Within the myriad of technical jargon that accountants and auditors frequently use is reference to the financial reporting tier structure. This blog looks at what these tiers mean in relationship to financial statements and audit requirements.

How financial statements are prepared

But before we dive any deeper, it’s important to first define what financial reporting is. Simply put, financial reporting is the preparation of financial statements. How these financial statements are prepared can vary greatly, depending on whether they are general purpose financial statements suitable for a wide audience, such as the general public. Or special purpose financial statements, which are suited to a smaller well-defined audience, such as the IRD.

Given general purpose financial statements are required to address the needs of a wide variety of stakeholders. This means they include broad variety of information. One of the key characteristics is the comparability of one organisation’s information with other similar organisations.  In order to achieve this, there are a set of standards that accountants preparing general-purpose financial statements must follow.  The standards are collectively referred to as Generally Set Accounting Principles (GAAP).

Understanding Tier structures

In New Zealand, we have a variety of standards. These differ as to their complexity – ranging from the simplest at Tier 4 for small, simple organisations through to Tier 1 for larger, more complex organisations, which have public accountability by virtue of the impact they have on our wider community. The standards are grouped – there are standards that apply to for-profit entities and standards that apply to not-for-profit entities, which will often have different reporting needs than for-profit entities. For-profit entities have a 2-Tier system whereas the not-for-profit entities have a 4-Tier system.

Accounting for not-for-profit organisations decoded 

Tier 1

Focusing on not-for-profit organisations, we see that the most complex not-for-profit organisations (those which have annual expenses more than $30 Million) must apply the full Tier 1 standards.  These are referred to as International Public Sector Accounting Standards (IPSAS). Whilst they are modelled on New Zealand Equivalents to International Financial Reporting Standards (NZIFRS), they are modified to take consideration of the specific needs of not-for-profit organisations. Organisations who also have public accountability must apply these Tier 1 standards, even if their expenses are less than $30 Million. This is because they are charged with a greater level of responsibility to the community. In part, this is relates to the fact that they may ordinarily have the right to tax or levy members of their community.

Tier 2

Tier 2 organisations have no public accountability and have operating expenses of less than $30 Million but more than $2 Million. As this threshold suggests, this includes a very wide variety of organisations – from medium not-for-profit organisations through to some quite significantly sized not-for-profit organisations.  The standards that apply to these organisations are called Tier 2 standards and are exactly the same as Tier 1 standards. However, the amount of information presented in the financial statements is reduced. Hence Tier 2 standards are referred to as IPSAS Reduced Disclosure Regime (RDR) standards.

Tier 3

Meanwhile, a large group of not-for-profit organisations fall within the Tier 3 level. These organisations have less than $ 2Million of expenses and have not elected to apply the more complex Tier 1 or Tier 2 standards. Obviously, expenditure less than $ 2 Million probably includes the greatest number of not-for-profit organisations in New Zealand and, thankfully, the accounting requirements for not-for-profit organisations who are Tier 3 are a lot less complicated than the Tier 1 and Tier 2 standards.  However, they have been developed to address the specific needs of not-for-profit organisations. The Charities Commission has developed some good templates to use for Tier 3 organisations to help them get started on the journey towards complying with the Tier 3 standards.

Tier 4

Lastly, the Tier 4 standards are for those organisations with operating expenses of less than a $140K. They are arguably the simplest standards to follow and apply cash accounting, as opposed to accrual accounting. In theory, this makes compliance with the Tier 4 standards much easier. We do, however, find sometimes that the application of Tier 4 standards can confuse people and that sometimes the adoption of the Tier 3 framework is easier to understand.

Incorporated societies financial reporting requirements

Whilst the four Tiers have been around for a number of years now and are really well understood by those organisations who have needed to apply them, with the changes to financial reporting and audit requirements for incorporated societies coming into force due to the implementation of the Incorporated Societies Act 2022, there will be a significant number of additional organisations who will need to start thinking about how they transition from their existing financial reporting systems to the more complex tiers reporting system.

Incorporated societies, which also have charitable status, will be applying the Tiers system already, but organisations which do not have charitable status will need to transition to the new set of standards. For example, if a not-for-profit organisation does not have charitable status and it is an incorporated society, it may be time to start thinking about how your accounting systems will need to be modified to collect the information required to comply with the standards. This is especially crucial given the need for comparative information in the financial statements. Interestingly, organisations need to think two years ahead because this certain financial information is required to be collected two years prior to the adoption of the tiers.

As always, if you have any questions concerning this comment, you are welcome to contact one of the team at BVO Audit.