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Although the accounting arrangements for private businesses can be complicated, the finances of a charity or charitable organisation can be even more complex. Whilst charities, businesses and individuals can enter contracts, charities can also receive financial grants which serve to help them achieve their objectives.
Although the contracts which charities choose to enter may also serve to assist them in achieving their aims, there are clear distinctions between contracts and grants and they must be treated differently. As grants are governed by trust law and contracts by contract law, there are different rules which relate to each type of arrangement as well as differing accounting measures and tax implications.
If a charity enters into a contract they may be agreeing to supply goods or perform services in return for payment. If a grant is given, however, this is a voluntary payment and the charity is not obliged to provide goods or services in return but the grant must be used for its intended purpose.
Many grants given to charities are known as simple grants which often require no more than a report on how the money was spent or the impact it had. A performance related grant is somewhat more complex and allows the donor to have more control over how the grant is spent. The complexities of such a grant mean that it can sometimes be difficult to distinguish between a grant and contractual arrangement.
The importance of distinguishing between grants and contracts, however, becomes apparent when we look at the different accounting practices for each. If a grant is received and its intended purpose is to advance the work of the charity, it is recognised in the Statement of Financial Activities. If the grant criteria has yet to be fulfilled and there is uncertainty as to whether they can be, the grant should be carried forward as a liability until it’s certain that the relevant conditions can be met.
Conversely, income which comes from a contractual agreement must be accounted for under the requirements of the Charities Statement of Recommended Practice as well as SSAP 4 and FRS 5. Until the performance of the contract has taken place, the transaction is treated as a payment in advance, providing the payment has been made. Once the transaction is completed the income is recognised in the Statement of Financial Activities.
Although contractual income received by a charity can be subject to certain tax exemptions, charities remain liable to pay tax in some instances. As grants are considered to be a donation they are not regarded as income and are not, therefore, taxable. These tax implications can affect the way in which a charity operates, particularly as income which exceeds the VAT threshold means the charity must also register for VAT.
Although distinguishing between grants and contracts is essential to ensure accurate charity accounting, it is a difficult and complex area. It is generally recommended that charities, however big or small, access independent advice to ensure they meet the relevant criteria and adhere to the relevant guidelines. In addition to helping charities meet their legislative obligations, specialist charity accountants and advisors can help ensure that charities and charitable organisations are operating as cost effectively as possible whilst minimising risk and maximising their funds.