Charities under pressure from IFRS proposals

The impact of new accounting proposals that are closely aligned with International Financial Reporting Standards (IFRS) could result in many charities breaching loan covenants with their banks.

Under current accounting rules social housing providers, universities and charities can adjust their accounts to recognise assets that have risen in value. According to a new PwC report this will no longer be allowed under new rules being considered for Public Benefit Entities (PBEs) and other private UK businesses.

While the introduciton of IFRS is generally accepted, the revaluation of assets issue - in particular for the impact on housing associations - is increasingly coming up as one thing that needs to change in the consultation process.

This situation could see the organisations break their banking covenants because the agreements are based on balance sheets showing the most up to-date value of those assets.

In particular the social housing and higher education sectors make extensive use of assets and have invested heavily in property projects.

In the future, such groups may only be allowed to hold those assets at cost as the Accounting Standards Board (ASB) works hard to make the rules governing unlisted UK companies more closely aligned to the international standards listed companies follow.

The ASB is preparing to release an exposure draft on a PBE standard, but the banking covenants issue remains on the table while the body seeks comment from businesses on its plans to harmonise UK accounting rules.

Matthew Hodge, a director at PwC said: “PwC welcomes the publication by the ASB of the draft standard, which recognises the unique accounting requirements of public benefit entities.

“However, there are clearly some key issues that these entities will have to face head-on if they want to keep honouring their banking agreements”, Hodge added: “It is vital PBEs take advice, because there are accounting options that may help avoid the need to renegotiate contracts with banks.”

The ASB has proposed a new three-tier accounting framework based on how publicly accountable the companies are.

The PBE standard will be drafted in compliance, but designed to act as a counterweight, with the second of these two tiers known as the FRSME.

Caron Bradshaw, chief executive of the Charity Finance Directors' Group (CFDG), said: "As it stands the FRSME [tier two under the new system] does not permit the revaluation of assets such as property and equipment, which could be an issue for some public benefit entities including charities.

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Comments

Loan to value problems ...

JC | | Permalink

Is over leaveraging assets a sound stance in the first place - and should charities be particpating in this scheme?

Here is an example including currencies - so what is the solution in this instance:

Suppose the Housing Associaton was UK based with a UK housing stock

  • now for the sake of argument (simple figures) they take out a 100% loan to value of £1,000 (i.e their entire housing stock is valued at £1,000)
  • this loan was taken out in USD$ a few years back when the rate was £1 = 2USD$
  • the GPB/USD rate falls to 1.50 - so the UK housing stock has instantly taken price drop 25%
  • along the way the UK housing stock has also taken a £ sterling drop in price in the home market of 25%
  • so the foreign currency loan is now bad news and there is a minimum 50% shortfall between loan & value

now what ....... ? The charity has a £1,000 debt against assets of £500 = shortfall of £500; of course they have breached their covenants and probably by a wide margin. The alternative is only allow, say, 25% of assets to be leaveraged & used as security which should provide adequate headroom for things to go bad

Otherwise in the example above the charity is in negative equity and vulnerable

Don't say that scenario could not happen because one only has to look back over the past 3 years - or perhaps the government should set up a charity bailout fund now as an insurance policy against the inevitable?