The revised Statement of Recommended Practice Accounting and Reporting by Charities (SORP 2000) was issued in October 2000 but has only now reached the point of mandatory application. The SORP formally comes into effect for accounting periods commencing on or after 1 January 2001. In practice, of course, this means accounting years ending on or after 31 December 2001. Early adoption of the SORP was encouraged, but few charities have in fact produced annual reports and accounts that apply it.

This article addresses a number of the practical issues and problems that will result from the application of SORP 2000. These matters need to be addressed within the first report and accounts to be prepared under SORP 2000, which in some cases will require the gathering of new information or the revision of comparative information. In addition, certain of the new disclosures need to reflect trustees' policy decisions, which in some cases will have a significant impact on the wider conduct of the charity. If these various matters have not been looked at before, then they must receive attention from the trustees, in general, and those responsible for the presentation of the charity's report and accounts promptly to ensure that the new disclosures are properly addressed in the 31 December 2001 report and accounts.

There is a growing body of support material to assist charities and their advisers with the application of SORP 2000. These include some useful publications from the Charity Commission. CC62, Charities SORP 2000: What Has Changed was published at the same time as the SORP. It summarises the main changes from the previous SORP, and can be used to ensure that the principal changes have been identified and addressed. A further essential publication is CC66, which contains seven complete examples of charity reports and accounts prepared in accordance with SORP 2000. The examples contain full trustees' reports, primary statements, statements of accounting policies and extensive notes to the accounts. They illustrate practice for small, community charities through to large, diversified charities with international activities. CC66 contains some excellent illustrations of the application of SORP 2000, and is a considerable improvement on the more limited examples appended to the old SORP.

The trustees' annual report

Paragraph 31 of SORP 2000 requires the trustees' annual report to 'explain what the charity is trying to do and how it is going about it. It should show whether the charity has achieved its objectives during the year and explain its plans for the future. It should also help the reader of the report and accounts understand how the numerical part of the accounts relates to the organisational structure and activities of the charity.'

The following narrative information should be included in the charity's report:

•   An explanation of its objects by reference to its governing document and, if appropriate, its mission statement.

•   The organisational and decision-making structure.

•   Relationships with related parties and other charities and organisations with which it cooperates.

•   A review of the activities of the charity (or group if applicable) in the context of its strategy, including significant changes, developments and achievements in the past year, post-balance sheet events and future plans. If applicable, comments should be made on the contribution of volunteers and the effectiveness of fundraising activities.

•   An explanation of any funds in deficit and what action is to be taken.

•   A statement confirming that the major risks facing the charity have been identified and reviewed and that systems have been established to mitigate them.

•   A statement of policies, and in particular those relating to:

-   reserves;

-   investment policy and performance against policy;

-   grant-making.

The approach to the trustees' report is less prescriptive than in the previous SORP. The report must provide a 'fair review' of the activities and achievements and must reflect ' successes and failures'. The Charity Commission has become concerned that trustees' reports were becoming increasingly bland, merely answering questions set by the old disclosure requirements and often repeating information given in earlier years, with dates being revised. SORP 2000 sees the trustees' report as a vital communication document that explains the work of the charity to its stakeholders. The trustees must take genuine responsibility for the authorship of their report, and should not delegate its preparation to the auditors or other advisers. Trustees, as a group, must ensure that they have reviewed and considered the impact of the disclosure requirements of the revised trustees' report well before the process of preparing and reviewing the year-end accounts begins.

Within the detailed disclosures in the trustees' report, there are two significant additions that will have a wider impact on the behaviour and operations of charities. These are the disclosures about reserves and risk.

Reserves

SORP 2000 requires the trustees' annual report to state the charity's policy on reserves, stating the level of reserves held and why they are held. Responsibility for establishing an appropriate reserves policy lies with the trustees, as does the responsibility for justifying and explaining the level of reserves held. This process should be an integral part of the charity's financial management. The requirement has been introduced because of concerns over the level of reserves that charities hold. At one extreme, some charities are perceived to hold 'excessive' reserves and 'under-use' the monies that have been given to them for expenditure on charitable purposes. At the other extreme there are charities 'operating at the margin' with limited spare funds to enable them to meet their obligations and support their clientele in the event of a fluctuation in cash flow.

The glossary to SORP 2000 clarifies the meaning of 'reserves'. The reserves policy should cover 'free' reserves, so it should not include permanent or expendable endowments, or restricted or designated funds. The SORP does not prescribe what the policy should be, nor does it suggest what the actual level of reserves should be, or set down the process for devising the policy. These are matters for the trustees to address, and will inevitably vary depending on the charity's objectives and characteristics.

The trustees may wish to formally review what they consider the 'free' reserves to be in the charity, and decide what the optimum reserves level should be. This needs to be based on a realistic assessment, bearing in mind factors such as the income and expenditure forecasts, contingencies and future needs.

Although the reserves policy may be proposed by senior employees or a sub-committee of trustees, it should be formally ratified by the whole body of trustees and minuted. The policy should be periodically reviewed and compared to the actual reserves position. If the optimum levels have not yet been achieved, the steps being taken to address this should be documented and disclosed.

The time spent formulating the policy and the extent of detail necessary will depend on the size and complexity of the charity. Further guidance on establishing a reserves policy can be found in CC19, Charities' Reserves. Whatever approach is adopted, trustees must ensure that a policy is in place and being implemented in time for the policy to be disclosed in the next annual report.

