The Charity Commission’s Nigel Davies introduces the new framework for charity accounting and reporting
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UK GAAP is changing with effect for accounting periods beginning on or after 1 January 2015. This new GAAP framework brings change to charity accounting in the UK and Ireland. The existing Statement of Recommended Accounting Practice: Accounting and reporting by charities (popularly known as SORP 2005) will be superseded by a new framework of two SORPs.
What is new GAAP?
As far as charities are concerned, new GAAP is comprised of three standards:
- Financial Reporting Standard for Smaller Entities 2015 (FRSSE) – a UK Companies Act-based standard retaining the terminology and many of the small company accounting treatments of existing GAAP.
- FRS 100, Application of Financial Reporting Requirements sets out the general framework and establishes the status of SORPs.
- FRS 102, the financial reporting standard applicable in the UK and Ireland, is an amalgam of accounting treatments available under existing GAAP and the IFRS for SMEs developed by the International Accounting Standards Board.
The role of SORPs is to provide application guidance to help practitioners prepare accounts under GAAP, so when GAAP changes, a new SORP is required.
Why two new SORPs?
A draft version of a new charities’ SORP was issued for consultation from July to November 2013. The consultation process culminated in 179 written responses and more than 1,600 people participated in 26 consultation events held across the UK and Ireland.
A significant minority of charities already use the FRSSE and 88% of respondents supported a solution that supported both FRSSE and FRS 102.
However, due to a new accounting directive from the European Union, the longer-term future of the FRSSE is very uncertain. A number of respondents also advocated separating out the two standards with separate SORPs, citing dissimilarities in terminology, definitions and accounting treatments.
Therefore, to address these concerns, there are two new SORPs. While any charity can follow the FRS 102 SORP, only those charities that fulfil two of three eligibility criteria may adopt the FRSSE SORP. In order to use the FRSSE, charities must meet two out of three of the following criteria: an annual gross income of less than £6.5m; total assets of less than £3.26m; or fewer than 50 employees. Charities now face a very clear choice for accounting periods beginning on or after 1 January 2015.
In writing the new SORPs, care has been taken to respond to feedback from the charity sector, particularly:
- Think small first so the text clearly distinguishes requirements that apply to all charities from only those that apply to larger charities. Larger charities are those required to have an audit under charity law.
- A clear differentiation between what ‘must’ be done to comply with the SORP, what ‘should’ be done as a matter of good practice and what ‘may’ be done by way of extra illustration or an option.
- Clearly distinguishing between requirements imposed by the SORP from the requirements of accounting standards.
- More explanatory text to help smaller charities understand what is required.
- Avoiding unnecessary changes and so as far as possible terminology has been kept consistent with that currently used rather than switching over to new GAAP terminology.
- Retention of the columnar approach to the Statement of Financial Activities (SoFA) but with simpler clearer headings for income and expenditure.
How has the SoFA changed?
The table opposite compares line headings from SORP 2005 with their respective location in the SoFA under the new SORPs. For clarity only an extract of each SoFA is shown. An important change required by accounting standards that applies in future is a requirement to give comparatives for each column in the SoFA either on the face of the SoFA or in the notes to the accounts.
How will preparing accounts under the FRS 102 SORP differ from SORP 2005?
There are key differences in the areas of accounting policies and disclosure. Reference must be made to the SORP as the following highlights are not exhaustive.
With respect to accounting policies the main changes are:
- The income recognition criterion of ‘virtually certain’ is replaced by ‘probable’.
- New guidance on the recognition of income from legacies using a portfolio approach.
- Donated goods for resale or distribution are recognised on receipt unless impractical and/or the costs outweigh the benefits.
- New guidance on recognising income under the UK retail gift aid scheme on an estimated basis.
- New guidance on the identification of onerous contracts.
- Recognition of a liability for paid annual leave and sick leave.
- The differentiation between ‘basic’ and ‘other’ financial instruments.
- New guidance on the application of a total return approach to investments (England and Wales only).
- New class of social investments and mixed-motive investments.
- Incorporated charities are prohibited from being treated as branches.
- New guidance on the use of and criteria for merger accounting.
- Equity method now used for consolidating joint venture entities.
- A definition of de facto trustees added.
- A revised definition of related parties.
