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 has also published a book entitled “Preparing Charity Accounts – New UK GAAP edition”, 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 each pot being constrained to be spent in a specific way. A company just does its income and expenditure, 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 restricted and endowments. Even then, within a pot you could have lots of small 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.

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 rules have changed a lot recently as well with FRS 102. Everything I have ever known I have had to throw away and start from scratch and so has every accountant. That probably sounds a bit extreme but you can’t rely on which bits have or haven’t changed on disclosures and more complex treatments. The basics are generally the same but relying on old knowledge now could be dangerous.

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 don’t pay tax on their profits there are exceptions, so they have to make sure they fall into the permissible activity.

VAT can be a complete nightmare because most charities cannot recover all of their VAT but they have to recover some of it. So they have to work out what bits and how much.

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 book I published 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 that side of things it is predominantly around income expenditure and because the expenditure fits in those categories you then have something called support costs, which no one will have ever heard of before. This is like overheads that have to be apportioned.

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.

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. 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 book “Preparing Charity Accounts – New UK GAAP edition”. 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.