Reviewing Accounts - a rough guide

Introduction

The objective of this paper is to give non-finance people the basic skills and
knowledge required to assess the financial statements of a voluntary
organisation.

There are many different reasons for reviewing a set of accounts. Clearly this
is not exactly an enjoyable past-time – few people would list this as a hobby.
So it is likely that the accounts are being reviewed to fulfill some duty or task.
Committee Members may review accounts to assess the performance of their
organisation; funding authorities may be looking for effective use of grants or
reserves; statutory authorities may be looking for compliance with the law
and/or accounting standards.

Unfortunately, it is not really possible to pick one aspect of the accounts and
focus on that. For example, if you are particularly interested in reserves, you
cannot focus only on the ‘balance sheet’. Any assessment of reserves must
consider other aspects of the financial statements. This is for the obvious
reason that a group may have low reserves because it has spent all its
money on 'unnecessary' items.

A review of the accounts often leads to more questions than answers. This is
why it is always advisable to read the Annual Report alongside the accounts.
Indeed, the two documents should really be seen as one.

In any set of account, it is almost impossible to avoid using some jargon. A

glossary is therefore provided as an appendix.

The Assessment Process

1.Consider the overall format of the accounts

1.i As a general rule, the accounts should be clear and neatly presented.
There are specific statutory regulations covering the format of
accounts for charities and companies, and the accounts should state
whether they have been prepared in accordance with these
regulations. If the accounts do not comply, or if they are unclear, it is
not a good sign

1.ii For example:

• a charity may submit accounts without a report by an auditor or
Independent Examiner
• the accounts may show an unusually large amount under 'sundries'
and an insufficient level of detail.
 • the accounts may be full of jargon which is not explained
• look for the obvious - missing pages, unsigned accounts, tippex!

2. Consider the Report from the Auditor or Independent Examiner.

2.i This will include an assessment of the suitability of the Examiner. Is

the person qualified, and do they have experience relevant for that
type of organisation? There are regulations for charities and
companies, so you may wish to ask how the Examiner was selected.

2.ii The actual report should be considered. Is it in the correct (statutory)

format, and is there any 'qualification'. This could be a serious
qualification such as the examiner being unable to make a report, or a
minor qualification such as the examiner not having seen all the
records. A qualified report does not mean the accounts are no good, it
merely shows that the examiner is not able to give a 'clean' report.
That said, it is still bad news!

2.iii In addition, an Auditor must, and an Independent Examiner should,

provide a follow up report to the group's Committee or Trustees. This
is sometimes called a Management Letter, and will set out areas of
concern and action required. It is quite possible to have a clean
'Report', but a lengthy 'Management Letter'. This letter should always
be presented to the group's Committee so it should be on file.
However, it is a confidential letter and any outsider would need to ask
permission to see a copy.

3. Income and Expenditure.

3.i Consider the Income – is it as you might expect?

It is not easy to spot financial irregularities from the accounts alone,

but you may see some clues in the income. For example, if a group
hires out its premises, is the figure for room hire as you would expect.
Is it significantly less that the previous year and, if so, is this explained
in the annual report?

3.ii Consider the expenditure – do you agree that it was necessary?

It is not uncommon for groups to spend large sums on unnecessary

equipment or even salary bonuses in order to reduce the cash
reserves at the year end. Low reserves could mean the group is poor,
or perhaps wasteful; high reserves could mean the group is rich, or
perhaps prudent and careful with the public's money

3.iii Consider the expenditure - do you accept that it was reasonable?

Sometimes a group may spend money on items which an outsider may

think were inappropriate. Charities are bound by regulation which will
limit the areas of legitimate expenditure to the 'objects' of the charity.
Non charities have no such external regulation. If there are doubts,
 information should be requested as to the reason for the expenditure
and how it was authorised.

A group may have low reserves because it has spent lots of money on
unreasonable items. As an extreme example, a group may provide first
class travel for its Trustees. This may have the effect of increasing
their expenditure and so reducing their reserves, but is it reasonable?
A funder would not be able to see this from the accounts, so if travel
costs seem high, the funder may ask to see the group’s policy. A less
extreme example is that a group may pay 7% pension contributions for
staff – is this reasonable?

4. The Balance Sheet

4.i The baic idea of a balance sheet is to show what the organisation has
got (the top half), and where it came from (the bottom half). While the
bottom line is important, especially if it is a negative number – it cannot
be the only focus of the review.

4.ii Some key numbers to look for are:

Fixed Assets - You may wish to clarify how these are valued and what
policy is used to ‘depreciate’ the cost of these assets over time.
Debtors – if these are too high, it might actually be a bad sign
Current liabilities – again, if these are high is might be a bad sign
Provisions’- it is possible to make a group look less well of by adding in
some ‘provisions’, but are these reasonable in your view.
Net Current Assets – this is a crucial number and is a good indicator of
the health of the organisation. For example, it might have total assets
of £1million, but if this compries £1,000,100 of fixed assets, £50 in the
bank, but creditors of £150, then the picture is not so good.

