Scrutiny of charity accounts

As part of its regulatory activity the Charity Commission for England and Wales has undertaken a study of the accounts prepared by charities and concluded that standards need to improve.  Their criticism is not just directed at trustees as the preparers of charity accounts.  The Commission has also highlighted the vital role that external scrutiny plays in ensuring that charity accounts are properly prepared and comply with all reporting requirements, and their report highlights where the standard of work performed by auditors and independent examiners is falling short. The Charity Commission is working with the accountancy bodies to improve the performance of professional accountants that act as charity auditors and independent examiners in meeting their responsibilities.

External scrutiny benchmark

As part of their review the Charity Commission compared a sample of accounts filed with them against their external scrutiny benchmark.  This comprises set criteria against which accounts are judged and reflects the different reporting frameworks that can apply to charities of differing size and legal nature, with more expected where the accounts are prepared on an accruals basis in accordance with the Charities Statement of Recommended Practice (SORP).

The Charity Commission hope that by publishing A benchmark for the external scrutiny of charity accounts it will help to drive up standards, both by clearly setting out the minimum standard of work that is expected and by providing a framework by which the performance of auditors and independent examiners can be assessed.  Where it highlights poor performance, it provides a basis for trustees to reconsider their choice of auditor or independent examiner and will assist the Charity Commission in identifying where regulatory action may be required to tackle shortcomings in the work of professional accountants.

Many of the criteria set out in the benchmark are relatively basic, such as ensuring that the accounts have been prepared under the correct reporting framework, add up correctly and are internally consistent.  It is also designed to check that the annual report contains all the components that are required, including a trustees’ report, the necessary primary statements and an appropriate auditor’s or independent examiner’s report.  The benchmark also addresses some key aspects of charity reporting, such as whether unrestricted and restricted funds have been clearly identified and that transactions with trustees and other related parties have been adequately disclosed.

The Charity Commission’s findings

In performing their review the Charity Commission looked at 296 annual reports for a range of charities of differing size and type.  Their findings can be summarised as follows:

This shows a general trend that the annual reports of larger charities demonstrate a greater degree of compliance with reporting requirements than those of smaller charities.  Given that the larger the charity the greater the level of external scrutiny that is required it is not surprising to find there is also a correlation between the level of external scrutiny and the degree of compliance that the annual report shows, as can be seen by the following results:

Charities with income of more than £25,000 but less than £250,000 are generally only required to have their accounts reviewed by an independent examiner who need not be an accountancy professional, so it is no surprise that the accounts of such charities show the lowest level of compliance with the benchmark criteria.  Larger charities, with income between £250,000 and £1 million, must appoint an independent examiner who, broadly speaking, is a member of a professional accountancy body (or a Fellow of the Association of Charity Independent Examiners), and these charities demonstrate a higher level of compliance with the benchmark criteria.

As you would expect those charity accounts which have been subject to audit show a greater level of compliance with the benchmark criteria than those which have only been subject to independent examination, a less rigorous form of external scrutiny.  To address this the Charity Commission has updated its guidance material Independent Examination of accounts: guidance for trustees

As part of their study the Charity Commission has produced a report on auditors’ and independent examiners’ compliance with their responsibilities. In its findings the Charity Commission is critical of the performance of both auditors and independent examiners and cites a lack of the specialist skills and experience of charity reporting that are required to provide effective scrutiny of charity accounts.  The Charity Commission is working with both the Institute of Chartered Accountants in England & Wales (ICAEW) and the Association of Chartered Certified Accountants (ACCA) to improve their members’ awareness of charity reporting and accounting requirements, and to identify any necessary improvements to the guidance they provide to their members and students.

Related party transactions

In their review of charity accounts the Charity Commission has highlighted the lack of adequate disclosure of related party transactions as being of particular concern to them, and have published a separate report regarding the reporting of related party transactions.

 The SORP requires charity accounts to be transparent about their transactions with persons and entities closely connected to the charity or its trustees.  Where related party transactions have not been adequately disclosed auditors and independent examiners are required to report this fact to the Charity Commission as a matter of material significance.

When considering whether accounts were compliant with the requirement to disclose related party transactions the Charity Commission considered three aspects of the required disclosure – trustees’ remuneration, trustees’ expenses and the disclosure of other related party transactions with persons and entities closely connected with the charity.  Their findings were as follows:

As can be seen there is a relatively high level of compliance for disclosing trustees’ remuneration and expenses, but less so for other forms of related party transactions, especially by smaller charities.

In many cases the Charity Commission suspects that the non-compliance relates to the new requirement that was introduced in the latest version of the SORP to include a statement in the accounts where there had been no related party transactions in the reporting period.  However it could also mean that significant transactions with related parties are being under reported.

The Charity Commission has expressed particular disappointment that where their study has shown that related party disclosures have been inadequate, on each occasion the charity’s auditor or independent examiner did not report this fact to them.  They are concerned that this could also mean that the related issue of a failure by trustees to adequately manage conflicts of interest is being under reported to them.  The details of the auditors and independent examiners involved have been reported to their professional bodies where they are members of either the ICAEW or ACCA so that action can be taken to address this issue and ensure a greater level of compliance by auditors and independent examiners going forward.

How Mercia can help

The Mercia charity specialist assignment manual provides guidance for both auditors and independent examiners and will help to ensure that the work performed meets the standards expected by the Charity Commission.  This includes work programmes setting out the testing that should be performed, disclosure checklists that will assist in ensuring that accounts have been properly prepared and a whistleblowing checklist of all the matters that auditors and independent examiners may need to report to the Charity Commission, including the lack of adequate disclosure of related party transactions.

Our training for charity specialists, whether online or at our range of courses at locations across the UK, is designed to include current developments in charity reporting and will feature matters such as those featured above that have been raised by the Charity Commission and other charity regulators and which need to be brought to your attention.