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Not for profit organisations


Learning objectives
By the end of this lecture you should be able to:
Explain what a not for profit entity is and what its
objectives are.
Explain how the financial statements for a not for
profit entity are different to companies and how this
impacts the audit.
Explain what a value for money audit is.
Understand the audit risks associated with NFP
Describe the audit reports given in respect of NFP

What is a not for profit organisation?

Some examples of not for profit organisations are:
Housing associations
Local councils
Public services
Trade unions

Not for profit organisations objectives

The goals of NFP organisations are likely to be

different from traditional companies.

The most important differences of NFPs compared to

privately owned companies are that 'NFP' entities:

do not have profit maximisation as their main objective. These

will be either social or philanthropic
do not have external shareholders; and
will not distribute dividends.

Lets think about different objectives

What are the objectives for each of the
following organisations?
a) Cancer research UK
b) Your primary school
c) Parkstone yacht club

What are the objectives for each of the following


Cancer research
Cancer Research UK aims to raise income to fund a

substantial programme of activities covering

research, information and influencing public policy
in respect of cancer treatment in the United

What are the objectives for each of the following


Your primary school

To nurture learning and to create a school where all

individuals, both children and staff feel valued.

What are the objectives for each of the following


Parkstone yacht club

Get young people involved in sailing.
Win competitions.
Maintain the facilities and fleet of boats.

Key comparison
Profit orientated entity

NFP entity


Some other form of

Maximise financial
returns in some way
(capital or income)

principals (agency theory)

No distributions of any
excess income


Types of NFP entities

There are two types of NFP entity:
Cooperatives, trusts, limited companies...
Sports organisations...

Usually some form of government dept.

How does a charity work?

(sort of equivalent to the
owners of a NFP the people
interested in the NFPs

Managers /
Stewards / Agents


(the people charged with

managing and running the
NFP entity)

(verified by auditors)

(produced periodically by the

Where do NFP entities get their funds from?

Charities are often self-financing (they generate

income through fundraising activities and donations)

Government departments are allocated x funds for

a budget period (usually from central government or

locally collected taxes)
Therefore the principals and those in governance

(agents) need to be sure of the validity of their

financial statements to render them credible

Financial reporting requirements

NFP entities may be set up like companies and therefore

have to follow a GAAP (e.g. UK GAAP / IFRS) however

they may also need to follow additional sets of guidance.
Charities Act 1993 / SORP (Accounting and Reporting
for Charities) 2005
Industrial and Provident Societies Act 1965
Friendly and Industrial Provident Societies Act 1968
Companies Act 2006

Ltd (by guarantee) Ltd, Cyf, plc, ccc, SE

The Limited Liability Partnerships (Accounts and Audit)

(Application of Companies Act 2006) Regulations 2008

Audit implications
NFPs may have differing audit requirements

compared to a traditional profit orientated entity.

Statutory audit
The objective of the auditor (to express an opinion on the truth
and fairness of the statements and compliance with
appropriate statutes, SORPs or other regulation) remains
Non-statutory audit
Audit objectives may vary (terms of appointment) but are
likely to be similar to those of a statutory audit

The audit approach

The audit approach remains unchanged too, with the

auditor focusing on areas of risk in order to detect

material misstatements.

Some of these risks will be different for a NFP entity.

Inherent risk
NFPs may be more inherently risky in terms of:

Safeguarding assets
Cash recording
Completeness of income and assets
Complex regulation

Assessing the going concern of a NFP entity may also be

more difficult, particularly for charities who are reliant

on voluntary donations.

Many issues, such as the state of the economy, could

impact on their ability to generate revenue in the short


Inherent risk
Often NFPs have cash that is set aside for a spectific

use this is know as restricted cash.

Restricted cash, if the amount is material, is shown
separately from cash and equivalents on the balance
The purpose for which the cash is restricted is
generally disclosed in the notes to the financial
The auditor must ensure these amounts are

identified, and that any restricted cash spent has

been used for its intended purpose.

Control risk
Some NFP entities (particularly smaller ones) may

have weaker control systems due to:

lack of segregation of duties, as the organisation will be

restricted with the amount of staff

the use of volunteers, who are likely to be unqualified and

have little awareness of the importance of controls;

the use of less formalised systems and controls.

Audit implications
Auditors of not for profit organisations will be

required to assess whether the aims of the

organisation are being met in an economic, efficient
and effective manner.

For this reason "value for money" audits are often more

Testing tends to concentrate on substantive

procedures where control systems are lacking. In the

absence of documentary evidence, procedures rely
heavily on analytical review, enquiry and
management representation.

Audit implications (continued)

The volumes of transactions in not for profit

organisations may be lower than a private one,

therefore auditors may be able to test a larger % of
Ultimately, if sufficient appropriate evidence is not

available the auditor will have to modify their audit


VFM audits: Overview

Value for money (VFM) is concerned with obtaining

the best possible combination of services for the least

It is often referred to as a review of the three "E's":

Obtaining the best quality of resources for the minimum cost.

