What is specific to the balance sheet of a charitable trust with 12A?
In the previous issue we discussed the different kinds of financial statements and the various components of the balance sheet. Now let’s see what is specific to a charitable trust with 12A.
A business company exists to make profit, but a charitable trust exists for charitable activities. Hence, what we call as “Profit and Loss Account” in the balance sheet of a business company, we call it “Income and Expenditure Account” in a charitable trust. What we call as “Profit” and “Loss” there, we call it “Surplus” or “Deficit” here. Thus, it is clear that charity, not profit, is the focus of a charitable trust. The balance sheet of a charitable trust is to be studied from this point of view.
What to Look For
What should we look for in such a balance sheet?
- Find out the current year’s surplus or deficit. This can be found at the end of the Income and Expenditure Account as “excess of income over expenditure” or “excess of expenditure over income.” The former is surplus and the latter, deficit. Let’s remember that this is the surplus or deficit for the current year alone, after taking into consideration the annual income and expenditure. But what about the past years? Hence, surplus or deficit of the current year alone does not mean much.
- Find out the accumulated or net surplus or deficit until the present. The figure shown at the end of the Balance Sheet as “Income and Expenditure Account” is the accumulated or net surplus or deficit until the present. This is the net of the balances carried forward over the years from the start of the balance sheet of the trust. If the figure appears on the liabilities side, it is net surplus; if it appears on the assets side, it is net deficit. A net deficit here should open our eyes to examine the past years and learn the necessary lessons.
- Find out the rate of interest on the investments of the trust. To get this data, we have to find out the total interest income of the trust for the year. This can be found on the “Income and Expenditure Account” page. Then let us turn to the “Balance Sheet” and find out the total volume of the investments under the “Assets” side. Now calculate the rate of interest using the formula “interest/total investments*100.” If the result is at par with or better than the prevailing bank interest, then it is good. If less, then we have to understand that something has gone wrong somewhere. A lesser rate of interest would mean that we have large funds lying in the savings account, or one or more matured fixed deposits are not renewed or the interest cheques have not been received or what was received has not been deposited in the bank, etc. Thus we try to spot the mistakes and take corrective measures.
- Check the total volume of the funds of the trust. Here we have to compare the present volume of the funds with that of the past and see if the total volume has increased or decreased. If it has decreased, why? While doing this, sufficient focus has to be given to check the volume of the corpus fund too. The corpus fund is the backbone of a trust and hence it is strongly recommended that every trust has its own corpus. Having sufficient corpus ensures the longevity of the trust and its activities. It is worth recalling here that all corpus donations (e.g., the endowment fund) form part of the capital of the trust and they are fully tax exempt too!
- Are the investments well diversified? The next point one has to consider is if the funds of the trust are spread out reasonably well. It is common sense that we do not invest the whole amount of money in the same bank or company or bond or mutual fund, lest we lose the entire capital due to some misfortune of the bank or company.
- How is the cash flow of the trust? It is possible that a trust has a large volume of funds, but the whole lot is locked up in the fixed deposits or other illiquid investments. Once again, it is common sense that knowing the on-going needs of the trust, we have to set aside sufficient money in the savings account. But care is to be taken that we do not park more than what is needed in the savings account as it would lead to loss of a sizeable amount of interest.
- Are the loans to be repaid and the recoverable loan within reasonable limits? Here we have to see if the loans to be repaid, which can be found under the liability side of the balance sheet and the loans to be recovered, which can be found under the asset side of the balance sheet, are within reasonable limits. A trust cannot overburden itself with a loan beyond its repaying capacity or with too many loans given out to its employees. Since going overboard on either of these will affect the activities of the trust, we have to monitor both these elements regularly.
- Proper attention to the above factors will mean that there is some financial planning in the trust. But is that all? The most important factor is to monitor regularly the obligation of the trust under section 11(2) of the income tax act, which stipulates that at least a total of 85% of the annual income has to be utilized for the objectives of the trust. It is possible that in some years there is a shortfall to this target. The shortfall can be due to factors such as a big donation is received towards the end of the year or the trust got a large income in during the year or expenses are controlled and funds are saved for the purpose of a new building or property. Whatever be the reason, the income tax act gives a special provision for charitable trusts. It gives a provision to set aside such excess or shortfall of the 85% to be used within the next five years. This is done with the resolution of the Body of Trustees (Board or Governing Body), giving the particular purpose(s) for which the funds are accumulated.
Attention may be needed here to see that no donation can be given out of the funds accumulated under section 11(2). The beauty here is that with such an accumulation done, it is deemed that the trust has fulfilled its obligation of having to spend 85% of its annual income! Here it is also to be noted that when this shortfall which is set aside under section 11(2) is utilized within the next five years, the trust cannot claim utilization again!
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