Accounting for Small Charities and Not-for-Profits

TL;DR: Key Takeaways for Charity Accounting

Charities SORP 2026: New rules apply from January 2026, introducing three tiers for reporting based on income, aiming for more proportionate disclosure.
Filing Thresholds: Independent examination threshold rises to £40,000, and accruals accounting threshold to £500,000 from September 2026.
Gift Aid: Reclaim 25p for every £1 donated by UK taxpayers, significantly boosting donations. Ensure donors are UK taxpayers and declarations are in place.
Fund Management: Differentiate carefully between restricted and unrestricted funds to ensure compliance and proper use of donations.

1. Understanding Charity Accounting Requirements

Accounting for charities in the UK is governed by specific regulations to ensure transparency and accountability to donors, beneficiaries, and the public. The primary framework is the Statement of Recommended Practice (SORP) for charities, which works in conjunction with FRS 102 (The Financial Reporting Standard applicable in the UK and Republic of Ireland).

Charities SORP 2026: Key Changes

The Charities SORP has been updated, with SORP 2026 applying to reporting periods starting on or after 1 January 2026 [1]. These changes aim to improve transparency, proportionality, and relevance in charity financial reporting. Key updates include:

Three-Tier Reporting Regime: A significant change is the introduction of three new tiers for reporting, making requirements more proportionate to a charity's size [1]:
- Tier 1: Income up to £500,000
- Tier 2: Income between £500,000 and £15 million
- Tier 3: Income over £15 million
Income and Lease Arrangements: New accounting rules with practical examples to help charities navigate complex income streams and lease agreements [1].
Trustees' Annual Reports: Refreshed requirements with additional guidance on reporting financial reserves, future plans, impact reporting, and environmental, social, and governance (ESG) issues [1].
Social Investments: Simplified accounting and reporting requirements for social investments [1].
Provisions and Contingencies: Easier to understand reporting requirements for provisions and contingencies [1].

Important Note:

Charities must ensure they understand which tier applies to them and adapt their accounting practices accordingly to comply with SORP 2026. Failure to comply can lead to issues with the Charity Commission.

Receipts and Payments vs. Accruals Accounting

Small charities in England and Wales have a choice in how they prepare their accounts, depending on their income level. This choice is between Receipts and Payments accounts and Accruals accounts.

Feature	Receipts and Payments Accounts	Accruals Accounts
Definition	A simple cash-based method recording money received and paid out [2].	Records income when earned and expenses when incurred, regardless of when cash changes hands [2].
Complexity	Simpler, suitable for smaller charities with straightforward finances.	More complex, provides a truer and fairer view of financial position.
Eligibility (from 30 Sept 2026)	Non-company charities with gross annual income below £500,000 [1].	All company charities, and non-company charities with gross annual income of £500,000 or more [1].
Reporting	Summarises cash movements, often accompanied by a statement of assets and liabilities.	Includes a Statement of Financial Activities (SOFA), Balance Sheet, and Cash Flow Statement.
Advantages	Easy to understand and prepare, lower administrative burden.	Provides a more accurate financial picture, better for planning and external scrutiny.
Disadvantages	Doesn't show a full financial picture (e.g., debtors/creditors), can be misleading for complex operations.	More time-consuming and requires greater accounting knowledge.

Tip:

Even if eligible for Receipts and Payments accounts, many growing charities opt for Accruals accounting early on. This provides a more robust financial overview and eases the transition as the charity expands.

2. Charity Commission Filing Thresholds

The Charity Commission for England and Wales sets various financial thresholds that determine a charity's reporting and auditing requirements. These thresholds were updated, with changes expected to come into effect on 30 September 2026, applying to accounting years ending on or after this date [1].

Requirement	Current Threshold (up to 29 Sept 2026)	New Threshold (from 30 Sept 2026) [1]
Independent Examination	Income over £25,000	Income over £40,000
Professionally Qualified Independent Examiner	Income over £250,000	Income over £500,000
Option for Receipts and Payments Accounts	Income below £250,000	Income below £500,000
Statutory Audit (Income Test)	Income over £1,000,000	Income over £1,500,000
Statutory Audit (Asset Test)	Assets over £3,260,000	Assets over £5,000,000
Group Accounts (Audit)	Aggregate income of group £1,000,000	Aggregate income of group £1,500,000

Key Implication:

The increase in the independent examination threshold to £40,000 means more small charities will be exempt from this requirement, reducing administrative burden. However, the threshold for submitting annual reports and accounts to the Charity Commission remains at £25,000 [2].

3. Reclaiming Gift Aid

Gift Aid is a UK government scheme that allows charities to reclaim basic rate tax on donations made by UK taxpayers. This means for every £1 donated, charities can claim an additional 25p from HMRC, effectively increasing the donation by 25% at no extra cost to the donor [3].

How Gift Aid Works (2026/27)

Donor Eligibility: The donor must be a UK taxpayer and have paid enough UK Income Tax or Capital Gains Tax in the tax year (6 April to 5 April) to cover the amount the charity will reclaim on their donations [3].
Gift Aid Declaration: The donor must make a Gift Aid declaration, confirming they are a UK taxpayer and agree to the charity reclaiming tax on their donation. This can be a one-off declaration or cover future donations [3].
Charity Claims: The charity collects these declarations and submits a claim to HMRC, usually online. Claims can typically be made for donations received up to four years after the end of the financial period they were received in [4].
HMRC Repayment: HMRC repays the basic rate tax to the charity.

Donation Amount	Basic Rate Tax Reclaimed (25%)	Total to Charity
£10	£2.50	£12.50
£50	£12.50	£62.50
£100	£25.00	£125.00
£500	£125.00	£625.00

Higher Rate Taxpayers:

If a donor pays higher (40%) or additional (45%) rate tax, they can claim the difference between the higher rate and the basic rate on their donation through their self-assessment tax return. This means their donation effectively costs them less, encouraging larger gifts [5]. Charities should inform donors of this benefit.

4. Other Key Accounting Considerations

Restricted vs. Unrestricted Funds

Proper fund accounting is a cornerstone of charity finance. Charities must clearly distinguish between different types of funds to ensure donations are used as intended by the donor.

Unrestricted Funds: These are funds that can be spent on any of the charity's purposes, at the discretion of the trustees. They are crucial for covering core operating costs (like rent, salaries, and administration) and provide financial flexibility [6].
Restricted Funds: These are funds given for a specific purpose or project defined by the donor or the terms of a fundraising appeal. They cannot be used for any other purpose without the donor's or the Charity Commission's permission. Misusing restricted funds is a breach of trust and can have serious legal consequences [6].

Best Practice:

Use accounting software that allows you to easily tag and track income and expenditure by fund type. This simplifies reporting and ensures you can demonstrate to donors exactly how their money was spent.

Trading Subsidiaries

Charities often engage in trading activities to raise funds. However, if a charity's trading is not directly related to its primary purpose (non-primary purpose trading) and exceeds the small trading tax exemption limit, the profits may be subject to Corporation Tax.

To protect the charity's assets from trading risks and to mitigate tax liabilities, charities often set up a separate trading subsidiary. This is a standard company owned by the charity. The subsidiary conducts the trading and can donate its taxable profits back to the parent charity via Gift Aid, effectively reducing its Corporation Tax liability to zero [7].

VAT for Charities (Partial Exemption)

VAT is notoriously complex for charities. Unlike businesses, charities often have a mix of activities:

Business Activities: Selling goods or services (e.g., a charity shop, ticketed events). These may be taxable (standard, reduced, or zero-rated) or exempt.
Non-Business Activities: Providing free services funded by donations or grants. These are outside the scope of VAT.

A charity can only reclaim VAT incurred on purchases that relate to its *taxable business activities*. VAT incurred on non-business activities or exempt business activities generally cannot be reclaimed.

When a charity incurs VAT on costs that relate to both taxable and exempt/non-business activities (like general overheads), it must use a partial exemption method to calculate how much VAT it can recover. This often requires complex calculations and careful record-keeping [8]. Note that from 1 April 2026, new VAT reliefs apply to businesses donating goods to charities, simplifying the process for corporate donors [9].

5. Best Accounting Software for Charities

Choosing the right accounting software is crucial for small charities and not-for-profits. The ideal solution should simplify financial management, ensure compliance with Charity Commission regulations, facilitate Gift Aid claims, and provide robust fund accounting capabilities. Here are some of the top choices for UK charities:

Xero

Overview: Xero is a popular cloud-based accounting software known for its user-friendly interface and extensive integration capabilities. It is widely used by small businesses and is increasingly adopted by charities [10].
Charity-Specific Features: While not exclusively designed for charities, Xero can be configured for fund accounting through tracking categories. It integrates with various third-party apps that can assist with Gift Aid claims and donor management [11]. Xero allows for easy generation of financial reports, which can be shared with trustees and donors [12].
Pros: Intuitive interface, strong reporting, excellent ecosystem of integrated apps, good for remote access.
Cons: Requires some setup for effective fund accounting, not purpose-built for charities.

QuickBooks Online

Overview: QuickBooks Online is another leading cloud accounting solution offering various plans suitable for different sizes of organisations. It provides features for managing income, expenses, and reporting [13].
Charity-Specific Features: QuickBooks Online can be set up with a charity-specific Chart of Accounts, which helps in categorising income and expenditure appropriately for non-profits. It supports tracking by class or location for fund accounting, and some versions offer more advanced reporting suitable for charities [14].
Pros: Comprehensive features, scalable plans, good for managing payroll, widely supported by accountants.
Cons: Can be more complex for very small charities, some advanced features may require higher-tier plans.

Sage Intacct (and Sage Accounting)

Overview: Sage offers a range of accounting solutions. Sage Intacct is a more advanced cloud financial management system often chosen by larger or growing non-profits due to its robust fund accounting and reporting capabilities. Sage Accounting (formerly Sage Business Cloud Accounting) is suitable for smaller charities [15].
Charity-Specific Features: Sage Intacct excels in multi-dimensional accounting, allowing for detailed tracking of funds, grants, and projects. It provides strong reporting and dashboard customisation, essential for demonstrating accountability. Sage Accounting offers simpler features for basic bookkeeping.
Pros: Powerful fund accounting (Intacct), strong reporting and analytics (Intacct), scalable for growth.
Cons: Sage Intacct can be expensive and complex for small charities; Sage Accounting may lack advanced charity-specific features.

Other Notable Mentions:

For charities with very specific fund accounting needs, solutions like Liberty Accounts and ExpensePlus are purpose-built for the charity sector in the UK, offering integrated Gift Aid and fund management features [16].

References

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