KA T H E A R N
A C C A F 8
C H A P T E R 1 7
Not
for
profit
Learning
objectives
By the end of this lecture you should be able to:
Explain what a not for profit entity is and
what its objectives are.
Explain how the financial statements for a not
for profit entity are different to companies and how this impacts the audit.
Explain what a value for money audit is. Understand the audit risks associated
with NFP entities
Describe the audit reports given in respect
What
is
a
not
for
profit
organisation?
Some examples of not for profit organisations are:
Housing associations Charities
Hospitals Schools Clibs
Not
for
profit
organisation’s
objectives
The goals of NFP organisations are
likely to be different from traditional companies.
The most important differences of NFPs
compared to privately owned companies are that 'NFP' entities:
do not have profit maximisation as their main
objective. These will be either social or philanthropic
Let’s
think
about
different
objectives
What are the objectives for each of
the following organisations?
a) Cancer research UK
b) Your primary school
What are the objectives for each of the
following organisations?
Cancer research
Cancer Research UK aims to raise income to
fund a substantial programme of activities covering research, information and
What are the objectives for each of the
following organisations?
Your primary school
To nurture learning and to create a school
What are the objectives for each of the
following organisations?
Parkstone yacht club
Get young people involved in
sailing.
Win competitions.
Maintain the facilities and fleet of
Profit orientated entity Shareholders Dividends Objectives: Maximise financial returns in some way
(capital or income)
NFP entity
Some other form of
principals (agency theory)
No distributions of
any excess income
Objectives:
Social
Charitable...
Types
of
NFP
entities
There are two types of NFP entity:
Private
Cooperatives, trusts, limited
companies... Charities
Sports organisations...
Public
Usually some form of government
dept.
How
does
a
charity
work?
Principals
(sort of equivalentto the owners of a NFP – the people interested in the
NFPs performance)
Managers /
Stewards /
Agents
(thepeople charged
with managing and
running the NFP
entity)
Financial statemen
ts
Where
do
NFP
entities
get
their
funds
from?
Charities are often self-financing (they
generate income through fundraising activities and donations)
Government departments are allocated ‘£x’
funds for a budget period (usually from central government or locally collected taxes)
Therefore the ‘principals’ and those in
governance (‘agents’) need to be sure of the validity of their financial statements – to
Financial
reporting
requirements
NFP entities may be set up like companies and
therefore have to follow a GAAP (e.g. UK GAAP /
IFRS) however they may also need to follow
additional sets of guidance.
Charities Act 1993 / SORP (Accounting and
Reporting for Charities) 2005
Industrial and Provident Societies Act 1965
Friendly and Industrial Provident Societies Act
1968
Companies Act 2006
Ltd (by guarantee) Ltd, Cyf, plc, ccc, SE
The Limited Liability Partnerships (Accounts and
Audit) (Application of Companies Act 2006)
Audit
implications
NFPs may have differing audit
requirements compared to a traditional profit orientated entity.
Statutory audit
The objective of the auditor (to express an opinion on
the truth and fairness of the statements and
compliance with appropriate statutes, SORPs or other regulation) remains unchanged
Non-statutory audit
Audit objectives may vary (terms of appointment)
The
audit
approach
The audit approach remains unchanged too,
with the auditor focusing on areas of risk in order to detect material misstatements.
Some of these risks will be different for a NFP
Inherent
risk
NFPs may be more inherently risky in terms of:
Safeguarding assets
Cash recording
Completeness of income and assets
Complex regulation…
Assessing the going concern of a NFP entity may
also be more difficult, particularly for charities
who are reliant on voluntary donations.
Many issues, such as the state of the economy,
could impact on their ability to generate
Inherent
risk
Often NFPs have cash that is set aside for a
spectific use– this is know as restricted cash.
Restricted cash, if the amount is material, is
shown separately from cash and equivalents on the balance sheet.
The purpose for which the cash is
restricted is generally disclosed in the notes to the financial statements.
The auditor must ensure these amounts
are identified, and that any restricted cash spent has been used for its intended
Control
risk
Some NFP entities (particularly smaller
ones) may have weaker control systems due to:
lack of segregation of duties, as the organisation
will be restricted with the amount of staff
the use of volunteers, who are likely to be
unqualified and have little awareness of the importance of controls;
Audit
implications
Auditors of not for profit organisations will be
required to assess whether the aims of the organisation are being met in an economic, efficient and effective manner.
For this reason "value for money" audits are often
more appropriate.
Testing tends to concentrate on substantive
procedures where control systems are lacking. In the absence of documentary evidence, procedures rely heavily on
Audit
implications
(continued)
The volumes of transactions in not for profit
organisations may be lower than a private one, therefore auditors may be able to test a larger % of transactions.
