What is it that makes charities different from businesses? Well there are a number of things; first and foremost, the purpose of a charity must fall within one of the 13 charitable purposes set out in legislation. Second, the governance structure is normally different with unpaid volunteer trustees taking overall responsibility for the charity. Then somewhere way down the list of differences comes fund accounting, a concept unique to charities.
The concept of fund accounting applies to all charities, regardless of size, and regardless of whether the charity produces accruals accounts or not. In their publication “Charity finances: trustee essentials” the Charity Commission makes it clear that trustees should understand their finances and must know what funds are restricted and how those funds can be used. The 2015 Charity SORP contains some helpful background information explaining fund accounting which in this instance applies to all charities.
The SORP sets out a useful summary of fund accounting stating that “fund accounting distinguishes between two primary classes of fund: those that are unrestricted in their use, which can be spent for any charitable purposes of a charity, and those that are restricted in use, which can only be lawfully used for a specific charitable purpose” (emphasis added). The SORP goes on to say that “the proper administration of individual charitable funds is essential if charity trustees are not to act in breach of trust”.
Let’s now look at the characteristics of each type of fund.
Unrestricted funds fall into two categories. First, there are general funds which can be spent at the discretion of the trustees to further any charitable purpose of the charity. This includes being used to supplement restricted funds where necessary.
Second, there are designated funds. These are still unrestricted, but have been set aside by the trustees and earmarked for a particular future project or commitment, e.g. P.A. equipment upgrade. The designation is for administrative purposes and carries no legal authority so in the same way that the trustees designate funds they are also able to remove that designation without seeking external approval. Whether designating or removing a prior designation, we suggest that any trustee decision is properly discussed and fully minuted.
Restricted funds are completely different. Restricted funds refer to funds held under “specific trusts”; in layman’s terms that is held for a specific charitable purpose. The restriction carries the weight of the law and so restricted funds can only be lawfully spent on the specific charitable purpose for which they were intended.
This restricted purpose may be declared by the donor when making a gift, e.g. a donation intended for overseas mission, or to help pay a particular employee of the charity; or it may originate from the terms of a financial appeal, e.g. raising funds for a new building or building refurbishment (please see our briefing paper on failed appeals for some dos and don’ts). A charity may have any number of restricted funds for different purposes and we have seen some churches with 20 or more!!
Restricted funds are further sub-divided into restricted income funds or endowment funds. Restricted income funds are to be spent within a reasonable period from their receipt to further the specific charitable purpose for which they were given. Restricted endowment funds require charities under trust law to invest the assets of an endowment, or retain them for the charity’s use rather than to spend them.
There is one further sub-division of endowment funds between permanent and expendable. The difference rests on the power of the trustees to be able to convert endowment funds into income or not (see SORP module 2 for more detail).
Transfers between funds
It is possible to transfer money between funds and there are various reasons why you might want to do this. Suffice to say that transferring between or from unrestricted funds is far easier than transferring between or from restricted funds.
Accounting for funds
Accounting software designed primarily for the charity sector normally includes functionality that makes fund accounting easier. More commercially oriented software does not handle fund accounting so well (if at all) and can cause a real headache to trustees and treasurers dealing with the financial aspects of a charity, especially charities operating with many different funds.
The more funds (designated or restricted) that a charity has, the more complex will be the accounting requirements necessary to maintain proper records. We therefore suggest that trustees think hard before creating too many designated funds and similarly consider carefully whether to receive donations for too many specific restricted purposes.
Accounts should show comparative prior year figures for each class of funds and the notes to the accounts will normally include an analysis of each individual fund.
Module 2 of the 2015 Charity SORP sets out in some detail the characteristics and regulations which apply to the different types of fund, covering in more depth the two types of endowment funds. We suggest this module is essential reading for all church treasurers regardless of whether your charity produces accruals accounts or not.
If you would like to read more on this topic, our briefing paper covers this in more detail: