Not-For-Profit Organisations and External Controls

Not-for-profit organisations and external controls

Contents

Key to resources

Introduction

Types of not-for-profit organisations

Accepting not-for-profit audits

Performing the audit

Role of the external auditor

Control in a not-for-profit organisation

Audit approach

Summary

This learning guide is based on the following resource(s):
Textbook
Internal Controls and Corporate Governance(2ndedn) (2002), Pearson/Prentice Hall
Online

The Australian Government Auditing and Assurance Standards Board Select the link Standards and Guidance which brings you to the AUASB Standards and Pronouncements to obtain all the auditing standards. You can download ASA 315 Understanding the entity and its environment and assessing the risks of material
The Australian Accounting Standards Board quick links selectAASBStandards to downloadAASB116 Property, Plant and Equipment.

Key to resources

Resource / Textbook
1 / Performance criterion 9.1 Explain the types of not-for-profit (NFP) organisations, why they are audited and who may audit them
2 / Attempt self-check questions 9.1a and 9.1b p225
3 / Performance criterion 9.2 Explain the considerations of the external auditor in accepting an audit engagement of an NFP organisation, p225
4 / Do the self-check questions 9.2a and 9.2b, p229
5 / Performance criterion 9.3 Discuss these aspects of performing the audit, p229
6 / Rules relating to financial dealings, p230
7 / Relevance of accounting standards, p 234
8 / Try self-check questions 9.3a to 9.3c, p235

* The term ‘performance criterion’is the reference used in the textbook. It is not related to the performance criteria for the unit of competency addressed in the learning guide.

Introduction

/ Now go to Resource 1
The location of this and all other resources for this learning guide is found in the Key to resources at the front of this document.

By definition, not-for-profit (NFP) organisations raise funds to provide a service to a particular group of people who access this service by becoming members. Any surplus funds are retained in the NFP to further their objectives or donated to a charity. To obtain and retain the special status of an NFP, surpluses are prohibited from being distributed to members.

Types of not-for-profit organisations

Examples range from sporting and social clubs to political parties, parents and citizens committees (PCs), churches, libraries, service organisations (Apex, Rotary and Lions) and kindergartens. There is a wide range of activities that come within the definition of NFP.

Why are they audited?

If the NFP is corporatised then they are subject to the Corporations Law and the audit requirements. There has been a trend to incorporate to provide limited liability to office bearers.

Non-incorporated bodies are finding insurance cover is dependent on audited financial statements. NFP organisations which handle large sums of money are also finding that members demandthat constitutions be amended to provide appointment of external auditors. Strata legislation (NSW) covering apartment living or investment requires the strata members’ annual meeting to vote on appointment of an external auditor.

Who may audit NFP organisations?

Once again incorporation may bring with it more legislative requirements to appoint a registered company auditor.

NFP organisations that are limited by guarantee (large clubs) require an audit by a registered company auditor because these are equivalent to a public company for legislative purposes.

Small NFP organisations may require an audit because this requirement is written in their constitution (eg kindergartens) and the audits may be performed by auditors who are not registered company auditors.

Considering the fraud case of National Safety Council of Victoria, it would be wise for anyone who audits NFP organisations to carry professional indemnity insurance. External auditors for the National Safety Council (Victoria Branch), Howarth and Howarth were sued by members Commonwealth Bank and others for $260 million. Accepting audits for not for profit organisations can be fraught with high risk if not covered by professional indemnity insurance and leave the auditor open to financial claims on their estate.

/ Now go to Resource 2
It’s time to attempt some self-check questions.
The answers to the questions are at the end of the chapter.

Accepting not-for-profit audits

/ Now go to Resource 3
This resource addresses the following questions: How do these organisations differ from profit-based organizations; what are their characteristics; which regulations affect the different types of organizations; what is their taxation status?

Differences between profit-based and NFP organisations

The nature of financial reporting is different for a profit-based organisation because the aim is to report and calculate on profitability. The users of financial reports from profit-based organisations arethe:

Australian Taxation Office (ATO)
Australian Securities and Investments Commission (ASIC)
Australian Prudential and Regulatory Authority
shareholders or proprietors
potential investors
management.

On the other hand, the nature of financial reporting for NFP organisations is to show how resources have been used to achieve the objectives of the organisations. The range of people who would use the financial reports of NFP organisations are:

members
office bearers or the executive committee
government agencies (particularly where grants are concerned)
controlling bodies
ASIC where the organisation is incorporated
banks or credit unions where some form of lending has occurred.

The information that is of interest to users of the financial statements relates to whether the available resources have been safeguarded or used efficiently. In addition to non-financial information, the following issues need to be addressed:

the nature and amount of resources available
financial viability
management performance
cost of services provided.

Characteristics of NFP organisations

According to a 1980 study by the Canadian Institute of Chartered Accountants, a not-for-profit organisation is defined as one which has altruistic aims. NFP organisations do not have transfer of ownership interests and members do not receive rights to profit or other direct economic gain. Based on this definition, cooperatives (like wine growers), credit unions and superannuation funds are not NFPs.

