FinOps Partners

Why Do Charities Need Specialised Accounting?

Being a charity trustee comes with a set of financial challenges that go beyond what a normal accounting system can handle. Your charity is not like a traditional business; it operates in a complex regulatory environment. Therefore, your financial practices must be highly transparent and accountable.

Having public trust on your shoulders and many strict legal requirements that need to be met, you must be very careful to make sure that every penny is accounted for and well used towards achieving your objective. So, it is not only helpful to have specialised accounting, but it is actually necessary to help solve the financial and operational problems that your charity has.

Let’s look at why specialised accounting matters and how it is different from other methods.

How Charity Accounting Differs from Regular Accounting

Charities are regulated to the thin line by the UK Charity Commission. Their financial reporting is also not ordinary as they must follow the Statement of Recommended Practice (SORP) for charities, which has some additional requirements over regular financial reporting. Let’s start with the basics:

Fund Accounting

The first element that sets charities apart is fund accounting. Companies can use their income freely, without having to track each income source and how it was spent; but a charity receives its income from donors, so it needs to follow a set of rules when it allocates them.

Fund accounting means keeping tabs on three types of funds: restricted, unrestricted, and designated.

• Restricted funds come with donor-imposed conditions, meaning charity trustees can only use them for specific purposes such as funding a particular program or project.
• Unrestricted funds, however, provide greater flexibility, allowing you to cover general operational costs.
• Designated funds are portions of unrestricted funds earmarked by trustees for specific projects or future needs.

Fund accounting is not necessarily more complicated than regular accounting, but it is different. You need this fund separation to show donors and grant institutions that you are using the grants and donations as agreed. For instance, if your charity receives a grant for youth education, fund accounting ensures that you are spending the funds on educational resources and materials and not using them for operational expenses.

Reporting Requirements

Charities in the UK that prepare accrual-based accounts (as opposed to cash-based accounts) are required to include a Statement of Financial Activities (SoFA) in their financial statements.

A charity accountant understands this type of document, which can be quite complex, including details such as income and expenditure across different fund types as well as information describing the organisation’s performance.

The SoFA may show how much income was raised from government grants versus individual donations and how these were spent on core missions versus administrative costs.

Compliance with SORP

The Statement of Recommended Practice (SORP) comes with specific rules for recognising income, valuing donated goods and services, and reporting on the charity’s impact. Compared to regular business accounting, charity accountants need to deal with a higher level of detail.

Let’s take a simple donation, which includes computers for a training program. You’ll need to evaluate these computers and include their value in the financial statement, so it reflects your charity’s financial resources accurately.

It’s part of the Charity Commission’s mission of pushing charities toward transparency, so they can maintain donor trust and funds.

Focus on Public Benefit

Unlike businesses, which aim to maximise profits, charities must show how their activities deliver public benefit. Your financial reports need to articulate how funds are advancing the charity’s mission, whether through direct service provision, educational campaigns, or community development projects.

If a charity’s mission is to reduce homelessness, its financial reports should detail how funds were spent on providing shelter, job training, or mental health support. This focus on public benefit distinguishes charity accounting from business accounting and highlights the organisation’s impact.

Tax and VAT Considerations

Charities benefit from various tax exemptions and reliefs that do not apply to regular businesses, but navigating these can be complex. For instance, trading profits are taxable unless they qualify for exemptions such as the small trading tax exemption. Similarly, charities can reclaim VAT on certain expenses, but only if specific criteria are met.

Effective management of these tax considerations requires specialised knowledge. A mistake in handling VAT claims or overlooking a trading exemption could result in financial penalties or lost revenue, underscoring the need for expertise in charity-specific accounting.

Governance and Oversight

Since trustees are legally responsible for ensuring that the charity’s finances are managed properly, they need specialised accounting guidance to avoid regulatory action.

Governance plays a more important role in charities, which means that you should not only follow reporting guidelines but also produce clear and transparent reports that are easy to understand by your donors and stakeholders.

If you fail to oversee financial transactions, you can deal with reputation damage or even the loss of the charity’s registration status.

Donor Reporting and Stewardship

Another important difference between regular companies and charities is that the first category reports only to shareholders; the second one, instead, must account for all its actions in front of the donors and the public. Therefore, the pressure to produce clearer reports is higher since they can decide whether the charity attracts new funds or not.

Risk Management

Last but not least, even if companies face financial risks associated with economic fluctuations and charities can be affected by these changes, they are far more vulnerable since they are operating based on donations. They need a specialised person to help them identify financial risks such as over-reliance on a single funding source and provide a solution before the organisation is affected.