The Expectation Gap

What an audit is (and is not)


We provide some thoughts on how our clients can help us to carry out the audit efficiently, and in so doing help keep costs down.

Here, we examine the main purpose of the audit: to provide an opinion on the accounts. Do they, in the famous phrase of the profession, provide a true and fair view of the organisations finances?

Although we are required to give an opinion, it is the responsibility of the trustees to prepare the annual accounts. Of course, we are often asked to help in making them SORP compliant. We also frequently assist with the preparation of monthly management accounts. Nevertheless, the ultimate responsibility rests with the trustees.

No doubt most people involved in charity management know this. However, we sometimes find that there is a degree of uncertainty about what, specifically, an audit coves (and what it dose not) the expectation gap, as it is sometimes called. This is particularly true when it comes to the effectiveness of systems and controls, and the assessment of risk.

All audits must now be carried out in accordance with international auditing standards, whether the organisation is a charity or a business. As part of this, the auditors are required to assess risks that the organisation faces, and discuss them with senior management.

Charities should have already prepared a risk register, which should make our task simpler. We will review the register with our clients, to ensure that the charity has given due attention to this matter. Should we notice any points that have been overlooked, we will draw them to the attention of management.

However, it is not our task to prepare the register or to examine the points in detail, but rather to comment upon it in a general sense. Of course, as mentioned above, we will point out any obvious areas of concern. But the preparation of the risk register and the assessment of those risks remains the responsibility of the client.

Sometimes, as a separate exercise, we help clients with the preparation of the register and suggest ways of appraising the risks for example, by assigning a numerical value to the likelihood of a risk happening, and to the potential seriousness if it dose. This, however, is not part of the audit.


During the audit we will also carry out a review of the systems and controls to determine if they are appropriate for the charity in question, using a detailed checklist. However, we will not test every control in detail, but rather do so on a sample basis. This means that we will tend to concentrate upon more critical areas, such as those related to payment procedures, where weaknesses are often found.


The samples are weighted depending upon risk factors and materiality. In our experience, it is more effective to examine a smaller number of transactions in depth, rather than a large number superficially.

For a low risk organisation, materiality is calculated at 1 per cent on the higher of income and gross assets. If, however, the gross assets and income are significantly different from each other, we would use one for the Balance Sheet and one for the Statement of Financial Activities (SOFA).


Overall, our main aim is to consider the systems and controls from the perspective of their impact upon the accounts. For example, we will consider their effectiveness in ensuring that purchases have been properly posted in the ledger.


We will also examine the balance sheet and verify the value of items there, and similarly verify any liabilities. At the same time, we will check to see if there are any items missing. It may be that an item appears in the ledger that should be reflected in the balance sheet. If it is absent, this may suggest a systems problem or a lost invoice.


We then carry out an analytical review, comparing the accounts with the previous years figures and with the budget. Should there be any material departures, we will examine the figures in more detail in order to understand the reason for the variance.


Should we detect deficiencies in any of the above, we will point them out in a management letter, and usually suggest remedial action. We often find that this can give rise to a certain misunderstanding.


Charities sometimes assume that if their auditors do not submit such a letter, it follows that their administration and accounting procedures are faultless. Unfortunately, this is not necessarily so. As only a sample of controls are assessed, it id at least possible that some shortcomings are not identified. Our testing is to satisfy ourselves that w can rely on the systems in relation to the preparation of the accounts, and not an all encompassing assessment.


Of course, it would be possible to go through every item in minute detail. But this would add hugely to the time needed to complete the fieldwork, and thus boost the cost of the audit dramatically. In auditing, as in most aspects of business, it is necessary to weigh costs against benefits.


However, we never approach an audit from a narrow point of view, declining to review matters simply because strictly speaking they do not assess our clients finances from a broad perspective, always remembering that the reassurance that they need.


AND HOW TO REDUCE THE AUDIT COSTS


Voluntary organisations are naturally anxious to keep all areas of cost to a minimum.

Here we suggest ideas that could result in lower audit fees.

The primary purpose of the audit is to express an opinion on the accounts. Auditing firms can only do this by reviewing a charity's books and records. The first rule in reducing costs, therefore, is this: ensure that records are complete, correct, understandable and easily accessible.

This may seem so obvious that it scarcely needs to be said. Yet it is surprising how often this simple piece of advice is ignored. The auditing firms fees will be based on time spent, and time spent searching for files or attempting to obtain answers to queries is time that is likely to be added to the bill.

How can this be so, it might be asked, when the fee will have been quoted in advance? The answer is that the auditor may well have formed a view about the state of the records before tendering a quote. If the charity is able to demonstrate from the outset that all necessary documents are to hand, and that books and records are clear, the quote is likely to reflect this fact. Conversely, if the records are in a poor state, the fee may increase in subsequent years, even if the agreement prevents an increase in the current year.


The subject of record keeping inevitably raises the question of how those records should be maintained. Although there is no single, preferred method, system of control, authorisation and documentation are vitally important. It is necessary to ensure that the build up of figures in the draft accounts is well documented in the working papers. It is also important that these figures are cross-referenced back to the original documents.


As auditors, we will not examine every transaction in the records, but will test their accuracy on a sample basis. The better the systems and more complete the records, the fewer the number of samples that will need to be tested.

Auditors employ an analytical review technique to reduce time and save costs, whenever possible. If records and accounts are in a good state, relevant figures can be compared with those of the pervious year, and explanations quickly obtained if there are material variations from the expected numbers. In fact, charities can assist by considering these matters themselves and obtaining answers before the auditors arrive on site.


THE PAPER TRAIL


No matter what system of record keeping a charity adopts, an outsider should easily understand it. Additionally, there should be a clear policy, understood and followed by all those responsible for the charity's finances, on which documents are to be kept, and which are not. Inconsistency is a sure way to cause confusion, and to cause a fruitless search for non-existent pieces of paper.


No matter how experienced the auditing team is in pursuing a paper trail, they cannot be expected to lay their hands immediately upon every document they need. It will be a considerable help, therefore, if relevant members of the charity's staff are on hand to answer questions throughout the auditing period. Once again, this may sound obvious, but every auditor can relate stories of lengthy searches through files simply because no one was available to answer a question.


Advance planning and good communication are key to controlling long term audit costs. And a crucial element in planning is to agree well before the process begins how much of the work will be done by the auditing firm and how much by the charity's own staff. The rule should be this: as much work as possible should be carried out in house.

As a fundamental part of the audit, bank account must be reconciled and supporting schedules prepared and agreed with the final accounts. If the charity has staff with sufficient skills, much of this can be done in advance, so the auditor has to check as little as possible to express an opinion on the accounts validity. Even if the charity lacks the expertise to prepare draft accounts, individuals without professional training can still handle much of the preparatory work.


Charities should discuss this with their auditors at the earliest possible stage. This will give the auditors an opportunity to assess the skill that exist in house, and to give guidance on the work that the charity should be able to undertake in advance.


It goes without saying that this can only be done if time is available. Ideally, planning meeting should be held before the financial year end or as soon as possible after the year end.


ALTHOUGH THE FUNDAMENTAL PURPOSE OF THE AUDIT IS TO REVIEW THE ACCOUNTS, GOOD AUDITORS SHOULD BE ALERT TO OPPORTUNITIES TO INTRODUCE MORE EFFECTIVE SYSTEM AND COST CONTROLS, IDENTIFY POSSIBLE COST SAVING AND GENERALLY PROVIDE CONSTRUCTIVE ADVICE WHUN IT COMES TO ACCOUNTS PREPARATION.


The fact that many charities do not use their accounting packages typically Sage and Quickbooks to the full. As a result, they could be missing out on important management information and also failing to present their accounts in a way that could speed up the task of the auditors, and perhaps reduce costs.


WHAT IS AN INTERNAL AUDIT AND WHAT CAN IT OFFER CHARITIES?


Mention the word audit and charity staff may be incline to reach for their diaries in the hope of booking a last minute holiday. Mention internal audit and the reaction can be even worse. Yet an internal audit dose not have to be an intimidating process of interrogation, with employees required to justify their positions. If carried out well it can contribute significant value to the organisation in terms of improved systems of management, cost savings, and higher staff moral.


Internal audits differ from external audits in a fundamental way: they do not focus purely on financial statements and financial risk. The internal auditors report directly to the audit committee (or in some cases the Board), which is responsible for setting the remit. An internal audit can therefore be used to investigate any areas of concern to trustees, including risk management, internal controls, and potential inefficiencies.


A RISKY BUSINESS


Mention risk, and the possibility of financial loss is perhaps the first thing that comes to mind. However, charities can face a range of risks that may or may not have immediate financial consequences. An internal audit can help identify these hazards and suggest ways of mitigating either the probability of occurrence or the impact.


Consider risk to reputation, for example. Clearly, the esteem in which a charity is held is crucially important, particularly for organisations that rely on donations as a major component of their income. Once a good reputation is harmed, it can be very difficult to recover, with potentially serious implications. An internal audit can be directed towards identifying potential threats to reputation, such as events arranged by well-meaning but inexperienced volunteers. Risk mitigation strategies strict guidelines to be followed when organising events, for example can then be developed.


Operational risk relates to the day-to-day running of the charity. Are systems in place to ensure that all transactions are genuine and recorded correctly, so that management is provided with accurate information on which to base strategic decisions? On a more prosaic level, are controls in place to ensure that photocopying is kept to a minimum, to minimise costs?


An internal audit can investigate and report on areas ranging from the fundamentally important to the more down-to-earth, so that the trustees can be satisfied the charity is running as efficiently as possible.


Then think of strategic risk. To a greater or lesser extent most charities will have goals for the future and methods for achieving them. But dose the current strategy make the most of the charity's potential?


One example is investment strategy. Normally, the responsibility for managing investments is delegated to an independent, professional fund manage; but is the return on investments maximised? An internal audit can report on investment effectiveness or highlight a lack of procedures to monitor the performance of the fund manager, such as comparing investment returns to market performance over a given period.


One example is investment strategy. Normally, the responsibility for managing investments is delegated to an independent, professional fund manager; but is the return on investments maximised? An internal audit can report on investment effectiveness or highlight a lack of procedures to monitor the performance of the fund manager, such as comparing investment returns to market performance over a given period.


MEASURING PERFORMANCE


Internal audit can also be used to assess the performance of a charity compared to similar organisations, a process generally referred to as benchmarking report can prove a useful tool for management, highlighting both strengths to be consolidated and weaknesses requiring attention.


The board of trustees is responsible for identifying, managing, and mitigating the risks facing a charity, and for safeguarding the charity's assets. That this is an important part of their duties is evident from the fact that they are required to make a declaration about risk in the Trustees Report.


However, some trustee boards fail o realise that risk mitigation goes beyond ensuring the office is kept locked at night and only senior staff are allowed to sign cheques. Each of the examples of risk outlined above could, if not adequately controlled, result in harm to the charity. This could take the form of potential cost savings not realised, or income lost as a result of poor asset management. By identifying areas such as these, internal audit reports can prove an invaluable management tool.

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