Are your charity accounts telling the full story?

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The mention of accounts and audit may set few hearts racing, possibly even among those who work in these professions. But that should not lead anyone to underestimate the importance of accounts in the charity sector, nor the damage that can be done if it emerges that those accounts might not be telling the full story.

The Charity Commission has just published a report on its research into the accounts of a sample of 296 charities and has revealed what looks like a disturbingly high level of non-compliance – even to the point of the figures not adding up.

This issue goes beyond the purely financial aspects of running your charity – it raises issues about good governance and also of your compliance with your legal duties as charity trustees. When you report on how your charity has used its resources, you are demonstrating that you can be trusted to make good use of donations and other funding, provided by members of the public either directly or through channels that are supported out of taxation. The chances are that your charity will also benefit from substantial tax relief (including Gift Aid) and there is a genuine public interest in ensuring that your charity is accountable for its use of these funds. It is for this reason that one of the core functions of the register of charities, which has been maintained by the Commission since 1961, is to enable the public not only to check that an organisation has been formally recognised as a charity, but also to have easy access to the charity’s accounts. This plays a major part in promoting public trust and confidence in your charity, and in charities generally.

So that these accounts are meaningful and can be read consistently, accounting standards have been developed for the sector that, for example, require all but the smallest charities to prepare a trustees’ annual report to accompany the bare financials, and to include information that is critical to the financial health and sound governance of the charity. Of course, preparing a charity’s accounts is only part of the story. There also has to be, at least for larger charities, a process of assurance and this is why charities with a gross annual income of over £1 million (and charities with income over £250,000 and assets worth more than £3.26 million) have to arrange for their accounts to be professionally audited and have to ensure that their accounts include the auditor’s report which should confirm whether, in the auditor’s view, the accounts have been prepared in accordance with the relevant accounting standards and present a true and fair view of the charity’s affairs. Charities with income between £25,000 and £1 million have a slightly more relaxed requirement for external scrutiny, in that they can have their accounts scrutinised by an independent examiner. These rules apply to about 64,000 registered charities – that’s approximately a third of all registered charities.

The Commission recognises that the primary responsibility to protect charity funds rests with the trustees themselves, but also sees the audit and independent examination requirements as an essential “second line of defence”. Alongside its latest report, the Commission has published a benchmark that is intended to enable charity trustees, their accountants or auditors and the Commission to assess whether a charity’s accounts comply with the basic requirements. And we are not talking about technical details here – the 15 separate criteria include whether there is a trustees’ annual report, and whether the figures in the accounts actually add up.

Tested against this benchmark, this sample of 296 sets of charity accounts does not fare well. The Commission states, with admirable bluntness, that “too many independent examiners and auditors appear to lack the necessary understanding of the external scrutiny framework for charities and of their reporting duties.” Looking through the research results, it might at first appear that the Times headline on 29 August (“Half of charity accounts below standard”) was displaying a bit of journalistic shorthand, but in terms of the overall levels of compliance with criteria that are actually quite fundamental to the scrutiny process, the compliance level for the whole sample is indeed a disappointing 54%. Compliance among charities sampled in the £1 million+ bracket (and this is of course the part of the sector where the vast bulk of charity money is concentrated and is therefore at the top of the Commission’s agenda) is a slightly more reassuring 76% but, given how basic most of the criteria are, this is hardly an excuse for self-congratulation.

This has to be worrying – not just for the Commission and for the general public, whose trust in the charity sector has been tested rather a lot in recent years, but also for charity trustees. This is particularly the case in respect of the failure of many charities accounts to disclose related party transactions – the sorts of financial relationships between the charity and its trustees, or people or companies connected with them, that can all to easily fall foul of the requirements of charity law and good governance. Even if you and your fellow trustees are successfully identifying and managing conflicts of interest, your efforts to ensure transparency and accountability are hardly helped if your accounts then fail to make the necessary disclosures. This is a complex area, and the duty to disclose related party transactions in your accounts is really only the tip of the iceberg: there are strict legal rules about what transactions are permitted, and what payments can properly be made to trustees and connected parties, and you will need to make sure that any transactions have the necessary legal authority long before you would have to disclose them in your accounts.

It is reassuring to see that two of the key professional bodies, the ICAEW and ACCA, were given a chance to comment on the research findings before publication and to emphasise their commitment to the job of ensuring that the reports that are filed with the Commission are timely, accurate and trustworthy.

For trustees, the key message seems to be that you should pay close attention to the Commission’s guidance on the appointment of independent examiners. Within the sample in the research, the Commission has provided guidance to the 135 charities whose accounts fell short of the mark , but the wider message is a rather familiar one: the responsibility for compliance rests with you as trustees – not only to make effective use of your charity’s funds but also to ensure that you are seen to do so.

For further information please contact our charity law solicitors on 01895 207862 or email charities@ibblaw.co.uk.