NFP reform
Key points
- NFP reform lags that in other sectors
- NFP directors don’t fully understand their legal risks
- But several reform initiatives are underway, including:
The Productivity Commission’s final report on the NFP sector
Treasury’s proposals to improve NFP reporting frameworks
Work being done by the Australian Accounting Standards Board
A wave of regulatory reform in the next few years will transform Australia’s $43 billion not-for-profit (NFP) sector and have important implications for boards in this sector. Change is coming on many fronts, from proposals for a new NFP registrar, streamlined reporting requirements for smaller organisations, new accounting standards and even a radical idea to standardise service-delivery reporting. Taken together, the proposed changes are the most significant in a decade.
They are also a long time coming. Australia’s NFP sector has been neglected in the reform stakes, even though the “third sector” is bigger than most industries.
It is estimated that there are more than 700,000 NFP enterprises in Australia. According to research by the Productivity Commission (PC), these enterprises employ about eight per cent of the workforce and another 4.6 million volunteers, providing the equivalent of $15 billion of work.
The Australian Institute of Company Directors’ Directors Social Impact Study, released in February, also found that a large number of directors in Australia are involved with NFPs – three out of five respondents (58 per cent) serve on NFP boards and almost one-third of respondents (30 per cent) hold more than one NFP directorship.
The sector is growing faster than the economy as governments outsource more functions to NFP enterprises and as an ageing population boosts demand for healthcare and other services. The PC says the NFP sector had average annual growth of 7.7 per cent between 2000 and 2007. To put that in perspective, revenue in the mining industry – which has had far more attention than the NFP sector – grew an average 8.5 per cent annually between financial years 2002 and 2008, IBISWorld data shows.
It is remarkable that Australia’s NFP sector is expanding so rapidly given its lack of regulatory support in the past decade, onerous reporting requirements for smaller enterprises, complexities in fundraising rules across states and a general lack of sector information. The NFP sector even emerged with far fewer enterprise collapses during the global financial crisis than expected. Clearly, there is more social innovation and entrepreneurship in the NFP sector than many realise.
“The pace of reform in Australia’s NFP sector has badly lagged that for big business, small business or several other parts of the economy,” says David Gonski AC FAICD, chairman of Coca Cola Amatil, the Australian Securities Exchange and Investec Bank, and a prominent contributor to the NFP sector through his involvement in several charities and government advisory panels. “It is archaic that an NFP enterprise, such as a small sports club, is required by law to have the same type of reporting as a subsidiary of BHP Billiton. That makes no sense. The compliance burden on NFP enterprises, especially smaller ones, is unrealistic.”
Change is needed, says Robert Fitzgerald, commissioner of the PC. “Several other countries have leapfrogged Australia with their NFP reforms. There have been several reviews and reports about our NFP sector since 1995 and many of their recommendations were well received and remain relevant today. But few recommendations have been implemented and the result is that reforms to Australia’s NFP sector have fallen well behind those in other areas of our economy,” he notes.
Fitzgerald says urgent action is required. “Current constraints in the NFP sector will only get worse and push the sector to breaking point this decade, especially in the human service delivery area. The NFP sector faces significant labour constraints as workforce shortages grow. There are real funding constraints – with the NFP sector unable to access capital in the same way as other sectors. But I also believe the NFP sector’s innovative capacity has been delivered a blow in the past two decades, with the sector generally becoming more responsive to the needs of government than identifying and creatively meeting emerging community needs.”
The need for NFP reform is well known, but achieving it is hard due to the diverse nature of the sector, which ranges from government, to universities, schools, sophisticated financial institutions such as industry super funds, community services, healthcare organisations, charities, clubs and religious bodies. Finding a regulatory framework that serves an NFP enterprise such as Melbourne University, which had $1.5 billion in revenue in 2008, and a local cricket club that survives on chook raffles, is complex.
A bigger problem in the past decade has been the lack of a single government body driving NFP reform. At a national level, sector oversight came under the Federal Treasury due to tax-concession issues involving the Australian Taxation Office. That compliance focus was not enough in a sector badly needing policy debate, reform, and more help. Under the Rudd Government, the Office for Social Inclusion, for which Deputy Prime Minister and Minister for Social Inclusion, Julia Gillard, is responsible, is at least a central government point to promote NFP sector issues.
