Charities are driven by purpose rather than profit, and their accounting practices reflect this fundamental difference.
Unlike for-profit businesses, charities must adhere to the Statement of Recommended Practice (SORP) for charities, which dictates the preparation of accounts to ensure transparency for donors, beneficiaries, and regulators alike.
While a limited company’s financial statements aim to present profitability and shareholder value, charity accounts focus on accountability and stewardship of funds.
Income is typically split into restricted funds (earmarked for specific purposes) and unrestricted funds (usable for general objectives).
This classification ensures charities cannot spend money raised for a new community centre on administrative overheads, for example.
Another critical aspect of this is the trustee report, which accompanies charity accounts.
This report outlines how funds have been used in alignment with the charity’s objectives, making it as important as the financial numbers themselves.
For a for-profit business, narrative reporting is typically a marketing opportunity whereas for a charity, it’s a legal requirement.
From an operational standpoint, charities often face additional challenges such as dealing with Gift Aid claims and VAT exemptions, both of which require meticulous record-keeping and compliance.
It’s an area where charities must walk a fine line – benefiting from tax relief without breaching regulations.
On regulations and reputations
Charities operate under a heavier compliance burden than their for-profit counterparts, with the Charity Commission and other regulators keeping a watchful eye.
For small charities, even the simplest mistake in reporting can lead to fines or reputational damage, while larger charities may also face public scrutiny if their compliance falls short.
The legal structure of a charity also affects its compliance obligations.
A charitable incorporated organisation (CIO), for instance, has streamlined reporting compared to a charity structured as a company limited by guarantee, which must adhere to both Companies House and Charity Commission requirements.
Moreover, fundraising activities create unique compliance challenges.
Charities must ensure that fundraising appeals are clear, truthful, and transparent, following the Code of Fundraising Practice.
Normal businesses, on the other hand, are not bound by such codes when soliciting investments or selling products.
Finally, the public nature of charitable operations means compliance is also about building trust.
Missteps in governance or financial reporting can lead to donor attrition, which is catastrophic for organisations reliant on public goodwill.
Charity auditing
Auditing for charities is partly about ensuring financial accuracy, but it’s also about ensuring funds are used appropriately and ethically.
While a standard business audit focuses on profit and operational efficiency, a charity audit delves into whether funds have been spent in accordance with donor restrictions and the charity’s stated objectives.
Charity auditors must assess the public benefit provided by the organisation, as this is a core requirement of charitable status.
For charities with a turnover exceeding £1 million or with gross assets over £3.26 million and an income of £250,000, audits are mandatory.
Smaller charities may only require an independent examination, which is less rigorous but still more detailed than the requirements for micro-entities or SMEs.
A particularly nuanced area is auditing fundraising activities, where auditors examine whether income from events, sponsorships, or corporate partnerships has been accurately recorded and reported.
This scrutiny is essential to maintain donor confidence, particularly for charities operating high-profile campaigns.
For charities receiving grants, auditors must also verify compliance with grant conditions.
Failure to meet these conditions could mean repaying the grant entirely.
If you run a charity and you’d like help with your accounting or auditing, please speak to one of our experts.