Obtaining the maximum departmental /organisational outputs
with the minimum use of resources.

Achievement of goals and targets (departmental /
organisational etc).

Value for money audits

Comparisons of value for money achieved by

different organisations (or branches of the same

organisation) are often made using performance
indicators that provide a measure of economy,
efficiency or effectiveness.
This is particularly common in NFP entities, but it

can apply to any company.

Example: VFM audit of a hospital

Examples of value for money indicators for a hospital

might include:
Economy cost of medical supplies per annum;
Efficiency number of patients treated per year;
Effectiveness recovery rates.

VFM audits

While reviewing acquisition of resources for

economy, the auditor tries to ascertain whether

resources have been procured in the right amount,
at right place, at right time and at right cost
The assessment of needs leads to identification of

requirements for which alternatives are analysed

to determine minimum cost

A difficult concept. The most commonly used standards,

however, are planned outputs for given inputs laid down

by the audited department itself.
Where they are not available other techniques are used to
assess the level of efficiency
Some of the commonly used techniques are as follows:
Inter-authority Comparison
Internal Comparison
Private Sector Comparison
Past Performance

Efficiency is the relationship of actual input/output

(productivity) to a performance standard.

E.g. the time taken for producing 80 bags of cement is one

machine-hour. This is productivity of the plant. This level of
productivity may be 80% of the standard which is 100 bags
per machine-hour

Review of effectiveness presumes existence of

measurable objectives or outcomes of public

Resources may have been obtained economically and
efficiently but the audited party may not have
achieved the objectives (that is, have been

Effectiveness (continued)
Appropriate performance measures to assess the

effectiveness of projects are very difficult to devise. There

are three main problems:

Problem of jointness: Where a number of different policies may

contribute to satisfying unmet needs

E.g. educational standards may be affected by the size of classes, the quality
of teachers and the. supply of equipment. It may be very difficult in practice
to analyse the effect of individual policies

External factors: Sometimes factors outside the control of the

management affect the outcome of a project or programme
E.g. income and social status of the consumers
Cost: Sometimes programmes cannot be carried out in the most
effective manner due to prohibitive cost.
E.g. it may be more effective to have more teachers than to provide
more books. But the cost of the former may be prohibitively high

Effectiveness (continued)
Objectives laid down in the plan may be taken as a

bench mark for some of the outcomes

Sources of Performance Measures can include
Citizen surveys
Trained observer ratings
Industry standards
Internal records

The relationship of economy, efficiency and

The economy, efficiency and effectiveness aspects of

an organization are closely interlinked

E.g. economy of post office department can be increased

manifold by delivering post once a week, but it would cut
down the effectiveness of the department to an unacceptable

The auditor should thus focus on the organisations

objectives in reporting on an EEE audit

Problems with VFM audits

Tendency to cost cutting
Tendency to short-termism
Where the product is not one with an identifiable

market value the measurement of effectiveness and

efficiency becomes difficult

Audit evidence
When designing substantive audit procedures for

NFPs the auditor must consider what the risks are.

Question: Imagine you are auditing a small

charity. Would you be concerned that they

would want to over / understate:
a) Assets
b) Incomes
c) Expenses

Would you be concerned that a small charity

would want to over / understate:

a) Assets - Understate
b) Incomes - Understate
c) Expenses - Overstate
Why? May want to encourage people to think they dont

have enough resources and therefore contribute more


Audit evidence (continued)

Completeness of income is one area that the auditor

should focus on.

Remember the NFP may wish to understate this.

Problems arise due to:

Fraud resulting in loss of income
Incorrect recognition of government funds
Significantly, with many charities, much of the income
received is by way of donation. These transactions will not
be accompanied by invoices, orders or despatch notes.

Audit reporting
Statutory audit required

Issue same audit opinion as for a profit orientated entity (see next
week in detail!).

Non statutory audit (e.g. audit performed for the benefit

of members / trustees).

Standard audit report may not be appropriate.

Auditor must bear in mind the objectives of the audit and make
suitable references in the report to those.
Report should still containing (from ISA 700):
Addressee of the report
What the report relates to
Scope of audit
Outlines responsibilities of auditor / management / trustees
The work performed
The opinion drawn.

Summary of learning objectives

You should now be able to:
Explain what a not for profit entity is and what its
objectives are.
Explain how the financial statements for a not for
profit entity are different to companies and how this
impacts the audit.
Explain what a value for money audit is.
Understand the audit risks associated with NFP
Describe the audit reports given in respect of NFP

Read Chapter 17.
Chapter 17 questions and quick quiz.
Practice and revision kit:

Question 54 Value for money audit

Question 62 Bluesberry
Question 104 FireFly Tennis Club
Tutorial questions.