Lessons learned from reviewing charity accounts

As part of OSCR’s work we undertake reviews of the accounts which charities submit to us, selected at random.

This work allows us to monitor compliance with accounting requirements, identify areas where charities require more help and guidance, and look at specific areas of interest.

Summary

This report outlines the results of our latest sample review of accounts which charities submit to OSCR. In this sample we reviewed the accounts of 60 charities.

The charities selected for review are representative of the full population of Scottish charities in terms of the proportion of charities which fall within each income grouping.

In this sample we also looked in detail at the charities' stated reserves policies.

Our key findings were:

  • A number of charities failed to include a Trustees’ Annual Report, or the report was deficient in comparison to the legal requirements.
  • Comparative prior year information was missing from several sets of accounts, either completely or partially.
  • Several charities did not follow the requirements of their governing documents, including not having the correct form of external scrutiny or the correct number of trustees as set out in their governing document.
  • In many cases, charities did not have a clear reserves policy and there was a lack of comparison of the level of reserves held against the level of reserves required.

We have produced this report to inform charities and sector advisors of our findings and to highlight the key issues that have emerged. In sharing these key issues, it is our expectation that charities will be able to learn from them and improve their own annual report and accounts.

1. Introduction

We undertook a review of 60 sets of trustees’ annual reports and accounts. The charities were selected on a random basis.

All charities in Scotland are required to prepare a trustees’ annual report and accounts, and file these with OSCR each year. The preparation of the accounts is a key way in which the charity trustees are accountable for their stewardship of the charity’s funds and can be transparent about how the charity has operated during the year.  More detail about the requirements for charity accounting in Scotland and OSCR’s monitoring of charities can be found in Appendix 1.

We have set out our findings and key messaging in section 2 of the report. Our random sampling process and the areas we looked at are set out in section 3, with the detailed checklist being included in Appendix 2. Our more detailed findings can be found from section 4 onwards.

2. Findings and key messaging

We undertook a review of 60 sets of Trustees’ Annual Reports and accounts. The charities were selected on a random basis.

In the sample we looked at the quality of the accounts submission, the governing document, activities of the charity and any stated reserves policy.  Our key findings were that several charities failed to meet the requirements for:

  • the Trustees’ Annual Report, which is the key mechanism for trustees to inform readers about what the charity has been doing
  • comparative information within the accounts, allowing readers to meaningfully compare from one year to the other

In addition, we identified that there is room for improvement in trustees’ understanding about reserves and reserves policies and how this can aid good financial management of their charity.   Many charities also failed to understand the requirements of their governing documents.   

Further detail on these four key issues is provided here:

Trustees' Annual Report

We found that there were several charities where the Trustees' Annual Report was either missing or deficient.

The Trustees’ Annual report is an opportunity for the charity to tell the story of its activities, achievements, and performance in the year under review and tie this in with the financial information. A good Trustees’ Annual Report can let the users of the accounts understand what activities the charity is undertaking and how it is meeting its objectives. This can encourage people to support the charity and provide funding. It also provides assurance to us as Regulator that the charity is operating appropriately.

Charity trustees should ensure that the Trustees’ Annual Report contains all the required information and properly tells the story of the charity. More guidance as to the Trustees' Annual Report can be found here.

Comparative information

Some charities failed to include comparative information within the accounts. This means that it is not possible to compare the performance of the charity from one year to the next, or to understand variations. It also means that it is difficult to understand if opening balances are correct and carry forward appropriately from the previous year.

Reserves policy

We found that around 67% of charities did include some information about their reserves. The OSCR work pack did prompt smaller charities preparing receipts and payments accounts to include some narrative. In most cases however the information provided did not meet the legal requirements. Many charities made simple statements about how funds would be applied rather than including a reserves policy. Where a reserves policy was included, it tended to be based on several months expenditure without a full rationale as to why this is. There is little evidence that charities are actively considering their performance against their reserves policy.

Charities need to better understand what a reserves policy is, how to develop a reserves policy and how to monitor against that policy. Charity trustees need to understand how proper management of the charity’s reserves is a key element of good governance.

We have now updated our FAQs and the guidance in the receipts and payments work pack to provide some better information for charities when considering their reserves policy.

