2010 Article, updated November 2017
Definitions – Audits and Reviews
According to the (former) New Zealand Institute of Chartered Accountants website in 2011, an audit is an engagement:
- where an independent expert, the auditor, provides an opinion on “a matter of accountability” (the subject matter),
- where the “matter of accountability” is the responsibility of someone else (usually the management of the entity, and
- which is designed to provide a high, but not absolute, level of assurance on the subject matter.
In contrast, a review engagement is designed to give the reader of financial statements limited assurance on the information.
- It is an independent examination of information,
- It requires enquiry and analytical procedures 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,
- A review provides a moderate level of assurance on the subject matter.
A generation or so ago most community organisations had their accounts audited. There used to be retired accountants, bank managers and trust officers around 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.
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?
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. The Registrar’ website suggests that filing these statements is merely required to provide him with evidence that a society still exists; “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 verification 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.
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 societies and charities be given 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 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 justifies 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 the local newcomer, 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 accounts 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.
The Exposure Draft Incorporated Societies Bill (published in 2015) did not include any requirements for societies to have their financial statements independently audited or reviewed. However:
- Clause 82 proposed that the committee of a society would be obliged to ensure that accounting records are maintained that correctly record society transactions, allow the society to produce compliant financial statements that can be readily and properly audited (if required under any statute). In addition, society committees would be obliged to establish and maintain a satisfactory system of control of the society’s accounting records, which would have to be in written form in English (or in a form or manner that is easily accessible and convertible into written form in English).
- Clause 83 proposed that a society committee would be obliged to have annual financial statements prepared and registered within 6 months after the end of the accounting period of the society (dated and signed by or on behalf of the committee by 2 members of the committee).