OG 43 B1 - Charity income reserves: What constitutes "reserves" and how to identify them

In this section...

OPERATIONAL GUIDANCE

CHARITY INCOME RESERVES

WHAT CONSTITUTES "RESERVES" AND HOW TO IDENTIFY THEM

OG 43 B1 – 15 May 2009

Purpose

Functional responsibility

For action

Charity Services

For information

Contents

1.The definition of the term ‘reserves’
2. What is NOT included in our definition
3. Income from expendable endowment
4. Restricted income funds (special cases)
5. How to identify a charity's income reserves
Glossary of Terms used in this Guidance

Index to further related information


The Law	Refer to a lawyer	Refer to an accountant

1. The definition of the term ‘reserves’
	The term is defined in the Charities (Accounts and Reports) Regulations 2008, regulation 2, which provides that ‘reserves’ means: (a) in relation to a charity, those assets in the unrestricted fund of a charity which the charity trustees have, or can make, available to apply for all or any of its purposes, once they have provided for: (i) the liabilities of the unrestricted fund; and (ii) any commitments of the charity or other planned expenditure intended to be met from the assets of the unrestricted fund; (b) in relation to any body that is not a charity, the net assets or liabilities of the body that are disclosed in the body’s balance sheet for the financial year in question.
	Generally we use the term reserves to describe that part of a charity's income fund that is freely available for its general (unrestricted) purposes. ‘Reserves’ are therefore the resources the charity has, or can make, available to spend for all or any of the charity's purposes, once it has met its commitments and covered its other planned expenditure. When considering planned commitments, the trustees may decide to set aside as a designated fund part of the charity’s unrestricted funds. By designating funds in this way they are actively identifying a planned use for these funds. A common form of designation is to identify the value of the functional fixed assets that are part of the charity’s unrestricted funds (for example land, buildings, equipment or vehicles) and designate an amount equal to this value at the year end. By doing this, the trustees show that these assets cannot be readily sold and added to reserves because these assets are essential to the charity’s ongoing work.
	In communicating with trustees or the charity’s advisers it is important to clarify what is being talked about to ensure a shared understanding because the term reserves can be used very loosely. The term ‘reserves’ may be used very widely indeed and is likely to include funds listed in section 2 below as excluded from our definition. Reserves as defined by us might more commonly be referred to as free, general or unrestricted reserves outside of the Commission. You need to be aware of this when speaking or writing to a charity or its professional advisers, and you need to make it clear that you are using the term as defined in CC19 Charities’ Reserves.

2. What is NOT included in our definition
	Our definition of reserves excludes:
	permanent endowment;
	expendable endowment (CC19 explains why - but see section 3 below about the income from such a fund);
	the value of total gift element of permanent endowment together with the unapplied total return where permanent endowment is managed on a total return basis;
	restricted income funds (but see section 4 below);
	designated funds (CC19 explains why); and
	fixed assets held for charity use which could only be realised by disposal.
	There are, however, exceptions. For instance, designation needs to be properly justified. If not, it may be simply a device to hide reserves. The amount set aside needs to be realistic: designated funds in excess of the amount required should properly be treated as reserves. A charity will not be justified in creating, or transferring resources to, a designated fund where the main purpose of doing that is to allow the charity to show a reduced level of reserves.

3. Income from expendable endowment
	Re-investing income generated from endowment funds does not have the effect legally of converting the income into extra endowment, unless there is a power or a duty to add the income to the endowment. The reinvested funds remain income funds and need to be taken into account when deciding what constitutes an appropriate level of reserves.
	Where a charity is replacing borrowed permanent endowment this reinvested income is added to the endowment.

4. Restricted income funds (special cases)
	For the purposes of applying the principles in this guidance, we recommend that trustees treat each material restricted income fund as if it were a separate charity and consider what, if any, level of reserves they need to hold.
	For instance, some NHS Trusts have a number of charitable funds restricted in that each may be applied for the benefit of a particular hospital amongst a group of hospitals managed by the same NHS Trust. We strongly recommend that each of these funds should have a policy on reserves which should be justified and explained in its own right.
	(See also section 5.4 of OG 43 C1).