We are reviewing our reserves policy factsheet to ensure that it clearly explains the link between the reserves policy and the charity's ongoing financial planning.

Governing documents

There is continuing evidence that in smaller charities, there is a lack of understanding of the requirements of the governing document. In our sample, several charities had audit requirements in the governing document which they were not adhering to. In addition, there were charities who did not have the required minimum number of trustees, compromising appropriate decision making and exposing the charity to potential criticism and reputational issues.

Our recent update to the annual return now asks all charities questions relating to their governing document. This should help smaller charities understand the need to review the governing document and ensure that they are following this.

3. Random Accounts Sampling

When we undertake random sampling, we ensure the sample is representative of the full population of Scottish charities in terms of the proportion of charities which fall within each income grouping. This means that we look at more charities with income under £25,000 as they represent around 60% of the standard charities on our Register. We exclude cross-border charities, registered social landlords, higher and further education charities and designated religious charities as these bodies have other regulators or oversight is exercised over these bodies in another way.

We have now completed our fourth set of random sampling of accounts work. In this sample we decided to look in more detail at how charities were reporting on their reserves policies and how the level of reserves held aligned with these policies. We also continued to look at the compliance of the accounts and how charities were meeting the requirements set out in their governing documents.

We are sharing our findings to help the sector understand more about the work we do, and to highlight common areas where improvement is required.

More information about the legislative requirements in relation to charity accounts and our monitoring role can be found in Appendix 1.

3.1 Random Sample

This report provides an overview of the results of this sample which covers 60 charities.

The sample we looked at was as follows:

Income

Number of charities

Less than £25,000

34

£25,000 to £250,000

21

£250,000 to £499,999

2

More than £500,000

3

3.2 Background information about the charities and their accounts

The following chart gives some information about the relationship between the legal form and size of the charities included in the random selection.

4. What did we look at?

When looking at our random samples we look at the complete position of the charity, not just accounting compliance. We review the trustees’ annual report and accounts together with other information we hold, such as the charity’s governing document.

We follow a checklist, shown at Appendix 2, to ensure that we consider all areas and that the reviews are carried out in a consistent manner. 

In this sample we introduced an additional area to look at which was the reserves policies of the charities. This is because one of our Regulatory Priorities is to improve charities understanding and management of their reserves.

In brief, within each main area of work carried out as part of the reviews, we considered:

General accounts compliance check

  • were the accounts prepared on the correct basis (Receipts and Payments or Fully Accrued)
  • were all the required elements included
  • did the accounts balance and include previous year information

Trustees’ Annual Report

  • was there a Trustees’ Annual Report
  • did it include sufficient information about the charity including its trustees, its purposes and the activities undertaken to achieve those purposes

Independent scrutiny report

  • had the accounts been appropriately scrutinised
  • was the report worded correctly and signed off by an appropriately qualified person

Governing document check

  • was the governing document fit for purpose
  • were the accounts prepared in accordance with it and were there the required number of trustees

Trustees remuneration

  • where trustees were being paid, we checked to see if there were any concerns around this
  • did it appear the conditions set out in the 2005 Act were being met and was the governing document being followed

Charity test and trading

  • whether the charity was undertaking activities, and these activities were in furtherance of its purposes
  • we also looked for any indicators that charities were breaching trading thresholds or were not managing the relationship with subsidiaries appropriately

Annual return governance questions

  • we reviewed the answers that charities provided to governance style questions on the annual return form
  • the annual return form changed for accounting periods on or after 30 November 2023, so we had some different information to review depending on the year end

Reserves policy

  • we looked at the Trustees’ Annual Report to see if the charity had included a reserves policy
  • we then looked at the quality of the policy in terms of whether it met the legal requirements and whether there had been any comparison of the actual reserves held against the reserves stated in the policy

5. Detailed findings from random sampling

Of the 60 charities we reviewed, there were 26 who had a ‘clean’ review and did not require any further contact. 

There were four charities where we were unable to accept the accounts and as such, we declined them and requested resubmission. We decline accounts where the submission does not provide sufficient information to allow us to determine an income and/or expenditure figure as this is key information we provide for all charities on the Scottish Charity Register. All four charities have now successfully resubmitted accounts which have been accepted.

