Just as charities and businesses differ significantly in their raison d’etre, so too do some of their accounting needs.
This can be especially confusing if you are entering the world of charity but have a business background, as the accounting standards, level of transparency and terminology may seem quite alien.
Here’s a brief look at some of the main differences.
Basic principles
Most businesses are ultimately formed to make a profit for their shareholders. While they may have one main idea as to how they will do this, they are not tied to it and can diversify – as long as they are trying to deliver profit. And many do. You could look at the PLC Associated British Foods, for instance, and see that its most successful business division is the clothes shop, Primark.
In the pursuit of profit, businesses will incur expenditure and generate income. This, along with assets and debt, is at the core of their financial statements.
Charities do not always have such freedom. They will have charitable objectives, and all activities must contribute towards those.
Rather than generating income which they can choose how to spend, they must show that it is meeting their charitable objectives. Sometimes, those who make donations can decide exactly how they want their donations to be spent.
To account for this, discrete pots of money have to be created that ringfence particular funds for particular purposes, subjecting them to certain restrictions.
Accounting standards
Most charities are subject to an accounting standard different to that of businesses, called the Charities Statement of Recommended Practice (SORP).
The SORP is designed to:
- provide recommendations for charity annual reporting;
- promote consistency in charity accounting standards;
- assist trustees in meeting their legal obligation for accounts to give a true and fair view.
Despite how the statement is described as “recommended”, the SORP, in practice, is mandatory.
Fund accounting
Unlike businesses, charities adopt a practice known as ‘fund accounting’.
This divides their income and expenditure into four pots, based on the purpose of the donations they receive.
One of these pots is called a restricted fund, which is made up of money that has been given to a charity for a specific purpose and cannot be used for anything else.
Another is a designated fund. These do not carry restrictions, but instead are used by trustees who have allocated funds for specific purposes. They can change their strategy on these funds, if they wish.
A third pot is referred to as general or unrestricted funds. These are donations that have been made without any specific charitable purpose. It is up to the trustees how they are spent – in line with their stated objectives of course.
And finally, we have endowment funds. These represent capital and charity law dictates that the trustees should use them for the charity’s purposes or invest them.
Normally, a permanent endowment cannot be made available for expenditure without the express permission of the Charity Commission.
Other considerations for charities
Good accounting planning for charities will consider other areas such as a reserves policy, donor reporting and how the use of the various funds can be optimised for paying overheads.
The Charity Commission has issued detailed guidance to charities on financial control in a publication known as CC8. This guidance is mandatory.
Specialist accounting services for charities
As you can see, accounting for charities is considerably different to that of businesses, but we have expertise in both.
If you would like to find out more about how we can help you and your charity, please contact us.