Financial Reporting


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Financial Reporting

  1. 1. Financial Reporting & Corporate Governance in Not-For-Profit Organisations
  2. 2. Financial Reporting & Corporate Governance in Not-For-Profit Organisations Introduction Charities and other not-for-profit organisations play a vital role in our society and yet there is little information available specific to the sector. The management of these organisations have limited comparative information against which to benchmark their own organisation's governing structures or the adequacy of their financial reporting procedures. We at PricewaterhouseCoopers, believe that this report, aimed specifically at the not-for-profit sector, provides comprehensive comparative benchmarks for not-for-profit organisations operating in Ireland on issues such as: • The board of directors/trustees - do the boards of Irish not-for-profit organisations operate within best practice guidelines relating to structure, constitution, composition, monitoring and appointments? • Accountability and risk - how do not-for-profit organisations ensure that all major risks are identified and the systems in place to mitigate those risks? • Financial reporting and disclosure - does the information provided by not-for-profit organisations in their annual report or financial statements meet the level of disclosure recommended under Statement of Recommended Practice 2 and other laws and regulations? • Internal control - are the control procedures adequate to allow the boards of directors/trustees of these organisations to meet their monitoring and control responsibilities. In order to compile the information for the report we asked a significant sample of charities and other not-for-profit organisations to complete a comprehensive questionnaire. As a result we believe that this report and its results will be a useful reference source for the board of directors of almost every charity and not-for-profit organisation in Ireland. We would like to acknowledge and thank the organisations that participated in our study for the time and assistance that they provided us with. We hope that you find this report interesting and informative. I, or any of my colleagues in PricewaterhouseCoopers, would be pleased to discuss with you any matters that arise from this report. The relevant contact details for each of our offices are set out in Section 5 of this publication. Teresa Harrington Not-for-Profit Practice PricewaterhouseCoopers
  3. 3. Financial Reporting & Corporate Governance in Not-For-Profit Organisations Section Page 1. The Board of Directors 1 Board Structure Board Size Board Meetings Board Membership New Member Orientation Term of Office Management Information 2. Accountability & Risk Assessment 13 Internal Control, Compliance & Risk Management Risk Assessment Control Environment and Control Activities Monitoring and Communication Audit Committees and Internal Audit Board Responsibilities 3. Internal Control 21 Supplier Invoices Supplier Statements Cheque Payments Cash & Cheque Receipts Public Collections Fund-Raising Events Investments Bank Reconciliation Statements Board Responsibility 4. Financial Reporting 33 Financial Statement Disclosure The Directors/Trustees' Report Internal Control Disclosures Board Responsibility 5. Not-For-Profit Sector Contacts in PricewaterhouseCoopers 41 6. PricewaterhouseCoopers' Not-For-Profit Practice in Ireland 45
  4. 4. 1. The Board of Directors
  5. 5. Financial Reporting & Corporate Governance in Not-For-Profit Organisations 1. The Board of Directors New media technology and a wider stakeholder community mean that corporate governance arrangements of companies and other organisations are coming under greater scrutiny. These requirements for greater transparency and increased accountability extend beyond public and private companies to all not-for-profit organisations operating in Ireland. Every not-for-profit organisation should be headed by an effective board that leads and controls its activities. There is, however, no "one size fits all" structure that can be applied to every organisation. Each board must be structured according to an individual organisation's circumstances. That said, there are best practices that all not-for-profit organisations should at least consider, regardless of the sector they are operating in or the services that they provide. In this section of our report we set out some of these best practices. Where appropriate, we have illustrated existing Irish not-for-profit board practices by reference to the responses received from our recent survey. 1.1 Board Structure The structures adopted by not-for-profit organisations' boards of directors vary widely depending on the nature of the organisation's activities. Generally, the board types may be summarised into two main categories: Two-tier Boards: In this model the supervisory and management functions are separated. The supervisory or upper-tier board is typically concerned with overseeing the strategic management of the organisation and consists wholly of independent members. The lower-tier management board is made up of executive directors who deal with the day-to-day management functions. One-tier: Here, executive and independent directors are brought together in a single unit which assumes all directors are equal and share collective responsibility for decisions - both strategic and operational. Page 1
  6. 6. Financial Reporting & Corporate Governance in Not-For-Profit Organisations Regardless of structure the board should operate within a corporate governance framework which ensures: • The board remains accountable to the organisation and its stakeholders; • The organisation's management is monitored effectively by the board; and • Board members are committed to achieving the agreed strategic aims. It is important that not-for-profit organisations appoint board members and senior executives with the necessary personal competencies and abilities to work together. A successful governance framework must involve a partnership between the board and senior management - with the board providing oversight and guidance, while management take responsibility for day-to-day operations. Best practice for board appointments is set out in more detail below. Well-run boards are all about working together and reaching a degree of consensus - they are not about the dominance of one individual or special interest group and the stifling of healthy debate. An effective board will include adequate representation of independent directors, who are able to bring an objective view to board deliberations. The board of directors or equivalent body within any not-for-profit organisation, or any sub- committees thereof, should have documented terms of reference. Such a charter provides a clear understanding of the board or sub-committee's role and sets out a framework within which the board is required to operate. Typically, the terms of reference should include: • Overall purpose and objectives of the board or sub-committee; • Details of board/committee membership; • The frequency and timing of meetings; • The roles and responsibilities, including qualifications and terms of office, of the various members; and • The relationship with management and stakeholders. Figure 1.1 shows that 75% of not-for-profit organisations participating in our survey have formal terms of reference in place for the board and any sub-committees thereof. Are there formal terms of reference in place for the board and sub-committees thereof? Yes 75% No 25% Figure 1.1 - % Of Irish not-for-profit organisations with formal terms of reference for the board and its sub-committees Page 2
  7. 7. Financial Reporting & Corporate Governance in Not-For-Profit Organisations 1.2 Board Size It is of course more important to have the right quality and experience of director on the board than sheer number of individuals. Figure 1.2 indicates the trends we noted regarding the average size of not-for-profit organisation boards during our survey: Board Size 16-20 20+ 1-5 10% 5% 10% 6-10 11-15 35% 40% Figure 1.2 - Size trends for Irish not-for-profit boards of directors There is a growing recognition of the role independent directors can play in providing a bridge between the management and stakeholders of not-for-profit organisations, notably in the areas of external communications, financial reporting and internal controls. As you can see from Figure 1.3, 95% of organisations surveyed have a majority of independent directors on their board. % of Not-For-Profit Organisations Where Majority of Board of Directors are Independent or Non-Executive Directors Board Majority are Independent/Non-Executive Members 95% Board Majority are Executive Members 5% Figure 1.3 - % of Not-For-Profit organisations using independent or non-executive directors 1.3 Board Meetings There are no firm rules for how, where and when board meetings need to be conducted, beyond any company law requirements that may apply to certain not-for-profit bodies. However, there are a number of characteristics that are likely to contribute to successful board meetings. The most important factor as far as board meetings are concerned is to maintain an open and inclusive atmosphere, in which members feel free to speak their minds. It is important that members understand their specific roles and responsibilities within the overall board structure. Much of the responsibility for this falls on the chairperson. He or she should direct the meeting in a way that stimulates open debate on each of the issues, ensuring that meetings neither get distracted by convoluted arguments, nor leap to hasty conclusions without due consideration. Best practice indicates that the Chairperson and the Chief Executive Officer should be separate and in 80% of organisations surveyed this was the case. Page 3