We contacted 20 charities about various accounts compliance issues, we will review their next submissions to ensure that our points have been addressed.  Four of these charities also had issues relating to their governing documents.

We contacted seven charities specifically in relation to their governing documents. This included where we did not have a copy of the governing document, or where the charity was not adhering to their governing document.

Two charities were contacted about trustee remuneration and one charity was contacted about its activities.

Basis of accounts preparation

Of the 60 charities that had submitted a set of accounts, 34 prepared on a receipts and payments basis and 26 prepared on a fully accrued basis.

Receipts and payments accounts by income

Out of these 13 used the OSCR workpack – 10 up to £24,999 and 3 up to £99,999.

OSCR work pack and accounts compliance

Of the 13 charities utilising the OSCR Receipts and Payments work pack we only had to contact four about accounts compliance.  These were as follows:

  • one with an error in the previous year balance
  • one where they had not used the workpack for the Statement of Balances and this was incorrect
  • two where they had failed to include a trustee remuneration note

This suggests that the use of the Receipts and Payments work pack does support charities with ensuring their accounts meet a basic level of compliance. Where we had to contact those charities using the Receipts and Payments work pack, this was where they had not used it fully.

There were 14 charities who prepared accounts on a fully accrued basis, who would, as a result of their income and legal form be able to prepare Receipts and Payments accounts. Their income was split as follows:

Charities can opt to prepare fully accrued accounts where they are entitled to prepare receipts and payments accounts. Where charities have more complex transactions, such as transactions relating to investments, or significant amounts paid or received in advance, fully accrued accounts may be more appropriate. If a charity’s income regularly fluctuates above and below £250,000, they may also decide to prepare fully accrued accounts for consistency. It is important however that charities understand the options available to them. Receipts and payments accounts can be a sensible option for many smaller charities as they are less complex and can be cheaper to prepare and examine.

6. Accounts compliance issues

6.1 Trustees' Annual Report

The Trustee’s Annual Report was again an area where we found that there was poor compliance.

Out of the 60 charities sampled we contacted eight about their Trustees’ Annual Report. In two instances there was no Trustees' Annual Report at all. These were both in charities preparing receipts and payments accounts with income under £25,000. In the other six charities there was a Trustees’ Annual Report, but it was insufficient in terms of requirements, two contained no information about who the trustees were and the remaining four did not contain sufficient detail to allow readers to understand the purposes of the charity and activities undertaken to further those purposes.

6.2 External scrutiny report

In this sample, all the charities had an external scrutiny report of some type. We had to contact three charities about their external scrutiny:

  • One where the independent examiner was not independent of the charity
  • One where there were English references to charity law rather than Scottish and;
  • One where the firm undertaking the independent examination had signed the report rather than the individual examiner.

It is encouraging to see that all charities sampled are having external scrutiny of their annual report and accounts undertaken.

There were four charities where the charity had a requirement in their governing document for an audit, but an independent examination was being undertaken. All four of the charities were preparing receipts and payments accounts with three using a voluntary independent examiner. We contacted these charities to advise them that they should update their governing document to allow for an independent examination.

6.3 Comparatives

There were six charities in the sample where comparative information for the prior year had either not been included or was not included in all areas.

Five prepared receipts and payments accounts. Of these, four had no comparative information at all and one had no comparative information on the Statement of Balances.

There was one set of fully accrued accounts with comparatives missing on the Statement of Financial Activities (SoFA).

Comparative information is important as it allows users of the accounts to understand how the position has changed from year to year and make appropriate comparisons. Comparative information also helps to ensure that opening balance information from the prior year is correctly brought forward into the current year.

6.4 Trustee numbers

We found that five of the charities had insufficient trustees compared to the requirements of their governing documents.

Three were unincorporated associations and two were trusts. All had income of less than £25,000 and, as such, we would not have previously asked these charities about trustee numbers on the annual return form. The new annual return form asks this question of all charities. It is hoped this will prompt charities to check their governing document and ensure they understand the trustee numbers required.

