The legal and reporting framework anchors the values shared by charities, while still allowing flexibility where there is divergence in business model. The guidance for financial reporting in charities, or the SORP, provides part of the anchor, but should also enable innovation. That’s where references in financial reporting guidance to new age concepts like social investment can come in. But it’s not just about the newbies; old chestnuts such as how to account for trading subsidiaries are also critical to innovation.
Charity trading has developed immensely, from something previously aligned with running a few charity shops, to contracting out services, selling intellectual property and running multi-million pound subsidiaries. Making sure that charities have the right guidance to account for and report on all of this diversity is more important than one might think. Without it stakeholders will be confused as to how money flows in and out of organisations, and where expenditure is incurred. Not good for trust.
Legal definition vs substance
The beauty of the developing approaches to reporting is that they enable the ‘substance’ of a transaction or structure to take precedent. Legal determinants have little to do with classification of funds in this context. In this sense many group, branch and subsidiary structures operating out of charities, have done so nicely without causing much trouble on the balance sheet (apart from when they go wrong), and without creating slightly strange off-balance sheet funds. If it looks like a branch of the charity and acts like one, it is one and should be treated as such and included in the accounts; if it’s not, it’s not. There was therefore confusion when the new draft of the SORP was released summer 2013 asking for branches operating from separate corporate structures (a legal distinction) to be reported separately…and then consolidated as subsidiaries. The consultation asked would this be a problem; well, ‘yes’ we said. There are a number of examples where separate corporate entities exist in order to carry out specific activities that are to all intents and purposes part of the charity, not to mention where legal hurdles in different jurisdictions force this in order to operate there. Major international charities have a right to be concerned about the impact this will have on representation of international branches in their accounts.
Increased reporting for subsidiaries
Elsewhere in the guidance we are looking down the barrel of the bureaucratic gun for our subsidiaries. The new UK accounting regime’s reduced disclosure framework for subsidiaries removes any sort of meaningful related party disclosures. Those setting the guidelines for charities felt they had no choice but to remove the option to apply a reduced framework altogether. This isn’t good if we want to enable charities to set up more flexible structures that enable them to use more complex and innovative ways of raising funds or delivering services, here and abroad. There’s nothing like the threat of having to do a cash-flow statement to stop you from setting up a perfectly useful subsidiary. CFG has asked for both of these areas to be looked at again and hopefully the issues will be resolved. However, this does demonstrate the importance of considering the substance, meaning and intention of a structure or transaction, rather than simply defining things by legal definition. It’s not that accountants and lawyers don’t mix; it’s that sometimes accounting and law don’t – see previous talk of legacies if you want another hair tearing example….
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