Charities face threat from new Public Benefit Entities rules

The law of unintended consequences being what it is, plans to bring accounting rules for unlisted companies into line with International Financial Reporting Standards (IFRS) could make it harder for housing associations and charities to fund their work. Under loan agreements, many Public Benefit Entities (PBEs) must revise the value of their assets, such as property and equipment, to reflect market value rather than original cost.

The proposals from the Accounting Standards Board (ASB), which would prevent PBEs from revaluing assets, could put charities and universities in breach of their loan covenants and make some appear technically insolvent, while housing associations may find it harder to finance the building of homes, according to accountancy firm PwC.

Although some agreements contain clauses to accommodate changes in accounting rules, PBEs could face tough talks with lenders if they are not prepared for the changes, due to be implemented in 2013. Though the changes were driven by the noble objective of simplifying the accounting system, the overall effect would be a step backwards for most PBEs.

Robert Humphreys, Oxfam’s finance director, tells Financial Director that any charity involved in service delivery is likely to be affected by the proposed changes. He is concerned that this will hit charities at the same time as proposed changes to the rules on the accounting of leased assets, whereby future liabilities would have to be recognised.

Oxfam operates 700 high street shops, many of them with operating leases of five, 10 or 15 years. The proposed changes would force charities to estimate the fair value of the right to use each of these leases on the balance sheet, along with an estimate of the liability for all future lease payments. “This could hit charities’ reserves as well as being a huge administrative load in preparing the calculations,” says Humphreys.

Charles Scott, group finance director of Age UK, says the proposed ban on the revaluation of assets would be compounded by the fact that charities often have significant off-balance sheet value that is not reflected in their accounts. “We have committed income streams in the form of direct debit donations, 8,000 volunteers who provide labour for free and significant brand value – none of which is on the balance sheet,” says Scott. “Charities will need to work hard to convince banks that their covenants are stronger than the rules might suggest.”

Housing worries

It is also feared that plans to prevent PBEs from capitalising interest on assets would affect the housing sector, warns Joseph Carr, finance policy leader at the National Housing Federation. Since 2005, the social housing sector in England alone has accrued £1.1bn to its balance sheet through capitalising interest.

Carr claims the changes will make it harder for housing associations to issue bonds and use their balance sheets to secure loans. “Balance sheet strength is important,” he says. “Housing associations have healthy reserves, but those reserves are not cash-backed. If you reduce them, it would weaken lenders’ confidence in the sector. Housing associations could struggle to obtain funding or the banks could ask for higher premiums”.

Jack Stephens, finance director of Thames Valley Housing, adds that banks are likely to use the opportunity to charge fees if covenants have to be renegotiated. In addition, housing associations that use bonds to raise capital will have to use the IFRS’s more onerous Tier 1 accounting rules, which permit assets to be revalued but require more preparation time.

“I think the ASB has underestimated the impact these changes would have,” says Stephens. “The UK’s accounting rules are inconsistent and could be improved, but I think it needs to be pragmatic.”