6.5 Trustee remuneration

In two instances we found that the rules on trustee remuneration had been breached. One charity had a statement in their governing document that no trustees could be remunerated, and another had trustees who were all related and as such the payment was in breach of the 2005 Act. In both instances we wrote to the charities to seek assurances that they would review their remuneration arrangements.

6.6 Incorrect references and terminology

We identified incorrect references and terminology in accounts and governing documents. For example, four charities who are SCIO’s made references to being companies in their accounts. We contacted these charities to ensure that they addressed this in their next submission. 

7. Reserves policies

In this sample we looked at the reserves policies of charities. Reserves are the funds that a charity has which can be spent freely on any of its charitable purposes. All charities need to have a policy which sets out the level of reserves the charity should hold. A good reserves policy can help show donors, funders, and beneficiaries how charity trustees are managing the charity’s money.

There are requirements for both receipts and payments accounts and fully accrued accounts to include details about the charities reserves policy in the Trustees' Annual Report.

In receipts and payments accounts charities must include ‘a description of the policy which has been adopted by the charity trustees for the purpose of determining the level of reserves which it is appropriate for the charity to maintain in order to meet effectively its purposes, including the level of reserves held, why they are held and quantifying and explaining the purpose of any designated funds and the likely timing of any expenditure that has been set aside for the future’.

In fully accrued accounts charities must ‘explain any policy it has for holding reserves and state the amounts of those reserves and why they are held. If the trustees have decided that holding reserves is unnecessary, the report must disclose this fact and provide the reasons behind this decision.’ There are also additional requirements for charities with an income of £500,000 or more.

We considered if the charity had a reference to a reserves policy in its accounts and then looked to see if the actual reserves held were stated and if there was a comparison made of the actual reserves held to the reserves policy itself.

40 of the charities sampled had some reference to a reserves policy in their accounts, with a further two stating they were in the process of developing a reserves policy.

Although the one of the charities in the income grouping ‘£500,000 or more’ did not have a reserves policy it noted the requirement to develop one and stated that this was in progress. It is a relatively new charity.

8. Quality of reserves policies

8.1 Receipts and payments

There were 23 charities who prepared receipts and payments accounts and had information in the accounts which was headed ‘reserves policy’ (this includes those using the receipts and payments work pack). Roughly two thirds of charities preparing receipts and payments accounts had some reference to reserves.

Of the charities who prepared receipts and payments accounts there were five which stated a clear policy and had some comparison of reserves against their policy. Four of these had a requirement of three months of reserves and one had a requirement of no more than 10% of income. 

Eleven charities did not detail a reserves policy but rather made a statement about what funds they held or the type of funds they held.

8.2 Reserves policies and the OSCR work pack

Out of the 13 charities using the OSCR work pack for receipts and payments accounts, there were 11 which had information in the reserves policy section.

Only two of these charities had a clear policy stating a level of reserves to be held and only one of these made any assessment of the reserves held in comparison to the policy.

There were a further two charities who stated they were developing a policy, and the remaining seven charities made a statement about funds held, or funds being applied for the purposes of the charity.

Although the use of the OSCR work pack may encourage charities to provide some information in this section, they are not sufficiently explaining the charity’s reserves policy and how the charity is performing in comparison to the policy. It appears that there are issues with charities understanding the requirements in this area.

8.3 Fully accrued

Of the 26 charities that prepared fully accrued accounts, there were 16 who included some information in the accounts about reserves. 

Of these 16, only nine stated the level of reserves that they should hold.  The remaining seven charities stated they had a reserves policy, but they simply referred to maintaining reserves to fund work or to promote their objects.

Of the nine who stated the level of the reserves that they should hold, there were six who stated the level that they currently hold.  Only three of the six were meeting their reserves policy.

8.4 Reserves policy details

Where charities had reserves policies that referred to an amount that the charity aimed to hold in reserve, these were often described as equivalent to a number of ‘months of expenditure’, with the most common being three months expenditure and costs for wind up. There was little explanation within the policies as to why these amounts were considered appropriate for the charity.

