Set out below is a round-up of charity accounting and reporting in 2016, and reflections on this year of significant change.
1. FRS 102 and the New Accounting Framework
This was the big news this year! After more than two years of anticipating the adoption of Financial Reporting Standard 102 and the revised Charities Statements of Recommended Practice (SORPs), this year has been the year of implementation (accounting periods starting on or after 1 January 2015). Many charities (and auditors as well) have found that no matter how well prepared, there are always practical issues where what seemed clear on first reading proved confusing, or unanticipated issues emerged. It should be said, however, that for some charities the change occurred almost unnoticed, reflecting the evolutionary nature of these SORPs.
As it was already clear last year that the FRSSE was to be withdrawn for accounting periods starting on or after 1 January 2016, probably the majority of eligible charities opted for the FRS102 SORP rather than have one change with the FRSSE SORP this year and another change to FRS102 SORP next year. Some charities opted to continue with the FRSSE for various reasons. In particular, some charities were averse to having to prepare a statement of cash flows, but had income above the £500,000 threshold for preparing them under the updated FRS102 SORP; for those such charities that were eligible for the FRSSE, using the FRSSE SORP was the only way to avoid a cash flow statement (although even then the charity would only be putting off the “evil day” for one more year). Indeed, before SORP Update Bulletin 1 was published in February 2016, even the smallest charities applying FRS102 would have had to prepare a statement of cash flows.
One tiresome issue has been the failure of the UK government to update the charity accounting regulations for England and Wales (as opposed to Scotland where there is no such problem) which still refer to the old 2005 SORP. It is therefore necessary for unincorporated charities and CIOs to use a “true and fair over-ride” to justify use of the 2015 SORP (charitable companies are governed by company law and not the regulations). This inevitably complicates the accounts and the Charity Commission requires independent examiners of such charities to adapt their report.
One technical issue that has arisen is the audit of trustees’ reports. The same legislation (SI 2015/980) that increased the small company thresholds, and which had to be early adopted in order to take advantage of the small entity exemption for statements of cash flow, also required auditors to confirm that directors’ reports were prepared in accordance with legal requirements. Previously they only had to confirm that the reports were consistent with the financial statements. This creates more work for auditors and means that they would normally have to modify their audit report if the requirements for trustees’ reports are not met in full. For accounting periods starting on 1 January 2016 this will apply to all charitable companies (the legislation does not apply to unincorporated charities or CIOs).
Finally, over the last year the whole sector (and perhaps the wider public as well) has had to reflect on the so-called scandals that had afflicted us in the previous year or two. The fallout from Kids Company and fundraising “scandals” have been the topics of a great number of our client conversations. A positive point to take from this is how so many in the sector have embraced the need to understand and learn from the concerns that were raised. This along with the approach of the Charity Commission has certainly raised interest in the issue of wider accountability.
2. The Experience of Adopting the Revised SORPs
Despite the inevitable teething problems, all the preparation for the new SORPs last year stood charities and auditors in good stead for the change and by and large it has been relatively painless, at least for the smaller or more simple charities. For larger or more complex charities, which not only had to cope with more detailed disclosure requirements than smaller charities, but also might have had a number of transitional adjustments (see below), there has been more effort, but such charities are generally better staffed to cope with the extra demands.
Perhaps the single most complicated issue has been that of transitional adjustments where the new accounting policies have resulted in different numbers in the accounts. Working out what has changed, and how, and the effect on comparative amounts and reserves has been a major exercise, particularly where there are multiple adjustments such as multi-employer pension schemes, holiday pay accruals, changes to legacy recognition and donated goods etc.
The first SORP Update Bulletin, mentioned above, brought the definition of “larger charity”, which is important for deciding the level of detail required for disclosures, into line with that used in Scotland and Northern Ireland, i.e. income over £500,000 instead of using the audit threshold which had increased from £500,000 to £1 million. It also exempted “smaller charities” from the requirement to prepare cash flow statements.
One important issue that has emerged over the last few months has been the issue of comparatives under FRS102. The FRS102 SORP requires charities to provide comparatives for all amounts in the SOFA. Effectively for the split between restricted, unrestricted and endowment funds instead of just the totals as previously provided. Some accountants were concerned that this did not go far enough in implementing the FRS102 requirement to provide comparatives for all amounts in the financial statements other than where specific exemptions were given in FRS102 (such as fixed asset and investment notes). As a result, the length of the notes section of accounts were virtually doubled because, compared to commercial accounts, charity accounts tend to have much more tabular analysis (like the SOFA). Most accountants tended to argue that massively increasing the length of the accounts did not lead to greater transparency and that if the Financial Reporting Council had been aware of the issue they would have provided extra exemptions for charities in FRS102. Unfortunately, the Charity Commission has now shown its hand by updating its example accounts to show comparatives for fund movements, indicating that it is supporting the move to universal comparatives. While this is not the same as formally amending the SORP by means of an Update Bulletin, it does look like accountants are going to have to start getting used to providing longer, more clunky notes.
