Trust in charities has been high on the public interest agenda in recent years, and one of the tools that regulators use to maintain it is the transparency and accountability provided by the preparation and publication of annual accounts.
Many believe that the variation in thresholds for reporting and mandatory audit are unnecessarily complicated. One option would be to have simple definitions of three groups – micro-charities with the simplest accounting and no external reports, small charities with a bit more detail and an independent report, and larger charities with the whole panoply of detailed reporting requirements and a full audit. These would offer three easily identifiable divisions within the sector, whether the entity is incorporated or not.
Everybody will have slightly different ideas of where the divisions should lie, but perhaps it is time to encourage simplicity and clear understanding by laymen. Over the years accounting and auditing standards have added layers of complexity to the traditional judgement of a trained accountant as to whether a reader of the accounts gets a true and fair view of the charity by reading the accounts. Paradoxically, the greater the detailed rules on these matters, the less likely the professionals are to encourage extra or tailored disclosures, even if they help the lay reader. After all, there’s a bigger target to audit and the costs will be higher, so why not keep things simple and consistently in line with software packages that help to produce rather anodyne numbers?
However, one of the best decisions made was to introduce the concept of an independent review for smaller charities. External scrutiny by someone financially aware, a sort of negative assurance as opposed to an audit, limited in scope but stringent enough to identify major mistakes or even a simple lack of accounts. The examiner looks for errors in the process of transferring the accounting records into the summary financial statement, and for any unusual matters that should be explained.
The Charity Commission guidance is easy to read and understand, albeit written from a rather top-down perspective that tries to cover a lot of different possible characteristics that the average examiner will never come across. It is guidance, not all mandatory, that tries to discourage a tick box approach. Nevertheless, to be an examiner one needs good financial awareness and to have read and understood the SORP.
Trustees have to choose their examiner with care, but there may not be a large population from which to do so. It really helps to have had an involvement in another charity, to have done it before, and to have some real practical experience in accountancy. Once the gross income of the charity exceeds £250,000 further restrictions limit the examiner to being a member of a list of professional bodies. The principle of a lighter touch regulation in this area is a good one, however much it upsets formally trained auditors.
Recently the Commission revised its guidance for examiners, based on a consultation process with examiners and accountants. There is a danger in any review process that a debate about requirements always produces further ones, and consultation exercises can be criticised if they reject respondents’ requests. So it is always easier to add to than delete guidance, without proper consideration of the benefits and the costs of changing the rules. Any standardsetting process therefore needs an oversight body to stop unnecessary expansion of the rules which will ultimately negate the logic of having the light touch in the first place.
On this iteration of the directions for examiners, the main changes have been to ensure that examiners have consciously recorded that they have not identified any conflict of interest that might bar them from appointment – a relatively easy point – but then adds two other principles to the list that some may consider part of the more complex lexicon of the audit profession.
They sound pretty simple. The examiner must make sure that “related-party transactions” are properly recorded, and consider whether the charity is a “going concern”. These provisions add to the robustness of the review, without doubt, and on occasion they will have a particular relevance, but they are concepts that the audit profession has been struggling with for a while.
Related-party transactions are a minefield for auditors – essentially auditors have to question the mindset of executives and trustees to see whether a decision to engage a supplier has been tainted by considerations that are not strictly commercial. When does a decision to use a supplier who you have used before, and trust to deliver, become a transaction with a friend? At one end of the scale it is obvious if there is any kickback arrangement, but alternatively a trustee may simply have decided to pay a higher cost to guarantee a quality of delivery. Difficult judgements ensue. It is interesting to note that a proposal to ask the examiner to consider whether conflicts of interest exist and how they are managed by trustees was rejected, but the need to record related party matters remains.
It must be said that the Commission has identified a number of cases during its investigations that led it to identify this as a common problem – often, when a charity’s governance goes awry, someone somewhere will be receiving an unauthorised benefit or payment, relatives are employed, trustees are paid, and charitable funds are thereby misdirected. Trustees must take responsibility for proper management, but examiners will find it difficult to identify hidden malpractice in those areas – and there is now a specific requirement to state that there are no related party disclosures to be made, and proving the absence of such transactions is difficult if not impossible, so there must be a test of reasonableness somewhere in the work of the examiner. Furthermore, it requires the examiners activity of simple testing of transactions to be extended into that more difficult area of sniffing for fraud, which is bread and butter for auditors but less easy for, for example, a bank manager.
The concept of going concern has also exercised the minds of accounting standard setters for decades. Now the examiner must ask the trustees whether they have considered if the charity will continue, and then go further to report if they have not carried out an exercise or if the examiner disagrees with them. This is one more step away from simple transactional review into probing the minds of the trustee board. Are there material uncertainties that might cause the charity to fold?
This addition to the process is clearly driven by an experience of increasing numbers of charities folding and probably by the high profile example of Kids Company where the trustees failed to ensure there was sufficient working capital maintained to tide the charity over more difficult periods. Government and local authority funding to the sector have both been cut, sometimes at very short notice in recent times, so many more charities are continuing with the hope rather than the expectation of sufficient future fundraising. Experience shows that at the smaller end of the sector this has always been the case; many charities exist to disburse donated funds, and if the funds aren’t there, no distributions can be made. However, many of these organisations have no long-term outgoings – no salaries to be paid, no building leases to continue – and in these cases the independent examiner can surely argue that even though activity might be reduced or suspended, the impact should not be terminal. Asking voluntary trustees for cashflow forecasts for the next twelve months may be met with rather blank stares and requests for a crystal ball. The working party redrafting the guidelines considered the matter at length and specifically excluded the need for the examiner to test the assumptions used by the trustees, so the judgement here is a fine one here.
The rules will be relevant where charitable money can be lost or will have to be used to cover long-term liabilities to third parties rather than reaching deserving beneficiaries, and this is what examiners must bear in mind. Judgement must be used to keep the light touch, appropriate, regulation that encourages trustees to be transparent and accountable, without feeling overburdened. One of the biggest challenges facing the sector remains finding good trustees, dedicated volunteers and competent assistance. The new guidance specifically excludes any requirement for the examiner to have a comprehensive knowledge of all the Commission’s publications, and the checklist for examiners is of real and practical value.
The regulators are clearly aware that in setting these regulations, they have to balance the need for maintaining accountability and trust against the willingness of volunteers to give their time and expertise. The volunteers must feel that they are carrying out an exercise that will add to the value of the charity sector, which is a gem that needs polishing and maintenance, rather than the ministrations of a sledgehammer.
Mark Spofforth is a partner at Kreston Reeves
Charity Finance wishes to thank Kreston Reeves for its support with this article