The absence of a Federal government body with a compliance and policy mandate has caused many problems, not the least of which is an absence of information about NFP enterprises. Important policy decisions are being made without detailed trend and performance data for the sector.
This information gap has sparked claims that Australia’s NFP sector has been poorly regulated, that some NFP organisations receive tax concessions even though they act more like commercial ventures and that parts of the NFP sector, especially in areas such as healthcare, have an unfair commercial advantage over for-profit enterprises that do not receive tax benefits. There have been many media reports in the past decade about NFP enterprises that have wasted public donations or been too slow to get public money to those in need.
This information problem is being addressed as newer organisations such as the Centre for Social Impact, based at the University of New South Wales, shed important light on the NFP sector and help teach a new generation of social innovators and entrepreneurs. The centre, led by Peter Shergold FAICD, a former Secretary of the Department of the Prime Minister and Cabinet, has a critical role in driving NFP sector research that can inform government policy and aid public understanding (see p26).
Lack of reform over the years has also substantially increased risks for NFP directors. “I believe many directors of NFP enterprises do not fully understand the legal risks they take on when joining a board in this sector,” says Gonski. “For example, many small charities sail near insolvency every day as they incur liabilities, but have few hard assets. The threat of trading while insolvent is a big issue for NFP directors.”
Poor reform, and the information void it has created, makes it much harder for NFP directors to do proper due diligence before joining a board, says Michael Traill, CEO of Social Ventures Australia, which funds NFP enterprises using similar techniques to venture capitalists. “If somebody wants to invest in BHP or Rio Tinto, or is considering joining the board of a listed company, he or she can get long-term comparative performance information at the flick of a switch. It’s almost impossible to get similar data for NFP enterprises,” says Traill.
Even when that data is compiled, it may not always be meaningful. “There needs to be much clearer, concise and comparable reporting from NFP enterprises,” observes Traill. “Financial reports of NFP enterprises need to become much more forward-looking, rather than just reviewing what has happened. We need more commentary on future trading conditions, service-delivery goals and long-term strategy. This alone would give directors, donors and other stakeholders much more confidence in NFP enterprises.”
Confidence is a recurring theme in NFP reform. Confidence that NFP enterprises are being properly regulated. Confidence that NFP enterprises have appropriate governance and are not saddled with unnecessary compliance that drains scarce resources. Confidence that accounting frameworks recognise that many transactions in the NFP sector are not about money. And, most of all, confidence that stakeholders can make informed decisions about enterprises they support.
The PC’s final report on the NFP sector Contribution of the Not-for-Profit Sector, released in February, proposes a regulatory blueprint that could transform the sector and improve confidence within it. Chief among its many recommendations is establishing a national registrar, or “one-stop shop” to consolidate Commonwealth regulatory oversight and tax endorsement. If adopted, the new body – effectively a Charities Commission without the policy reform component – would reduce the compliance cost and burden on charities and improve public confidence in the NFP sector, especially in the granting of tax concessions.
The PC separately recommends a new policy centre within the Australian Government to drive policy and reforms for the NFP sector. Separating compliance and policy makes sense, as it removes an inherent conflict of interest if the regulator is responsible for policy development. The report also urges the Federal Government to establish a Centre for Community Service Effectiveness to build a better knowledge base and evaluation practices, especially in relation to government-sponsored programs.
In addition, the PC proposes fast-tracking the harmonisation of state laws, especially in areas such as fundraising, which are big problem for national charities, broadening the scope of gift deductibility for charities, and reforming government purchasing and contracting arrangements to reduce the compliance burden.
Another important recommendation supports the broad thrust of changes proposed by Federal Treasury to improve corporate reporting frameworks. The key change for the NFP sector relates to changes for companies limited by guarantee, an incorporation structure used mostly by growing NFP organisations.
Currently, all companies limited by guarantee must prepare a full, audited financial report in accordance with Australian accounting standards and a directors’ report that complies with the Corporations Act 2001. This creates disproportionate reporting burdens on smaller NFP agencies.
As Treasury notes: “The small size of companies limited by guarantee means they may not have the capacity to comply with extensive corporate reporting requirements.” Treasury proposes a three-tiered differential reporting framework that exempts small companies limited by guarantee from reporting and auditing requirements, while maintaining appropriate transparency and governance. The proposals also streamline the distribution of annual reports to NFP members.
