Is there a need for auditing for not-for-profit orgainzations? Essay Example

Is there a need for auditing in Not-For-Profit organizations?

By Yee Ming Lee

Executive summary

While it is not a legal requirement that all not-for-profit organizations prepare audited accounts, many of them opt to prepare audited statements while some have internal audit departments. The issue is whether there is need for not-for-profit organizations auditing? This report looks at the reasons why such organizations should have audit departments and even set up internal audit department. The paper starts by introducing the issue of auditing for not-for-profit organization.

In so doing, the paper then cites the reason that necessitates their auditing. Such reasons include lack of financial knowledge and training on the part of such organization’s management and directors. Other reasons include the need to detect fraud and hence the need to put in place strong internal controls. Finally, the government and donors at time require that such organizations be audited before they can be registered and hence access donor funds. Though auditing for such organizations has been criticized as wastage of funds, the paper recommends auditing for not for profit organizations.

Table of Contents

Is there a need for auditing for Not-For-Profit organizations? 1

2Executive summary

Table of contents 3

Introduction 4

5The need for auditing in Not-for-Profit Organizations

5The nature of the organization’s operations

9Strengthening internal controls

10External audit

11Arguments against auditing for not-for-profit organizations

Inherent limitations arising from auditing for not for profit organizations 12

13Conclusion

References: 15

Introduction

At times, the federal governments or the states do not have legal requirement for not-for-profit organizations to conduct audits on their financial operations whether it is internal audit or external audit. Under charity law in England and Wales, charitable organizations are required to conduct audit in case of their income exceeds £25,000. Furthermore, the organization is subject to audit if its gross income exceeding £1 million or $250,000 whereas its gross assets are over £3.26 million. Otherwise, they are required to conduct independent examinations. Although those not-for-profit organizations was not falling into the legal audit threshold, it still prefers to conduct audits. Given the fact that the main aim of such organizations is not profit making, many people tend to think that they ought not conduct audits. Is there a need for auditing in not-for-profit organizations? This paper details out the reason why there is a need for auditing in such organizations. In conclusion, the paper argues that such organizations ought to conduct audits so as to increase transparency as well as accountability for donors’ funds. This is in line with the fact that the management of organization as well as those charged with the governance are ensuring that they have put in place sound internal controls, quality risk management and governance practices all aimed at ensuring that organization’s funds was well managed. It will also be argued that the organizations should also put in place sound internal audit functions in order to ensure maximum benefits from the resources given to them while more efficiently and effectively achieving their strategic objectives.

The need for auditing in Not-for-Profit Organizations

Despite the widely held beliefs, there are more advantages of auditing for not-for-profit organizations than its disadvantages. The reasons why there is need for auditing in not-for-profit organizations are explained below.

The nature of the organization’s operations

Many not-for-profit organizations are operated by donor funds. The sole responsibility of ensuring that such funds are put into proper use and that the most benefit is derived from them lies solely on the trustees and their executive management. As such, they ought to ensure that there is no fund mismanagement and misappropriation. Unfortunately, the board of directors in not-for-profit organizations are often characterized by who are voluntary and also do not possess financial expertise to help them effectively carry out their duties (Gross et al., 2006). The fact that they do charity and also rely on charity makes them to believe that all their stakeholders are dedicated to their charitable cause. This means that their employees, donors and volunteers operate in an environment of trust. In most case, the essential tasks in organizations may be undertaken by people who are devoid of financial expertise as well as lacking of training on the necessary controls against errors. Owing to the lack of financial expertise and little supervisory knowledge in their operations, the donations given to the organizations become fertile ground for fraud. This gives rise to the need for auditing in such organizations.

Fraud

There is need for not-for-profit organizations to undertake auditing activities in a bid to safeguard themselves against fraud. It should be noted that the organizations receive funds from donors to carry out charitable activities. As such, they have to safeguard these resources in a bid to ensure that the resources are put into their intended uses. It is for this reason that the issue of fraud has been of great concern to the organizations especially given the declining donor environment. Therefore, any resources lost through fraud greatly reduces the amount of resources at their disposal to carry out their activities. In addition, fraud in such organizations is followed by bad publicity that has the effect of reducing the number of contributors as a result of falling in contributions and grants in future. This is because volunteers and donors obviously demand for accountability and transparency in the use of their funds. It is worth noting that the cases of fraud in the non-for-profit organizations have been on the increase further heightening the need for auditing in the organizations. Greenlee et al. (2006) state that the increasing cases of fraud have arose from increased media attention on fraud in the organizations especially given their rising amounts estimated at $665 billion. In addition, the sector employs nearly 12 million people with 65 million volunteers implying an increasing number of people having access to their revenue and assets. All these factors indicate that the level of fraud in the organization is increasingly becoming extensive. As Greenlee et al (2006) noted, over 2000 sites that were asking for funds online for the victims of Hurricane Katrina were fraudulent.

