Audits or Reviews of Accounts
Definitions – Audits and Reviews
According to the www.youunlimitedanz.com website in April 2021:
A financial statement audit is an independent check that the organisation’s financial reports are prepared properly. As an external auditor, Chartered Accountants assess how the organisation manages the process of recording their business operations, and how they portray that in their financial statements. The output of the audit is a report by the external auditor on whether the organisation’s statements fairly reflect their financial position. As they work through the audit process, the external auditor may identify where business systems or controls seem lacking and will discuss these with the organisation’s management or directors.
Through audit and assurance services, Chartered Accountants may help to increase trust in business. Wherever funders or consumers want comfort that what they are being told is appropriate, audit or assurance can assist because the Chartered Accountant provides an independent opinion.
In contrast, a review engagement is designed to give the reader of financial statements a more limited assurance about the information:
- It is an independent examination (but not audit) of information,
- Enquiry and analytical procedures are used to assess the information,
- The reviewer needs to have a level of knowledge of the organisation in order to be able to identify the events and transactions that may have a significant effect on the financial statements, and
- A review provides a moderate level of assurance about the subject matter.
Community auditing
A generation or so ago most community organisations had their accounts “audited” by retired accountants, bank managers and trust officers who would do this as a community service, usually rewarded with a bottle of whisky or a dozen beers. Those days are well-past, and there is an ever-diminishing number of accountancy firms prepared to do audits, especially on a pro bono basis. The cost of auditing is now a significant burden on community organisations, and “reviews” (which do not need to be undertaken by qualified auditors) have become common.
An experienced auditor of community organisations provided me with a snapshot of the problems involved in such audits – “sets of accounts (and rules) that are frankly hopeless,” and “in the worst example, a copy of the cash book was presented as an income statement, and also pasted in as representing the balance sheet/statement of financial position.” He noted that such organisations “can continue to submit ‘financial statements’ to the regulators, notwithstanding they are inaccessible and unintelligible to society members and the public” and “deficient in fiduciary and taxation obligations.” “In consequence, it has been suggested to me that the New Zealand Institute of Chartered Accountants actively discourages its members from providing audit services to not-for-profit entities where reasonable accounting standards and practices are not followed.”
What is and is not required in not-for-profits’ financial accounts?
The fundamental problem is that the legislative requirements relating to the financial accounts of entities that are not charitable are inadequate.
- Under section 23, Incorporated Societies Act 1908, every society must deliver annually to the Registrar a statement of the income and expenditure of the society during the society’s last financial year, the assets and liabilities of the society at the close of the said year, and all mortgages, charges, and securities of any description affecting any of the property of the society at the close of the said year.
- There is no equivalent requirement under the Charitable Trusts Act 1957.
In 2011, the Registrar’s website suggested that filing these statements was merely required to provide him with evidence that a society still existed:
It’s important to file a copy of the annual financial statement to meet the society’s reporting obligations as set out in section 23 of the Incorporated Societies Act 1908. Filing also shows the Registrar that the society is still operating and should stay on the Register. If a society doesn’t file a financial statement, the Registrar may take this as an indication that the society has ceased operations and begin to take steps to dissolve the society (remove it from the Register).
Charities registered with the Charities Board are required by section 41, Charities Act 2005, to file an annual return with Charities Services within 6 months of its annual balance date (and if the charity is registered under the Incorporated Societies Act it is not required to file annual financial statements under that Act). Because of Charities Services’ monitoring functions one can expect them to check that what is filed complies with its requirements.
It is worth noting that the Charities Board does not require audits, and the Incorporated Societies Act, Charitable Trusts Act, and Charities Act do not require that accounts be audited or, even, looked after or prepared by a qualified person.
Any requirement for an audit or a process to verify accounts is normally found in an entity’s constitution, and if there is a requirement for an audit then, until the constitution is changed, an audit should be carried out.
