By Hayes Knight – 9 July 2012

Will proposed legislative assurance requirements instil a new found respect for accounting standards and the important role they play, or will it just be an unnecessary compliance cost?

As noted in an earlier article, the Ministry of Economic Development’s (MED) is proposing to enact mandatory audit and assurance requirements over the annual financial statements of large charities in New Zealand.  The objectives behind such a regulatory requirement is to:

  1. promote greater public trust and confidence in the charitable sector;
  2. help support potential funders and donors to make informed decisions about the charities they will support; and
  3. promote charities’ accountability to the public by providing information about whether the funds or other assets they have obtained from the public are being used effectively and efficiently.

In short it is about improving the overall quality and reliability of financial statements, by making assurance providers the independent policemen that ensure that charities comply with the correct accounting standards and adopt a standardised and reliable approach to reporting.

It has been interesting exploring this topic with others in the sector.  At a recent forum I attended there was quite a vigorous debate with a person from a large and complex charity espousing the view that legislation was not needed and it should be left to market forces to set the standard.

So here are some Q & A’s on this topic:

Q: Is there a need for Government intervention?

A: Yes. If you agree that the Government essentially provides a grant to charities via income tax exemption on behalf of the general public and that accountability of public funds is important.  However the general public have no power to specify the form and content of financial information from charities.  It therefore falls to the Government to require this on the public’s behalf.

Q: Is poor financial reporting, (i.e. non-compliance with reliable recognised accounting standards) a widespread problem that needs addressing?

A: Hard to tell with accuracy. But then that is part of the problem; unless financial information can be relied upon as accurate you cannot easily tell if there are any underlying problems from simply looking at financial statements. That said an independent study by an academic commissioned by the MED identified reasonably widespread problems.  Anecdotally as an audit provider in the sector we also see quite a high number of examples of non-compliance and poor financial reporting that result in unreliable information.  Hence we would agree action is needed.

Q: Surely the market will sort out any financial reporting problem and funders will dictate an audit if one is needed?

A: Unfortunately from our experience we would disagree.  Many funders request and appear to rely on an audit of a charity’s financial statements.  However there are two problems with this:

  1. Funders may not be getting the assurance they seek because they do not fully understand the audit process and outputs.  In our experience of discussing financial statement audits with funders; most are seeking specific assurance that any funding they have issued has been used for the purposes it was originally intended for.  An audit of annual financial statements will not provide this assurance unless this additional requirement is specifically scoped into it; and
  2. Many funders do not specify who must carry out the audit.  Therefore if an audit is performed by an unqualified auditor and does not fully comply with the audit standards then its reliability and usefulness is greatly diminished.

An example of the latter point: We took over an audit of a charity where the previous year’s financial statements had been “audited” and contained an audit report that appeared to comply with the audit standards.  However on further investigation we found out that the previous “auditor” had no accounting qualifications, no audit experience and was unable to provide any audit work papers to support any work having been performed.  They had however managed to copy the audit report format from another charity that did have a qualified auditor!

The net result was a set of financial statements with an audit report that on first glance looked reliable.  However our subsequent work in carrying out an audit in accordance with the appropriate standards proved there to be quite a few problems with the previous “audited” financial statements, showing them to be unreliable and inaccurate.

Q: But how do you ensure the cost of legislating for compliance doesn’t outweigh the benefit?

A: By setting a cut-off limit i.e. that such legislation should not be mandatory for very small entities – as is proposed by the MED.  However that raises the question of how does one fairly set arbitrary cut-off levels?  There is no easy answer to this.  Our submission to the MED (somewhat ironically as we are advocating for a position that would disadvantage our business as auditors) is that the proposed levels are too low.  Legislate for the larger and let the market take care of the smaller as long as it is clear to the market what standards have been followed.

For more information on these changes please contact us.