The Audit of Not-for-Profit Organization - Assignment Example

 Table of Contents Auditing of Non-Profit Organizations 3 Non-Profit Organizations 3 Objectives of Non-profit Organizations 4 Differences in Audit and Review of Profit and Not-for-Profit Organizations 5 Regulation & laws (companies act vs. charities act) 6 Reporting changes (statement of comprehensive income vs. statement of financial activities) 6 Materiality 7 Directors vs. trustees 8 Goals 8 Risk 9 Income 10 Value For Money Audit 11 Economy 11 Efficiency 12 Effectiveness 13 Conclusion 14 Bibliography 15 Auditing of Non-Profit Organizations “An Assurance Engagement is an exercise where a practitioner (Accountant) expresses conclusion designed to enhance the degree of confidence of the intended user other than the responsible party about the outcome of the evaluation or measurement of a subject matter against criteria” (Puttick, Van Esch, & Kana 2007 p. 62). It involves high level of testing and application of audit procedures which results in high level of assurance, providing reasonable assurance on financial statements that financial statements are true and fair in all material aspects. However Assurance Engagement is expensive, so companies which are exempt from statuary audit may go for a Review Engagement. “The objective of a review engagement is to enable an auditor to state whether, on the basis of procedures which do not provide all the evidence that would required in an Assurance Engagement, anything has come to the auditor’s attention that causes the auditor to believe that the financial statements are not prepared, in all material respect, in accordance with an identified financial reporting framework” (Puttick, Van Esch, & Kana 2007 p. 73). As it is less expensive so it involves application of less detailed audit procedures than an Audit and provides moderate level of assurance which is expressed in the form of negative assurance. The review engagement is hence, suitable for small NFPs to ensure the donators and volunteers of their fairness of operations and activities to achieve the goals of the organization. Non-Profit Organizations There are many forms of business organizations and non-profit organizations are one of the sorts which are increasingly gaining attention by authorities. Non-profit organizations include charities, local government bodies like councils and other government funded bodies like housing associations. Broadly speaking, NFP’s include bodies whose aim is to provide some educational, health or other social service with an intention to aid the society rather than generating wealth or profits of the organization (Wood & Powell, 1989). Charity is of the most common forms in not for profit organizations. The major differences between a company and a charity when it comes to auditing involve the presentation criterion which differs for both. Charities are normally tax exempt hence auditing changes for the charities. Auditing scope and method changes greatly as charities rely on cash donations and grants for the regular operations of the organization (Becker & Terrano 2007, pp. 1-5). However, larger NFPs and charities must have good internal control system to prove the controls reliable for the audit purposes reducing the overall work requirements for the audit engagement. Objectives of Non-profit Organizations Non profit organizations are either public sector organizations or other organizations whose primary purpose is to benefit the public rather than generating profits, which differentiate them to profit organizations whose main objective, is to maximize share holders’ wealth. Not just they differ from commercial organization; non-profit organizations differ from other non-profit organization for example: Local councils and public services organizations’ objective is to provide local services to a budget based on public money which is likely to be based on value for money. While clubs, associations and unions’ objective would be of furtherance of the aims of club and to provide services to members which may include managing subscriptions paid and keeping costs of running the club down. Non-profit organizations are more into delivering benefits to the public or their desired stake holders so would not concentrate on other logistics say for example accounts department. A good non-profit organization would have accounts department but would be small as compared to a profit making organizations’ accounts department. The reason behind this fact is that non-profit organizations’ main purpose is to benefit public not to earn profits so they would be less focused on accounts, marketing and other non core business dealings. Moreover, even if the non-profit organizations pay attention to other business activities like for example setting up a proper accounts department, they would still lack the competence level as compared to other commercial organizations. This will have an impact on the audit as human errors might go undetected due to the lack of competence and training. Moreover, since few people would be involved in the accounts there would be less or no segregation of duties which is typically found in medium sized non profit organizations resulting too much fettered power wasted on one or few persons. This lack of segregation then might perpetuate fraud or even if fraud is restrained, there are chances of errors being left undetected as there would not be one person supervising juniors directly or at worst no supervision at all. Differences in Audit and Review of Profit and