Audit of Not-for-profit Organisation (NPO)


 Audit of Not-For-Profit Organisation (NPO)This paper considers the practices applied in the auditing of NPOs and the improvements introduced in the standards and regulations. It also considers the implications of the audit and vulnerability of NPO to fraudulent activities.
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Table of Contents
INTRODUCTION……………………………………………………………………………….3
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Audit of Not-for-profit Organisation (NPO)  PAGEREF _Toc276412643 \h
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Statistical Study - Increase in NPOs and Reasons behind Increase  PAGEREF _Toc276412644 \h
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Statistical Study - Increase in fraudulent practices in NPOs  PAGEREF _Toc276412645 \h
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Objectives of NPO Audit  PAGEREF _Toc276412646 \h
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DEVELOPMENT  PAGEREF _Toc276412647 \h
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Increase Scope and Diversity on Accounting & Auditing  PAGEREF _Toc276412648 \h
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Revised Audit & Accounting Framework  PAGEREF _Toc276412649 \h
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SOX Act 2002 – Whistle Blower Protection & Protection of documents  PAGEREF _Toc276412650 \h
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Change in FASB Codification (ASC Section 958) HYPERLINK \l "_Toc276412651"
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Revised OMB Circular 122 & 133 HYPERLINK \l "_Toc276412652"
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COSO Framework – Enterprise Risk Management  HYPERLINK \l "_Toc276412652"
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 Internal Code of Ethics  PAGEREF _Toc276412653 \h
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Training Arms – ACAUS & ICAEW  PAGEREF _Toc276412654 \h
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CASE STUDIES  PAGEREF _Toc276412655 \h
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Case Study 1 - Red Cross Scandal  PAGEREF _Toc276412656 \h
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Case Study 2 - The Salvation Army of Australia  PAGEREF _Toc276412657 \h
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Conclusion  PAGEREF _Toc276412658 \h
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Future direction  PAGEREF _Toc276412659 \h
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REFERENCES  PAGEREF _Toc276412660 \h
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APPENDICES…………………………………………………………………………………..21

Introduction
Audit of Not-for-profit Organisation (NPO)
Not-for-Profit Organisations (NPOs) are charities or service organisations which do not run their operations on share capital, as they operate on funds and donations. Any surplus is not distributed to the organisation as dividend or any other incentives to its members. The purposes of settling up NPO is to support government in helping society by provision of education for poor children, support for senior citizens, sports facilities for athletes, or health services.
Unlike for profit organisations, audit of NPO is not required by law, but considering the recent circumstances, most organisations have established a firm requirement for the audit of NPO. Moreover, with the revolution of NPOs changing into business-like entity, stronger emphasis is essential to comply with voluntary corporate governance policy. It is enforced by the Internal Revenue Service, if an NPO earns profit more than $25,000 it has to file an annual Form 990. Likewise, NPO need to have all the managerial activities such as having a budget to control costs, monitoring utilization of resources on activities, a risk management plan to counter any unforeseeable events besides conducting fundraising activities to generate and acquire funds to fuel their activities and services.
Statistical Study - Increase in NPOs and Reasons behind Increase
The significant growth of NPOs can be inferred from the fact that, 1.5 million NPOs were registered with the Internal Revenue Service in 2007. There is a 60% increase in size of Public charities (Wing, 2009) under S501(C)(3) within time span of a mere 10 years, from 1997 to 2007. Alarmingly, the cumulative assets owned by NPOs increased by 70% in this decade.



