The new Charities SORPs – initial matters for consideration
The accounting requirements for charities which prepare 'true and fair accounts' are changing for periods commencing on or after 1 January 2015: OSCR and the Charity Commission have published two new Statements of Recommended Practice (SORPs).
Charities which meet the small company definition (See note 1 below) are eligible to apply the Financial Reporting Standard for Smaller Entities (FRSSE) and can use the Charities SORP (FRSSE); all other charities must apply the Charities SORP (FRS 102).
Both versions of the SORP are available on the SORP microsite.
The main driver for the changes is the Financial Reporting Council's (FRC's) future withdrawal of existing UK accounting standards and their replacement with a new suite of accounting standards, including core standard, Financial Reporting Standard (FRS 102). However, it is the forthcoming implementation of a new EU Accounting Directive which made the publication of two separate SORPs expedient.
The Directive will significantly reduce the mandatory disclosure requirements of small companies (excluding non-profit making companies) for accounting periods commencing on or after 1 January 2016 although the accounts of such entities will still be required to show a true and fair view. At the same time it is proposed that the financial reporting qualifying conditions for small companies will be raised (See note 2 below). This is expected to necessitate the withdrawal of the FRSSE 2015 and its replacement with new guidance for small companies to be contained in a FRS 102-based framework with reduced disclosures. The potential implications of the withdrawal of the FRSSE for charities applying the Charities SORP (FRSSE) are explored further in this article.
The Charities SORP (FRS 102)
While there are many differences between the Charities SORP (FRS 102) and the Charities SORP (2005), the main difference between old and new is application of the fair value approach under the SORP (FRS 102) in relation to the recording of some transactions and balances, although historic cost accounting remains a feature in some instances, for example, fixed assets can continue to be measured at historic cost. Some of the other changes introduced by the SORP (FRS 102) are:
Statement of financial activities (SoFA)
- Income and expenditure classifications have been amended to reduce the number of line items.
- Gains and losses in investment assets must be treated as part of the income or expenditure of the charity and therefore go 'above the line'.
- Comparative figures for each column must be presented. However, the comparatives for each class of fund may be included within the notes rather than in the SoFA.
- In the SoFA, or in the notes to the accounts, material items must be separately disclosed where this is necessary to give a 'true and fair' view. This requirement is similar to the old UK GAAP requirements on exceptional items.
Statement of cash flows
A statement of cash flows must be prepared even if a charity chooses to apply FRS 102 rather the FRSSE.
Notes to the accounts
- Support costs, including costs classified as governance costs, must be disclosed separately. Governance costs are no longer reported as a separate line item within the SoFA.
- Charities must disclose the total amount of all employee benefits received by key management personnel in relation to their services to the charity.
- Charities must either disclose the fact that there were no employees who received remuneration in excess of £60,000 or disclose the number of employees remunerated above £60,000 in bands of £10,000.
Recognition and measurement
- Income, including legacies, must be recognised when receipt is 'probable' rather than 'certain'.
- Charities may adopt a new portfolio approach to the recognition of legacies.
- Donated goods for resale or distribution must be recognised at fair value on receipt unless it is impractical to do so.
- Holiday pay must be accrued in relation to any outstanding annual leave entitlement at the year-end.
- Two broad financial instrument categories are introduced 'basic' and 'other', accompanied by requirements for each category on recognition, measurement and disclosure. The other financial instruments' category picks up all financial instruments which fall outside the definition of basic, in essence complex financial instruments.
- Charities which do not recognise their share of a defined benefit pension scheme deficit, must recognise the net present value of agreed deficit contributions.
Accounting for business combinations
- Charities engaged in restructuring must comply with new tailored guidance on accounting for acquisitions and mergers.
The Charities SORP (FRSSE)
Applying the SORP (FRSSE) should in theory limit the extent of any changes required to a charity's accounts. However, this will depend on the circumstances of each individual charity. Also, the limited shelf-life of the SORP (FRSSE) and its possible replacement with FRS 102 based requirements for accounting periods commencing on or after 1 January 2016, may mean that adopting the SORP (FRSSE) could lead to two years of upheaval rather than one.
