When it comes to legacy accruals, consistency is the best policy

Neil Kirk Good Practice in Legacy Management

Weekends mean ‘lie-ins’ in our household (in a very loose sense of the word). The chance to enjoy the comforts of a soft mattress and a bit more shut-eye for an extra hour or so until the necessities of the day and the co-ordinating of children can’t be put off for any longer.

There’s no formal system but my good wife and I know who’s turn it is to look after the kids and who gets to enjoy the bed for longer. If it was me who got up last few times then I know I’ve got a right to a lie-in or two coming up (and this won’t be forgotten).

That right to some future benefit (or cost!) underlies the essence of accruals. It’s about understanding what present and enforceable right or demand there might be based on an event and making sure it’s accounted for in a more formal sense. It operates in a financial way to make income and expenditure accounts clearer and be more logical.

At its simplest level, it’s about matching any benefit or cost to the period in which it was attributed. If I run a business selling luxury pillows (to keep with the bed theme) and have a main supplier who takes months to send in their invoices for high class feathers in the short term it’s going to look like my costs are wonderfully low. I’m seeing the money coming in and there’s little cost to match it against so the business is looking profitable and it’s happy days. However, at some point that inevitable, very large, invoice is going to land on my door-step and then reality will hit and the accountants will panic. What I need to be doing is making a note of what I’m waiting for and matching the cost to the benefit each month so that there are no surprises. Accountants don’t like surprises and as accountants write the accountancy book they’ve written it to minimise this.

When it comes to Legacies though, the water is a bit more muddied. Charities know they’re due some benefit in the future but when this will be and how much they’ll get is often an unknown (particularly with residual gifts). FRS102 (the accounting Bible for financial reporting) is aware that legacy income isn’t really the norm for most entities but helpfully includes a small section on it in Appendix B (PBE34B.5-7). It states that legacies should be recognised when a) it is probable that the legacy will be received and b) its value can be measured reliably.

If the charity is getting a pecuniary legacy of £5,000 and the estate accounts have been received and show there’s a large surplus after liabilities then it makes perfect sense to account for this income in the current financial year as accrued. Although the benefit is yet to come the event that triggered it has happened and so it makes sense to match the two in the same financial year.

Where this isn’t so straight forward is where the charity isn’t sure on the following:
a) If the liabilities will be more than the assets
b) If there might be a claim on the will which will affect the amounts paid
c) Where the charity has no idea how much it will receive because the donor has only recently died and valuations haven’t been completed

Where the picture isn’t so clear, it is recommended to wait until the executor has made sure there’s sufficient assets in the estate, after paying the liabilities, to pay the legacy, even if this does take some time. From an accountability viewpoint, it’s much better to delay and wait until there’s sufficient confidence in the amount, than to include too high a figure and then try to awkwardly explain to the higher levels of management the following year why there’s a reversal and less cash. The old mantra ‘it’s better to undersell and over deliver, than oversell and under-perform’ applies. At the same time making sure you can always support and justify the amount you do decide to put into the financial statements.

It might also be that for larger charities with a high number of very small legacies, trying to individually identify and assess each one will be particularly time consuming. FRS102 allows for this and permits a portfolio approach to be taken (PBE34B.7). As well as the accrual concept, it’s also very important that financial statements are applied consistently to avoid devious entities doing things one year to maximise surpluses and then changing them the next to do the same. This is why auditors allow for some degree of flexibility in how a charity may accrue for the legacy income, so long as year after year the same principles are consistently applied.

So for me this potentially helps to provide more weight to my argument for a lie-in at the weekend – if I’m going to follow the rules, I consistently need to have a lie-in. I wonder if my wife will accept that…