Restricted funds – the importance of robust internal financial controls

There was a recent article in Third Sector about a major disability charity suffering financial difficulties. The charity is currently subject to a Charity Commission inquiry, regarding spending funds donated as restricted funds alongside general reserves.

The charity has a newly appointed board which is actioning a three-year recovery plan, aiming to strengthen the charity’s financial controls and governance. Its accounts state that “due to historically poor IT systems and finance processes, the charity was not able to identify all eligible expenditure related to specific restricted funds”. Restricted funds are created where a restriction is defined by the donor or a fundraising campaign but is still within the wider objects of the charity.

If the donor gives money to the charity in a way that specifies how that money should be spent, or the charity runs a fundraising campaign for a specific project or activity – for example, as part of an appeal for donations to the Fund – the charity is required by law to spend it for that purpose. The charity cannot borrow it to use it for another purpose, because it is not at the charity’s disposal.

Restricted funds are distinct from unrestricted funds (including designated funds). Unrestricted funds are income or income funds which can be spent at the discretion of the trustees in furtherance of any of the charity’s objects.

This instance serves as a reminder about the importance of strong internal financial controls:

• Charities should have an internal financial controls policy which is fit for purpose, understood and followed.  A financial controls policy should cover how your charity handles money. This is to give confidence to stakeholders that the charity’s finances are being properly managed and to provide transparency on how funds raised will be held and spent by the charity.
• Trustees can delegate the detailed work on financial controls to one or more trustees or to a member of staff, e.g. a CFO, but remain responsible for their charity’s financial management and for ensuring effective implementing and monitoring.
• The Commission’s guidance CC8, ‘Internal financial controls for charities’, is a must read for trustees and the checklist attached to the guidance is a helpful resource to ensure that the charity’s approach is comprehensive and effective.
• Specifically in relation to restricted funds, trustees should understand what they are, how they can be lawfully used and how they should be accounted for. Internal financial controls should ensure that restricted funds can only be spent on their specific purposes and make sure any permanent endowment the charity holds complies with legal requirements.
• Trustees should monitor their internal financial controls to ensure they are fit for purpose, for example, by ensuring that they are given regular information about the financial performance of the charity and this is discussed at each trustee meeting, by having clear terms of reference for any finance sub-committee (including reporting to the board in accordance with those terms of reference), by checking controls to ensure the funds are spent on the purposes the funds are given for.
• Financial controls policy and procedures should be reviewed at least once per year.
• Trustees should be aware when their duty to report a serious incident to the Charity Commission kicks in, for example: where a financial crime such has fraud, theft, cyber crime or money laundering is suspected; where large donations are received from an unknown or unverifiable source, or there is suspicious financial activity using the charity’s finds; other significant financial loss or insolvency.
• There is a useful checklist in the CC8 guidance so that you can benchmark your approach to financial controls against the Commission’s expectations.

The Charity Commission asks charities, as part of the annual return, if they have a policy for internal financial controls – so charities should ensure they have one in place that is tailored to their activities.