Preparing Charity Accounts

Charities operate differently from traditional businesses. While a company's primary objective is to generate profit, charities focus on fulfilling their mission, whether that’s supporting a cause or providing community services. Due to this difference in purpose, charity accounts are subject to unique rules and frameworks that even seasoned accountants may find challenging.

Key Differences in Preparing Charity Accounts

Charities don’t just report income and expenses like a typical business. Instead, they need to separate their income into multiple "pots" based on how the funds can be used. The most common categories are unrestricted, restricted, and endowment funds.

Restricted funds must be used for specific purposes, while endowment funds are often investments that generate income for specific projects. This distinction requires an extra level of diligence when preparing accounts, as each pot comes with its own set of reporting and spending rules.

Steve, a charity sector specialist at Finance Box, highlighted the complexity of charity accounts: “A company just accounts for its income and expenditure in total, but a charity has to look at income, put it into separate pots, and explain what each is for.”

Steve also mentioned that charities face a major difference in how income is recorded. In business, money is generally received in exchange for goods or services. However, in the charity sector, donations are often given with no expectation of something in return, which shifts the way income is recognised.

Complying with Charity-Specific Regulations

Charities in the UK are regulated by the Charity Commission and must comply with specific accounting standards laid out in FRS 102 and the Charities SORP (Statement of Recommended Practice). These standards ensure that financial reports are transparent and provide clear information about how funds are raised and used.

One of the biggest misconceptions, according to Steve, is that “charities don’t pay tax.” In reality, charities need to be just as informed about taxes as businesses, especially in areas like VAT and trading income.

Certain forms of trading can disqualify a charity from tax exemptions, so it’s important to be vigilant about the distinction between permissible and non-permissible activities.

VAT can also be particularly tricky for charities, as they don’t typically charge VAT on their income. However, they can recover some VAT on their expenses under specific circumstances. Steve points out, "VAT can be a nightmare because most charities do not charge VAT on their income, but they need to know how much they can recover on their expenses through partial exemption."

The Complexity of Funding and Income Recognition

One of the trickiest areas of charity accounting is income recognition, especially when it comes to grants, donations, and multi-year funding. Sometimes, income is recognised immediately upon receipt, while other times, it must be deferred until the funds are used.

Steve highlights the confusion this can create: “You can have the income one year and expenditure the next, which can confuse trustees. A loss in a given year might just be a timing difference, not a true financial loss."

This complexity makes it vital for charity accountants to be well-versed in how and when income should be recognised, ensuring the organisation remains financially transparent to trustees and donors.

Specialist Training for Charity Accountants

Preparing charity accounts requires specialist training. For accountants used to working with businesses, charity accounts can initially seem foreign. Steve describes how accountants transitioning into the charity sector often find the financial jargon and structure unfamiliar: “Income and expenditure accounts are called SOFA (Statement of Financial Activities), and there’s just so much jargon. Our guidance helps translate that into terms that accountants can understand."

In the charity world, key financial terms differ from what you'd expect in a business setting. For example, charities don’t refer to "turnover." Instead, income is broken down into specific categories like donations, legacy gifts, grants, and trading activities. Expenses are classified differently too, as "raising funds" or "charitable activities," rather than the typical administrative or operational costs found in businesses.

The balance sheet in charity accounts looks familiar to business accountants, but with the addition of a funds section. This reflects the different types of funds the charity manages, each with its own restrictions and reporting requirements.

The Importance of Accurate Reporting and Transparency

One of the core principles of charity accounting is transparency. Unlike businesses where profit indicates success, charities need to use detailed reporting to explain their financial health. A financial loss in one year doesn’t necessarily signal a problem—it may simply reflect the timing of donations and spending. That’s why it's crucial to provide clear, detailed reports that explain the narrative behind the numbers.

As Steve notes, trustees and donors often rely on these narratives to make sense of the financial statements. "Explaining the result for the year and why you have funds (or reserves) is very important. A deficit might simply mean you're using funds from the previous year."

Final Tips for Charity Accounts

If you’re new to charity accounting, don’t be intimidated. Steve's advice to those starting out: “Don’t run away! It may look daunting at first, but with some effort and the right resources, charity accounts will start to make sense.” Thankfully, there are numerous guides and online resources available to help accountants get familiar with charity-specific terminology and practices.

For detailed guidance on charity accounting standards, you can refer to the “Charity (Charities SORP)” section on Croner-i Navigate UK GAAP Accounting. These resources break down the jargon and help understand how to manage and report charity finances effectively.

If you need help preparing your charity accounts, Finance Box has a team of experts ready to assist. From handling restricted funds to navigating the complexities of VAT, we offer specialist accounting services designed specifically for the charity sector. Visit us at Finance Box to get started today.