Charities applying the FRSSE will need to understand when to apply 'current practice' and when it is appropriate to apply 'accepted practice'. 'Current practice' in this context means compliance with new UK GAAP i.e. FRS 102 and 'accepted practice' means compliance with old UK GAAP. Referencing two different accounting frameworks adds complexity and if time had allowed, OSCR and the Charity Commission, may well have consulted on prohibiting the use of the FRSSE by charities.
OSCR and the Charity Commission have issued three helpsheets to assist charities and their advisors understand the changes. Helpsheet 3 will assist in understanding the differences between the two versions of the SORP.
The SORP (FRSSE) sets out the required approach to the selection of accounting policies in module 3. First, charities using the FRSSE must refer to the FRSSE and the relevant modules in the SORP, thus emphasising that the FRSSE is the main underlying standard. However, there are three important caveats to this:
- Current practice must be followed as set out in the SORP "to reflect the special factors prevailing or transactions undertaken in the charity sector." Each module of the SORP (FRSSE) specifies when current practice must be followed and when there is flexibility.
- For existing transactions where current practice is not mandated and which are not specifically dealt with in the FRSSE, charities may retain their existing accounting policies provided those policies reflect accepted practice and include the relevant disclosures in the SORP (FRSSE).
- For new transactions not specifically dealt with in the SORP or the FRSSE, charities are required to have regard to current practice but are not compelled to comply with current practice.
Charities which are eligible to use the FRSSE but choose to apply FRS 102 will be required to prepare a statement of cash flows. The equivalent exemption from preparing a cash flow statement under old UK GAAP does not exist under FRS 102. The key message is that all charities preparing true and fair accounts must review all their accounting policies in preparation for applying the new Charities SORPs. This applies equally to charities applying the SORP (FRSSE) and the SORP (FRS 102).
As the new SORPs apply to accounting periods beginning on, or after, 1 January 2015, charities with 31 December 2015 year ends must prepare comparatives on the same basis for the year to 31 December 2014. To achieve this, opening reserves at 1 January 2014 must also be established. For charities where transactions, assets and liabilities have to be re-measured due to changes in accounting policy, additional information will need to be collected in respect of previous years. Charities applying FRS 102 should also be aware of and comply with Section 35 of FRS 102 entitled 'Transition to this FRS'.
More detail about possible changes in 2016
The withdrawal of the FRSSE in itself for periods commencing on, or after, 1 January 2016 would lead to the withdrawal of the SORP (FRSSE) as it would have no underlying standard to support it and the Office of the Scottish Charity Regulator (OSCR) and the Charity Commission would need to consider what, if anything, may replace it. Although the Directive does not apply directly to charitable companies and non-company charities it is expected to influence the future of charity accounting: the FRC plans for all entities which meet the new small company definition to be eligible to use the FRS 102 reduced disclosure framework. This is likely to be a factor in the charity regulators' deliberations on whether or not replace the SORP (FRSSE) with material based on the FRS 102 reduced disclosure framework or to require all charities preparing true and fair accounts to comply with the full version of the SORP (FRS 102). If charities apply the FRSSE for periods commencing on, or after, 1 January 2015, the likelihood is that they will need to make some changes in their approach towards the recognition and measurement of assets and liabilities the following year. However, if charities apply FRS 102 rather than the FRSSE for periods commencing on, or after, 1 January 2015, this could lead to additional work, for example, on the preparation of a statement of cash flows and more detailed disclosures which may not be required in future years.
Note 1: Definition of a small company
As a reminder, a charitable company or non-company charity meets the small company definition in a particular year:
- If the qualifying conditions are met in that year and the preceding financial year;
- If the qualifying conditions are met in that year and the company qualified as small in relation to the preceding financial year;
- If the qualifying conditions were met in the preceding financial year and the company qualified as small in relation to that year.
(Although the wording of the Companies Act 2006 has been revised in relation to the above, the substance of the requirements remains the same.) The qualifying conditions are met by a company in a year in which it satisfies two or more of the following requirements:
- Turnover of not more than £6.5 million
- Balance sheet total (gross assets) of not more than £3.26 million
- Employees of not more than 50
For charities 'turnover' is interpreted by the charity regulators as 'gross income'.
Note 2: Proposed revised definition of a small company from 1 January 2016
The definition of a small company will be revised through amending the qualifying conditions. From 1 January 2016, the conditions are expected to be:
- Turnover of not more than £10.2 million
- Balance Sheet total (gross assets) of not more than £5.1 million
- Employees of not more than 50