Compiled for BAC 411 by CPA Francis. K.

Gitagia, Kenyatta University

ACCOUNTING FOR TRUSTS

INTRODUCTION
The main purpose of this lesson is to analyze the accounting system that is necessary in the case
of trusts
5.1: LEARNING OBJECTIVES

By the end of this lecture, you should be able;

 To define a trust
 Identify the different types of trusts
 Appreciate the duties and powers of a trustee
 Prepare the necessary trust accounts

5.2: DEFINING A TRUST

Trust is an obligation attached to the ownership of property and arising out of confidence laid in
and accepted by the owner or declared and accepted by him/her for the benefit of another. The
person in whom the confidence is laid is referred to as the trustee while the person who lays
confidence is referred to as the creator or settlor. The person for whose benefit the confidence is
laid is referred to as the beneficiary. A trust can therefore be said to be a relationship in which a
trustee is compelled to hold real or personal property for the benefit of the beneficiary. A trustee
of the property is usually considered to be the legal owner while the beneficiary is considered to
be an equitable owner. The document which creates a trust on its part is referred to as the Trust
instrument.

5.3: CLASSIFICATION OF TRUSTS

Trusts may broadly be classified into two categories namely;
 Express trusts
 Trusts created by operation of the law

5.3.1: EXPRESS TRUSTS

These are trusts that are created in express words by the settlor.  An express trust is created not by
facts and circumstances, but by the express words of the settlor. It may be created in the following
ways:
 A declaration of trust by the settlor whereby he makes himself the trustee of property for the
benefit of some person; or
 The transfer by the settlor of the ownership of the trust property to trustees, and the
communication to the trustees of the terms upon which they are to hold that property; or
 By will.
Express trusts are further categorised into two groups namely;
i) Public trusts
These are trusts created for a general charitable purpose such advancement of education or

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improvement of health conditions. These trusts are established for the benefit of a large and
fluctuating group of people. Public trusts may also be referred to as purpose trusts because these
are created for some specific purposes such as;
 Relief of poverty
 Advancement of education
 Advancement of religion
 Advancement of sports
 Any other purpose that is beneficial to the community.
ii) Private trusts
These are trusts created by settlors for the benefit of particular persons or groups of persons and not
for some institution or public purpose. These type of trusts are usually created in writing to ensure
the certainty of their terms. An express private trust will be valid only if the following three
certainties are present.

Certainty of words
There is no need for a settlor to use the word "trust" in order to constitute a trust; it is enough if the
words used in the instrument clearly establish an intention to create a trust. The words must be
imperative and not merely a request i.e. precatory word

Certainty of subject matter

Where the property subject to the purported trust cannot be identified there will be no trust. Where
the beneficial interests to be taken by the beneficiaries are not certain, the trust will be a resulting
trust for the settlor. However there is no uncertainty in the following cases:-
 Where the trustees are empowered to determine the beneficial interest to be enjoyed;
 Where the court is able to apply the maxim "Equality is Equity", and divide the property into
equal shares.

Certainty of objects
The objects of a trust must be certain i.e. a trust will only be valid if it can be said with any
certainty that any given individual is or is not a member of the class of beneficiaries. Generally,
trusts which fail to meet this requirement are void for uncertainty.

NOTE

 In the absence of certainty of words the person to whom possession of the property has been
given takes the property for his/her own benefit.
 In the absence of the other certainties there is generally a resulting trust in favour of the settlor
or his estate.

Private trusts are further classified as;

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i) Discretionary trusts
These are trusts in which the trustees may have discretionary powers vested in them either by the
trust instrument or by general law. In such trusts the trustees are given discretion to pay or apply
all or part of the trust income for the benefit of the beneficiaries as they deem fit.

ii) Non discretionary trusts

These are trusts in which the trustees are required to follow the terms stated in the trust
instrument strictly.

iii) Protective trusts

These are trusts which give some protection to the beneficiaries against some misfortunes. Such
trusts normally give the beneficiaries life interests in the trust properties. If income is settled on
"protective trusts", this operates to give –
 A life interest for the principal beneficiary determinable on alienation or bankruptcy; and
thereafter;
 A discretionary trust for the trustees to apply the income for the benefit of the principal
beneficiary, his spouse and issue, or, if there is no spouse or issue then for the benefit of the
principal beneficiary and those who would be entitled to the trust property or the income
thereof were he dead.

