OPERATIONAL GUIDANCE

CHARITY INCOME RESERVES

WHAT CONSTITUTES "RESERVES" AND HOW TO IDENTIFY THEM

OG 43 B1 - 11 January 2007

Divisional responsibility

For information:

Charity Support Division

Contents

1. Our 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

Meaning of expressions - list of Glossary terms used in this Guidance
Index to further related information

1. Our definition of the term "reserves"

There is no legal definition of "reserves" in relation to charities and no specific legal rule about the amount or proportion of a charity's income funds which it is allowed to hold as a reserve. Our definition has been drawn up to inform the lay person of our understanding of reserves.

Generally we use the term to describe that part of a charity's income funds that is freely available for its general (unrestricted) purposes. "Reserves" are therefore the resources the charity has or can make available to spend, for any or all of the charity's purposes, once it has met its commitments and covered its other planned expenditure. More specifically, we define reserves as:

• income which becomes available to the charity and is to be expended at the trustees' discretion in furtherance of any of the charity's objects (sometimes referred to as "general purpose" income); but which

• is not yet spent, committed or designated (that is, it is "free").

(But see section 4 below - in some circumstances a restricted income fund may itself have reserves.)

You also need to be aware that there is a common understanding of the term amongst accountants that is different from our definition. In accounting, "reserves" is often 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.

2. What is NOT included in our definition

Our definition of reserves excludes:

• permanent endowment;

• expendable endowment (paragraphs 15 and 16 of CC19 explain why - but see section 3 below about the income from such a fund);

• restricted income funds (but see section 4 below);

• designated funds (paragraphs 19 and 20 of CC19 explain 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 is an appropriate level of reserves.

Where recoupment is directed the 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 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

Essentially, reserves are simply that part of the charity's general purpose funds which do not need to be spent immediately and which are not committed or designated. 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.

5.1 Trustees' annual report
5.2 The accounts

The Exposure Draft of the revised 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.

The accounts will provide you with figures which should support and accord with the narrative in the trustees' annual report. It will also indicate whether the reserves level has increased or decreased over 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 the position of the charity at a particular point in time - the end of the accounting year. (For instance, the general purpose 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 expenditure, 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.

The following words and phrases are defined in the Glossary of Terms:

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annual report
designated funds
expendable endowment
income funds
NHS Trusts / Charities
permanent endowment
restricted funds
SOFA
SORP
trustees

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