A charity in Kaduna raises money from street collections, church and mosque donations, postal cheques and a few large gifts that must be used for specific projects. It has no sales invoices, few staff and many volunteers. Its trustees want an audit because donors ask for one. The auditor cannot use the usual tests of completeness of income, because there is nothing to compare receipts against.
Auditing a not-for-profit organisation uses the same principles as any audit, but its aims, risks and evidence are different.
This topic covers what a not-for-profit organisation (NFPO) is, how its objective shapes the audit, and the audit approach under planning, risk, internal control, evidence and reporting, together with the special factors for charities. The previous topics covered planning and risk for commercial entities. The next covers the public sector.
In 30 seconds
NFPO: an organisation whose objective is to provide a service to society or a group, such as a charity, a club or a publicly owned body, within the resources it has. Audit: required by law for some, voluntary for others.
Approach: same structure as any audit; plan around objectives and local law; analyse inherent, control and detection risk; key controls are segregation of duties, authorisation of spending, cash control, control of income and use of funds for authorised purposes only. Evidence: usually substantive because controls are weak. Report: standard report if the law requires; if voluntary, follow the structure of ISA 700.
Key terms in plain English
| Term | What it means |
|---|---|
| Not-for-profit organisation | An organisation that provides a service and does not aim to make a profit |
| Beneficiary | A person or group the organisation exists to help |
| Restricted fund | Money that may be used only for a stated purpose |
| Substantive approach | Testing balances and transactions directly |
| Voluntary audit | An audit not required by law |
| Completeness of income | Assurance that all income received was recorded |
Syllabus check
This topic is in syllabus area A, process of audit and assurance (20% of marks). It covers:
- the audit of not-for-profit organisations
- audit risk and internal control
- the peculiarities of public sector audit
CAMA 2020 and not-for-profit organisations
The Companies and Allied Matters Act 2020 (CAMA 2020) is the company law of Nigeria. The sections below apply to this topic.
| Section | What it says | Link to this topic |
|---|---|---|
| Incorporated trustees provisions | Charities and associations may be incorporated as incorporated trustees under CAMA 2020, and their trustees are accountable for the funds they hold | Trustees are accountable for the funds |
| s. 404(1) | Where a company limited by guarantee is audited, the auditors report to the members | The report goes to those who govern the body |
| s. 407(3) | Right of access to books, accounts and vouchers | Needed because controls are weak |
The rules in more depth
The objective of a not-for-profit organisation
In any audit it is important to understand the entity and its environment, and a key point is the objective the entity pursues. In a commercial company the objective is to make a profit for the shareholders. In a not-for-profit organisation the objective is very different. It is usually to provide a service to society as a whole or to a group in society.
Examples are charities, clubs and societies, and publicly owned organisations. An NFPO must provide the service within the resources it has, so it tries to meet its objective as far as possible with the money and other resources available.
A charity or a government department shows the typical features. It has defined beneficiaries, such as starving children or the public who use hospitals. It raises funds from the public, through donations or tax. And it tries to spend those funds as effectively as possible for the beneficiaries.
Why the audit differs
An NFPO may be required by local law to have an audit, or may choose a voluntary one to add credibility to its statements. The difference in objectives influences the audit approach. In addition there may be specific auditing and reporting requirements in local law for certain types of NFPO, which affect the work and the form and content of the opinion.
If the NFPO asks for a voluntary audit, or a review, the scope of the work and the nature of the report are agreed in advance with the auditor. The auditor is still performing an audit, and its overall structure is like that of a commercial audit, but the detail differs.
The audit approach by area
| Area | Points to bear in mind |
|---|---|
| Planning | The objectives and scope of the work; local regulations; the environment of the organisation; the form and content of the final statements and the opinion; key audit areas including risk |
| Risk | Carry out an audit risk analysis under inherent risk (the nature of activities and environment), control risk (inadequate controls, especially over cash collected by volunteers) and detection risk (that the auditor fails to find a material error) |
| Internal control | Segregation of duties (hard in a small body with few staff); authorisation of spending; cash control; controls over income, such as donations, cash collections, membership fees and grants; use of funds only for authorised purposes |
| Audit evidence | A substantive approach is likely in a small NFPO because the controls are weak. Key areas are the completeness of recording of transactions, assets and liabilities, and possible misuse of funds. Analytical procedures help to make sense of the figures. A review of the final statements includes a review of the accounting policies. |
| Reporting | If the law requires a report, the standard external auditor's report can be used. If the audit is voluntary, the report reflects the agreed objective, and it is good practice to follow the structure of ISA 700: title, addressee, opinion, basis for opinion, responsibilities of auditors and management, other reporting responsibilities, and date, name, signature and address of the auditor. |
Other factors to consider
- Cash. Cash may be significant in small NFPOs, and controls are likely to be limited.
- Income. Income is a risk area, especially where money is donated or raised informally, because completeness cannot be proved by reference to invoices.
- Scope limitation. There may be a limit on the scope of the audit if evidence is hard to obtain.
- Analytical review. Income may be unpredictable and may have no clear relationship with expenditure, which makes analytical review less useful.
- Restricted funds. Where the organisation may use certain funds only for specific purposes, the auditor tests that the restrictions were followed and that the funds were separately accounted for.
- Sensitive statistics. The proportion of revenue spent on administration is closely watched, especially for charities, so there is a risk of mis-classification of costs.