4.iii If you are interested in ‘free’ reserves, this will require close scrutiny.
Specific questions are
• has there been an appropriate distinction made between funds that
are 'restricted' and those which are not - if the accounts are all
mixed up, the group will not be able to identify its general reserves
• has there been a significant change in the balances held from one
year to the next and, if so, is this reasonable - any significant
change should be capable of explanation
• are any 'provisions' or 'designated funds' reasonable, given the
nature of the organisation - a common way to attempt to hide
excess reserves is to create designated funds or to make
provisions which are not necessary
• are the funds held primarily in cash, or are they tied up in fixed
assets like buildings and equipment - the funder's main concern
should be with 'liquid assets'.
• if certain projects or funds have been charged for 'overheads', are
these charges reasonable and consistent - clever people can
reduce the general fund's reserve by forgetting to charge the
restricted funds for their share of the core running costs. This is a
potentially complex area - if in doubt, ask questions.
5. Evaluation of Free Reserves

5.i What to look for in the balance sheet.

Having clarified the accounts, an evaluation must be made as to the

level of Reserves. The basic aim is to clearly identify the level of ‘free,
or ‘general reserves’. Once identified, further information should be
requested if these are over 25% of annual expenditure (or payments),
or under 10%. These limits are simply a guide and have no legal basis.

5.ii Restricted Reserves will should not be taken into consideration unless:
• the nature of the restriction is the same as the reason for which
grant aid is sought.
• any restricted fund has not been 'charged' with its fair share of the
overheads.

5.iii Designated Reserves should not be taken into consideration unless:

• the nature of the designation is considered to be unreasonable or
inappropriate
• the 'fund' is simply being built up without any real intention of being
spent
• any designated fund has not been charged with its fair share of
overheads

5.iv Contingency Reserves will be considered to be free reserves.

The Language

As with any profession, accountants have developed a language of their own.

The joke is that all the accounting standards, together with company law and
charity law state that the aim is make accounts more 'decision useful'. In
other words they say that the aim is to make them more understandable.
Others may think that the whole point is to make them less understandable so
that people have to employ accountants to explain them!
To help, the following list is a 'rough' interpretation of some of the jargon used
in accounting. These definitions would not stand up to rigorous criticism, but
they'll do for now:

Accruals. This is where the accounts are prepared in a way which shows not
only what happened in a period, but what should have happened in the
period. E.g. if you get a gas bill the day after the year end, in accruals
accounts it would be included since the gas was actually used before the year
end.

Audit. Any registered Auditor must follow a set of guidelines issues by the
Audit Practice Board. The Auditor does not say that the accounts are correct,
but simply expresses an opinion on the accounts. Auditors must be registered
in accordance with the 1989 Companies Act

Assets. These can be fixed - big things that last a long time, or current -
cash, or things that can be turned into cash within a short period. Current
assets would include stock, money in the bank, petty cash, prepayments and
debtors.

Balance Sheet. This is a statement within the accounts that explains what
the group has and where it came from. The first part adds up the good things
(like money in the bank), and subtracts the bad things (like bills you haven't
paid yet). The second half usually shows which project or fund it all belongs
to. Only larger charities and companies need to do this.

Creditors. These are people you owe money to at any particular time.
Usually they are listed at the year end in the accounts.

Debtors. Money owed to the organisation. Although ‘debtors’ are considered

an asset, if you are owed a vast amount this might not be so good!

Deferred grants. These will be grants received in one period but actually
intended for spending in a future period. Sometimes this may be called
‘grants in advance’.

Depreciation and Amortisation. Depreciation is simply a way of spreading

the cost of an asset over the expected life of that asset. Amortisation is the
same, but for the income (usually a capital grant) with which the asset was
purchased.

Independent Examination. This is a service, similar to an audit, where a

group’s accounts are checked by an independent person. There are rules for
who can do this, and guidelines on how it should be done. It is of particular
relevance to charities

Liabilities. Money you owe others. These can be current (payable within one
year), or long-term.

Liquidity. This is the measure of how much cash you have and is it enough
for your needs. It can include things that can be turned into cash quite quickly
like debtors and other current assets. A ‘liquidity problem’ is where you don’t
have enough cash to pay your immediate bills.

Materiality. This is a concept often used into accounts. It basically means

'big enough to bother about'. For example a £100 error in the petty cash may
be very 'material' to a small group but 'immaterial' for a big national group.
The basic test of materiality is - if the reader of the accounts would form a
different opinion if they knew about it, then it is material.

Net Current Assets. This is a figure that appears in the Balance Sheet. It
comprises the current assets less the current liabilities. It can be a very
important figure. For example, you may have total assets of £1,000,001, but if
a million of this is an old building and only £1 is in the bank then it’s not so
good.

Overheads. Sometimes called 'central costs' these are the costs usually
incurred at the office, which must be borne (paid for) by all the activities
(projects) of the organisation . Examples would include Audit fees, some
salaries, office rent etc.

Reserves. Each year, income is received and expenditure incurred resulting

in a surplus or deficit. Year-on-year, this builds up (hopefully) as a Reserve.
Reserves can be:
• 'restricted' -money where the donor has specified what it must be spent on
• 'designated' - money the Trustees have set aside for a particular purpose
• 'general' - uncommitted reserves

SORP. This is the Statement of Recommended Practice for Charities and it

sets out the regulations for accounting by charities. Larger charities must
follow the full SORP. Smaller charities have different (easier) regulations to
follow.

Statement of Assets and Liabilities. This is an accounting statement

common in the accounts of smaller charities. It is basically a list of the good
(fixed assets etc.) and the bad (creditors etc.).