  8. 8. Financial Reporting & Corporate Governance in Not-For-Profit Organisations A board that fails to hold regular meetings runs the risk of being unable to fulfil its responsibilities to the organisation and its various stakeholders. Moreover, directors who do not meet on a regular basis could be leaving themselves open to legal or other action from employees, stakeholders or regulatory bodies for failing to discharge their duties. The frequency of meetings will depend on the company's specific situation, and on internal and external events and circumstances. As a general rule, full board meetings should be held no less than quarterly, and quite possibly monthly. Sub-committees of the board tend to meet less frequently, perhaps three to four times a year, but again this will vary with circumstances and the specific functions of the sub-committee. Figure 1.4 shows the frequency with which Irish not-for-profit organisations meet. How often does the board meet? Semi - Annual Quarterly 35% 5% 10% Not-Specified 50% Monthly Figure 1.4 - Frequency of board meetings 1.4 Board Membership The appointment of suitably qualified members to the governing body of a not-for-profit, or indeed any, organisation is a critical factor in that body and the organisation's performance. Best practice suggests that a nomination committee be established for identifying and screening new board members and senior executive officers. Only 40% of participant organisations in our survey have indicated the use of a nomination committee in making recommendations to the board on all new appointments - see Figure 1.5. Page 4
  9. 9. Financial Reporting & Corporate Governance in Not-For-Profit Organisations Is there a nomination committee to make recommendations to the board on new appointments of directors or executives? Not specified 10% No 50% Yes 40% Figure 1.5 - Use of nomination committees when appointing directors or senior executive officers It is important when making new appointments to director or senior executive officer roles that there are clear and transparent procedures in place. Figure 1.6 indicates that 75% of our survey participants have formal procedures in place for the appointment of new directors or executives. Formal and transparent procedures exist for appointment of new directors or executives No 25% Yes 75% Figure 1.6 - Use of formal and transparent procedures for the appointment of new directors or executives. All board members should have the ability to read and understand basic financial statements including the organisation's balance sheet, income and expenditure statement and cash flow summary. It is also beneficial for one or more of the independent directors to have accounting or financial management expertise. This could have arisen through past employment in finance or accounting, a professional qualification in accounting, or any other comparable experience. This skill set is useful to the board when it comes to discharging its financial oversight and internal control responsibilities. To fulfil their responsibilities board members need to dedicate a significant amount of time and energy to board activities. This will include familiarisation with the organisation's activities and sector; preparation for, and attendance at, meetings; and informal meetings with interested parties and other groups. The number of other directorships held by board members may affect the amount of time they are able to devote to the organisation's activities. When evaluating potential candidates the board should therefore consider the number of other directorships held by candidates and factor this already committed time into their decision-making. Page 5
  10. 10. Financial Reporting & Corporate Governance in Not-For-Profit Organisations It will not be possible for every board member to have the full technical knowledge required for every decision and therefore it is important that procedures exist for board members to take independent professional advice as required to discharge their duties. 65% of survey participants confirmed that procedures exist within their not-for-profit organisation for the directors, or members of the board of management, to take independent professional advice required to assist them in the discharge their board responsibilities. The remaining 35% represents a sizable minority. These organisations may be leaving their directors and the organisation itself exposed to personal or corporate liability where the directors pursue a strategy without the necessary professional advice having been sought and included in their discussions. 1.5 New Member Orientation Board members should be provided with sufficient background information and training. The education process should begin as soon as the candidate is appointed to the board. New members should meet with the financial and operations managers to ensure that they have an appropriate understanding of the organisation, its services, areas of risk and its internal controls and financial reporting systems. New board members need to understand the requirements and objectives of the board and so should review the board's terms of reference, minutes of prior meetings and any recent reports prepared for the board. 84% of the directors of not-for-profit organisations participating in our survey do not receive appropriate training on the first occasion of being appointed a director - see Figure 1.7. While the exposure that this can create is mitigated in cases where the candidate is an existing director of another organisation it is nonetheless best practice and our recommendation that all new board members receive appropriate orientation and training on appointment. Do directors receive appropriate training on the first occassion of being appointed director? Yes 16% No 84% Figure 1.7 - Provision of new member training Term of Office The number of years that members serve on a board varies. Best practice would suggest a common term is 1-3 years, with possible reappointment for a second term, but longer or open terms are also possible. In our survey we found that almost one-fifth of the participants had no fixed term in place for members of the board of directors. Page 6
