the Tier 2 standard, PBE IPSAS 17: Property, Plant and Equipment. You might want to do this if the value of your land and buildings has increased significantly over time, and you see the merit in reflecting this in your Statement of Financial Position.
Key concepts for PBE IPSAS 17 in a Tier 3 context:
- If you adopt PBE IPSAS 17 you must use it for all transactions of that type i.e. all land and buildings – you can’t cherry pick certain assets
- Once you adopt it, you cannot then go back to revaluing it at cost if you change your mind in future periods
- PBE IPSAS 17 uses “fair value” to value assets. Tier 3 standard permits you to use current rateable or government valuation
- Revaluing assets will cause an increase or decrease in valuation accounting entry. As described in PBE IPSAS 17 paragraph 54, the increase or decrease will need to be recorded in other comprehensive revenue or expense. If you are using the optional template, you will need to adjust it to accommodate this
- You need to disclose in the accounting policies of your Performance Report that you have adopted the Tier 2 standard for revaluing assets and state which classes of assets this applies to.
Revaluation of Investment
The type of investment that we get the most questions about is unit trusts or portfolio investment entity (PIE) schemes. These are where you purchase units in a scheme, and the scheme invests the money into a variety of things such as shares, cash, bonds, notes etc. The value of your investment is dependent on how the investments are performing in the markets. These types of investments are usually managed by portfolio managers and they report to investors regularly with an update on the value of the investment.
Under the Tier 3 standard, for simplicity, investments are required to be valued at cost, which would be the amounts originally paid for the investment. Quite a few charities made their investments many years ago, and some are finding it hard to find the original cost values. In these cases, they want to record the current or market value of the investments, and to do this, they must opt up to the relevant Tier 2 standards and assign a “fair value” to the investments.
This is probably one of the most complex areas of the Tier 2 standards and therefore we would recommend seeking professional guidance if you are not familiar with these concepts. The relevant Tier 2 standards are:
- PBE IPSAS 28 Financial Instruments: Presentation
- PBE IPSAS 29 Financial Instruments: Recognition and Measurement
- PBE IPSAS 30 Financial Instruments: Disclosures
Key concepts for PBE IPSAS 28, 29 and 30 in a Tier 3 context:
- Choosing the appropriate category for the investments in accordance with PBE IPSAS 29
- There are certain note disclosures that need to be included such as categorising the types of investments in accordance with PBE IPSAS 30
- You need to disclose in the accounting policies of your Performance Report that you have adopted the Tier 2 standard for the purposes of revaluing investments, how the fair value of the investment was determined and accounted for
- Similar to revaluation of property, plant and equipment, any revaluation will cause an accounting entry in the Statement of Financial Performance. Depending on the category selected, this could be in unrealised gains/losses or other comprehensive revenue and expense.
For charities applying the Tier 3 standard, wherever possible we would encourage you to stick to the standard to make things as simple as possible for yourself. In the first instance we suggest you carefully read the Tier 3 standard and associated guidance notes. If you are having problems getting the information you need, please get in touch with us and we will try and help you or find a solution where possible. Call 0508 CHARITIES or e-mail firstname.lastname@example.org
Application of PBE Standards
7. An entity that is eligible to apply this Standard, and elects to do so, may elect to apply the requirements of a PBE Standard that is part of the Tier 2 PBE Accounting Requirements to a specific type of transaction, as long as it applies that option to all transactions of that type. For example, an entity may decide to opt up to PBE IPSAS 17 Property, Plant and Equipment so that it can revalue a class of assets (in which case it must apply the whole standard).
8. If, for a particular type of transaction, an entity elects to apply the requirements of a PBE Standard that is part of the Tier 2 PBE Accounting Requirements instead of applying the requirements in this Standard, the entity shall disclose this in the statement of accounting policies.
9. If, for a particular type of transaction, an entity elects to apply the requirements of a PBE Standard that is part of the Tier 2 PBE Accounting Requirements instead of applying the requirements in this Standard, the entity cannot then choose to return to applying this Standard unless the entity complies with the requirements of this Standard for changes in accounting policies (see paragraph A180).***Paragraph 4.2 of the Tier 3 standards states: If an entity controls another entity it shall prepare a consolidated performance report which combines the assets, liabilities, net assets/equity, revenue and expenses of the controlling entity with those of the controlled entity in accordance with the requirements in PBE IPSAS 6 (NFP) Consolidated and Separate Financial Statements (Not-for-profit).