Many examples exist about fraud in not-for-profit organizations. For instance, in 2005, the federal trade commission wanted the man behind the creation of Ameridebt to refund $172 million in fees its customers paid over the years. This is because it operated as a not-for-profit credit counseling agency yet they were a for profit venture for his and his friend’s self-enrichment. In 2001, Armand Tiano was convicted of $3.5 million fraud. He was convicted of many felonies including embezzlement, tax fraud, theft as well as money laundering while running his charity called Santa Clara County Police and Sheriffs Athletic League. Though he sought donations for the children of injured or dead police officers, he was convicted of using much of the money to pay his lavish sports car collection as well as a new San Jose home. Another example of charitable organizations fraud involved Aaron Token who was sentenced by the federal court for a 63 months’ jail term for taking more than $3 million funds and hence was convicted of mail and wire fraud. He and his organization were found guilty of diverting donations to bank accounts that were actually not charity funds in the name of performing arts foundation and Giving back fund. In 2015, an Alamogordo nonprofit is accused of overbilling the state government by over $656,000. This was just one of the fifteen cases that were being investigated by the attorney general’s office following the allegations by human services department. The above and many more examples indicate a rampant increase in fraud involving charitable organizations.

As discussed above, the rate of fraud in the not-for-profit organizations is alarming. The result of this is lack of trust between the donors and the organizations. This results in lower level of donations which on the other hand denies services to those who deserve them. It is for this reason that not-for-profit organizations should consider auditing as a way of increasing transparency as well as trust between them and the donors (Keating, 2010). While many not-for-profit organizations have been hailed for doing a lot to the public good, the above cases of fraud have successfully eroded donors’ confidence. While donors are willing to donate for such causes as environmental protection, hunger alleviation, human and animal rights, they may now not do so unless they have the surely that the not-for-profit organizations to which they are donating is devoid of fraud and that it will be a strong steward of the resources it donates (Wells, 2005). This is despite the fact that the donor organization may not have the opportunity to be part of the not-for-profit organization’s board of directors and thus assure itself of financial transparency. As such, auditing would be the only way of establishing fiduciary trust that the donor organizations and the public so much require off the safety of their funds. Auditing is a way for the non-for-profit organization to show commitment to financial transparency. By giving the audited reports to those that need them, the organization depicts transparency needed by donors. In many cases, the donors will call for accepted standards for handling finance. As a result of fraud, most private and public donors who at times include the government nowadays require that the not-for-profit organizations give audited financial reports and conduct auditing so that funds can be availed to them. Thus, auditing should also be seen as a way through which the organization can build its reputation regarding transparency, professionalism and integrity. It should also be noted that the government is concerned about fraud in the not-for-profit organizations. This is because the rising charitable organizations cheating means increasing burden to the tax payer. Note that the tax laws treat donations favorably. This means that increasing fraud in the not-for-profit organizations will also result in billions of unfavorable deductions. This is a burden to the tax payer since the government will not be able to provide value for tax payers’ money owing to the taxes foregone as a result of the fraud ((Gordon, 1999). Thus, this is part of the reason why the government would require charitable organizations to have their accounts audited. In other words, conducting audit would also help the not for profit organizations keep on the right side of the law by ensuring that all loopholes are sealed and that the organization fully complies with all legal requirements especially as far as taxation is concerned . This would make them avoid unnecessary suits regarding taxation which would threaten their very existence.

