OPERATIONAL GUIDANCE

ENDOWED CHARITIES: A TOTAL RETURN APPROACH TO INVESTMENT

ACCOUNTING FOR TOTAL RETURN

OG 83 B5-20 November 2001

Purpose: This guidance explains trustees' responsibilities in relation to accounting for total return.

Divisional responsibility

For information:

All operational divisions

Meaning of expressions - list of Glossary terms used in this Guidance
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1. Accounting for total return

1.1 Accounting responsibilities and the total return approach to investment
1.2 Accounting recognition of the investment return under the total return approach to investment
1.3 Accounting for the allocation of the unapplied total return to the trust for application (income)
1.4 Accounting treatment where the allocation exceeds investment return of the financial year
1.5 Accounting disclosure of the unapplied total return
1.6 Trustees' annual report disclosure
1.7 Accounting thresholds

1.1 Accounting responsibilities and the total return approach to investment

Trustees will need to account for both the investment return and the allocation to the trust for application (income) in a manner consistent with the methods and principles of the Statement of Recommended Practice – Accounting and Reporting by Charities (SORP 2000). In addition trustees will need to make the specific disclosures required by the consent Order in their annual report and notes to the accounts.

1.2 Accounting recognition of the investment return under the total return approach to investment.

Under the total return approach the investment return initially accrues to the permanent endowment. Whilst the investment return forms part of the unapplied total return it remains permanent endowment until such time as the trustees determine to allocate to the trust for application (income). The investment return should therefore be credited to the permanent endowment column of the statement of financial activity (SOFA).

Whilst investments are managed so as to optimise the investment return, the distinction between investment income and capital gains and losses should be preserved in the SOFA analysis:

• investment income should be credited to the endowment funds column, as an incoming resource, at line A of the table in paragraph 69 of the SORP 2000;

• capital gains and losses should be disclosed in the endowment column as gains and losses on revaluations and disposals of investment assets at line G of the table in paragraph 69 of the SORP 2000.

Investment income should be analysed by note to the accounts in accordance with paragraph 113 of SORP 2000. Trustees may choose to expand this note by giving details of capital gains and losses so that the user of the accounts has a better appreciation of the overall investment return generated.

1.3 Accounting for the allocation of the unapplied total return to the trust for application.

Where the trustees have exercised their power under the order to allocate part of the unapplied total return to the trust for application (income), the amount so allocated in respect of the financial year should be disclosed by way of a transfer from the endowment funds column to the relevant income funds column of the SOFA. This transfer should be disclosed at line D of the table in paragraph 69 of SORP 2000.

The notes to the accounts should provide details of the nature of the transfer, explaining that it represents the allocation of the unapplied total return to income funds. (See SORP paragraph 49 (d)).

1.4 Accounting treatment where the allocation exceeds investment return of the financial year

The allocation to the trust for application (income) is made from the unallocated total return and is therefore not necessarily limited to the investment return obtained in a particular year. Circumstances may arise where the allocation made exceeds the investment return obtained in the year, for example, the investment return for a particular year is insufficient to discharge the duty of even-handedness to current beneficiaries.

Such situations should also be dealt with by a transfer in the current financial year and not by prior year adjustment of funds brought forward. The transfer reflects the exercise of trustee discretion in a particular financial year, and the transfer between endowment and income funds reflects the exercise of that discretion. Where the allocation exceeds the investment return for the year trustees may wish to explain the circumstances in their annual report (see section 1.6).

1.5 Accounting disclosure of the unapplied total return

The accounts for each financial year are required by the consent Order (OG 83 C5 section 7) to give particulars of the movements in the value of the unapplied total return for the financial year by way of notes to the accounts. The particulars required are:

• the aggregate value of the assets representing the unapplied total return at the beginning of the financial year;

• any increase or decrease during the year in the value of the assets representing the unapplied total return;

• the part of the unapplied total return which the trustees have, in the financial year, allocated to the trust for application (income) for the purposes of the charity; and

• the aggregate value of the assets representing the unapplied total return at the balance sheet date.

The aggregate value of the unapplied total return at the end of a financial year continues to form part of the permanent endowment and does not constitute a separate fund for accounts purposes.

1.6 Trustees’ annual report disclosure

The consent Order (OG 83 C5 section 6) also requires specific disclosures by the trustees in their annual report (or by notes to the accounts if no trustees’ annual report is required) to explain the policies adopted by them in identifying and allocating the unapplied total return. The disclosures required are:

• to state the policy adopted by the trustees for making the initial identification of which part of the existing assets of the charity represents its unapplied total return, and state the date from which the analysis was performed if different from the date when the charity was established;

• to give an explanation of the consideration and policies relevant to the trustees’ determination of the part of the unapplied total return that is allocated to the trust for application (income) in that financial year; and

• to identify the person(s) who provided advice as to the use of the power so as not to prejudice the ability of the charity to meet the present and future needs which are designated by its trusts.

1.7 Accounting thresholds

The amount of any unapplied total return allocated (ie transferred) to the trust for application (income), in respect of a financial year, forms part of gross income for statutory threshold purposes. The investment return initially accruing to the endowment fund does not form part of gross income.

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

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Order
Trustees

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