Ultimately, if sufficient appropriate evidence
VFM
audits:
Overview
Value for money (VFM) is concerned with
obtaining the best possible combination of services for the least resources.
It is often referred to as a review of the three
"E's":
Economy
Obtaining the best quality of resources for the
minimum cost. Efficiency
Obtaining the maximum departmental /organisational
outputs with the minimum use of resources.
Effectiveness
Achievement of goals and targets
Value
for
money
audits
Comparisons of value for money achieved
by different organisations (or branches of the same organisation) are often made
using performance indicators that provide a measure of economy, efficiency or
effectiveness.
This is particularly common in NFP entities,
Example:
VFM
audit
of
a
hospital
Examples of value for money indicators for a
hospital might include:
Economy – cost of medical supplies per
annum;
Efficiency – number of patients treated per
year;
Economy
While
reviewing
acquisition
of
resources
for
economy,
the
auditor
tries
to
ascertain
whether
resources
have
been
procured
in
the
right
amount,
at
right
place,
at
right
time
and
at
right
cost
The
assessment
of
needs
leads
to
identification
of
requirements
for
which
Efficiency
A difficult concept. The most commonly used
standards, however, are planned outputs for
given inputs laid down by the audited department
itself.
Where they are not available other techniques are
used to assess the level of efficiency…
Some of the commonly used techniques are as
follows:
Inter-authority Comparison
Internal Comparison
Private Sector Comparison Past Performance
Efficiency
Efficiency is the relationship of actual input/
output (productivity) to a performance standard.
E.g. the time taken for producing 80 bags of cement
is one machine-hour. This is productivity of the plant.
This level of productivity may be 80% of the standard
Effectiveness
Review of effectiveness presumes
existence of measurable objectives or outcomes of public programmes
Resources may have been obtained
Effectiveness
(continued)
Appropriate performance measures to assess the
effectiveness of projects are very difficult to
devise. There are three main problems:
Problem of jointness: Where a number of different
policies may contribute to satisfying unmet needs
E.g. educational standards may be affected by the size of classes,
the quality of teachers and the. supply of equipment. It may be very difficult in practice to analyse the effect of individual policies
External factors: Sometimes factors outside the
control of the management affect the outcome of a
project or programme
E.g. income and social status of the consumers
Cost: Sometimes programmes cannot be carried out in
the most effective manner due to prohibitive cost.
E.g. it may be more effective to have more teachers than to
Effectiveness
(continued)
Objectives laid down in the plan may be
taken as a bench mark for some of the outcomes
Sources of Performance Measures can
include…
Citizen surveys
Trained observer ratings Industry standards
The
relationship
of economy,
efficiency
and
effectiveness
The economy, efficiency and effectiveness
aspects of an organization are closely interlinked
E.g. economy of post office department can be
increased manifold by delivering post once a week,
but it would cut down the effectiveness of the
department to an unacceptable level
The auditor should thus focus on the
Problems
with
VFM
audits
Tendency to cost cutting Tendency to short-termism
Where the ‘product’ is not one with an
identifiable ‘market value’ the measurement of effectiveness and efficiency becomes
Audit
evidence
When designing substantive audit
procedures for NFPs the auditor must consider what the risks are.
Question: Imagine you are auditing a
small charity. Would you be concerned
that they would want to over /
understate:
Question
Would you be concerned that a small
charity would want to over / understate:
a)
Assets
-
Understate
b)Incomes
-
Understate
c)Expenses
-
Overstate
Why? May want to encourage people to think
they don’t have enough resources and therefore
Audit
evidence
(continued)
Completeness of income is one area that the
auditor should focus on.
Remember the NFP may wish to understate this.
Problems arise due to:
Fraud resulting in loss of income
Incorrect recognition of government funds
Significantly, with many charities, much of the
income received is by way of donation. These
transactions will not be accompanied by invoices,
Audit
reporting
Statutory audit required
Issue same audit opinion as for a profit orientated entity
(see next week in detail!).
Non statutory audit (e.g. audit performed for the
benefit of members / trustees).
Standard audit report may not be appropriate.
Auditor must bear in mind the objectives of the audit
and make suitable references in the report to those.
Report should still containing (from ISA 700):
Addressee of the report
What the report relates to
Scope of audit
Outlines responsibilities of auditor / management /
trustees
The work performed
Summary
of
learning
objectives
You should now be able to:
Explain what a not for profit entity is and
what its objectives are.
Explain how the financial statements for a not
for profit entity are different to companies and how this impacts the audit.
Explain what a value for money audit is. Understand the audit risks associated
with NFP entities
Describe the audit reports given in respect