  11. 11. Financial Reporting & Corporate Governance in Not-For-Profit Organisations When determining the length of time board members may serve two opposing considerations should be weighted against one another - continuity and freshness. Rapid turnover can be detrimental to a board's effectiveness since members need time to familiarise themselves with the organisation's activities and understand any specific technical issues. On the other hand, new members bring a fresh perspective to the board. To balance these considerations, the board may wish to establish staggered terms for members. Figure 1.8 sets out the trends noted in our survey relating to directors' terms of office. Our survey noted that 70% of participant organisations that have specified terms of office for board members comply with the suggested best practice period of 1-3 years. What is the specified term for directors’ appointments 1-3 years 70% 1 year 15% 3+ years 15% Figure 1.8 - Terms of office for board members Management Information To govern a not-for-profit organisation effectively the board must receive timely, relevant, and reliable reports on progress against the organisations business objectives or principal objects and financial and other information needed for decision-making and management review purposes. Frequency with which the board is supplied with Management Information Not Specified 10% Annually 5% Monthly 50% Quaterly 35% Figure 1.9 - Frequency of Management Information Figure 1.9 above indicates that approximately 50% of the organisations participating in our survey provide their board with monthly management information and 35% update the board quarterly. Anything less frequent than this should probably be reviewed with a view to increasing the timeliness with which information is provided. Page 7
  12. 12. Financial Reporting & Corporate Governance in Not-For-Profit Organisations What type of information should be provided to the board of a not-for-profit organisation? The type of information provided will vary depending on the nature of the organisation's activities but may include: • Year-to-date income and expenditure details; • Year-to-date cash flow details; • Period end balance sheet; • Year-to-date actual results compared to budgeted levels; • Year-to-date investment performance • Market value of the organisations investment portfolio; • Details of significant applications for aid or support; and • Details of progress made against committed actions or initiatives. Page 8
  13. 13. Financial Reporting & Corporate Governance in Not-For-Profit Organisations Figure 1.10 outlines the key management information provided by the organisations in our survey to their board of directors. Type of management information supplied to the board 95% 80% 70% 50% 50% 40% Income & Cash Flow Balance Sheet Budget Vs Investment Applications Expenditure Actual Performance for Aid/Support Account Comparison Figure 1.10 - Management information supplied The management information above primarily deals with updating the board on the financial performance of the organisation and its operational activities. In addition best practice would suggest that the board of a not-for-profit organisation should set targets and quantifiable objectives for the organisation's performance against its strategic objects or achievement of its principal objects. Only 40% of our survey participants include a "principal objects" measure in their standard board reports - see page 10. Page 9
  14. 14. Financial Reporting & Corporate Governance in Not-For-Profit Organisations Is the board provided with details of the organisations performance against indicators specific to principal objects? Yes 40% No 55% Not specified 5% Figure 1.11 - Information relating to progress against principal objects In addition to performance management information, directors of not-for-profit organisations should seek information reports on the progress of the organisation in meeting its principal objects. While this information can be harder to measure the board can, by determining appropriate criteria for measuring such progress and establishing relevant goals to be met, further motivate the organisation, and indeed the public at large, by reporting progress against the organisation's stated principal objects. In addition details and improved trends in these areas can assist both the board and management in seeking further funds for their activities from corporate donors and the public. When properly structured and with a clear mandate, the board can be of great benefit to a not- for-profit organisation. By playing a proactive role board members enhance the performance of the organisation and strengthen its ability to achieve its principal objectives. Page 10
  15. 15. 2. Accountability and Risk Assessment
