Diarmuid McDonnell explains why charities should be aware of the red flags the regulator will spot when examining their annual accounts

In light of recent scandals (actual and perceived) in the sector, charities and the institutions tasked with their oversight are under increasing pressure to demonstrate their legitimacy. While this may be old hat to many charities, they should be aware of how the regulator responds to this pressure.

One question trustees must ask themselves is whether they take the concerns of the regulator (and by extension the public) seriously enough? In this era of increased scrutiny of the sector and knocks to its reputation, trustees must understand that perceived misconduct is just as damaging as actual and even if they believe everything is fine, they should treat these concerns seriously in order to better demonstrate the good work achieved by their organisations.

As part of my PhD research, I examined the nature and extent of regulatory concerns surrounding Scottish charities’ annual accounts. Termed financial exceptions by the Office of the Scottish Charity Regulator (OSCR), these 32 measures alert OSCR to potential accountability and financial risks in the sector.

In spite of the relative frequency of exceptions in general, the encouraging news is that they are almost always justified

Diarmuid McDonnell

Applicable only to organisations that complete the supplementary monitoring form, exceptions are experienced by more charities than you would think: over the period 2007 to 2013, over 60% of charities triggered at least one and the average number of exceptions is nine.

If an exception is triggered it is most likely to concern a possible failure to apply funds for charitable purposes (in particular, excessive fundraising costs and insufficient spending on charitable activities) and threats to viability (e.g. negative reserves and net assets). Though uncommon, exceptions relating to the adequacy of the governing board and transactions with trustees are potentially as damaging to public confidence in the sector as the more common triggers.

In spite of the relative frequency of exceptions in general, the encouraging news is that they are almost always justified and are usually the result of natural fluctuations in charity finances or interactions with trustees. Therefore the question remains: if exceptions are not great measures of vulnerability or misconduct, then what do they capture? And what can trustees learn from them?

Considering the findings in the context of discussions with other stakeholders in the sector (including independent examiners, the regulator and academics), it is clear to me that exceptions are a better measure of a charity’s competence with respect to governance, financial procedures and communication. In many cases trustees simply do not understand their charity’s accounts well enough, nor do they provide adequate detail and clarity when asked to justify an exception. Some of this can be rectified by the use of independent examiners and auditors that understand the information requirements of key stakeholders.

Finally, trustees should see the triggering of these exceptions as an opportunity to review progress and performance, which brings us back to the oft-aspired to yet rarely-achieved aim of the sector: communicating achievements in a way that inspires confidence and support in charities. As always, trustees make the difference.

Diarmuid McDonnell is a doctoral researcher at the University of Stirling