K A T H E A R N

A C C A F 8 C H A P T E R 1 7

Not for profit organisations

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 of NFP

entities.

What is a not for profit organisation?

Some examples of not for profit organisations are: Housing associations Charities Hospitals Schools Clibs Associations Local councils Public services Trade unions

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 do not have external shareholders; and will not distribute dividends.

Let’s think about different objectives

What are the objectives for each of the following organisations?

a) Cancer research UK

b) Your primary school

c) Parkstone yacht club

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 influencing public policy in respect of cancer treatment in the United Kingdom.

What are the objectives for each of the following organisations?

Your primary school

To nurture learning and to create a school where all individuals, both children and staff feel valued.

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 boats.

Profit orientated entityProfit orientated entity NFP entityNFP entity

Shareholders

Dividends

Objectives: Maximise financial

returns in some way (capital or income)

Some other form of principals (agency theory)

No distributions of any excess income

Objectives: Social Charitable...

Key comparison

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.

Hospitals Museums...

How does a charity work?

Principals(sort of equivalent to the

owners of a NFP – the people interested in the NFPs

performance)

Managers / Stewards / Agents

(the people charged with managing and running the

NFP entity)

Financial statements

(produced periodically by the agents)

Financial statements

(verified by auditors)

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 render them credible

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) Regulations 2008

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) but are

likely to be similar to those of a statutory audit

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 entity.

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 revenue in the short term.

Inherent risk

Often NFPs have cash that is set aside for a spectificuse– 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 purpose.

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;

the use of less formalised systems and 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 analytical review, enquiry and management representation.

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 is not available the auditor will have to modify their audit report.

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 (departmental /

organisational etc).

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, but it can apply to any company.

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;

Effectiveness – recovery rates.

VFM audits

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 alternatives are analysed to determine minimum cost

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 Targets

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 which is 100 bags per machine-hour

Effectiveness

Review of effectiveness presumes existence of measurable objectives or outcomes of public programmes

Resources may have been obtained economically and efficiently but the audited party may not have achieved the objectives (that is, have been ineffective)

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 provide

more books. But the cost of the former may be prohibitively high

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 Internal records

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 organisation’s objectives in reporting on an EEE audit

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 difficult

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:a) Assetsb) Incomesc) Expenses

Question

Would you be concerned that a small charity would want to over / understate:a) Assets - Understateb) Incomes - Understatec) Expenses - Overstate

Why? May want to encourage people to think they don’t have enough resources and therefore contribute more generously

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, orders or despatch notes.

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 The opinion drawn.

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 of NFP

entities.

Homework

Read Chapter 17. Chapter 17 questions and quick quiz. Practice and revision kit:

Question 54 Value for money auditQuestion 62 BluesberryQuestion 104 FireFly Tennis Club

Tutorial questions.