5. How to identify a charity's income reserves
	Our definition of reserves is set out in section 1 above. There is no one figure in a charity's accounts which will normally be expressly labelled ‘income reserves’ - you will need to examine both the trustees' annual report and its accounts to obtain a true picture. When analysing the accounts it is important to obtain accountancy advice either to confirm your analysis or provide the analysis of reserves. It is also useful to look at trends in reserves by looking at previous years.
	5.1 Trustees' annual report 5.2 The accounts

	5.1 Trustees' annual report
	The SORP recommends that the trustees' annual report should include a statement of the charity's policy on reserves stating the level of reserves held and why they are held. This, therefore, should normally be the first place to look to check both the amount held in reserve and the policy adopted by the trustees.
	(All registered charities must prepare an annual report).

	5.2 The accounts
	The accounts will provide you with figures which should support and be consistent with the narrative in the trustees' annual report. It will also indicate whether the level of reserves has increased or decreased since the last accounting period and how much is held in designated and restricted funds. (Although not included in our definition of reserves the amount and purpose of these other funds may have a bearing on the overall position - see section 5 of OG 43 C1). You will, however, need to bear in mind that the balance sheet in the accounts represents a snapshot of the position of the charity at a particular point in time - the end of the accounting year. (For instance, the unrestricted funds carried forward may be inflated by a significant grant or donation received by the charity at the very end of the accounting year.) This is why it is important to read what the trustees say in their annual report about their reserves policy, what the charity is trying to do and how it is going about it.

	Accounts prepared on the accruals basis
	The charity's Statement of Financial Activities (SOFA) should show all the charity's incoming resources and expenditure over the accounting period. It should differentiate between restricted, unrestricted and designated funds and reconcile all changes in these funds. In relation to each fund, it should show the balance brought forward from the previous financial year and the balance carried forward to the next financial year.
	The balance sheet provides a high-level snapshot summary of the charity’s financial position at close of business on the last day of the accounting period. It lists and analyses all the assets and liabilities of the charity including the value of all the various funds (where restricted or designated funds exist).
	You will need to look at both the SOFA for levels of incoming and outgoing resources and the balance sheet to examine the asset structure.
	It may be that the unrestricted fund balances as shown on the balance sheet are represented by fixed assets held for the charity's use - such as a village hall in the case of a community charity. This would not fall within our definition of reserves and its value would need to be deducted from the ‘fund balance’ to give a more accurate picture of the assets freely available for immediate use.
	The notes to the accounts should provide any additional explanation and information necessary to gain a proper understanding of the financial activities and financial position of the charity.
	Accounts prepared on the receipts and payments basis
	The Receipts and Payments Account (RPA) of a charity preparing accounts on the receipts and payments basis should distinguish clearly between the unrestricted (general) funds of the charity and any restricted funds (separate statements can be provided if the trustees wish). The receipts and payments, the net receipts, and the cash and bank balances carried forward for each fund should be shown. Corresponding figures for the previous year should be provided as a comparison.
	The Statement of Assets and Liabilities summarises the assets and the liabilities of the charity at the end of the accounting period. It should indicate to which fund each asset or liability disclosed belongs. (It is not obligatory for values to be provided for non-monetary assets.)
	You will need to study both the RPA and the Statement of Assets and Liabilities to obtain a reasonable picture of the charity's position.

Glossary of Terms used in this Guidance
	annual report
	designated funds
	expendable endowment
	income funds
	NHS Trusts / Charities
	permanent endowment
	reserves
	restricted funds
	SOFA
	SORP / the Charities SORP
	trustees

Index to further related information

In this section...

1. The definition of the term ‘reserves’

2. What is NOT included in our definition

3. Income from expendable endowment

4. Restricted income funds (special cases)

5. How to identify a charity's income reserves

Glossary of Terms used in this Guidance