The Scottish Government’s recent announcement that it will introduce regulations to raise the audit income threshold for Scottish charities from £500,000 to £1,000,000 later this year is undoubtedly beneficial and long overdue.
This is excellent news for many organisations as it will alleviate a significant administrative burden and potentially allow more funds to be directed towards charitable activities. I fully support this change.
However, might this pose a threat to financial governance and organisational sustainability for some charities? This article explores this further and what, in my view, charities should do to prepare.
A Challenging Environment
Many Scottish charities are currently facing a perfect storm of significant financial pressures, including rising costs due to the cost of living crisis, increased demand for services caused by cuts to public services and social security, challenges in funding with depleting reserves and unmet calls for adequate government support, economic uncertainty with high inflation reducing purchasing power, donor fatigue, and regulatory and compliance costs including higher employer National Insurance contributions – the list goes on (and on). These issues make it increasingly difficult for Scottish charities to sustain operations and effectively support their communities.
Audits are often time-consuming and costly, and for charities operating with tight budgets, the compliance costs can be prohibitive. Raising the threshold means that fewer charities will be required to undergo audits, freeing up valuable resources for direct charitable work. Growth may also be encouraged where a higher threshold might empower some charities to expand their operations without fearing increased regulatory costs. Overall, the change is proportionate and very welcome, reducing the regulatory burden on smaller charities and aligning the threshold with England & Wales.
So, What’s the Problem?
The benefit of an audit is that it is designed to provide a level of independent assurance in relation to governance, financial transparency, and financial sustainability. Different auditors have different approaches, but it generally extends to much more than checking the numbers. Auditors have a regulatory obligation to ensure this is the case.
Audits serve as a crucial mechanism for accountability, providing an independent review of a charity’s finances to ensure appropriate fund usage.
Unlike an independent examination, an audit provides a thorough and detailed review of a charity’s financial records.
Auditors, through their expert knowledge and experience, can be the catalyst for a charity governance review. This is often when professionals, like me, are brought in.
Auditors can pinpoint areas where the charity’s financial processes could be enhanced, propose methods to strengthen financial controls, and provide counsel on adhering to legal and regulatory mandates. Their expertise uncovers nuances and complexities in financial records, ensuring potential issues are addressed before escalating.
As the saying goes, “you don’t know what you don’t know,” and auditors play a crucial role in bridging that knowledge gap, providing insights and recommendations that enhance a charity’s financial and governance health.
The loss of this expertise and independent assurance needs to be considered as charities are cut-loose from the regime.
Practical Steps
Any charity moving away from the audit regime should consider the risks this presents.
What gaps will be created, and how will these be filled to ensure adequate oversight and control by charity trustees and continued assurance to the charity’s donors and stakeholders?
In addition, does the charity’s governing document allow the charity not to have an audit?
The following points should be applicable to all charities but are particularly important in this context.
1. Review the Governing Document
Check what the governing document says about independent scrutiny of annual accounts. If the governing document specifically mentions the requirement of an audit, then the charity will remain bound by this, notwithstanding the change in the threshold. This can be addressed by updating the governing document as soon as possible.
Also, ensure a process is in place to periodically review the governing document to ensure continued alignment with the charity’s governance and operations.
2. Check Funder Agreements
Some funders may require that a charity’s accounts are audited as a condition of their funding. Check funding agreements and enter into early dialogue with any relevant funder.
3. Have a Handle on the Financial Position
The financial governance of a charity is ultimately the collective responsibility of the charity trustees, irrespective of whether an audit is required. Charity trustees must have a understanding of the charity’s finances. Is this the case?
Implementing monthly or quarterly financial reporting can help monitor income, expenses, and cash flow, and reviewing how reports are produced to ensure they are easy to understand for all. Regular variance analysis can identify discrepancies and address them promptly.
Trustees must have the ability to look forward. What do the next 12 months’ finances look like?
4. Budgeting and Forecasting
Developing annual budgets and financial forecasts can help charities plan for future activities and ensure financial sustainability. This proactive approach can prepare charities for potential financial challenges.
5. Strong Internal Controls
Establishing strong internal controls, including approval processes for expenditures and regular reconciliations, can help manage finances effectively. Regularly review these controls to ensure they are being followed and agree on who will carry this out.
6. Review the Training Needs of Charity Trustees, Key Staff and Volunteers
Providing financial literacy training for charity trustees and others can improve their understanding of financial management and reporting. Continuous learning and staying updated on best practices and regulatory changes can help trustees make informed decisions.
Charity trustee boards’ may wish to identify training on how to implement and carry out an internal audit.
Reviewing the skills and experience profile of the charity trustee board from time to time is also relevant. This should feed into both training requirments and charity trustee recruitment requirements.
7. Review Risk Management Strategies
Have a process in place to actively assess risk. Identifying potential financial risks, such as funding cuts or unexpected expenses, and developing mitigation strategies can help charities remain financially resilient.
8. Review Internal Audit Processes
Implementing internal audits such as random sample testing enhances the credibility of financial statements and also fosters a culture of vigilance and precision. Regular testing, coupled with comprehensive training for charity trustees, solidifies the framework for robust internal controls and proactive risk management, ultimately safeguarding the organisation’s financial integrity.
9. Know when to Seek Professional Advice
Do not struggle in silence or leave it until it’s too late. In matters of governance and financial management, the cost of neglecting to take professional advice at an early stage can end up being substantially more than the cost of the advice itself. Missteps can lead to governance failings, financial mismanagement, loss of donor trust, and potential legal ramifications.
Conclusion
In conclusion, overall, the upcoming increase to the audit threshold is a change to be celebrated.
However, it is important that transitioning charities remember to;
- check that they can make the change with reference to their governing document and any funding agreements; and
- consider any steps that need to be taken to secure continued, effective, oversight and control of the charity.
If your charity requires any advice in relation to changing its governing document, or in relation to any of the other governance matters raised here, please contact Sarah Brown (sarah@sarahbrowncharitylaw.com) who will be happy to chat with you.
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