5.3.2: TRUSTS CREATED BY OPERATION OF THE LAW

These trusts include;
i) Statutory trusts
These are trusts which are created by law as an automatic consequence of certain circumstances.
For instance if land is conveyed to two or more persons then the legal owners hold the land in
trust for sale.

ii) Implied trusts

These are non express trusts which are based on the presumed intentions of the settlors. An
implied trust arises where the settlor's intention is inferred from his words and his conduct. Some
implied trusts are also called resulting trusts. This is because the beneficial interest results to the
settlor. Resulting trusts occur where equity regards the property which is held by a trustee as
belonging in equity to the person who transferred it to, or caused it to be vested in the trustee. They
may arise in four situations -
a) Purchase of property by one person in the name of another
 Where a person buys land and has it conveyed into the name of another, or into the joint names
of himself and another, there is a presumption that the property is held on trust for the person
supplying the purchase money;
 If two people advance money to purchase property, but the conveyance is taken in the name of
one only, the other takes a beneficial interest in the property in proportion to the money

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advanced by him. In some cases the relationship between the two parties will raise a
presumption of advancement which displaces the presumption of a resulting trust i.e where the
person supplying the purchase money is under an obligation to maintain the other e.g. a father
or a husband.
 
b) Voluntary transfer of personal property by the owner into the name of another or into their joint
names
 
c) Failure to exhaust the beneficial interest. The settlor fails to dispose of the whole of the
beneficial interest in the trust fund. The undisposed of part is held by the trustees on resulting
trust for the settlor or his estate.
 
d) Where a private express trust fails for uncertainty of objects or for non-compliance with
statutory formalities there will be a resulting trust in favour of the settlor.

iii) Constructive trusts

These are trusts that arise by the operation of the law either because of the implied intentions of
the parties or because it would be inequitable not to impose a trust. In this case the court gives
the authority to a person in good faith to perform the duties of a trustee. The concept has been
applied in a number of situations such as;
 It is a rule of equity that a trustee must not permit his interests to conflict with his duties: note
particularly, a trustee may not profit from his trust: where he does so he holds the gains on a
constructive trust.
 If a person who is not a trustee obtains information with the help of a trustee which enables
him to make a profit, he holds the proceeds on constructive trust.
 If a person receives trust property with knowledge (actual or constructive) that it is trust
property, and it is transferred to him in breach of trust, he holds the property as trustee.
 A person who does not actually receive trust property but assists a trustee to fraudulently
dispose of it is liable as a trustee.
 
NOTE

Strangers are not to be made constructive trustees merely because they act as the agents of trustees
in transactions within their legal powers, e.g a solicitor who creates a fraudulent document on the
instructions of the trustee. They will be liable only if:-
 They receive the trust property; or
 Act in a manner consistent with that of a trustee; or
 Assist with knowledge in a dishonest and fraudulent design on the part of the trustees.

5.3.3: SECRET TRUSTS

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Introduction
The initial basis of the doctrine of secret trusts was the refusal of equity to permit a statute to be
used as an engine of fraud .Certain formalities are necessary for the creation of inter vivos trusts of
land for testamentary dispositions. A trust of land must be evidenced in writing; and all
testamentary dispositions must comply with the Law of Succession Act. In the case of wills, secret
trusts are of two types, fully secret trusts and half secret trusts.
 Fully secret trusts
This is where neither the existence nor the terms of the trust are disclosed in the will. The trust will
be enforced only if the following conditions are complied with.
 The testator must leave property by will to the secret trustee apparently for his own benefit;
 The testator must tell the secret trustee that he wants him to hold the property on trust for the
secret beneficiary: this communication must take place during the testator's lifetime: but
whether it is before or after the date of the will is immaterial
 The secret trustee must promise to carry out the testator's intention: such promise may be
express or implied. Silence after hearing the testator's intention will normally be treated as an
implied promise
 The testator's decision to make a disposition in favour of the secret trustee or to leave an
existing disposition unaltered must be made on the faith of the secret trustee's promise;
 No trust will arise if the alleged trustee only learns of the alleged trust after the testator's death.
 