  16. 16. Financial Reporting & Corporate Governance in Not-For-Profit Organisations 2. Accountability and Risk Assessment 2.1 Internal Control, Compliance and Risk Management The topic of "risk" and how to manage it is one that now dominates the debate about internal control and strategy development in most organisations. Significant risks faced by most organisations include those related to liquidity, legal, health and safety, reputation, foreign exchange and financial misstatement. The concept of risk is now much broader, and it is no longer limited to the possibility of something bad happening, but covers a continuum of future outcomes ranging from the very negative to the very positive. So it also represents an opportunity as well as a threat - and managing risk proactively is an important element in the success of any well-governed not-for- profit organisation. In this section we explore the issue of accountability and risk management. We also look at some of the questions that board members should be asking about the control environment and risk management in their own organisations. 2.2 Risk Assessment The board should ensure that the organisation has a continuous process in place to identify risk, assess its potential impact, and take the action required to manage it. Historically, boards may have taken a passive role, which involves being informed of major risks "after the event" and checking that the right corrective action is being taken. This approach leaves the organisation exposed to new risks as they emerge, with potentially damaging results - either in the form of financial loss or missed opportunities. Page 13
  17. 17. Financial Reporting & Corporate Governance in Not-For-Profit Organisations What is needed is a systematic approach to identifying and managing risk. Management should examine the risks involved in achieving key objectives - including the potential barriers to success, and the factors critical to that success. This should encompass areas such as economic, competitive, political, environmental, and technological risk. In conducting such an examination it is important that management have a clear understanding of what risks are acceptable to the board. Figure 2.1 shows that in 85% of organisations surveyed management had a clear understanding of what risks were considered acceptable by the board. Is there a clear understanding by management as to what risks are acceptable to the board? Yes 85% No 15% Figure 2.1 - Understanding of acceptable risks Based on this external examination and analysis of the risk factors facing the organisation management can decide what actions are needed to manage these risks, and then identify and implement the additional controls needed to ensure these actions are carried out. Once the internal control and risk management systems are in place, the board should ensure that a regular review of their effectiveness is conducted. Such a review should be performed on at least an annual basis with a report back to the board on the results. Only 20% of the not-for-profit organisations surveyed undertake an annual review of the effectiveness of their internal control systems - see Figure 2.2. Does the board undertake an annual assessment for the purpose of making a public statement on internal control? Yes 20% No 80% Figure 2.2 - Performance of annual internal control assessment To be meaningful this review should cover all controls, including financial, operational and compliance controls. To assist them in their review the board may engage the assistance of staff specifically designated for the purpose, the internal audit function, the external auditors, or a combination of all three. Page 14
  18. 18. Financial Reporting & Corporate Governance in Not-For-Profit Organisations In conducting the review the board will consider how significant risks were identified, evaluated and managed. If any major control weaknesses were identified during the period, the board will want to consider how those were dealt with and whether any further remedial action is needed. 2.3 Control Environment and Control Activities The board of a not-for-profit organisation should have clear strategies for dealing with the significant risks that have been identified. For example, the organisation's code of conduct, human resource policies and performance reward systems should support the organisation's objectives and the risk management or internal control systems. The board should also ensure that authority, responsibility and accountability levels are clearly defined so that decisions are made and actions taken by appropriate members of the management team. Figure 2.3 below indicates that within 65% of the organisations participating in our survey authority, responsibility and accountability levels are clearly defined. Are authority, responsibility and accountability levels defined clearly? No 35% Yes 65% Figure 2.3 - Authority, responsibility and accountability levels No organisation can expect to manage risk effectively without creating a basic system of internal controls. Section 3 of this report discusses the issue of internal control systems and the more common control procedures in detail. 2.4 Monitoring and Communication The board should ensure that there are on-going monitoring processes and communication channels established that observe the application of the risk management policies, processes and activities. Such processes may include conducting a self-assessment of internal controls, performing internal audit reviews, or commissioning an external party to review the policies and activities on a periodic basis. There should also be appropriate communication to the board on the effectiveness of these monitoring processes on risk and control matters. This should include reporting any significant failings or weaknesses on a timely basis. Page 15