Specific procedures for common risks
| Risk | Possible procedure |
|---|---|
| Street collections not fully banked | Review the controls: sealed boxes, opening in the presence of two people, count sheets signed by both and banking the same day. Compare takings by collector and by place over time. |
| Donations posted but not recorded | Test the post opening and recording procedure; compare bank credits with the donations register; review post-year-end receipts for cut-off. |
| Restricted funds spent on other purposes | Obtain the donor conditions; trace spending to the specified projects; confirm separate fund accounting. |
| Administration costs mis-classified | Test a sample of costs to the nature of the spending and the policy for allocating shared costs. |
| Weak segregation of duties | Increase substantive work; look at management's supervision, trustees' review and bank reconciliations. |
| Incomplete income | Ask whether any check can give assurance. If none, consider a comment in the report on the limit of the work. |
Worked examples
Example 1: objective. Why does a charity's objective affect the audit?
- The charity's aim is service, not profit, so profit-based analysis is less useful.
- The auditor focuses on whether funds were used for the stated purposes and on the completeness of income.
Example 2: approach. A small sports club with three part-time staff has weak controls.
- A systems-based approach cannot be relied on.
- The auditor uses a substantive approach, focusing on completeness of income, cash and misuse of funds.
Example 3: restricted funds. A donor gives ₦20 million for a borehole project. The charity spends ₦5 million on staff salaries from the fund.
- The fund is restricted, and the spending breaches the condition.
- The auditor reports the matter to the trustees and considers the effect on the statements and the report.
Example 4: voluntary report. A club asks for a report on its accounts although the law does not require one.
- The scope and report are agreed in advance.
- The report follows the ISA 700 structure so that readers know what was done.
How to score full marks
- Start with the objective and contrast it with a commercial company.
- Use the headings planning, risk, control, evidence and reporting.
- Name cash and the completeness of income as the key risks.
- Say why a substantive approach is usually needed.
Common mistakes in the exam
- Writing about profit as the aim of the organisation.
- Describing a full systems-based audit for a small charity.
- Ignoring restricted funds.
- Giving a standard report for a voluntary audit without agreeing its scope.
Quick revision
- Objective: service within resources.
- Same audit structure, different detail.
- Key controls: segregation, authorisation, cash, income, purpose of funds.
- Substantive approach; completeness of income is the main problem.
- Voluntary report follows ISA 700 structure.
Practice questions
Questions 1 to 10 are multiple choice. Questions 11 to 13 are written. Try each before opening the answer.
Question 1. The objective of a not-for-profit organisation is usually to:
- Make a profit for shareholders
- Provide a service to society or a group
- Reduce tax
- Raise share capital
Show the answer
B. Service within the resources available.
Question 2. An NFPO audit may be:
- Required by law or voluntary
- Only voluntary
- Only required
- Banned
Show the answer
A. Either.
Question 3. A key risk in a charity is:
- Completeness of donated income
- Receivable days
- Interest cover
- Dividend cover
Show the answer
A. No invoices to check against.
Question 4. A substantive approach is likely in a small NFPO because:
- Controls are weak
- There is no cash
- It has no income
- It is large
Show the answer
A. Weak controls.
Question 5. Restricted funds are funds that:
- May be used only for specific purposes
- May be used for anything
- Are tax-free
- Belong to the auditor
Show the answer
A. Donor or constitutional conditions.
Question 6. A voluntary audit report should follow the structure of:
- ISA 700
- ISA 200
- ISA 530
- ISA 315
Show the answer
A. Good practice.
Question 7. An important statistic for many charities is the:
- Proportion of income spent on administration
- Gearing
- Earnings per share
- Dividend yield
Show the answer
A. It is closely watched.
Question 8. A scope limitation on an NFPO audit arises when:
- Evidence cannot be obtained
- The fee is high
- The year end changes
- The trustees meet
Show the answer
A. The auditor cannot get enough evidence.
Question 9. Cash controls in a charity matter because:
- Large cash amounts may be collected by volunteers
- Cash is never used
- Banks do not exist
- It is tax free
Show the answer
A. Volunteers collect cash.
Question 10. Segregation of duties in a small NFPO is:
- Hard to achieve
- Always achieved
- Unnecessary
- Forbidden
Show the answer
A. Few staff.
Question 11 (10 marks). Explain how the objectives of a not-for-profit organisation affect the audit. (5 marks)
Question 12 (10 marks). Describe the audit approach to a charity under the headings planning, risk, internal control, evidence and reporting. (10 marks)
Question 13 (10 marks). Explain the audit problems with income and restricted funds in a charity. (5 marks)
Model answers
Show the model answer to Question 11
Commercial entities aim at profit; NFPOs aim at service to beneficiaries within resources. (2) The auditor looks at whether funds are used for the objectives, at misuse of funds and completeness of income, and at specific legal requirements and report form. (3)
Show the model answer to Question 12
Planning: objectives, local regulations, environment, report form, key risk areas. (2) Risk: inherent, control and detection risk analysis. (2) Control: segregation, authorisation, cash, income, funds for authorised purposes. (2) Evidence: substantive; completeness; misuse; analytical procedures; policies review. (2) Reporting: standard report if required; otherwise ISA 700 structure. (2)
Show the model answer to Question 13
Income: donations and cash have no invoices, so completeness cannot be proved; volunteers may keep cash; the auditor considers a report comment if no check gives assurance. (3) Restricted funds: must be used only for stated purposes; the auditor tests the conditions and separate accounting. (2)
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