First-tier companies limited by guarantee (annual revenue less than $250,000 and no deductible gift-recipient status) will not have to prepare a financial or directors’ report currently required by law. Second-tier companies (annual revenue between $250,000 and $1 million, irrespective of deductible gift status) will still have to prepare a financial report but will be permitted to have it reviewed rather than audited and will be permitted to prepare a streamlined directors’ report. Third-tier companies limited by guarantee with annual revenue above $1 million will still have to provide an audited financial report, but will be permitted to prepare a streamlined director’s report. Put simply, the proposal potentially removes a huge amount of unnecessary reporting for small companies limited by guarantee.
Gina Anderson MAICD, CEO of Philanthropy Australia, welcomes the broad thrust of the proposed changes (her organisation suggested the minimum level be raised to $500,000). “About 80 per cent of NFP enterprises turn over less than $1 million in annual revenue, yet they have to report against standards designed for much larger organisations with many more resources. It’s simply overkill to audit the accounts of small NFPs. And, it’s a waste of time having CEOs spend so much time writing unnecessary compliance reports, or having directors spend time on audit committees, or dealing with auditors when the organisations are small.
We want to free up NFP executives and directors so they can get on with the job of improving service delivery and executing strategy.”
Another important recent development is the Standard Chart of Financial Accounts for NFP enterprises developed by Professor Myles McGregor-Lowndes, director of Queensland University of Technology’s Australian Centre for Philanthropy and Nonprofit Studies. Federal and state governments (through the Council of Australian Governments) have agreed to adopt the Standard Chart of Financial Accounts for NFPs receiving government grants. The chart removes a lack of consistency in accounting categories and terms required by government departments that fund NFP organisations and should slash red tape and reporting costs.
“Essentially what it means for these organisations is that they no longer have to negotiate the chaotic maze of government guidelines and instead can focus their efforts on the real business of NFP organisations, which is improving the lives of others,” McGregor-Lowndes said in December.
Another big reporting change will come from work by the Australian Accounting Standards Board (AASB) on the NFP sector. A constant complaint from the sector has been the lack of NFP-specific accounting standards. “Accounting standard reform is an important issue for the NFP sector and something the AASB is looking very closely at,” says AASB’s deputy technical director, Robert Keys. “The challenge is implementing a common framework across such a diverse sector.”
A key change could come on accounting standard AASB 1004 Contributions, which tells the NFP sector how to account for donations and government grants. The standard has been criticised for requiring NFP enterprises to recognise revenue too early, which can distort an NFP enterprise’s accounts by making financial performance appear stronger. For example, a charity that receives a grant on 29 June has to account for it in that financial year, even though it may not spend the money for another 12 months, or may be subject to certain performance obligations to get the full amount.
AASB has issued an exposure draft, AASB ED 180, to deal with this problem. The AASB could issue a new accounting standard to deal with income from non-exchange transactions in the third, or more likely, fourth quarter of 2010. “I suspect this change, if adopted, would level out income from period to period of many NFP enterprises, by allowing them to defer the recognition of revenue in their operating statements,” says Keys.
Another AASB project looks at the disclosures NFP enterprises make in their financial reports. Phase one of the project, now underway, examines whether NFP enterprises should disclose additional, more useful, information. Phase two of the project, yet to start, will consider whether current disclosures required of NFP enterprises are meeting the needs of stakeholders. Simply put, AASB wants to get the disclosure balance right by stripping out unnecessary reporting requirements and adding in requirements that potentially improve reporting.
As part of phase one, the AASB is considering whether there should be non-financial performance reporting standards – a huge change if it happens. All current accounting standards focus on financial reporting and it is still unclear whether non-financial reporting should be part of AASB’s brief.
A standardised reporting framework for non-financial performance metrics, such as inputs, outputs, outcomes and key performance indicators, could transform the NFP sector by allowing stakeholders to compare organisations on service delivery rather than traditional financial metrics. Such standards would make it easier for directors to assess the performance of an organisation’s CEO, for example.