  19. 19. Financial Reporting & Corporate Governance in Not-For-Profit Organisations 40% of the organisations participating in our survey have specific arrangements in place for management reporting to the board on risk and control matters - see Figure 2.4 below. The board of an organisation should establish specific arrangements for reporting to them on risk and control matters of particular importance such as suspected breaches of law, regulations or other improprieties. 60% of not-for-profit organisations surveyed have established channels of communication for all employees to report suspected breaches of law, regulations or other improprieties - see Figure 2.5 below. Are there specific arrangements for management reporting to the board on risk and control matters? Not specified 5% Yes 40% No 55% Figure 2.4 - Board reporting arrangements in place on risk and control matters Are there established channels of communication for employees to report suspected breaches of law, regulations or other inproprieties? Not specified 5% No 35% Yes 60% Figure 2.5 - Existence of communication channels to report suspected breaches of law and regulations 2.5 Audit Committees and Internal Audit There is a growing recognition of the importance and usefulness that audit committees can play in supporting the board of directors with their financial reporting, risk management and internal control responsibilities. An audit committee will typically be assigned prime responsibility for these matters to ease the pressure on both management and the board of directors. Audit committees are now widely recognised as a key force in protecting the interests of an organisation's stakeholders and assisting in the organisation's communication process. Despite these trends only 40% of the organisations in our survey had an audit committee in place - see Figure 2.6. Page 16
  20. 20. Financial Reporting & Corporate Governance in Not-For-Profit Organisations Does your organisation have an audit committee? Not specified 10% Yes 40% No 50% Figure 2.6 - Audit Committees Recent reports in the UK have again highlighted the role independent directors and audit committees can play in the areas of external financial reporting and internal controls. Calls to implement the practices set out in these reports have been made here in Ireland by the Institute of Directors and it is likely in today's environment of increased transparency and accountability that we will see an increase in the use of audit committees in public interest organisations - including the not-for-profit sector. Another area enjoying renewed popularity at the moment is the internal audit function. Internal auditors assist the board and the audit committee in discharging their risk management and internal control responsibilities. Some of the functions performed by an internal auditor include objective assessments of the organisation's risk management policies, detailed reviews of the organisations internal control and management reporting systems; and participating in internal special investigations. Does your organisation have an internal audit function? Yes 30% No 70% Figure 2.7 - Use of internal audit function 70% of Irish not-for-profit organisations surveyed do not have an internal audit function and of those only 29% assess the need for such a function on an annual basis - see figures 2.7 and 2.8. Page 17
  21. 21. Financial Reporting & Corporate Governance in Not-For-Profit Organisations If no internal audit function exists does the board assess the need for such a function annually? Yes 29% No 71% Figure 2.8 - Annual assessment of need for internal audit function An internal audit function may not be cost-effective or appropriate in all organisations but it is a function that can play a vital role in assisting the board of directors to discharge their risk management and internal control responsibilities. Outsourcing is a popular option for many of the smaller not-for-profit organisations. This option allows the directors to meet recommended best practice by performing annual control effectiveness reviews but does not add significantly to the organisation's cost base. 2.6 Board Responsibility Like it or not, the board is ultimately responsible for an organisation's risk management and internal control systems. Once these policies have been established and communicated to management, staff and stakeholders alike the board is required to monitor and assess them on a regular basis. Members of the board should ensure that management and other officials are aware of their responsibilities and that they receive adequate information about the organisation's compliance with the risk management policies on a regular and timely basis. Finally, the board should review the adequacy of internal controls on a periodic basis to ensure that they remain effective and to check that the risks which the controls were intended to mitigate have not changed in the intervening period. Page 18
  22. 22. 3. Internal Control
