Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Module 12 Auditing in Nonprofit Organizations

Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Two Types of Audit For charities, there can be two different types of audit –One audit might be for financial review only. That is, to ensure the financial reports and the books are accurate This type of audit primarily interested in the finances This type of audit is usually initiated by the charity –Another type of audit, a charitable audit. This audit is specifically conducted by CRA to ensure that the charity is following the requirements set out by the Income Tax Act It is usually initiated by CRA Both of these audits are important and will be reviewed in this chapter

Financial Accounting Dave Ludwick, P.Eng, MBA, PMP What is a financial audit? A financial audit is a process for testing the accuracy and completeness of information presented in an organization's financial statements. People outside the agency will make decisions (budgeting, funding, resourcing decisions) based on the content of the report –Therefore it needs to be accurate This testing process enables an independent accountant to issue an “opinion” on how fairly the agency's financial statements represent its financial position. –The opinion also indicates whether the statements comply with generally accepted accounting principles (GAAP). Board members, staff, and their relatives cannot perform audits because their relationship with the organization compromises their independence.

Financial Accounting Dave Ludwick, P.Eng, MBA, PMP What is an “opinion”? Based on the auditor’s review of the financial Statements, the auditor indicates whether the financial statements, taken as a whole, give a fair representation of the organization's financial picture. As we'll see in a few slides, the auditor does not review the complete accounting record. Two types of opinions: –An unqualified opinion includes wording such as, "In our opinion, the accompanying financial statements present fairly the financial position of ABC Agency at the fiscal year ending June 30, 20XX,... in conformity with generally accepted accounting principles." –A qualified opinion is issued when the accountant believes the financial statements are, in a limited way, not in accordance with generally accepted accounting principles. A qualified opinion might include wording such as, "In our opinion, except for the omission of... the accompanying financial statements present fairly..."

Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Who “owns” the audit? Ultimately, the Board of Directors have financial accountability for the organization to its stakeholders (contributors, government, beneficiaries, employees, etc) It is the Board who recommend or request that an audit be carried out. –Usually an audit is a regular annual activity

Financial Accounting Dave Ludwick, P.Eng, MBA, PMP What info is in the Financial Statements, again? It is worth reminding ourselves of the info that is contained in the Financial Statements Usually the Financial Statements contain –At least the 4 major financial reports (Balance Sheet, Income Statement, Cash Flow statement, Statement of Accumulated Surplus) –It may also contain a high level narrative of the major events or statistics of the year X number of mental health patients helped An account of fund raising events Strategic decisions regarding endowment funds Strategic decisions or lobbying events with the government –It may also contain information pertaining to next year

Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Why audit? Again, people outside the organization will be making decisions based on the agency’s financial position. Decisions like –Adding more people or resources –Alternative ways to generate funds –Making strategic decisions to change focus or direction

Financial Accounting Dave Ludwick, P.Eng, MBA, PMP What will an audit contain? The audit report is addressed to the board of directors as the trustees of the organization. The report usually includes the following: –A cover letter, signed by the auditor, stating the opinion. –The financial statements. Many audits show comparative information between fiscal years. –A statement of functional expenses, since expenses receive the most attention throughout the year. –Notes to the financial statements, as required by GAAP, which might include information about functional expenses, a depreciation schedule, further information about contributions, volunteer services, and other significant information not obvious in the financial statements. In addition to the materials included in the audit report, the auditor often prepares what is called a report to the board of directors. This report cites areas in the organization's internal accounting control system which the auditor evaluates as weak.

Financial Accounting Dave Ludwick, P.Eng, MBA, PMP What does the auditor do? The auditor will request information from individuals and institutions to confirm –bank balances, contribution amounts, –conditions and restrictions, contractual obligations, and monies owed to and by the organization. The auditor will review physical assets, journals and ledgers, and board minutes to ensure that all activity with significant financial implications is adequately disclosed in the financial statements. The auditor will select a sample of financial transactions to determine whether there is proper documentation and whether the transaction was posted correctly into the books. The auditor will interview key personnel and read the procedures manual, if one exists, to determine whether the organization's internal accounting control system is adequate. The auditor usually spends several days at the organization’s office looking over records and checking for completeness.

Financial Accounting Dave Ludwick, P.Eng, MBA, PMP What else does the auditor do? Auditors are not expected to guarantee that 100 percent of the transactions are recorded correctly. –They are only required to express an opinion as to whether the financial statements, taken as a whole, give a fair representation of the organization's financial picture. In addition, audits are not intended to discover embezzlements or other illegal acts. –Therefore, a "clean" or unqualified opinion should not be interpreted as an assurance that such problems do not exist.

Financial Accounting Dave Ludwick, P.Eng, MBA, PMP How do we prepare for an audit? The Board of Directors will make the recommendation for an audit at the end of the fiscal year An auditor is selected, if the organization does not already have one The auditor will make requests that info be prepared in advance (maybe 2 months ahead of the audit), to save time. –Donations records, Payroll records, Expenses, Budgets, Board minutes, leases, contracts, etc Finally, consider the non-financial aspects of the audit. –Staff should understand what is involved in an audit, and that they may be asked a few questions in relationship to that examination. –Assign one person to be the audit coordinator. In a small nonprofit, that may be the bookkeeper or executive director. In a larger organization, it may be the finance director. –The audit coordinator should have access to all information the auditors may need –In addition, set aside a physical location for the auditors to work

Financial Accounting Dave Ludwick, P.Eng, MBA, PMP What is a charitable audit? Also called a Field Audit For charities, CRA will also audit to address other potential issues. Since charities have special tax situations, CRA wants to ensure rules are followed: Audits are triggered by –Random selection –A need to review compliance with legal obligations under the Act; –A need to follow-up on possible non-compliance or complaints; and –A desire to confirm that assets have been distributed after revocation of registered status

Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Points to keep in mind for a field audit The CRA generally notifies the charity ahead of time to arrange a mutually acceptable date for the audit Mutual cooperation makes the audit go quickly CRA will inspect both the books and the activities of the charity CRA will inform the charity of the results of the audit CRA will counsel the charity on how to comply with the law if there is a violation CRA always gives the charity a chance to address an issue before they take any action

Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Who gets audited? Each year, CRA audits a number of registered charities to ensure that they are complying with the requirements of the Income Tax Act. The following methods are those most frequently used to select a registered charity for audit: –random selection; –Select agencies to review compliance with specific legal obligations under the Act; –Select agencies to follow-up on possible non-compliance or complaints; and –Select agencies to confirm that assets have been distributed after revocation of registered status. If the charity is selected for audit, CRA will contact the organization's representative in advance to arrange a mutually convenient date to begin the audit. –Once the audit is completed and reviewed, CRA advises the charity of the audit results. –For more information, see the brochure T4118, Auditing Charities.