Not-for-Profit Organizations There are a number of differences in the auditing procedures and techniques of profit and NFP organization. These differences include the following: Regulation & laws (companies act vs. charities act) All organizations are regulated and follow laws and regulations pertaining to their sector. However, non-profit organization differ greatly from profit making organizations as it can be evidenced that charities being a non-profit organization has to comply with Charities Act 2006 while commercial organizations are to comply with Companies Act 2006 (O'Halloran, MacGregor-Lowndes, & Simon 2008, p. 475). This difference impacts the auditor’s scope of work and need of knowledge of those laws and regulations of the organization to complete audit effectively and to comply with ISA 250 Consideration of Law and Regulations. Reporting changes (statement of comprehensive income vs. statement of financial activities) A good governed organization will issue and disclose matters to the stake holders regularly, of which one important issue is of annual accounts. Annual accounts of profit making organization will at least include statement of financial position, statement of comprehensive income, statement of cash flow, notes and other explanatory material along with the audit report. Annual accounts of non-profit organization (say for example charity) would include the same as above but would include Statement of Financial Activities instead of Statement of Comprehensive Income. Statement of Financial Activities shows all resources made available to the charity and all expenditures incurred and reconciles all changes in its funds (Epstein, Nach, & Bragg 2009, p. 1222). If the charity is also to comply with Companies Act 1985 then it would issue a summary of income and expenditure in addition to Statement of Financial Activities. Materiality Materiality concept is at the heart of audit because an auditor does not check all transactions rather he uses sampling techniques and draws out conclusion of the overall population from those samples by extrapolating errors found. So at start of audit he would set materiality level, which is based on user of the report which is mainly share holders in profit making organization or in non profit organization it would most probably be public at large (Gross, McCarthy & Shelmon, 2005 p. 484). Materiality means the relative importance of a specific matter in the context of whole population or matters for example on the basis of financial statements. Something is material to user group if its omission or misstatement would reasonably affect the economic decision of the user group. It is calculated on auditor’s audit judgment and past experience (Whittington & Delaney 2009, p. 56). It is usually calculated in terms of profits and would increase from previous year if the business has increased, so if a company did not increase in statement of financial position as well as in statement of comprehensive income then auditor’s last year’s materiality can be sound this year. Materiality indicators can be percentages of profits, sales, cost of sales, assets, liability, equity, etc. but indicators would be used on the all accounts for example if an account (provision) hits both statement of financial position and statement of comprehensive income so materiality indicators are to be used on all element of statements like on assets, liabilities, profits or sales. But when the organization is non profit organization then there is a change in the indicators of materiality. As these are, in the normal course of activities, not focused on sales, profits, and cost of sales so these would not be used rather new indicators like percentage based on donations may be used. Directors vs. trustees To be effective every organization is led by an effective board (board of directors or trustees). The question that strikes our mind is to know the difference between a trustee and a director. And the answer is that there is no significant difference in duties and responsibilities. But however they both are differentiated in society for making clear if they are working for a profit organization or a non profit organization. And Trustees are more inclined to benefit public at large while directors are more concerned with their legitimate or powerful stake holders say share holders (Jennings 2004, p.3). The auditor, hence, checks the reliability of the trustees in order to identify the aim of their activities in a non-profit organization. The auditors need to analyze the decisions made by the Trustees to assess their intentions of running a particular organization. If the decisions made by Trustees are not in line with the organizational objectives and the decisions are solely made to benefit the trustees or achieve some other objective which is not complied with the organizational goals, the auditor needs to express these results in the report. Goals Every organization set goals and then set up strategies and ‘policies and procedures’ to achieve the desired goals and objectives. But the direction of these goals differs greatly when comparing profit making and non profit organizations. A profit making organization would most probably set financial goals and would be measured in same way for example increase in sales by 10 % to last year, increase in share price by 5 %, increase in gross profit by 20 %, etc. On the other hand, non profit organizations would go for non profit goals, for example tackling cancer, malaria, reducing unemployment or poverty in