Accrual basis accounting
Income and Expenditure vs Receipts and Payments
The Charities Commission (for England and Wales), The Office of the Scottish Charity Regulator (OSCR) and The Charity Commission for Northern Ireland require charities, including charitable incorporated organisations, to apply the Charities SORP (Statement of Recommended Practice). From 1st January 2019 this is the SORP 2019.
Regulators recognised that the usual business-type profit and loss presentation fell short of fully explaining all a charity's activities and some years ago introduced the Statement of Financial Activities (SOFA) as the major financial schedule for Charities.
The SOFA may be either on an Income and Expenditure or Receipts and Payments basis depending on circumstances.
Income and Expenditure versus Receipts and Payments
An income and expenditure report is presented on an accruals basis.
Accruals are amounts of money that have been earned or spent, but not yet paid. Accrued means that these amounts of money can increase over a period of time - accrue.
In many respects the accruals basis for reporting a charity’s financial activities is the preferred option. Accruals accounts record the income and expenditure of the charity and the increase or reduction in its assets and liabilities.
All income and charges relating to the reporting period must be considered without regard to the date of payment or receipt. Accruals accounts are compiled on a 'true and fair' basis in accordance with accounting standards.
Larger charities and those charities that are also incorporated under the Companies Act must use the accrual basis and prepare a SOFA as an Income and Expenditure report.
Smaller charities, those with income of £250,000 pa or less, are also encouraged to use the Income and Expenditure basis where it provides a reader with a better understanding of the situation of the charity. The Regulators suggest this may be where:
Donors may require accruals accounts to be prepared as a condition of a grant.
Trustees may need to explain more about the use of their resources than simply cash movements.
- a charity has significant non-cash assets, or fixed assets which the trustees would like to value and depreciate in the accounts
- a charity has received significant non-cash donations, gifts in kind or valuable gifts of service
- a charity operates a total return policy in relation to permanent endowment investments
Growing in size and complexity
the charity, despite having an income below the £250,000 threshold, is growing in size or complexity. For example the charity may use a trading subsidiary, or the charity is involved in joint operations with other charities.
Receipts or payments from asset and investment transactions
the charity has significant receipts or payments arising from asset and investment sales and purchase, and the trustees consider that the preparation of accruals accounts would explain these transactions more clearly.
Programme related investments as equity or loan
the charity carries out its activities mainly by making programme related investments by way of equity or loan rather than by making grants to beneficiaries and the trustees consider that the preparation of accruals accounts would explain these transactions more clearly.
The Receipts and Payments basis is a relatively simple form of reporting and consists of a summary of money received and paid during the financial period. Unlike the Income and Expenditure basis there is no statutory requirements for Receipts and Payments reporting, although the Charities Regulators offer some guidance notes. As a Receipts and Payments SOFA is not prepared in accordance with accounting standards it does not necessarily offer a 'true and fair' view to the reader.
Income and Expenditure Report - Accruals Basis SOFA
The Income and Expenditure SOFA will include all items of income and expenditure and were relevant, changes in values of assets and liabilities. It is consistent with the Charities SORP 2019 (FRS102).
For any particular fund, the fund balance will be sum of all assets less liabilities allocated to the fund.
Receipts and Payments Report - Cash Basis SOFA
The report is based upon cash transactions and so will not show non-cash items such as depreciation or re-valuations. It will also not show the income from any sales invoices raised but for which a receipt had not been received in the period of the report. Supplier bills that have not yet been paid will also not show.
The Net Movement in Funds line from a Receipts and Payments SOFA will be the difference between the opening balance and closing balances for bank and cash balances and the Fund balance will be the value of closing bank and cash balances.
Comparing and Income and Expenditure SOFA with a Receipts and Payments SOFA
The differences between the two reports will relate to those items in the Income and Expenditure report that are of a non-cash nature. Note, if the payroll system is being used any payroll journals charging expenditure accounts are treated as cash items in the Receipts and Payments report. So things such as:
- Any Depreciation charged
- Changes in any Customer balances from the start of the accounting period to those at the end
- Changes in any Supplier balances from the start of the accounting period to those at the end
- Purchases or disposals of investments or fixed assets
- Any non-journals that have been posted to income or expenditure accounts with the exception of system payroll journals charging expenditure accounts
- Changes in the value of any other non-cash asset or liability
By inspecting the items described above a user will be able to understand the differences between an Income and Expenditure SOFA and a Receipts and Payments SOFA for the same accounting period.
By way of example the following is a simple layout. An I & E reporting charity will have a Balance Sheet in addition to the SoFA that indicates all aspects of the changes the value of assets and liabilities being reflected in Fund Balances.
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