The main additional disclosure requirements are:
- Any material uncertainties of which the trustees are aware in making their going concern assessment must be disclosed.
- Detailed disclosures for income from government grants.
- Additional disclosures of related party transactions and the employee benefits received by key management personnel.
- The disclosure of the number of staff paid £60,000 or more in bands is extended to all charities that submit accruals accounts.
- Extensive disclosures to do with financial instruments.
- Summary analysis of heritage asset transactions.
- Extensive disclosure of nature of concessionary loans.
- New disclosures where the charity is a subsidiary of another entity.
- New merger disclosures.
- Additional disclosures for associates and joint ventures.
How different is the FRSSE SORP?
The FRSSE sits within a framework of existing GAAP which is being withdrawn. To allow for this, FRSSE 2015 provides that where an entity is facing an item or transaction of a kind for which it has no existing accounting policy (termed ‘accepted practice’) it should refer to FRS 102 to identify the ‘current practice’ to follow.
The FRSSE SORP requires if the FRSSE specifies a solution for specific items or transactions that the FRSSE must be followed, otherwise for charity (public benefit entity) specific items or transactions ‘current practice’ (new GAAP) must be adopted. The FRSSE SORP also identifies when charities can retain their existing accounting policy for non-charity specific items or transactions, provided this is consistent with ‘accepted practice’ (existing GAAP).
The main differences between the FRSSE and FRS 102 SORPs are:
- The opportunity to retain certain accounting policies for non-charity specific items or transactions.
- The Statement of Cash Flows is voluntary.
- Investment gains/(losses) do not count towards the net income/(expenditure) figure.
- The recognition of a liability for annual leave and paid sick leave is not required.
- A different approach to calculating the present value of liabilities and written down value using government bonds rather than a credit risk adjusted market rate (this is likely to result in higher present values).
- Fewer disclosure requirements for items in the accounts, especially to do with financial instruments, group accounts, and related party transactions.
What are the main changes to the trustees’ annual report?
The form and content of the trustees’ annual report is common to both SORPs. The two changes that affect all charities are:
- A charity must disclose its reserves policy or it must state it does not have a reserves policy and give reasons.
- All trustees who served in the accounting period and/or are in position at the time the report is signed must be named.
Changes that affect only larger charities are:
- A description of the principal risks and uncertainties facing the charity and its subsidiary undertakings, as identified by the charity trustees, together with a summary of their plans and strategies for managing those risks.
- The arrangements for setting the pay and remuneration of the charity’s key management personnel and any benchmarks, parameters or criteria used in setting their pay.
- An explanation of social investment policies and how any programme related investments contributed to the achievement of its aims and objectives.
What will need restating when preparing the accounts?
In preparing the accounts under a new SORP, the comparatives for the previous period need to be restated on a like-for-like basis which requires a revised comparator opening balance sheet and closing balance sheet for the previous period together with a SoFA for the previous period. Also if FRS 102 is followed, a comparative for the Statement of Cash Flows is needed.
The items most likely to require adjustment are:
- Material items of income known to the charity at the balance sheet date (or items that would otherwise be an adjusting item) to which the charity was entitled and that could be estimated reliably that were not accrued at the relevant balance sheet date solely because receipt was not virtually certain.
- If staff costs are a material item and the accounts are to be prepared under FRS 102, the initial accrual of paid annual leave and paid sick leave is likely to be material.
- If the charity is a member of a multi-employer defined benefit pension scheme and in the absence of notification of its share of the actuarial scheme deficit it has agreed to make additional contributions based on past service costs but has not recognised this liability and the accounts are to be prepared under FRS 102.
- The charity receives a material value of donated goods for distribution or resale and it is both practical to, and the benefits outweigh the costs of, recognising those goods on receipt.
- The charity elects to change its accounting policy for example to recognise concessionary loans at fair value rather than on the basis of the amount paid/received adjusted for accrued interest and repayments of principal.
- If the accounts are to be prepared under FRS 102 and a material item falls under the definition of an ‘other financial instrument’ and has not been previously recognised at fair value.
In respect of charitable companies and/or non-current debtors, material items of revenue under contract or from the sale of goods where extended credit terms are offered and the embedded financing arrangement has not been previously recognised.
Nigel Davies is technical secretary to the charities SORP committee at the Charities Commission.