Charity Financial Reporting Standards
Not Fit for Purpose ?!
This "Thought" is about how charities are currently required to report (and, by implication, manage) their finances. It makes the case that current guidelines are not fit-for-purpose, particularly for the vast majority (>85%) of small charities with annual incomes less than £250,000.
The Charity Commission seems to be of the same opinion.
In a recent (25 May 2021) letter to the Financial Reporting Council, the Commission said:
"The focus of accounting standards is very much on the interests of the providers of risk capital to for-profit businesses.
Charities are established for the public benefit and not as owner managed for-profit businesses and, although welcome, the PBE paragraphs are proving insufficient in addressing the reporting needs of the users or charity accounts and avoiding for-profit orientated disclosures detracting from the quality and character of public benefit accounting and reporting."
And Caron Bradshaw, chief executive of the Charity Finance Group, is reported as saying:
“The government’s drive to increase trust and transparency is to be welcomed by all. However, we need to break this long but flawed habit of shoehorning charities into regulation and legislation designed for the for-profit world to avoid the unintended and harmful consequences such an approach brings about for the third sector.
This "Thought" is a summary of a much longer (35 pages) article which provides more detailed evidence of "Not Fit for Purpose" (which can be downloaded by clicking HERE). In November 2020 it was submitted to the "Smaller Charities and Independent Examiners" Engagement Strand of the recent SORP review which commented:
"the thrust of your concerns about the current provisions of the SORP very much chime with our own".
The preparation of a charity’s financial accounts, and (for charities with incomes over the relevant threshold) having those accounts verified by audit or independent examination, is seen as one of the fundamental corner-stones of assurance to donors and the public at large that monies donated to charities are being used Efficiently, Effectively and Economically for the charitable purposes for which they were given.
In 2016 a survey by Populus commissioned by the Charity Commission had found that, at 57%, public trust in small charities was considerably higher than the 34% public trust in large charities.
In 2018, Populus was again commissioned by the Commission to undertake an independent survey of public opinions of the charity sector. The survey found that being “transparent about where money goes” was the most important factor in promoting public trust in charities.
But the latest (August 2019) review by the Charity Commission of charity annual reports & accounts found that:
- less than half (44%) of the annual accounts of small charities (incomes in the range £25,000-£250,000) complied with its benchmark standards;
- Larger charities were more, but still not fully, compliant with the standards;
Charities with incomes in the range £250,000-£1,000,000 were only 51% compliant;
Charities with incomes over £1,000,000 were still only 75% compliant
In other words: the Charity Commission’s own reviews show that the more compliant charities accounts are with complicated (obfuscational) accountancy standards the less likely they are to be regarded as “transparent and trustworthy” by the public.
A still more recent (March 2021) survey of trustees’ views of the SORP accounting standards by the Chartered Governance Institute reported the following comments from trustees (many of whom were reported as having qualified accountancy expertise):
- “I just think the amount of financial information that has to be provided is too extensive.
Note that the entire SORP runs to 203 pages and the index alone runs to 7 pages.”
- “It is too long and complicated for a non-financial trustee.”
- “The current presentation of financial figures is more difficult for nonfinancial practitioners who have to work quite hard to get an overall picture.”
In other words:
It is self-evident from these diverse reviews that the current reporting standards for charities are not fit for purpose – particularly for the majority of “small” charities.
“We can’t solve problems by using the same kind of thinking we used when we created them”.
The problem of current charity accounting/reporting standards being “not fit for purpose” for small charities is not a new one, “suddenly popped up from nowhere”. It has been around for at least a decade, probably for much longer.
So why is it still such a growing problem?
Because Einstein’s advice is being ignored !
Thinking that the problems can be resolved by either “adjusting some of the detail” of the current FRS-102/SORP and R&P accounting/reporting procedures or, worse, by promoting them even more enthusiastically is only perpetuating the problems, not solving them.
Accruals reporting or R&P reporting are the current “Hobson’s Choice” – “take it or leave it” – of charity financial management for small charities.
Accruals reporting standards are the “shire horse” of financial reporting in the commercial sector. Although undoubtedly huge and magnificent to the eyes of accountancy aficionados, as the March 2021 review reports, they are hopelessly “over-the-top”, cumbersome and inappropriate for ordinary every‑day use by the majority of small charities, particularly those which do not have the resources to employ accountancy professionals.
(a) they are unnecessarily dependent on complicated, stylised/jargonised and obsolete double-entry bookkeeping methodology, requiring a significant amount of professional financial training which is beyond the reasonable capabilities of the non-accountant, unpaid volunteers & trustees of small charities;
(b) they unnecessarily require assets be assigned hypothetical valuations (financial “magical money” - produced out of nowhere by the "wave of an accruals wand") which have to be included in a charity’s accounts as if they were “real money”. That, in turn, requires that any fluctuations in the “magical money” valuations of assets have to be included in a charity’s counts as if they were “real money” income and expenditure.