There are certain characteristics of NFP organisations that you have to be aware of to understand the impact on auditing.

Limitations of accounting skills: lack of accounting skills, particularly in small organisations, makes the task for external auditors more difficult particularly in terms of internal controls and record keeping.
Status under taxation legislation: income tax should not be a problem if the NFP does not breach its surplus distribution prohibition and it maintains the principle of mutuality and retains its ideals and objectives that provided the NFP status in the first place.

GST is another issue altogether. NFP organisations with turnover of $100000 or more are brought into the scope of the legislation and the lodgement of business activity statements (BAS).

In some ways it has been a blessing in disguise in that NFP organisations have had to improve their accounting systems and record keeping, as well as consult accounting firms when lodging a BAS.

There are provisions for relief from paying fringe benefits tax and in some state land tax.

Different types of NFP organisations: NFP organisations can be established as:

–unincorporated (mostly)

–incorporated as a ‘limited by guarantee’ company

–friendly societies

–associations corporation (Victoria and NSW).

Varying audit requirements: auditing requirements will vary depending on:

–the NFP’s constitution

–whether incorporated or not

–annual meetings.

It is unusual for unincorporated NFPs to have a constitution that does not require an annual meeting.

There is no choice where incorporation has taken place.

Incorporation: apart from the federalCorporations Act, some states have an Associations Corporation Act as mentioned above. The requirements are not as onerous as the Corporations Act but do provide reasonable protection to office bearers.

These NFP organisations have to include ‘Inc’ after their name. You will find lots of garden and art societies that incorporate this way.

/ Now go to Resource 4
It’s time to attempt more self-check questions.

Performing the audit

/ Now go to Resource 5
This resource examines the role of the external auditor, the types of controls which should exist in a not-for-profit organization, the approach to be taken by the auditor, the role of accounting standards, and reporting requirements.

Role of the external auditor

The role of the external auditor depends on whether the NFP organisation is incorporated or not.

Incorporation has legislative audit requirements that are far more demanding than for an unincorporated body.

For example, the auditor is to report to the executive on the state of the internal controls and whether in forming a ‘true and fair’ opinion on the financial statements they were able to depend on those controls. In many NFP organisations, internal controls do not exist because of the NFP’s size in terms of members and funds involved.

In many cases the external auditor is required to complete the accounting work before attempting the audit. This is usually detailed in the audit engagement letter between the external auditor and the organisation’s executive and is reflected in the fees charged.

Control in a not-for-profit organisation

Some basic internal controls can be put in place, particularly in the following:

counting and receipt of monies to be counter-checked and signed (raffles, donations, fairs and exhibitions)
two signatures on cheques
deposits countersigned
expenses substantiated by original documentation and cancelled and countersigned
monthly bank reconciliation by persons other than the treasurer
petty cash checked regularly, especially at the time of float replenishment.

/ Now go to Resource 6
This resource highlights some model rules relating to financial dealings.

Audit approach

In practice, the audit approach is not much different for a profit-based or for an NFP organisation. When auditing an NFP organisation, a predominantly substantive audit approach is used because control risk is usually assessed as high. Therefore more evidence is required by the auditor in order to form an opinion.

Here are a few actions and procedures to note:

assets are required to be verified in terms of existence and value
the internal controls that do exist should be checked for effectiveness and be reported on
gain external confirmation of balances
verify membership records
review minutes of executive meetings
review the bank reconciliation
check any petty cash float
review depreciation schedules and related expense
review remuneration of office bearers
check any taxation compliance requirements.

An obvious difference for an NFP is that members are prohibited from receiving distributions from any surplus.

Here are some useful audit approach headings:

Revenue approach
Donated goods and services
Subscription and membership revenue
Expenses
Non-current assets (fixed)
Depreciation
Fund accounting (different funds for different programs)
Consolidated financial statements
Fraud
General matters (gross profit ratios for such things as bar trading and poker machines)

Relevance of accounting standards

Accounting standards are more applicable to those NFP organisations that are regarded as reporting entities.

/ Now go to Resource 7
Find out what factors determine whether an organisation is a reporting entity.

There is no specific auditing standard for NFP organisations but external auditors must still comply with any appropriate auditing standard that affects the final auditor’s report.

/ Activity

Using your favourite search engine, eg Google, download the accounting standard AASB 116. Scan the contents in the paragraphs on ‘Measurement after Recognition’ and ‘Depreciation.’ Make notes in the space below.

______

Read on when you’ve finished the activity.

Reporting requirements

Whether it is profit-based or NFP, any material departure in the financial records or statements from auditing standards or accounting standards will require the auditor to modify the auditor’s report.

/ Now go to Resource 8
It’s time to attempt the self-check questions.

Summary

Corporate governance based on basic internal controls is still essential whether the NFP is a small local social club or a major sporting club. Funds are collected from the community and hopefully spent in the community. Accountability by those who have the stewardship of the assets and funds of the entity is a requirement no different to a public company listed on the stock exchange.

External audit of all NFP organisationshelps achieve this high ideal.

Not-for-profit organisations and internal controls1