Strengthening internal controls

In a bid to curb incidences of errors and fraud, management and trustees are charged with the responsibility of putting in place strong internal controls which are vital. for creating checks and balances necessary for a number of purposes. First, they are aimed at helping the not-for-profit organizations’ management and trustees meet their legal obligations of safeguarding the organization’s assets. The controls also help the management in administering the organization’s assets and financial resources in such a manner capable of identifying and managing risk (Brown, 2015). In addition, the controls are necessary for ensuring quality financial reporting by ensuring that adequate accounting records are kept and maintained in a timely manner. In a bid to ensure proper management of assets and financial resources, the trustees as well as the board of directors ought to ensure that proper internal control procedures are put in place in a bid to ensure they achieve their aims and objectives. Such controls are necessary for reducing though not eliminating the risk of fraud and theft as well as detection of errors (Charity commission, 2015). Where such risks do occur, strong internal controls help in unearthing them and hence be able to take remedial actions well in advance. Such controls are also necessary for achievement of value for money by ensuring that donations are only channeled to the right projects (Vscpa.com, 2016). It should however be noted that not-for-profit organizations management often lack the requisite financial management knowledge to be able to put up such internal controls. In addition, it is worth noting that such organizations greatly differ in terms of size, the nature of activities they are involved in as well as their complexity. Thus, it would be important for the management of such complex organizations to consider hiring auditing professionals and even hire external auditors who would be in a position to advise them on the appropriateness and adequacy of internal controls they are supposed to put in place. The most important benefit that would accrue from auditing therefore is that of prevention and detection of fraud and errors (Jegers, 2002). Auditing would also perform the very important function of monitoring the internal control procedures put in place by the trustees and management (Vscpa.com, 2016). If the internal controls, policies and procedures are regularly examined by the audit function, this will limit the charity’s exposure to fraud and related losses. This is because auditing will not only test such controls but it will also ensure compliance with policies and procedures. The audit function is also important for it will offer guidance to the management on the areas of improvement of internal controls, policies and procedures thus ensuring that the organization is fully shielded from errors and fraud and hence related losses.

External audit

Owing to rising levels of fraud in the not for profit organizations, some donors demand that such organizations be audited by independent auditors if they are to qualify for funding. As such, external auditing is at time seen by such organizations as a way of increasing chances of being funded. Furthermore, such organizations should embrace external auditing as a way of improving their reputation as law abiding organizations both in the eyes of the public, the donors and even the government (Guidestar.org, 2016). External auditing should be conducted by the not for profit organizations for a number of reasons. Such auditing is governed by international auditing standards implying that it calls for more rigorous activities including testing on sample basis the completeness, cut offs, validity as well as the existence of assets and other items. Thus, the result is a positive statement on whether the organization’s set of accounts depicts the true and fair view of its financial affairs or whether material errors and omissions have been discovered (Smith and Euwema, 2015). The auditors’ opinion is usually based on the evidence he gathers. Thus, the opinion is vital in providing assurance and hence giving comfort to both internal stakeholders such the trustees and management as well as external stakeholders including the donors and beneficiaries. External auditing also results in management letter which may request the review and testing of the organizations systems of internal controls. Thus in addition to providing the much needed assurance to donors that their funds are being put into proper use, it also leads to helpful recommendations to the trustees and management of the not for profit organization. Thus, where organizations are well endowed financially, they should not shy away from conducting external auditing (Bell, 2016). This is because it leads to increased confidence in the organization by donors thus leading to continued flow of funds or even increased funding while increasing the organization’s reputation as an organization that is law abiding and that puts donors’ money into proper use.

Arguments against auditing for not-for-profit organizations

As stated above, not all not-for-profit organizations are required to conduct auditing of their financial statements by law. Furthermore, some of them have the option of conducting independent examination of their sets of accounts instead of auditing (Motazedi, 2016). Thus, it is argued that such organizations ought not to conduct auditing since it does not add any value to them. If should be noted that auditing is a complex and rigorous process that consumes a lot of financial resources. Thus, auditing in not for profit organization is seen as wastage of time and money given that external auditors have to charge fees while if the organization has to have an internal audit department, it has to pay the professionals responsible for running the department (Hudson, 2015). This consumes the much needed resources that could otherwise been used for giving charitable activities to the society. It is worth noting that an audit requires more auditor input as well as management time adding to the cost the company has to incur. In addition, auditing has to be undertaken in line with the international auditing standards implying that it can only be conducted by professionals with enough exposure to ISAs. To reduce cost, it has been suggested that such organizations conduct independent examination which is much cheaper. However, not for profit organizations ought not to shy away from auditing citing costs. For instance, the organizations do not have to maintain an internal audit department but they can use other professionals say in the accounting department to conduct auditing on part time basis without having to incur a lot of resources. Furthermore, it is worth noting that the benefits likely to accrue from auditing in terms of error detection and prevention of fraud are much more compared to the costs incurred as discussed above.