Half secret trusts
In this type of trust the will states that the gift is on trust, but the name of the beneficiary is not
specified. Since the existence of a trust is disclosed, the trustee is unable to claim the property for
himself. The following points should be noted:-
 
 Evidence tending to establish a half-secret trust is inadmissible if it contradicts the terms of the
will.
 Communication of the trusts to the trustees will be ineffective if it takes place after the will has
been executed.
 Where there is no proper communication to the trustees, the property belongs to the residuary
legatee or, if no such person, the testator's next of kin.
 
NOTE

Secret trusts operate outside the will. Thus:

 A beneficiary under a secret trust does not lose his interest if he witnesses the will or if he
predeceases the testator;
 Where a secret trustee predeceases the testator, the legacy and the trust fail.

5.4: ESSENTIALS OF A TRUST

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For the creation of a trust some conditions must be fulfilled which are known as essentials of a
trust. These conditions include;
 The existence of trust property
 Express or implied intention of creating a trust
 The identification of settlor, trustee and beneficiary
 Certainity of words, subject matter and object
 Capacity to create a trust
 Lawful purpose of creating a trust

5.5: CAPACITY AND APPOINTMENT OF TRUSTEES

Any person with legal capacity to hold property may be a trustee, except an infant. However
bankrupt persons and criminals are not considered capable to be appointed as trustees. A trust
corporation has also the capacity to be appointed as a trustee. A trust corporation means the public
trustee or any corporate body empowered by law to conduct trustee business. The following can be
appointed as a trust corporation;
 Any company appointed by the court
 Certain charities
 Certain local or public authorities
 Certain public officers e.g Public trustee

5.5.1: Appointment of trustees

A trustee may be appointed in the following ways;
i) Under the trust
The settlor usually appoints the first trustees when the trust is created. Once the trust is
established the settlor has no further power of appointment unless such power is expressly
reserved in the trust instrument. The trust instrument may also give express power to some other
person to appoint the new trustees.
ii) Appointment by court
The court may appoint trustees:
 Whenever it is difficult, inexpedient or impracticable to appoint without the court’s
assistance, on the application of a trustee or a beneficiary e.g. in substitution for a trustee
who is bankrupt, mentally defective or a convicted criminal.
 A judicial trustee (an officer of the court), on application by settlor, trustee or beneficiary, in
substitution for all or any of the existing trustees;
 The public Trustee, on application of a trustee or beneficiary even though this is forbidden in
the trust instrument.
iii) Under Trustee Act
New trustees may be appointed in writing to replace a trustee who:
 Is dead;
 Remains continuously out of Kenya for more than one year;
 Desires to be discharged;

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 Refuses to act;
 Is legally unfit to act, e.g. Bankrupt;
 Is physically incapable of acting, e.g is removed under a power in the trust instrument; or being a
corporation, is dissolved.

The appointment is made by-:

 Persons having power to appoint under the trust instrument; or if no such person, or no such
person is willing and able to appoint, then
 The surviving trustee or trustees; or
 The personal representatives of the last trustee.

Additional trustees
Apart from the appointment of the trustees (above), additional trustees may be appointed in
writing at any time by:
 Persons given power to appoint by the trust instrument; or if no such person willing and able
to act then
 The trustees for the time being provided that –
i. No existing trustees is a trust corporation and
ii. The total number of trustees will not exceed four.

5.5.2: Termination of a trustee

A trustee may be terminated in the following ways;
a) Disclaimer
A trustee may disclaim a trust provided that he/she has not already done something to signify
his/her acceptance such as taking possession of part of the trust property. Disclaimer is usually
effected by deed.

b) Retirement
A trustee may retire;
 Under an order of court
 With the consent of the beneficiaries if they are all of full age and capacity
 Under a provision in the trust instrument
 Under the provisions of the Trustee Act

c) Removal
A trustee may be removed;
 Under a power contained in the trust deed
 By a court order

d) Replaced
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If the trustee has been replaced under the provisions of the Trustee Act

