Preparing charity accounts: The differences between charities and businesses

Charities work a little different to everyday businesses as they are not run for the basis of making a profit. So when it comes to charity accounts there are some major differences that will seem odd even to a trained accountant.

We spoke to charity sector specialist and Partner at Price Bailey, Helena Wilkinson, to uncover the differences with charity accounts. Helena also authors the “Charity (Charities SORP)” online section of Croner-i Navigate UK GAAP Accounting to guide those that work in charity finance into understanding charity accounts.

What are the key differences for charities when you’re preparing accounts?

There are a few. Firstly there is a need to account for your income in more than one pot – with some pots being constrained to only be spent in a specific way. A company just accounts for its income and expenditure in total, but a charity has to look at income to put it into these separate pots and explain why you have each pot and what it’s for. They are called unrestricted, restricted and endowments. Restricted and endowment funds are the [pots where the funds in those pots are constrained. Even then, within a pot you could have lots of smaller pots. As an example, you could effectively have your hands tied behind your back in five different ways because five funders gave you five different requirements on what to do with the money and how to spend it.

Another aspect is that normal accounting standards don’t really apply because if you look at a normal accounting standard for a business you’re getting money in return for something whether its goods or services, something by which you generate profit. In the charity world that doesn’t work because you’re quite often given money by people who get nothing in return – a donation. So there’s this whole concept of being given something for nothing and then accounting for how you spend it. This means that you need special guidance on this and that changes the concepts behind accounts completely.

The requirements are set out in FRS 102. In addition the Charities SORP then helps interpret this for the specific requirements of charities.

What are the things to look out for regarding regulations for charities?

There is a misinformed view that charities don’t pay tax, but the reality is that they have to know more about tax and VAT than most other businesses, because although they generally don’t pay tax on their profits there are exceptions, so they have to make sure they fall into the permissible activity. Charities have limits on how much they can trade to purely generate profits as opposed to trading which is what they were set up for. So if you are a charity with its purpose to look after the elderly, care home fees would not be trading as the trade is permissible but selling Christmas cards would be trading.

VAT can be a complete nightmare because most charities do not charge VAT on their income. As a result, they cannot recover all of their VAT they incur on their purchases/expenses but they are able to recover some of it; so they have to work out what bits and how much. It is called partial exemption and it is complicated – it can be easy to get it wrong especially when concerning income, or the amount that needs to be reclaimed on expenditure.

How complex is the area of funding for charities?

Funding is most difficult when thinking about recognising income. It’s incredibly difficult, because sometimes you recognise it when you receive it regardless of whether you’ve spent it or not; and sometimes you don’t. So you can end up carrying unspent monies as balances in funds and that can confuse the trustees a lot because you can have the income one year and expenditure the other, and if they’re used to profit and losses they can see it as a bad thing when they get a loss, when actually it’s not a loss it’s a timing difference. So the way that charity accounts are put together is not instinctive for most business people and it needs some understanding to interpret the numbers and what they actually mean.

Do you need extra specialist training as an ordinary accountant to prepare charity accounts?

Yes. When you enter the sector and you pick up a set of charity accounts they can be frightening. That’s what a lot of people will say: they don’t understand them, they don’t feel right, they don’t make sense, and they’ll look different. There will be so much terminology they’ve never heard of before.  For example your income and expenditure account is called a SOFA (Statement of Financial Activities). There is just so much jargon that goes with the reporting. The online guidance I help write effectively tries to tell you what the jargon is and what it means, how do you deal with it and how do you report against it.

So the terminology is very different?

For a start most of your income streams in businesses use of the word “turnover” – this doesn’t appear in charities. So you analyse your income by various categories which relate to donations, legacy, grants, other trading activities, charitable activities, investment income – they’re your key income sources.

With your expenditure you don’t have admin and operational costs as you would for a company. You have two categories of expenditure: raising funds and charitable activity. So they’re not usual terminology that anyone would’ve come across and you need to understand what goes where, and how. On one side is income which is categorised by how it is received – like a legacy or a donation. On the other side is expenditure which is analysed by what you spent it on. However there is a split between direct costs (like the cost of on laundry costs in care home) and support costs, which no one will have ever heard of before. This is like overheads that have to be apportioned (like the HR and finance departments which are overhead costs of running the care home).

The balance sheet is pretty much a balance sheet apart from the fact that you’ve got funds, which will appear at the bottom. The rest of the balance sheet will look like you’d usually expect and there isn’t that much of a difference.

Does this give charities an unfair advantage or is it just a different way of doing things?

For anyone coming into the sector it will take time to get used to the terminology and the jargon. Therefore they’ll take a while to get up to speed on what the accounts look like and how to interpret them because the profit or loss for a company means how well or badly that organisation has done. Profit or loss in a charity doesn’t mean anything. This is why the narrative is so important and that’s why charities need to focus on that narrative. That’s why they need to go into so much detail with the information they put into a trustees report to try and make the numbers make sense to someone who picks them up with no knowledge. A loss (or a deficit) in a year could purely relate to spending monies you received the year before so it is not really a loss at all and could be a break even position if you took the two years as one. So explaining the result for the year and why you have funds (otherwise known as reserves) is very important.

What final tips would you give to someone involved in charity finance?

Don’t run away! It can look really daunting. It is accessible, you just need to put some effort into some of the jargon and the different way of recognising income, then you’re fine. There is lots of guides out there and the Charity Commission have some great 5 minutes  guides to explain the different responsibilities of Trustees which help explain the governance requirements of charities.  As soon as you get that, then you’re back into being an accountant and being more confident.

For expert step-by-step guidance that takes you through charity accounts take a look at Helena’s “Charity (Charities SORP)” online section of Croner-i Navigate UK GAAP Accounting. For further information you can get in touch with Helena at [email protected] or visit www.charitysorp.org.

We also regularly host charity insight events that give you the inside track on the industry – Take a look at our latest events.

[Article reviewed and updated 31 January 2024.]