UK: Financial Reporting In The Charities Sector

Last Updated: 20 September 2011
Article by Fiona Reid

The ASB has issued an exposure draft of the proposed public benefit entity accounting standard.

The UK Accounting Standards Board (the ASB) has a current project called "The future of UK GAAP" with the long-term goal of converging UK Generally Accepted Accounting Practice (UK GAAP) with International Financial Reporting Standards (IFRS). The initial ASB proposal was for a three-tier approach.

Tier 1

Full IFRS should apply for publicly accountable entities. It is proposed that publicly accountable entities should include those with listed debt or equity instruments, or entities that hold assets on behalf of a large group of outsiders (e.g. banks, insurance companies). There will be a small number of charities that fall within this tier. The Companies Act will have to be amended to allow charities to apply IFRS as this is currently not permitted under UK law.

Tier 2

Entities that are not publicly accountable but do not meet the small company criteria as defined by statute will apply the Financial Reporting Standard for Mediumsized Entities (FRSME), a proposed UK version of IFRS for medium-sized entities.

Tier 3

Entities that are not publicly accountable and qualify as small companies can prepare accounts under the existing UK Financial Reporting Standard for Smaller Entities (FRSSE).

In response to public consultation, the ASB has suggested that these proposals might be changed, so that:

  • tier 1 would be applicable only to those entities required by law or other regulation to use full IFRS
  • the FRSME would be changed to allow greater consistency with existing UK GAAP and full IFRS
  • the effective date will be put back from 1 July 2013 to 1 January 2014.


The FRSME has been developed for use by for-profit entities. The ASB is developing the Financial Reporting Standard for Public Benefit Entities (FRSPBE) for not-forprofit entities that will follow the FRSME, and issued an exposure draft (FRED 45) of this in March 2011.

The FRSPBE will be mandatory for public benefit entities (PBEs) applying the FRSME and will be considered best practice for other PBEs. The aim of the FRSPBE is to provide guidance on transactions which are unique to not-for-profit entities and are not covered by the FRSME.

PBE statements of recommended practice (SORPs) will be retained as part of the financial reporting framework. The Charities SORP Committee is currently developing a new SORP which reflects the proposed changes. The draft of this will not be issued for consultation until the FRSPBE is issued in final form, which means that the SORP consultation period is likely to be in the first half of 2012, at the earliest.

The draft FRSPBE deals with a number of issues specific to PBEs:

  • concessionary loans
  • property held for the provision of social benefits
  • entity combinations
  • impairment of assets
  • funding commitments
  • income from non-exchange transactions.

Property held for the provision of social benefits

Property held for the provision of social benefits would include housing properties for social rent, care homes, schools, hospitals and similar properties. The exposure drafts of the FRSME and the FRSPBE require that such properties be measured at cost if held for use in the charity's primary purpose service provision.

While revaluation of charitable property is relatively rare, in the social housing sector it is more common. This would be a significant change and it seems likely that the ASB will be forced to reconsider following responses received during the consultation period.

Impairment of assets

The FRSME requires that an asset be written down to its 'recoverable amount' if it is impaired. This requirement is the same under existing UK GAAP. 'Recoverable amount' is defined as the higher of fair value less selling costs, and value in use. Determination of value in use for a for-profit entity is based on the present value of future cashflows generated, but this method is not appropriate for PBEs. Therefore an alternative valuation method has to be applied, usually depreciated replacement cost. This is defined as "the most economic cost required for the entity to replace the service potential of an asset at the reporting date". This definition sounds simple, but in reality could be difficult and potentially costly to assess. In contrast, UK GAAP currently allows charities to use non-financial measures of impairment, the most common method being the use of the service potential. Currently a financial impairment would not necessarily need to be recognised if the property was being fully utilised to provide services to the charity's beneficiaries.

The FRSPBE requires that PBEs carry out an impairment review if any of the indicators of impairment that are included in the FRSME are present. This is a contentious requirement as one of the indicators listed in the FRSME is "the carrying value of the net assets of the entity is more than the estimated value of the entity as a whole". This is relevant to profit-making entities, but is irrelevant to not-for-profit entities.

The existence of an impairment indicator requires an entity to undertake an impairment review. That is, calculate fair value less selling costs and value in use, and consider whether any write down is necessary. This is potentially an expensive exercise as charities are likely to require the assistance of external advisers.

The FRSPBE introduces an additional indicator for charities, being any indication that the service potential of the asset has been impaired, for example if there is reduced demand for the service provided. This does not represent any change from the current requirements of the Charities SORP. However, as noted, the key difference is that under UK GAAP service potential is both an indicator of possible impairment and a method by which any impairment can be assessed. Under the FRSPBE, the service potential is simply one of a number of impairment indicators.

Incoming resources from nonexchange transactions

The two important areas covered by this section of the FRSPBE are Government grants and donated assets.

The FRSPBE is relatively silent on Government grants and refers to the treatment required by the FRSME. Many in the charity sector consider that this is an omission in the FRSPBE, particularly as the accounting for grants varies significantly within the PBE sector, where social landlords and education establishments have differing treatments compared to charities. This is an area where clarification would be useful.

Charity accounting requirements state that Government grants should not be deferred just because they are for capital expenditure. The FRSPBE does not intend to change this, but it also does not explicitly deal with this scenario therefore leaving it open to misinterpretation. There is also concern in the sector that the FRSPBE does not distinguish between performance conditions and restrictions on income; the former might give grounds for deferral whereas the latter would not.

In general, donated assets are recognised as a donation at their value when received. However, the exception to this has always been goods donated to charity shops which have previously only been recognised as income when sold.

The FRSPBE requires PBEs to value goods received via a non-exchange transaction at fair value. This will apply to goods donated to charity shops as well as – for example – donations of major assets. It is the widening of this requirement to value goods donated to charity shops which has caused the most contention. The guidance allows an entity to "estimate the value of those [donated] goods taking into consideration past experience and expectations". In the case of stock donations, such estimations are unlikely to be accurate, and, if the stock figure represents a significant value in the accounts, it is likely that the valuation method would become a contentious audit issue.

In some areas the FRSPBE serves to retain the accounting treatment that charities have been following for many years. However, some of the proposals, if included in the final version of the FRSPBE, could have a significant impact on charities. (For example the valuation of stock in charity shops and the requirement to carry social housing properties at cost).

Charities will no doubt be hoping that the ASB takes on board their comments from the consultation period and revise some of the more contentious requirements of FRED 45 before the standard is issued in final form.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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