5.5.3: Duties of a trustee

Duties impose an obligation upon the trustees to act. They include;
 He/she must execute the trust i.e fulfil the purpose of the trust and obey the directions given
except as modified by the consent of beneficiaries competent to contract or when express
obedience to the directions would be impracticable, illegal or injurious to the beneficiaries.
 He/she must inform himself/herself of the state of the trust property. If the trust property for
instance has a debt outstanding on personal security and the deed leaves no discretion to leave
it outstanding, he/she must recover the debt without delay.
 He/she must protect the title to the trust property i.e he/she must bring and defend all necessary
suits and take all possible steps to preserve the trust property.
 He/she must not change for himself/herself or another set up any title to trust property adverse
to the interest of the beneficiaries
 The trustee must exercise reasonable care i.e must act as a reasonable prudent person would
deal with his/her own property.
 Must be impartial. If there is more than one beneficiary then he/she cannot execute the trust for
the advantage of one beneficiary at the expense of other beneficiaries.
 Must prevent waste. This is where the trust is created for the benefit of persons in succession
and one of them is in possession.
 Must not make any profit from his/her office unless expressly authorised by the trust
instrument.
 Should invest only in authorised securities. A trustee is not allowed the same discretion in
investing the moneys of the trust as if he/she were allowed to deal with his/her own estate. It is
the duty of a trustee to confine himself/herself to the class of investments which are permitted
by the trust instrument or as defined by the Trustee Investment Act
 Must be ready with accounts. A trustee must keep clear and accurate accounts and at all times
furnish the beneficiary if the latter so desires full and accurate information as to the amount and
state of the trust property.

5.5.4: Powers of a trustee

Powers give trustees a discretion, which they can only exercise if they are unanimous. A power
may be coupled with a duty, in which case the trustees must act, but have discretion as to the
manner of acting e.g in relation to investment of trust funds. The powers of a trustee include
power;
 To use the trust property for the maintenance, education or benefit of a beneficiary who is a
minor
 To use the trust money for the benefit of a beneficiary
 To sell the trust property or mortgage the property
 To settle claims by or against the trust
 To invest the trust funds at his/her own discretion provided the necessary requirements are
followed
 To insure trust property against loss or damage by fire upto three quarters of its value

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 To adopt necessary steps which are reasonable and proper for the realisation, protection or
benefit of trust property and for the protection and support of the beneficiary who is not
competent to contract.

5.5.5: Delegation
A trustee cannot delegate unless:
 It is necessary or in the ordinary course of administration or
 Authorised by the trust instrument or
 Authorised by statue. The statutory powers of delegation are:
i. He may employ and pay an agent, e.g. a solicitor, banker ore or stockbroker to do any
necessary act without liability for the agent’s default if he was employed in good faith;
ii. He can, by means of a power of attorney, delegate the exercise of all or part of his trust for
up to 12 months. He may not delegate to a sole co-trustee unless it is a trust corporation.
The power of attorney must be witnessed by at least one person. Notice of the delegation
must be given within 7 days to co-trustees and persons with power to appoint new trustees.
He must specify the date of commencement, duration, the delegate, reason for delegation,
and, if delegation is partial, which part of the trust, is delegated. The trustee remains
personally liable.
iii. He may appoint a competent and independent surveyor or valuer to value property
mortgaged as security for trust money lent, and is not liable if he lends more than two-
thirds of the valuation and the valuer’s or surveyor’s report advised the loan;
iv. Trustees for sale of land my delegate powers of leasing and management to the person
entitled to possession, being of full age, without liability for his acts or defaults.

5.5.6: Maintenance
Trustees may pay to the parent or guardian out of income of a fund held on the trust for an infant
reasonable sum for his/her maintenance and education, having regard to his age and station in life,
subject to the following conditions:
 The power is subject to any prior interest or charge affecting the property;
 A payment must be in proportion to amounts paid from other available funds (if any);
 The power is not affected by the existence of a person bound by law to maintain or educate the
infant; nor it is affected by the fact that particular sums have already been set aside for this
purpose;
 The power exists whether the infant’s interest is vested or contingent (provided, in the latter
case, that the trust carriers the intermediate income);
 Payments out of capital may be valid, but should normally only be made under requirements of
the Act or with the consent of the court;
 The residue of the income must be accumulated and invested;
 The trust instrument may exclude this power.