Inherent limitations arising from auditing for not for profit organizations

Critics also cite the fact that auditors for such organizations will only be able to give reasonable assurance as far as the truth and fairness of accounting reports as opposed to giving absolute assurance. This is because the auditors apply professional judgment in identifying risks, selecting the appropriate auditing procedures and when interpreting the audit evidence that they gather. This means that the auditor may sometimes misjudge the situations and hence he/she may overlook an incident of fraud or error ((Brown, 2015). To minimize such incidences however, auditing standards have been developed for guiding auditors in making such professional judgments and hence there is no need for such worry.

Another worry is the fact that auditors have to apply sampling techniques in limiting the number of balances or transactions to be tested so that audit can be performed cost effectively as well as efficiently. Such sampling may however give results that fail to represent the entire population. As such audit procedures can fail in detecting material misstatements owing to auditors’ inability to perform detailed auditing of the transactions and balances. Thus, critics argue that auditing such organizations is not a guarantee that fraud and errors will be detected or entirely prevented. Neither is it a guarantee that managements work is professional devoid of any errors or fraud. Thus to them, auditing such organizations is a wastage of time and money.

Conclusion

This essay has shown that auditing will give the not-for-profit organizations an opportunity for their financial reports to be independently examined thus increasing their value as well as credibility. This will have the effect of increasing the confidence of donors in the statements produced by the trustees and board of directors. It will also have the effect of reducing the risk of fraud. This will ensure that the financial resources expended to the organization are used for the right purposes. This is especially so because most not for profit organizations are characterized by trustees and management without professional knowledge that would help them deter fraud, theft and errors and hence the related losses. Thus, auditing will serve to help them better safeguard the organization’s resources. It is also worth noting that most donors demand that the organizations audit their financial reports to ensure that their donations are put into proper use. Furthermore, the government requires that not for profit organizations be audited in a bid to ensure that there are no tax losses which would add more burden to the tax payer. Though critics would see auditing of not-for-profit organizations as wastage of the much needed resources, it is obvious that the benefits of auditing to such organizations would far outweigh the demerits as discussed above. Thus, this essay recommends that not-for-profit organizations should embrace auditing due to the need to safeguard their resources against fraud and theft.

References:

Bell, J (2016) Is it time for an audit? Retrieved on 26th February 2016, from; http://www.blueavocado.org/content/it-time-audit

Brown, C. (2015) Accounting and reporting for Not-For-Profit organizations, AICPA, London.

Charity commission (2015) Internal financial controls for charities, Charity commission.

Gordon, T. (1999) Tax-exempt organization financial data: Availability and limitations,
Accounting Horizons, vol.13, no. 2, pp.113-128.

Greenlee, J., Fischer, M., Gordon, T. &, Keating, E. (2006)
An investigation of fraud in nonprofit organizations: Occurrence and deterrents, The Hauser Center for Nonprofit Organizations, Harvard University. No. 35—— please check http://www.ksghauser.harvard.edu/PDF_XLS/workingpapers/workingpaper_35.pdf

Gross M., McCarthy, J. & Shelmon, N. (2005)
Financial and accounting guide for not-for-profit organizations, Hoboken, N.J., John Wiley & Sons. (PLEASE LET ME KNOW WHAT THE PROBLEM IS WITH THIS REFERENCE)

Guidestar.org (2016) The Sarbanes-Oxley Act and implications for nonprofit organizations, Retrieved on 25th February 2016, from; https://www.guidestar.org/Articles.aspx?path=/rxa/news/articles/2003/sarbanes-oxley-act-and-implications-for-nonprofit-organizations.aspx

,Independent examination vs. AuditHudson, M. (2015)

Jegers, M. (2002) The economics of non profit accounting and auditing, The International Journal of Not-for-Profit Law, vol.5, no. 1, pp.1-8.

Keating, E. (2010) Reengineering nonprofit financial accountability: Toward a more reliable foundation for regulation, Public Administration Review, vol. 63, no.1, pp.3-15.

Motazedi, R. (2016) Internal audit for charities and not-for-profit organizations, Deloitte.

Smith, L&, Euwema, K. (2015) Not-for-profit financial reporting headed for a change, Retrieved on 25th February 2016, from; http://www.journalofaccountancy.com/issues/2015/jul/not-for-profit-financial-reporting.html

Vscpa.com (2016) Audit guide for small nonprofit organizations, Retrieved on 25th February 2016, from; http://www.vscpa.com/Content/Files/vscpa/Documents/2011/Audit.pdf

Wells, J. (2005) Principles of fraud examination, New Jersey: John Wiley & Sons, Inc.