(c) as a consequence, accruals reporting is seen as confusing, misleading and irrelevant – ie: untrustworthy – by many who are not trained in financial “bean counting”, particularly the typical non-accountant trustees and other volunteers, beneficiaries and other stakeholders of small charities.
In contrast: Receipts & Payments (Cash) reporting standards are the “Eeyore” of financial reporting. Although ostensibly “simple and likeable”, in practice they are rather inept and error-prone. The are the “simple alternative” for those who can’t cope with “proper” accruals reporting.
(a) the separation of the transfers of funds from the activities to which they relate can (and often does!) create significant distortions in the charity’s financial reports;
(b) the notion that keeping R&P-focused financial records is “simpler” than keeping accruals-focused financial records is wrong and misleading.
Both Accruals(FRS-102/SORP) and Receipts & Payments (Cash) reporting standards are primarily not fit for purpose, particularly for small charities, because neither were designed to meet the needs of most of those who will create, use and read them.
Which is why all too often when it comes to standards for financial reporting the non-accountant trustees of small charities tend to take a “blow that for a bowl of cherries” approach, disregard the formal accounting standards and instead produce something that they, and their supporters can actually understand.
Which is why significantly more than half of small charity accounts fail to meet the Charity Commission’s financial reporting standards, while significantly more than half of the public find small charities more trustworthy than large charities whose financial reports are better at complying with the reporting standards.
What is needed is to abandon both the FRS-102/SORP (accruals) and the R&P (Cash) reporting standards – certainly for all charities with annual incomes less than £1M – and replace them with a single standard which:
1: is designed “from the bottom up” – based on the way that the “ordinary” non-accountant trustees and other volunteers and staff of the majority of small charities work naturally and intuitively to optimise their use of resources to meet the needs of their beneficiaries.
ie: charity reporting systems should NOT be just an adaptation of reporting systems designed for the commercial sector with quite different objectives, namely the optimisation of their resources for the financial benefit of their investors;
2: is designed to take full direct advantage of the features of modern relational database technology (ie: abandons obsolete double-entry bookkeeping concepts);
3: records both the date of the activity to which the transaction relates (ie: as in Accruals reporting) and the date on which the “money changes hands” (ie: as in R&P reporting). That will allow one simple set of data to produce both activity based reports (eg: for the end of year financial report to the Charity Commission and the public record) and cash-flow reports (ie: for the day-to-day financial management of the charity, and for reporting to donors);
4: does not separate financial records and reports into isolated siloes (eg: financial reporting, management reporting, budget reporting, creditors & debtors reporting, cash-flow reporting) but is simultaneously producing all such reports and updating them in “in real time” as transactions are entered or updated;
5: does not create unnecessary and irrelevant confusion by creating hypothetical (“magical money”) values of a charity’s assets (operational, investments and heritage) and then integrating those “magical money” numbers along with the charity’s “real money” cash assets (including changes in those “magical money” values as if they there income or expenditure, even though no “real money” ever changes hands).
It is acknowledged that criticising the current standards is “the easy bit”.
But the above proposals are not as hypothetical as the accountancy “magical money” of which they are so critical.
On the contrary: ALL the above features are demonstrated as being feasible, practical and robust by the open-source “Charity Accounts Made Easy” spreadsheet created by Small Charity Support.
“The proof of the pudding is in the eating”.
The Small Charity Support's “Charity Accounts Made Easy” spreadsheet has been in existence since 2014 and is used successfully by a number of small charities some of which produce Receipts & Payments financial reports and others which produce Accruals financial reports.
- Financial transaction data entry is simple and intuitive requiring no special “bookkeeping” skills;
- Routine financial management reports (Budget, Cash Flow, Debtors/Creditors) can be produced “in real time” (ie: by a “click of a button” as transactions data are entered);
- End-of-Year Annual Accounts and Financial Statements – compliant with current guidelines for small charities – can similarly be produced “in real time” at the click of a button for inclusion directly into the Trustees’ Annual Report.
This article is not a commercial promotion of the Small Charity Support financial recording & reporting spreadsheet.
Instead the spreadsheet was developed as a practical and working demonstration of the application of the “Simple is Beautiful” concept to the financial management and reporting of small charities.
The spreadsheet is, always has been (since 2014), and always will be, open-source software, free to download from the Small Charity Support website and use by charities and other not-for-profit organisations for non-commercial purposes.