All charities have had to grapple with the concept of key management personnel (important particularly because of the need to disclose aggregate remuneration paid to them), but generally there has been little controversy over who should be so classified in addition to the trustees. Where there is a senior management team they have tended to be the obvious candidates.
3. The demise of the FRSSE
Despite the generally pain-free adoption of the FRS102 SORP noted above, there were still a reasonable number of charities that did want to use the FRSSE (Financial Reporting Standard for Smaller Entties) SORP, often for specific reasons and we were happy to support that decision.
Generally our experience has been that the transition from SORP 2005 to the FRSSE SORP 2015 has been relatively painless at least for smaller charities. While there have been inevitable changes to areas such as the accounting policy notes, generally there have been comparatively few changes. In particular there are relatively few changes to the Trustees report and no new requirement for statements of cash flows (as for the FRS102 SORP). The format of the SOFA was simplified, but there was no change for small charities applying the natural classifications.
As for charities applying the FRS102 SORP, there has been the issue of identifying key management personnel, although this is an FRS102 concept it was incorporated into the FRSSE SORP.
Although, as with FRS 102 SORP, income had to be recognised when probable rather than when virtually certain, in many cases this made no practical difference.
This is not to say that the FRSSE SORP did not bring substantial changes compared to SORP 2005, but in practice these changes mainly did not affect many charities.
4. The Independent Examination Consultation
This consultation by the Charity Commission was important to us as we undertake a considerable number of independent examinations. The consultation on the new directions for independent examiners included proposals for further guidance on:
- Additional points on examiners’ independence
- Conflicts of interest
- Related party disclosures
- Financial sustainability/going concern
- Group accounts (and in particular whether there should be guidance on the independent examination of such accounts)
- Reporting matters of material significance and relevant matters to the charity regulator
It also proposed welcome simplification of the examiner’s report and more generally attempts to adopt a simpler and clearer style. None of these issues are particularly controversial and we therefore expect most of these points to be reflected in the new directions when they are published in 2017.
We would particularly welcome clearer guidance on the important issue of independence. New ethical standards for auditors were issued in 2016 which strengthen further the framework for audits, and we consider these criteria are fundamental to the assurance provided by all external scrutinies of charity financial statements.
5. The Charity SORP Consultation
Just when you thought it was safe, there is no getting away from the SORP! One might have been forgiven for thinking that we would all have a break from it after all the shenanigans over the last two or three years (including the February 2016 Update Bulletin). But no, the Charity Commission and OSCR (Office of the Scottish Charity Regulator) are already consulting on the next SORP which is expected to be published in 2019. Specifically they are consulting on 5 areas:
- The SORP’s structure, format and accessibility.
- Implementation issues that require improvements to the SORP.
- SORP Committee member suggestions for changes (including the possibility of an extra layer of reporting for the largest charities, meaning 3 different sets of requirements depending on size; changes to the Trustees’ report; more specific definitions of support costs and fundraising costs; and looking at the perceived problem where capital grants are recognised in full in the year of receipt while the associated expenditure is only recognised over the life of the associated asset).
- The Charity regulator suggested themes for possible changes (public benefit reporting, risk management, going concern, enhanced analysis of expenditure, disclosure of where funding comes from and disclosure of key facts).
- Other ideas for items to remove, change or add to improve the SORP. This is an opportunity to sort out problems with the SORP (such as the often impractical requirement to disclose the total donations made to a charity by its related parties).
The consultation closed on 11 December 2016. For more information, search for “charities sorp research exercise”.
6. Other Reporting Requirements
Beyond financial reporting, there are some areas of concern both immediately and in the more distant future. These include the Common Reporting Standard, that particularly affects grant makers, and the lack of clarity over the rules is causing considerable worry; and in the longer term, Making Tax Digital will affect how most of us interact with HMRC, and whilst charities have significant exemptions, many will still be affected, such as through requirements applicable to trading subsidiaries.
7. Consultation on Reporting on “Matters of Material Significance”
This consultation caused some concerns with both auditors/ independent examiners and charities. Generally we are concerned that the proposed revisions will add significant and largely unnecessary burden held by auditors and independent examiners and we made this clear in our submission to the Charity Commission in response to the consultation. We are also concerned that there should be greater clarity on what is precisely meant by the expression “matters of material significance”. We take particular exception to three proposals:
- Reporting on any modified audit or independent examination report, regardless of its relevance to the Charity Commission in its regulatory capacity.
- Reporting where charities have not taken our advice given in management reports etc., which we believe could result in charities putting pressure on auditors to water down their reports.
- Reporting on conflicts of interest in accordance with Charity Commission guidance, which we believe places an undue burden on auditors, and even more so on independent examiners, who would be expected to keep up to date with the large body of Charity Commission guidance on this issue.
There seem to be an increasing number of tenders that we receive where the time required to undertake the review thoroughly has been grossly under-estimated. Charities need to take care that the value of the process is not undermined by it being undertaken without sufficient care or with undue haste.
If you have any concerns or would like to discuss the issues raised in more detail, please contact Hannah Farmborough or call on 0207 429 4147 to be put in contact with a member of our Not for Profit team.
This article originally appeared on the blog of our member firm, MHA MacIntyre Hudson.