society. And these goals become critical success factor for these organizations and would be measured in terms of key performance indicators. Hence, before carrying out or planning auditing process, the auditor needs to carefully analyze the goals of the organization. If the organization aims to the provision of lower cost or free healthcare services to the public, the auditor needs to analyze the provisions of such services made form the last audit. The targets should be matched with the actual results and the services provided last year should be compared with the current year’s performance (Holland & Ritvo, 2008). The auditor, in simple words, need to assess the organizational move towards achieving its goals. Risk Organizations set goals and objectives which they struggle to achieve. However, the activities of a business bring risk to the organization deterring it to achieve those objectives. For example if a company’s one objective is to sell its goods and services on internet, this objective will bring many risks like fraud, embezzling of receipts, credit card fraud, data theft, integration & training problems, etc. The risks pertaining to the organization differ from organization to organization but within sector it has most or some of the risks in common. But when sector changes the risks affecting organization dramatically changes too. For example for a non profit organization like charity, would be mainly facing risks of unpredictability of donations, theft and may be poor internal controls leading to more risks. The auditor needs to analyze the risks involved within the non-profit organization in order to set the scope and timing of audit. If the risks related to internal controls are high, the auditor needs to spend more time in order to detect fraud and errors in the statements. Moreover, the internal control system provides an insight to the organization’s processes which may help in determining the level of competence and error detection processes (Zietlow et. al., 2007, pp. 32-51). If the organization involves less segregation of duties, the auditor may need more time in analyzing the data provided as well as time to personally inspect the functions carried out within the organization. Income Since income is accounted for on cash receipt basis due to less or no trading, the lack of documentation may create a great difference to the performance of NFPs. Since staff is limited and competence level is low in the staff it is highly probable that many transactions may be eliminated from the accounts. This alone creates a great limitation on the reliability of the audit report as the auditors cannot be sure of the completeness of the records presented. Analysis of controls on cash receipts cycles and record maintenance can help the auditor to gain assurance to some extent and analytical procedures may help in minimizing the issues related to transactional data but it is unavoidable as the trustees and volunteers may or may not be following those procedures throughout the year or business cycle. In order to avoid such issues the auditor seeks written representation from the board on the reliability of the records produced and income recorded (Ruppel 2008, p. 3-7). Value For Money Audit Value for money audit is a performance measurement audit which is carried to by management (usually internal audit department) to assess economy, efficiency and effectiveness of the processes of an organization whether private or public. Value for money audit is also known as three Es (economy, efficiency and effectiveness). Value for money audit can often be judged by comparing other methods of operations or alternative resources to be used as inputs. The objectives of audit of a particular process need to be specified and understood first in order audit to be efficient and effective. In profit making organization, objectives would be stated in terms of financial targets like profit or return (Cutt & Murray 2002, pp. 197-198). An organization or operation which generate income separately are said to have been effective if they have achieved the specified target profit or return. While in non profit organization targets are not easily measured as compared to profit making organization because of non financial targets or the targets which are to be realised in foreseeable future. It is encouraged and supported by many commentators as it is necessary to ensure that the desired impact is achieved with minimum use of resources, but some commentators have negative expression of it being spreading costs in public expenditures. Economy Economy means attaining appropriate quantity and quality of inputs (resources like labour, raw materials, etc) at lowest cost. An activity would be economic if it attains the desired objective with minimum costs, for example the labour or raw materials purchased of the suitable quality at lowest cost. But economy does not means straight cost cutting as resources are to be acquired of a requisite quality (cost cutting should not sacrifice quality). Economising by buying poor quality raw materials or labour is ‘false economy’. A value for money audit into a hospital would look at economy of the resources for hospital (the use of doctors, nurses; operation equipments; hospital building, administration, etc) and whether these resources are being used for their purpose at lowest possible cost. The economy, hence, should be achieved by bargaining power, availing discount offers, bulk purchasing, long-term contracts and so on, rather than compromising on the quality of