Many charities funding other activities are concerned that their charitable status may be prejudiced if they fund entities which are not subject to an auditor’s scrutiny. Funding agencies (especially Government funders and established charities) may require an entity to have its accounts audited as a pre-condition of grants being made. In such cases a cost-benefit analysis is required – can an audit be funded and will the funds raised exceed the audit cost. It is, of course, difficult to answer those questions when the entity does not know whether a grant will be made and how much it may receive!
Inherent limitations in any audit or review process
Audit reports are invariably highly qualified, with phrases along the lines of “we do not supervise/observe every transaction and therefore ….”. That is a practical reality as no auditor is able to supervise every transaction to ensure that money received does get banked, or to verify that goods and services referred to in an invoice have been provided to and used by the entity.
Why then do society and charitable trust constitutions commonly require that annual accounts be audited? In an age where “accountability and transparency” are common catch-cries, auditing may be a means to that end, but the cynic would say that audits seldom identify fraud or other losses (which is probably somewhat unfair to auditors).
What advice to give about audits or reviews of accounts
Given the cost of audits and doubts about their efficacy, what advice should be given to societies and charities about audits or reviews of accounts? I offer a few suggestions:
- Ensure that a good accounting system is set up, if necessary after obtaining professional advice about the minimum requirements.
- The accounts must be controlled by an honest person with basic business skills. A Police check of members or employees involved in financial management is a basic protective measure.
- Never, ever, adopt or condone the pre-signing of cheques – that is an invitation for misappropriation.
- If the entity’s activities justify investing in an accounting system, look closely at what is available and whether investing in a computerised system would be worthwhile. There are many basic accounting software programmes readily available, and Xero has a lot to offer, especially to larger entities.
- Adopt robust procedures to ensure that income is banked and that expenditure is justified, and get all payments approved (not just rubber-stamped) at regular governance meetings.
- Consider very carefully what the constitution says, or, more importantly, should say about audits or reviews of annual accounts.
Sections 94 and 95 of current (2021) Incorporated Societies Bill do not include any requirements for societies to have their financial statements independently audited or reviewed (but many entities constitutions include such a requirement), but provides as follows:
94 Accounting records must be kept
(1) The committee must ensure that there are kept at all times accounting records that—
(a) correctly record the transactions of the society; and
(b) allow the society to produce financial statements that comply with the requirements of this Act; and
(c) would enable the financial statements to be readily and properly audited (if required under any enactment). 20
(2) The committee must establish and maintain a satisfactory system of control of the society’s accounting records.
(3) The accounting records must be kept—
(a) in written form in English or te reo Māori; or
(b) in a form or manner that is easily accessible and convertible into written form in English or te reo Māori.
(4) The accounting records must be kept for the current accounting period and for the last 7 completed accounting periods of the society.
95 Annual financial statements must be prepared and registered
(1) Every society must ensure that, within 6 months after the end of the accounting period of the society, financial statements are—
(a) completed in relation to the society and that accounting period; and
(b) dated and signed by or on behalf of the society by 2 members of the committee.
(2) The financial statements must be prepared in accordance with,—
(a) in the case of a specified not-for-profit entity, generally accepted accounting practice; or
(b) in the case of a small society, any of the following:
(i) generally accepted accounting practice; or
(ii) a non-GAAP standard that applies for the purposes of this section; or
(iii) the requirements set out in section 97; or
(c) in any other case, either of the following:
(i) generally accepted accounting practice: 10
(ii) a non-GAAP standard that applies for the purposes of this section.
(3) Every society must ensure that, within 6 months after the balance date of the society, copies of the financial statements of the society for the period ending on that date are given to the Registrar for registration.
These new requirements for incorporated societies, if enacted, will require most incorporated societies to review their systems and practices for the management and retention of accounting records.
For specific advice the issues discussed in this article, please contact Mark at mark@nfplaw.co.nz (while noting that he is not an accountant).