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5.5.7: Advancement
Trustees may apply not more than half of the presumptive or vested share of the capital held in
trust for any person (infant or adult) for his advancement or benefit (including maintenance) on the
following conditions:
 The trust property consists of money or securities or property held on trust for sale;
 No advance can be made to prejudice any person with a prior interest, unless that person is of
full age and gives his written consent;
 The interest may be vested or contingent;
 The advance must be brought into account on his becoming absolutely entitled;
 The power may be excluded by the trusts instrument

5.5.8: Insurance
Trustees may insure trust property against loss or damage by fire subject to the following
conditions:
 The insurance must not exceed the full value of the property;
 The trustees must not insure if:
i) The trust instrument forbids this, or
ii) The trustees are bound to convey the property absolutely to the beneficiary on request;

 Premiums may be paid out of income of the trust property (not necessarily the property
insured);
 Insurance money received is to be treated as capital, and held on the same trusts as the property
insured.
 
5.5.9: Protection against claims
 The trustees may protect themselves against claims after discharge in the following ways:
 As regards liability for rent and other obligations under a lease or rent charge, they may pay all
outstanding liabilities and make provision for fixed and ascertained future claims, and may
then distribute the property to a beneficiary or purchaser entitled thereto without any further
provision.
 Before conveying or distributing the trust property they may advertise for claims in the Gazette
and a local paper requiring interested parties to send in particulars of their claim within a stated
time, being not less than two months, and are not liable after the time limited in the
advertisements to persons of whose claims they have no notice; but they must make all proper
searches and enquiries.
 They may pay into court monies or securities remaining in their hands, and the receipt of the
appropriate officer of the court operates as a good discharge.
 
5.5.10: Settlement of liabilities

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 Wide powers of compromise are granted to trustees by the Trustee Act. Two or more trustees or a
sole trustee, where authorised, may:
 Pay or allow any claim on any evidence they think sufficient;
 Accept a composition or a security, real or personal, for any claim;
 Allow any time for payment of a debt;
 Compromise, compound, abandon, submit to arbitration, or otherwise settle a claim.

ILLUSTRATION
Kimaru and Majiwa are life tenants of a trust set up by their uncle. The trustees have investment
powers restricted to those contained in the Trustee Act (Chapter 167 of the Laws of Kenya)
except they could hold at their absolute discretion 300,000 shares of Sh.10 each in Kilimanjaro
Enterprises Limited, a horticultural exporting company run by the uncle..
On 31 March 2011, the balance sheet of the trust was as follows:

Sh.’000’ Sh.’000’
Fixed interest investments
Sh.2 million 10% Kenya stock 2016 (cost) 2,000
Sh.2 million 9% Kenya stock 2015 (cost) 1,800
Cash at bank 200 4,000
Wider range investments
40,000 shares of Sh.100 in E.A. Breweries 4,000
Ltd (cost)
Special range investments
300,000 shares in Kilimanjaro Enterprises 3,000
Ltd. (cost) 11,000

Trust capital
Fixed interest fund 4,000
Wider range fund 4,000
Special range fund 3,000
11,000

In the year to 31 March 2012, the following occurred:

2011
30 June Interest for the year ended 30 June 2011 was received on 10% Kenya
stock. School fees for Kimaru and Majiwa were paid immediately
using the whole amount received.

30 September A final dividend of 75% for the year ended 30 June 2011 was received
from E.A. Breweries Ltd. (payout rate 10%).

30 November The E.A. Breweries Ltd. shares were sold at Sh.110 each. At the same
time, a satisfactory buyer was found for the 300,000 shares in

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Kilimanjaro Enterprises Limited – these shares were sold for Sh.15

each. Some high yielding 12%Kenya stock 2017 was available at par
on this date. It was decided to use all the wide range cash available to
purchase this stock and designate it as a wider range investment.

31 December Interest was received for the year on the 9% Kenya stock and Sh.42,
000 interest was received on the fixed interest cash at bank.

2012
28 February 61,250 Sh.10 ordinary shares in ICDI Limited were purchased for
Sh.40 per share using the fixed interest cash and a suitable switch was
made to ensure adherence to the requirements of the Trustee Act. The
market value of the 12% Kenya stock 2017 on this date was still par.

31 March All remaining income cash was paid across to the life tenants, after trust
administration expenses of Sh.120, 000 were paid for the year.

(a) Write up the trust cash account, the income account (showing payments to beneficiaries
in this account) and the trust capital account for the year ended 31 March 2012.

(b) Prepare the trust Statement of Financial Position as at 31 March 2012.

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