(Source: Urban Institute, National Centre for Charities statistic, the IRS Business Master File)
The growth in NPOs is a result of government granted benefits in the forms of tax exemption, limited liability, grants and donations, and the power to organise (IPC). Tax exemptions are provided to NPOs from local, state and federal taxes; which include property tax, income tax, and sales tax amongst others. Another benefit of an NPO is that no individual will be personally liable for debts and obligations. Government also assists registered non profit organisations. NPOs are being established on a too fast pace without need for them in various area. According to Broekhoven, donations run into billions which makes NPOs vulnerable to fraud.
Statistical Study - Increase in fraudulent practices in NPOs
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(Source: Association of Certified Fraud Examiners)
From the above data, it can be seen that the trend of fraud peaked in the year 2008. The increase in the cases of fraud are due to; economic downturn in the past years, ineffective internal controls and ineffective measures for transparency of operations in NPOs. That is the reason why rigorous requirements have been developed to conduct audit of NPO.
A sharp drop in the cases of fraud was observed after 2008 and this can be attributed by; reestablishment of economic circumstances, stability in employment, and restrictions imposed by donors for accountability and transparency. According to Mueller, et al 2006 it is morally right for NPOs to be accountable as they receive money from government as well as volunteer donors; this step is important because it enhances accountability. Udochi, 2007 held that management failed because they followed traditional interpretation of accountability.
Objectives of NPO Audit
The failure in compliance with the regulations and statutory requirements has led NPOs to engage themselves in unethical acts like corruption, fraudulent financial statements, and asset misappropriation. The American Red Cross is used to illustrate how it engaged in acts of corruption such as bribery, establishment of illegal gratuities to earn illegal profit and economic extortion. Fraudulent financial statements are also prepared that show excessive expenses or overcompensation and the amount covered under those false heads is utilized illegally.
To address the increasing frauds and misappropriation of funds in NPOs, the objectives to inculcate development in auditing standards and regulations are: to enhance the accountability, transparency and integrity for NPOs; to improve regulations and standards that provide framework for the operations of NPOs; to provide a criteria which defines the credibility of NPOs; and to make the functions of NPOs even more effective.
DEVELOPMENT
To achieve the objectives, steps taken by governments to ensure that NPOs act ethically are the establishment of the following:
Increase Scope and Diversity of Regulators
Initially there were no legal requirements for the checks on non profit organisations and audit of NPOs was not necessary. But keeping in view the statistics of cases of fraud as presented above, the scope of procedures in order to enhance the accountability of NPOs has been widened. The NPOs should be controlled by the government regulatory that have been created by the Non-Profit Organizations Act. To state a few, The Charity Commission is the regulator for charities in England and Wales (Charity Commission for UK and Wales, 2010); they ensure NPOs maintain the standards of governance, transparency and public accountability. While in the US, The American Institute of Philanthropy acts as a charity watchdog to ensure NPOs serve the public in an ethical manner.
Revised Audit & Accounting Framework
Not-for-profit organisations are required to comply with several standards as set by the American Institute of Public Accountants (AICPA) and contained in the General Accepted Accounting Principles (GAAP). SOP 98-2 accounting for cost of activities of Not-for-Profit Organisations and State Local Government Entities that include Fundraising provides guidelines on how an NPO should account for fundraising related activities, (Clark &Jordan, 2001). U.S. Federal Office of Management and Budget offers guidelines and circulars in costing and auditing for NPOs (Garfinkel, 2002).
SOX Act 2002 – Whistle Blower Protection & Protection of documents
The SOX Act 2002 provisions are mainly addressed to public companies. There are only two provisions that suitably apply to all organisations, the rest of SOX requirements regarding best practices on governance are not binding for NGOs. However, NPO is free to establish an internal audit function that will benefit the NPOs by improving financial reporting, minimising fraud cases, improved internal controls and increase credibility of the NPOs (AICPA, 2010).
Whistle blower protection (SOX Section 806)
SOX Act requires an organization to develop, adopt and disclose a formal process to deal with the complaints from the employees of the organization. In order to protect retaliation against the complaints made by any employee, an organization is advised to develop procedures to protect the employee. An organization is required to execute a proper investigation on the basis of complaints made by the employees and to rectify the flaws in the system.
Protection of documents (Board Source, 2006)
In order to ensure accountability, regulations require all NPOs to have a proper written record of its activities, along with electronic files and voicemails. The retention of documents is specifically important for any official investigation conducted on the basis of written documents therefore a complete record of documents needs to be maintained and all the documents need to be provided in order to avoid criminal obstruction.
Change in FASB Codification (ASC Section 958)
In US and UK, the NPOs should prepare the financial statements according to the International Financial Reporting Standards while auditing is guided by the International Auditing Standards. FASB No.116 deals with contribution made and received. This Statement requires NPOs to differ between contributions received that increase permanently restricted, temporarily restricted, and unrestricted net assets. It also requires NPOs to recognize the expiration of restrictions imposed by donor. FASB No. 117 provides guidelines for Financial Statements of Not-for-Profit Organisations (FASB, 2010). The recent changes made in the standards are: accounting for contributions and presentation of financial statements, investments, statement of cash flows, accounting of contributions received, gains or losses incurred on investment made by the organisation from contributions.
Revised OMB Circular 122 &133
OMB Circular 122, Cost Principles for Non-Profit Organizations and OMB Circular 133, Audits of States, Local Governments and Non-Profit Organizations were enacted in May 2004 (revised) and June 2003 respectively. OMB Circular 122 establishes principles for determining costs of grants, contracts and other agreements with non-profit organizations. OMB 133 makes it a statutory requirement to conduct audits of non-profit organizations (WhiteHouse.gov).
Committee of Sponsoring Organizations Internal Control – Integrated Framework
COSO framework is a model which is used to evaluate risk within the internal controls of an entity. The internal control of an entity is a process that is affected by its board of directors, management and key personnel who possess an effective control over the operations of an organization. For an NPO, COSO model possesses high importance to establish and evaluate an effective internal control in NPOs, especially where risk of fraud is significant. COSO model also includes risk management principles which can be used to identify and mitigate risks.
Internal Code of Ethics
Internal code of ethics includes principles of honesty, truthfulness and commitment to task. This is an extremely important aspect because by application of code of ethics, a culture of honesty can be developed in a non profit organization. An example is represented by the Evangelical Council for Financial Accountability. This organisation is responsible for ensuring the accountability in protestant evangelical churches organisations in USA. They reviewed the standards to include adherence to the Biblical teac...