We understand that many charity trustees mistakenly believe that OSCR has a required level of reserves, commonly quoted as equivalent to three months of expenditure. OSCR has no set level of reserves which a charity should hold. All charities are different and have different requirements. It is very important that trustees consider the appropriate level of reserves for the charity, taking into account a number of factors including the activities and beneficiaries of the charity. 

It does not appear, on the basis of this sampling work, that reserves policies are used effectively as a financial management or business planning tool. There does not seem to be the level of detail and understanding that we would expect to see in these policies. More importantly there is only a small minority of charities who are actively considering whether the current level of reserves they hold meets the policy which they have set out as appropriate for their charity. Charities should be using their reserves policy as a governance tool, it should be an active policy, regularly under review, to ensure that it is appropriate. Comparison of actual reserves held against the policy should be undertaken regularly to ensure that the charity trustees are aware of relevant risks to the charity’s sustainability and financial health.

Appendix 1 – Background information and legislation

Background

All charities in Scotland are required to prepare a Trustees’ Annual Report and accounts, and file these with OSCR each year. The preparation of the accounts is a key way in which the charity trustees are accountable for their stewardship of the charity’s funds and can be transparent about how the charity has operated during the year.

OSCR currently publishes the Trustees’ Annual Report and accounts of charities with income of £25,000 and more and all those constituted as Scottish Charitable Incorporated Organisations (SCIOs) on the Scottish Charity Register, unless they are published elsewhere. Moving forward OSCR will be publishing the unredacted accounts for all charities. This is designed to help those who wish to find out more about the charity have access to useful information. OSCR views the preparation of a high-quality trustees’ annual report and accounts as an important part of good governance of a charity.

Legislation for charities in Scotland

The Charities and Trustee Investment (Scotland) Act 2005 (the 2005 Act) is the legislation that sets out the relevant accounting requirements which charities registered with OSCR must comply with.

In terms of the 2005 Act, a charity must:

  • keep proper accounting records,
  • prepare for each financial year of the charity, a statement of account, including a report on its activities in the financial year,
  • have the statement of accounts independently examined or audited, and
  • after such examination or audit, send a copy of the statement of account to OSCR.

There are also Regulations which set out the required format and content of the accounts and external scrutiny requirements. These are the Charities Accounts (Scotland) Regulations 2006 (as amended) (the 2006 Regulations).

Charity accounts

The 2006 Regulations require charities to prepare accounts in one of two ways depending on their income, legal form, and their governing document. These are:

  • Receipts and payments accounts: a simple form of accounting that consists of a summary of all monies received and paid by the charity during its financial year in both cash and via the bank account, along with a statement of balances at the year end.
  • Fully accrued accounts: accounts prepared using the accruals basis allocate the costs or income of a particular activity according to when the liability is incurred, or when there is entitlement or certainty about income. This is not necessarily the date on which money is received or paid out. Fully accrued accounts must be prepared in accordance with the methods and principles of the Accounting and Reporting by Charities: Statement of Recommended Practice (the SORP). Copies of the SORP can be downloaded from charitiessorp.org.

To help charities to get it right, we have produced guidance about charity accounting and reporting requirements: A Guide to Charity Accounts.

External scrutiny of charity accounts

The 2006 Regulations require all charities registered in Scotland to have their accounts checked by someone who is independent of the charity. This is called external scrutiny. There are two types of external scrutiny:

  • Independent examination: an independent examination looks at a charity's accounting records and annual accounts and considers whether the accounts are a fair reflection of the underlying records.
  • Audit: this is a more comprehensive examination of a charity’s accounts and accounting records which must be carried out by a Registered Auditor. The auditor must carry out such investigations as are necessary to enable them to form an opinion on the charity’s accounts.

Monitoring by OSCR

Section 1(5)(c) of the 2005 Act states that one of OSCR’s general functions is ‘to encourage, facilitate and monitor compliance by charities with the provisions of the 2005 Act’. OSCR must encourage and help charities to comply with the law, and check that they do so.

To monitor compliance with the accounting requirements we do a basic check of the information we receive to make sure there are no obvious mistakes. We don’t do a full check of every set of reports and accounts submitted. However, we do detailed checks throughout the year of some charities reports and accounts.

