12 Jan 2016
Recent high-profile cases of financial irregularities in certain non-profit organisations have once again shone the spotlight on the role of the auditor in such cases and how such matters can be prevented.
Challenges in Auditing Non-profit Organisations
Non-profit organisations (NPO) such as charities, associations and religious bodies exist to serve a specific cause rather than generating profits. The audit is often more challenging than that of a commercial organisation. There would be unique circumstances that are absent in a typical profit driven entity. The generation of monies does not require a delivery of a good or service, hence it may be more difficult to account for the funds received from the public.
For instance, many NPOs receive funds which are restricted to certain usage as pre-specified by the respective donors. A NPO which is a religious organisation may have received millions of dollars for new building facilities. To ensure that the restricted funds are utilised for the right purpose, usage of these restricted funds should be carefully monitored and unutilised amounts separately tracked in the financial statements. An auditor would need to understand the nature of such arrangements between the NPO and their donors when carrying out the audit.
Similarly, as the source of income is dependent on donations, it important that the funds are not misused. Charities are required under the relevant Charity Regulations to use any donations received according to the objectives that were communicated to donors. Donations are public monies and it is only right that charities should be held accountable on how the donations are utilised. Auditors of charities need to be cognisant of such regulations when conducting their audits.
Management intent on committing fraud are also devising more tricks up their sleeves, for example, creating shell companies with no commercial substance and entering into convoluted transactions with them. Misrepresentation and concealment of facts can happen.
Defining the roles
Even though the financial statements are reviewed by the external auditor, it does not absolve the preparers of their responsibilities. Management is still primarily responsible for maintaining proper financial records and preparations of the financial statements. It is imperative that they constantly remind themselves of the need for high ethical conduct, knowing that they are custodian for public funds.
Governing board members of NPOs are required to act in the best interests of the NPOs and be actively involved in the management and decision making process. They are required to establish good governance practices that increases transparency and accountability and exercise strict control over financial matters of the NPOs to ensure that charitable funds and assets are used reasonably, and only for the furtherance of the NPOs’ objectives. They are also required to ensure proper management of the NPOs to prevent abuse and conflict of interest.
During instances of fraud, the auditor may be questioned by the governing board for not detecting the fraud. In our view, this is counter-productive since it does not address the root of the problem – poor governance practices, which is the responsibility of the governing board.
An audit is not meant to be a fraud investigation and it is not the primary objective of the auditor to “sniff out” fraud during an audit. However, an auditor is nonetheless required by the auditing standards to identify and assess the risk of material error in the financial statements as a result of fraud and any fraud risk. For instance, the auditors are required to evaluate if the NPO’s risk management framework is effective in preventing misstatements.
In other words, while auditors are not expected to be able to detect all financial irregularities, they are required to identify control weaknesses that could lead to the proliferation of financial fraud. Also, auditors should conduct the audit with professional scepticism. They should remain vigilant and be on the look-out for tell-tale signs that something is amiss when they are performing the audit.
One key warning sign is evidence of familiarity between the NPO and its business associates, as it could be a sign that the key relationships have not been completely disclosed to the auditor.
Once the auditor detects such tell-tale signs, he should amend or extend the scope of the original auditing procedures to substantiate their suspicions. Dive deeper into the issue, seek corroborative evidence and incorporate an element of unpredictability.
If the NPO had diverted the use of its building funds into certain investments, an auditor would have reason to be suspicious if he or she discovers that senior management are close friends with the owners of the investee company, but this relationship was not previously disclosed. Another example is when funds are used but for objectives that are not aligned with the mission and directives of the NPO.
To prevent misuse of restricted funds, an auditor should properly understand the nature and use of the money contributed by donors. They should also perform procedures to check if these funds were properly utilised. Alarm bells should be raised if the auditor has noted that funds allocated to building new facilities were being diverted to other usage, such as investments that are not commercially sound.
Examination of projections and forecasts is another way by which misuse of funds could be detected. In the same scenario, the auditor could have detected that something was amiss, when he or she noted that projections for the investments were overly optimistic as compared to current market conditions.
In conclusion, while the objective of an audit is not meant to detect fraud, it still acts as a deterrent. However the auditor must be conscious not to turn it into a check and tick exercise but demonstrate professional judgement and scepticism, especially when involving NPOs.
An audit should not be taken as a substitute for good corporate governance, which is putting in place a proper system of checks and balances to prevent and detect fraud. That is the responsibility of the governing board and not the auditor’s.
Titus Kuan is Director and Ang Soon Lii is Manager of Technical Advisory and Professional Standards at Institute of Singapore Chartered Accountants.
An edited article was published in The Business Times on 8 January 2016.
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