How do you cope when you are trying to solve a problem that it seems cannot be solved? A boyhood hero of mine was the nineteenth century Liberal Prime Minister William Gladstone who spent his later years trying to solve ‘The Irish Question’. There is a satirical quote, ‘every time the English tried to solve the Irish Question the Irish changed the question.’ The question was not answered in his lifetime.
It may sound farfetched but I sometimes have the same feeling about accounting for legacy income! It has similar characteristics. It is a question that never seems to lead to a satisfactory answer. But as we approach the time when there will be another iteration of the Charity SORP, I believe that the ‘legacy question’ needs to be asked – and answered.
What I wish to do in this article is to ask what the legacy question is, why it matters, what is wrong at the moment and what can be done about it.
What the legacy question is
In the commercial world, you will know what you have supplied to your customers and what will need to be invoiced. But with legacy income there are so many unknowns. Someone, the legator, has decided that he or she wants to give a charity income when they die. But the charity will rarely know about this. So, when the legator dies, how does a charity know that it might be entitled to that income? The distribution of this income is under the control of the executor(s) of the estate. As a result, how do you know how much income that might be or how reliable that figure may be?
As charity accounting became more allied with the principles of general accounting practice, it was understood that entitlement to the income could be traced further back than the receipt of that income. Initially, it was agreed that the completion of estate accounts could provide certainty of legacy income for charity. This led to legacy income received after the year end being accrued in the previous year’s charity accounts. This was where the estate accounts were agreed in that year and the charity was only subsequently made aware of this. Whilst this was an improvement, it meant that the legacy income figure could depend on how quickly you prepared your statutory accounts after the year end. This reflects the fact that it can take a long time for the executors to inform the charity of the payment of the legacy.
But conceptually it can be argued that the real point of ‘entitlement’ to this income is when the legator dies and the legator’s will can no longer be changed. The charity then has a right to that income. In many cases, grant of probate (for England and Wales) will be the first practical point at which a charity can quantify what income it is entitled to. In other cases, a charity may only know it is entitled to a legacy when it is received.
Why answering the legacy question matters
Legacy income contributes so much to the charity sector and it is a growing source of income. I work for Cancer Research UK. In our accounts for the year to 31 March 2023, our legacy income was £261m. It exceeded our income from general donations. Not surprisingly, that annual income funds a significant proportion of our research.
The Institute of Legacy Management (ILM), which is the charity sector body for charity legacy professionals, estimates that in total annual legacy income for charities comes to £4bn!
When the level of legacy income is so high it is important to get our accounting for legacies right. Not only for that reason. How can you get a real impression of the financial health of a charity like mine without a good understanding of its entitlement to legacy income?
In the accounting standard setting process, it often seems to me that charities can be very good at recognising their liabilities whilst not always being so good at recognising their assets.
Some years ago at Cancer Research UK we moved away from a cautious approach to legacy income recognition to one which we consider presents a more realistic evaluation of the income we are due. That ultimately enables more cancer research to be funded.
For many smaller charities, the receipt of a legacy may be a rare event and a world away from the Cancer Research UK experience. But when it does happen it can transform a charity’s finances. As a result, with smaller charities it is also very important that they can be clear about accounting for legacies so that they know when income can be recognised and what disclosures should made about that income/potential income.
Accounting for legacy income can be hard work. Dealing with valuations and legal disputes can be judgmental. But it does not mean that it should not be done and put on the far too difficult pile!
What is wrong with accounting for legacies at the moment?
Whether by accident or design we seem to have ended up with a form of words in the Charity SORP that is ambiguous in some key aspects of income recognition. This can allow a preparer of charity accounts to adopt a preferred accounting approach rather than one that should be consistently applied across the charity sector. This wording has been in place for some time. Without concerted effort to change it now, it may remain in place for some time to come. This is a particular risk as the next Charity SORP will need to allow for significant new requirements relating to leases and income recognition. Minds will be elsewhere!
This issue would not be so important if charities were getting it right despite ambiguous guidance. But, according to The ILM, ‘there is significant variance in the way that charities account for legacies’ (ILM submission to the Financial Reporting Council on the consultation on FRED 82). Something needs to be done.
In our next article ‘How can we answer the legacy question in the next Charities SORP?’, we will explore what can be done to answer the legacy question in the next Charities SORP.
*The views expressed are the author’s and not ICAEW’s