services or products. Efficiency Efficiency means producing maximum output for any given inputs for example maximizing number of transactions recorded per employee, or having minimum inputs for a specified quality and quality of outputs or services provided. Outputs mean the outcomes or results of an operation, measurable as the finished goods or services to be provided and its quality. It is the ratio between the outputs (goods and services to be provided) and inputs (resources used to produce them). For example, a value for money audit into a hospital would look at efficiency in terms of number of operations or treatments per doctor, utilisation of hospital beds, use of drugs, etc. but however there are problems associated with measuring output and efficiency. Measuring output of an activity would not be same or satisfactory for all activities or processes within an organization (Berman & Berman 2006, pp. 190-195). For example efficiency measured in terms of number of cancer surgery by a surgeon with normal fever check up by another doctor will not give a realistic result due to incomparability of the two variables. Measuring efficiency in profit making organization can sprightly be measured by simple financial ratios for example gross profit margin, and their outputs having a market value. But measuring efficiency in non profit organization can be problematic as firstly because their outputs do not have market value and secondly it is difficult to compare the efficiency of one operation (for instance, an emergency operations) to other operation (like dental extraction surgery). Effectiveness Effectiveness means how well the activities of an organization are achieving its targets or other intended effects (achievement of goals). It is also known as impacts because in this last phase of Value For Money Audit the accountant checks that outputs of the activities are achieving their desired impacts or achieving objectives for example in a profit making organization in terms of maximization of share holder wealth; and in non profit organization like a hospital it would be measured in terms of achievement of objective like reduction of disease or spreading education in society (Pickett 2010, pp. 642-646). In not for profit organization the quality of services provided will be a significant feature of their services for example a hospital has its various different objectives, effectiveness of the objective of providing health awareness can only be judged by establishing what standards or quality of service is required. The effectiveness of health services could be said to have improved if hospital had greater success rate. But as a consequence there will be more visitors and longer waiting lists of patients which in turn would affect effectiveness. Conclusion In conclusion, we can say that auditing of non-profit organizations differ greatly mainly because of the distinct objectives of both forms of organizations. The limitations on the scope of audit of Not-for-Profit (NFP) organizations are due to lack of internal control, competent staff, limited documentation and inherent and control risks that prevail. These organizations are often managed by non-professional volunteers with shorter periods of services. NFP organizations are highly susceptible to thefts and frauds which may not be detected due to limited information provided to the auditor. Keeping these risks in view the auditor needs to check whole of the transactional data rather than sampling to reach better opinions on the reports. Bibliography BECKER, HOWARD, & TERRANO, RICHARD J. (2007).Not-for-Profit Reporting 2008. Cch Inc. BERMAN, E. M., & BERMAN, E. M. (2006). Performance and productivity in public and nonprofit organizations. Armonk, N.Y., M.E. Sharpe, Inc. CUTT, J., & MURRAY, V. V. (2002). Accountability and effectiveness evaluation in non-profit organizations. London, Routledge EPSTEIN, B. J., NACH, R., & BRAGG, S. M. (2009). Wiley GAAP codification enhanced. Hoboken, NJ, John Wiley & Sons. GROSS JR, M. J., MCCARTHY, J. H., & SHELMON, N. E. (2005). Financial and Accounting Guide for Not-for-Profit Organizations. Hoboken, John Wiley & Sons, Inc. http://public.eblib.com/EBLPublic/PublicView.do?ptiID=228481. HOLLAND, T. P., & RITVO, R. A. (2008). Nonprofit organizations: principles and practices. New York, Columbia University Press. JENNINGS, B. (2004). The ethics of hospital trustees. Washington, D.C., Georgetown University Press. Top of Form O'HALLORAN., K., MACGREGOR-LOWNDES., M., & SIMON, K. W. (2008). Charity law & social policy national and international perspectives on the functions of the law relating to charities. Library of public policy and public administration, vol. 10. [Dordrecht], Springer. PICKETT, K. H. S. (2010). The internal auditing handbook. Hoboken, N.J., Wiley. Bottom of Form PUTTICK, G., VAN ESCH, S. D., & KANA, S. P. (2007).The principles and practice of auditing. Lansdowne [South Africa], Juta. RUPPEL, WARREN. (2008). Knowledge-based Audits of Not-for-profit Organizations With Single Audits 2008-2009. Cch Inc. WHITTINGTON, R., & DELANEY, P. R. (2009). Wiley CPA exam review 2009-2010. Volume 1, Outlines and Study Guides. Hoboken, NJ, John Wiley & Sons, Inc. WOOD, J. R., & POWELL, W. W. (1989). Review of The Nonprofit Sector: A Research Handbook. American Journal of Sociology. 94, 1442-1443. ZIETLOW, J. T., HANKIN, J. A., SEIDNER, A. G., & HANKIN, J. A. (2007). Financial management for nonprofit organizations: policies and practices. 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