The new charity SORP – get ahead of the game now

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This month we will get our first look at the new Charity SORP (Statement of Recommended Practice), at least in a draft form.

We already know the details of some key changes that will be included, as the Charity SORP is based on FRS 102 (the core UK accounting legislation already approved by the Financial Reporting Council).  Two key changes are income recognition and leases - two of the biggest amendments to UK accounting in recent years – and will impact how charities report their financial activities from 2026.

Whilst some charities won’t be affected, for those where the changes do apply, it affects the charity’s reported surplus or deficit, and the balance sheet presentation. In turn, this could impact:

• The charity’s reserves and reserves policy
• Meeting banking covenants
• Audit or Independent Examination requirements

These changes are significant, and charities will need to start preparing by assessing the potential impact on their financial statements, reviewing lease arrangements, and considering whether they need to implement new systems or processes to comply with the incoming requirements.

Income recognition  

The new income recognition rules primarily affect income earned in exchange for delivering services or products. Donations, legacies and grants won’t be affected by these rule changes (but that is not to say that the SORP won’t additionally provide much-needed guidance in these areas).

Impacted organisations will include, for example:

• Social care providers – that deliver services funded by local authorities.
• Membership organisations - that give members rights to a service in return, such as a historic home or a professional support charity.
• Care homes - providing residential services

Such organisations will need to follow a ‘five-step model’ to determine when and how much revenue to recognise under the new accounting rules. This process includes identifying the services being provided, attributing income to each service, and choosing an appropriate point in time or period over which to recognise the income for each service.

As an example, a membership organisation may currently simply spread all of the income evenly over the 12-month or relevant membership period.  The new five-step model assessment will result in a change where the membership fee gives members access to different services being delivered at different points in time. The allocation of income to the different services could be particularly challenging, especially if membership offers a discounted amount for buying the services as a bundle rather than individually.

It may be that the income recognition won’t change significantly or at all, but the charity will need to go through the 5-step process to work that out. 

A charity with a December year-end will need to start to apply the new income recognition for its 31 December 2026 year-end, but could also choose to retrospectively adopt the accounting and change comparative periods.

How to prepare for the new income recognition accounting

To prepare for the new income recognition accounting:

1. Find all the customer contracts the charity holds.
2. Review the terms of the contracts following the detailed 5-step model guidance.
3. Forecast forward the income statement charge that will arise from the new income accounting, and determine the impact on reserves, covenants and audit thresholds.

Leases

The second major change concerns how charities account for leases. Currently, many leases are classified as "operating leases" and are held “off-balance-sheet,” with only the annual rental payments showing in the accounts.

From 2026, most of these operating leases will need to be recognised on the balance sheet with

• a "right-of-use asset" representing the right to use the leased item; and
• a corresponding liability representing the obligation to make lease payments.

For charities with significant leases, this change fundamentally alters the balance sheet structure, but also the amount charged in the income and expenditure each year will vary as well. This is because the straight-line charge - that was previously included in the accounts under the old accounting - will be replaced by a depreciation charge on the right-of-use asset, and also a notional interest charge on the liability included in creditors.  The depreciation may be straight-line and consistent year on year, but the interest won’t be.  The effect is to front-load the overall income and expenditure charge to earlier years of the lease, and hence this will affect the net surplus reported in the year.

There are some exemptions that release you from the obligation to apply the new accounting, for example for low-value assets such as small office furniture and mobile phones and short-life leases of less than 12 months.

A charity with a December year-end will need to account for the leases for the first time in its December 2026 accounts. The charity does not have the choice to go back further and adjust its comparatives. However, it will need to evaluate the leases as of 1 January 2026, to get the correct starting point for the 2026 accounts.

How to prepare for the new lease accounting

To prepare for the new lease accounting you will need to:

1. Identify all the leases that the charity holds

Review the terms of the lease, to work out the remaining lease payments that will form the basis of the lease calculation.  There are some potential challenges here, such as how to deal with optional extensions to the lease, or variations in the lease charge due to indexes often seen in property leases.

2. Work out an appropriate rate to use to discount the payments to fair value

Forecast forward the income statement charge that will arise from the new lease accounting, and determine the impact on reserves, covenants and audit thresholds.

Whilst the new SORP may offer further guidance for the charity sector on lease accounting, it cannot change the underlying FRS 102 requirements. As such, the exemptions for low-value and short-life assets cannot be made more generous in principle, and so the SORP guidance in this area is unlikely to offer much respite for charities, particularly those that lease properties for their operations, be it head offices, warehouses or charity shops.

Ensuring a smooth transition

Although 2026 may seem distant, the complexity of these changes means charities should begin preparations soon. By proactively addressing these changes, charities can ensure a smooth transition to the new accounting requirements while minimising disruption to their financial reporting.