These and other proposed reforms offer great hope for the NFP sector. At a minimum, they should free up executives and directors to do what they do best: help make a better community. And they should improve public confidence in parts of the NFP sector. Change, as always, will be slow, with public consultation for many reforms still underway. And, there is uncertainty about how the Henry Tax Review will deal with the NFP sector, with fears that parts of the sector, such as religious groups, could lose billions of dollars worth of tax concessions.
But after years of false starts and reform promises, the NFP sector is right to demand action rather than talk. The early signs, at least, are the best in the decade, with real progress being made.
Q&A with Peter Shergold
Company Director spoke to Peter Shergold FAICD, a former Secretary of the Department of the Prime Minister and Cabinet, about proposed reforms to the NFP sector and the role of directors of NFP enterprises. Shergold is the Macquarie Group Foundation Professor at the Centre for Social Impact, based at the University of New South Wales.
Company Director (CD): What can directors of NFP enterprises do to help the sector?
Peter Shergold (PS): First and foremost, they must be absolutely aware of the mission and values of their organisations. A board can’t just look at a loss-making program and decide to chop it in the same way a board of a for-profit enterprise would. They need to be very clear on the social outcomes and effectiveness of that program before they make that decision. I would urge directors of NFP enterprises to focus on helping their organisations measure impact. Most NFPs have become much better at measuring the cost of service delivery, but so much more needs to be done to measure outcomes. Directors should know what social return the organisation is producing on every dollar invested – and how that compares to similar organisations. This information should be made public.
Directors should also focus on making their organisations as transparent as possible: transparent reporting on performance is an enormous asset for stakeholders and increases public trust.
CD:It’s said that directors of NFP enterprises with significant for-profit experience often leave their business skills at the door when they join a NFP board. Do you agree?
PS: I do agree, although it’s always dangerous to generalise across the sector. In my experience, NFP enterprises recruit directors from the commercial sector to their boards because they want that business experience. They want people with economic rigour who can look at things differently to other directors who come from the NFP sector and have different networks and skills. It is very important that directors maintain their business approach, while understanding the differences between for-profit and NFP enterprises and how they affect the role of NFP boards.
CD:How has Australia’s NFP sector responded to the global financial crisis?
PS: Recent research from the Centre for Social Impact shows the NFP sector has generally weathered the crisis. Like commercial entities, it has cut costs and restructured, and is now placing greater emphasis on raising revenue. A cautious optimism is returning. That is a credit to the staff and volunteers of NFP enterprises and the boards that govern them. Certainly, many people expected to see more casualties in the NFP sector as a weaker economy affected fundraising. But that did not happen to any great extent.
CD:What’s your view on the Productivity Commission’s proposals for the sector?
PS: The report is generally along the right lines. There is certainly a great need for regulatory overhaul in this sector. Having a central registrar for the sector that can make incorporation and registration easier for NFP enterprises is important. My fear is that changes may lead to more red tape, though I’m confident the Productivity Commission is very focused on reducing the compliance burden on NFP organisations.
CD:How big a problem is the lack of information and understanding about the NFP sector?
PS: It is a very significant problem. We desperately need a comprehensive information hub for the “third sector” that can record and compare organisational performance and underpin evidence-based policy. This is something our centre is working on. Such information would create more confidence in the NFP sector and aid public understanding of just how large and important this sector is in Australia.
Through education, we can also help develop the next generation of social innovators and entrepreneurs who have specialist skills in running NFP enterprises. Over time, we will see more such people on NFP boards and leading these organisations.
In support of NFP reform
In November 2009, the Australian Institute of Company Directors made a submission in response to the Productivity Commission’s draft research report into the contribution of the not-for-profit sector. Among other calls, we advocated:
- Government support for the training of NFP management and boards;
- A reduction in the compliance burden for NFPs;
- A single regulatory regime to cover all NFPs; and
- A measurement of the NFP sector’s contribution to the economy.
The submission can be viewed in the Representation section of our website at: www.companydirectors.com.au
The Not-for-Profit Board
The Australian Institute of Company Directors’ Not-for-Profit Board course is specifically targeted at NFP directors and the challenges they encounter. To find out more, visit the Education section of the website at: www.companydirectors.com.au
To find out more about the Australian Institute of Company Directors’ Directors Social Impact Study, visit the website at: www.companydirectors.com.au