We often have to guide clients through the minefield of different funds held by charities since this can be a confusing area. On the face of it, one would expect it to be clear whether a particular income source is restricted or not, but this is often not the case.
Let’s go back to basics. Charities can have four different types of funds:
1. Unrestricted
Funds with no particular terms and conditions, which the trustees are free to spent as they see fit in accordance with the charity’s objectives.
2. Designated
These funds are those unrestricted funds which have been set aside by trustees for an essential spend or future purpose. In a sense, these funds are then 'ring-fenced' and no longer form part of your unrestricted general funds. Common designated funds are redundancy funds to cover the costs if the charity were forced to close, or to cover the cost of replacing one of the charity’s assets.
Trustees are free to transfer into and from designated funds, however, the decision to make transfers should be made prior to the charity’s financial year end, and should be documented.
3. Restricted
Used to track income and related expenditure where a third party gives the charity money and imposes terms and conditions stipulating the funding must be spent on a particular purpose. Often there is a repayment clause which means the funding has to be repaid if it is not spent for the purposes intended.
Restricted income funds are to be spent or applied within a reasonable period from their receipt to further a specific purpose of the charity. It is important to note that the specific purpose will be to further one or more but not all of the charity’s charitable purposes. If all of the charity’s charitable purposes are furthered then it is likely that the income should be classed as unrestricted.
4. Endowment
These are funds which the trustees are legally required to invest or to keep and use for the charity’s purposes. Endowment may be expendable or permanent.
Reserves
The term ‘reserves’ is also routinely used. Reserves, or sometimes referred to as ‘free reserves’ are the part of a charity’s unrestricted funds that is freely available to spend on any of the charity’s purposes. Free reserves therefore exclude:
- tangible fixed assets used to carry out the charity’s activities, such as land and buildings;
- programme-related investments those held solely to further the charity’s purposes;
- designated funds;
- commitments that have not been provided for as a liability in the accounts.
It is useful for charity accounts to include a designated fund equal to the value of fixed assets (less any related to restricted funds) so that the unrestricted fund balance represents the value of the true balance the charity has readily available. It is good practice to refer to the level of free reserves clearly in financial review or reserves section of the trustees’ report. Large charities have to state their level of free reserves when they complete their Charity Commission annual return.
Your reserves policy
It is important that trustees set a strong reserves policy, and for this to be reviewed regularly to ensure that too much or too little is not being set aside. The policy should set out:
- how much your charity needs to hold in reserve and why
- how and when your charity’s reserves can be spent
- how often the reserves policy will be reviewed.
All charities preparing accruals accounts (all charitable companies plus any unincorporated charities with income over £250,000) must, by law, set out their reserves policy – or reasons for not holding reserves – in the trustees’ annual report.
Funds and reserves can therefore be a confusing area. If you have any questions or require guidance interpreting the funds in your accounts, or setting a reserves policy, please contact me or one of our Charity and Not-for-Profit Sector team.
Alternatively, fill out our contact form here.