We undertake accounts compliance checks of a proportion of all charities submitting accounts to us for the first time. This lets us understand if charities are getting it right and to provide them with guidance at an early stage.

We also review the accounts of any charities where we identify a need to take a closer look at their accounts. This can happen for several reasons including:

  • where we have noticed a deficiency in a set of accounts, and we want to make sure it is corrected in the following submission
  • where we have an inquiry into a charity

To supplement these checks, we also undertake thematic reviews of groups of charities which allows us to look at areas where we have identified potential risks.

To ensure that all charities have a chance of being selected for a review of their accounts, we undertake random sampling to supplement our other work.

Appendix 2 – Checklist

Standard information

Charity name

Charity number

Legal form

Year end

Minimum number of trustees per governing document (record number)

Remuneration provision in governing document (record information)

Audit requirement in governing document

Purposes per governing document

Basis of Accounts (Receipts and Payments or Fully Accrued)

Income £

Assets £

Accounts compliance check

General

Do the accounts make reference to the correct legal form?

Are the accounts prepared on the correct basis?

Do the accounts include either a receipts and payments account (if receipts and payments accounts) or a statement of financial activities (if accruals accounts)

Does the receipts and payments account or statement of financial activities provide an analysis of expenditure and income?

Do the accounts include either a statement of assets and liabilities (if receipts and payments accounts) or a balance sheet (if accruals accounts)?

Do the closing balances on each statement reconcile to each other?

Have comparatives been included and does information from comparatives carry forward correctly?

Is the set of accounts as a whole understandable, transparent and internally consistent?

Independent scrutiny report

Has an independent scrutiny report been submitted?

Has an audit report been submitted if an audit was required?

Is the wording correct?

Is the report signed by an appropriately qualified person?

Is the report qualified?

Trustees annual report

Has a trustees’ annual report been submitted?

Do the number of trustees equal or exceed the minimum?

Does it appear that the trustees may be connected (from surnames, addresses etc)

Does the annual report explain what the charity was there to achieve (its purposes)?

Does the explanation of its purposes agree to our understanding of its purposes from the governing document?

Does the annual report explain what the charity had done during the year to carry out its purposes (its activities)?

Remuneration

Are any trustees being paid remuneration – disclosed in either accounts or annual return form?

Is there any apparent breach of remuneration provisions in the Act or in the charity’s governing document?

Does the level of remuneration raise concern?

Are there any other transactions with trustees and the charity?

Charity test and trading

Has the charity undertaken activities in furtherance of their purposes?

Does a review of the accounts/TAR indicate any activities which are not in furtherance of the charity’s objectives?

Have trading thresholds in accordance with HMRC be breached?

Are there any unusual transactions which may require further consideration?

Are reported gift aid reclaims in line with our expectations?

Does the charity have a trading subsidiary?

Has the charity provided finance to the trading subsidiary?

Are there indicators of private benefit?

Going concern

Are there any indicators of going concern issues, including details included in notes to the accounts or in scrutiny report?  

Reserves

What is the level of reserves available per the accounts

Has the charity included details of a reserves policy in the Trustees Annual Report

Does the reserves policy include current level of reserves held and if so do these agree to our calculations

Is the reserves note compliant with the type of accounts being prepared

Annual return form y/e prior to 30 November 2023– medium and large

Does the charity appear to have adequate financial procedures?

Does information provided in connection with trustee remuneration agree to that on the accounts?

Has the charity received over 20% of its income from a person connected to the charity? 

If yes to the above do we have any concerns over this arrangement?

Annual Return form – 30 November 2023 onwards

Has charity been issued with any guidance on completion of the return (if so detail which guidance)

If guidance issued is this the first period guidance issued?  Have we contacted charity separately

Next steps

Do we need to contact the charity about any accounting compliance issues? (check if charity has already been contacted)

Do we need to contact charity to reiterate guidance issued – 30 November 2023 onwards

Do we need to make a referral to HMRC?

Do we need to contact charity about any apparent breaches in remuneration provision?

Do we need to contact the charity to gain a better understanding of transactions or activities?

Do we need to hold internal discussions around issues identified – or is a referral required?

Should we flag the next submission for review? (check if already flagged)

 

 

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