Risk

A statement must be given that the major risks to which the charity is exposed, as identified by the trustees, have been reviewed and systems have been established to mitigate those risks. For many charities, giving these disclosures will be a major challenge, and trustees must support the disclosures by establishing a process of risk identification and risk management

Charities are often, by their very nature, operating in inherently 'risky' areas, and experience shows that in many cases they already have in place mechanisms for identifying and managing risks. The key will be to identify these processes, collate them, formalise them and document them. There should also be a process for ensuring that there is ongoing monitoring and review. As the charity's activities evolve, and as the environment in which it is operating changes (for example, through legal or economic developments), so will the major risks to which the charity is exposed.

The statement about risk will need to be supported by evidence of the risk identification and management process. Trustees may want to include this as a regular item on their meeting agenda, and when risk issues are discussed, they should be documented and the actions minuted.

Trustees should be in a good position to use their knowledge and wider experience to identify a variety of risks facing the charity, such as financial, operational, and regulatory risks, as well as - perhaps of most concern - risks in connection with damage to the charity's reputation. A practical way to capture this information is through the development of a high level 'risk register'. This could highlight the major risks, then document the controls, procedures or other factors that are in place to manage, mitigate or eliminate them. The trustees should review the register regularly to ensure that it remains complete and up to date.

The risk management process should become part of the charity's day-to-day activities, as opposed to an exercise that is divorced from what the charity is trying to achieve. It may enable the trustees to identify areas where more risk may be taken, or where opportunities are not being fully exploited. The risks facing the charity will exist, whether or not the trustees choose to recognise and address them - it is better to identify and manage them with confidence than to be exposed to them unwittingly.

Statement of financial activities (SOFA)

The SOFA remains the principal primary financial statement, and the general layout remains unchanged. There have, however, been a number of changes to the internal structure of the SOFA, which means that new account captions must be used and the comparatives for the previous year must be restated. The components of both 'incoming resources' and 'resources expended' have been revised. Existing 'charts of accounts' will need to be revised, and charities must review carefully the definitions of each of the revenue and expense captions to ensure that the right items have been included under each caption. In particular, the new 'costs of generating funds' caption is very broad, embracing publicity costs, the cost of sales of charity shops, investment management costs and the costs of applying for grants. The new 'support costs' caption is poorly defined, appears to take in 'back office' costs such as research, planning and logistical support, but needs to be carefully applied in the light of the individual charity's circumstances.

The SOFA will also be affected by changes in the approach to consolidation. In most cases a group arises where the charity has a trading subsidiary. Under the old SORP, subsidiaries were consolidated on a 'single line' basis whereby their net income was included under 'incoming resources'. Under SORP 2000 'line by line' consolidation must be used, meaning that subsidiaries' gross revenues appear under 'incoming resources' and the gross cost of sales is included within the 'cost of generating funds'. Again, the comparatives must be restated to reflect the change in approach to the consolidation.

SORP 2000 introduces clearer guidance about revenue recognition. This guidance particularly affects accounting for legacies and intangible income. Legacies must be recognised on an accruals basis, once the charity has received clear information about the timing and amount of receipts from an estate.

Charities have often used cash accounting for legacies, and this is no longer permitted for material receipts. Charities must also account for the 'deemed income' and 'deemed expenditure' represented by gifts of goods and services where the donor is clearly bearing the cost of the gift and the benefit is measurable. This would cover, for example, the provision of rentfree or heavily subsidised accommodation, the provision of services or the use of assets such as vehicles or IT equipment.

Inalienable and historic tangible fixed assets

The most significant accounting changes in the balance sheet concern the treatment of inalienable and historic tangible fixed assets.

FRS 15, Accounting for Tangible Fixed Assets, requires all tangible fixed assets to be capitalised, even if they have been gifted or acquired on terms that they can never be sold or can only be used for purposes particular to the charity's objects. This creates potential difficulties for some, and is addressed by SORP 2000. The SORP permits assets to remain off balance sheet under certain circumstances. These arise if reliable cost information is not available and conventional valuation approaches lack sufficient reliability, or significant costs are involved that may be onerous compared with the additional benefit derived by users of the accounts in assessing the trustees' stewardship of the assets.

As an example, consider a charity that operates nature reserves on several sites of redundant farmland. The land has been acquired through various purchases, gifts and bequests. Reliable costs or valuations may not exist for the current land holdings and it may be difficult to determine a reliable and objective basis of valuation for the land. Therefore, it would appear appropriate to leave these assets 'off balance sheet'. However, new acquisitions are acquired for a known cost and a reliable value can be attributed to new gifts and legacies. Also, if a visitor centre were to be constructed on one of the sites, then the costs of the construction should be capitalised and depreciated.

Conclusion

SORP 2000 contains many detailed changes to the content of a charity's report and accounts. The general principles of reporting have not changed, but there are new requirements that require detailed consideration by charities and their advisers and cannot be resolved by merely presenting some 'standard words'. Trustees must set aside time to address the requirements of SORP 2000 and, in particular, establish a reserves policy and a risk management process for their charity.

David Chitty is technical partner at Chantrey Vellacott DFK and co-author of Charities: An Industry Accounting and Auditing Guide, published by ABG.