  23. 23. Financial Reporting & Corporate Governance in Not-For-Profit Organisations 3. Internal Control We saw in Section 2 of this report that the board of directors and the management of not-for- profit organisations are responsible for identifying and evaluating the risks faced by the organisation. The board and management of an organisation are also responsible for designing, operating and monitoring a basic system of internal controls that safeguards the assets of the organisation. An internal control system should enable the organisation to respond appropriately to business, financial and compliance risks; safeguard the assets from inappropriate use and loss from fraud or error; help ensure the quality of internal and external reporting, through the proper maintenance of records and information flows; and facilitate compliance with applicable laws, regulations and internal policies. In this section we outline examples of best practice internal control techniques that should be used by not-for-profit organisations. We also share with you the extent to which these common control procedures have already been adopted and are in use in the Irish not-for-profit sector. 3.1 Supplier Invoices Supplier invoices, credit notes and related documentation should be checked to: • A record of the goods received to ensure that the organisation does not pay for goods or services not received. If a record of goods received is not maintained the organisation could be exposed to the possibility that the goods or proceeds from sale may be misappropriated; • A record of the goods or services ordered to ensure that the organisation doesn't pay for items which have been not ordered; • Supplier price lists. Pricing and calculation errors can result in considerable loss to an organisation if not identified on a timely basis; • Ensure the accuracy of the additions and other calculations on the invoice. Errors in additions and calculations are often used to hide misappropriations. Page 21
  24. 24. Financial Reporting & Corporate Governance in Not-For-Profit Organisations Do you check supplier invoices to: 90% 90% 80% 80% Record of Goods Records of Goods Supplier Price List Accuracy of Received Ordered Calculation Figure 3.1 - Use of supplier invoice control checks As indicated in Figure 3.1 the majority of not-for-profit organisations surveyed have control procedures in place to perform these basic checks on supplier invoices. In addition to performing the above checks the supplier invoices and credit notes should be sequentially numbered on receipt to ensure that they are subsequently processed in the purchase ledger. If these documents are not controlled in this manner invoices mislaid or suppressed may not be detected for some time. As a result the financial statements or other management information may be misstated. If a credit note is not recorded the organisation may erroneously pay for goods that were returned. Do you sequentially number invoices on receipt to ensure that they are subsequently processed to the purchase ledger? Not specified 10% Yes 45% No 45% Figure 3.2 - Supplier invoice tracking 45% of organisations surveyed do not sequentially number supplier invoices on receipt exposing themselves to the risks outlined above. Page 22
  25. 25. Financial Reporting & Corporate Governance in Not-For-Profit Organisations 3.2 Supplier Statements Every organisation should periodically reconcile its creditor balances with the related supplier statements. By performing such a reconciliation invalid adjustments, deliberate or otherwise, to the creditors accounts are more likely to be detected preventing excessive or irregular payments from being made. In addition this reconciliation also acts as a deterrent against any employee setting up a fictitious supplier in an attempt to extract money from the organisation. Best practice would suggest that monthly or quarterly supplier reconciliation statements be prepared to ensure that any errors or misstatements are identified and corrected on a timely basis. Figure 3.3 shows that 65% of not-for-profit organisations participating in our survey prepare supplier reconciliation statements. The boards of the remaining 35% run the risk of overpaying suppliers or facilitating fraud. Do you reconcile creditors accounts periodically to suppliers’ statements? Yes 65% No 35% Figure 3.3 - Preparation of supplier reconciliation statements While the preparation of supplier reconciliation statements is a useful control technique in itself it is also important that these reconciliation statements are reviewed and approved by the finance manager or financial controller. In the absence of this type of review the reconciliation may not be performed adequately. 55% of the organisations in our survey that prepare supplier reconciliation statements, require the supplier reconciliation to be reviewed and approved by the finance manager or equivalent executive - see Figure 3.4. If supplier reconciliations are performed are these reconciliations reviewed by the finance manager? Yes 55% Not Specified 15% No 30% Figure 3.4 - Requirement for supplier reconciliation review Page 23
  26. 26. Financial Reporting & Corporate Governance in Not-For-Profit Organisations 3.3 Cheque Payments At least two people should be required to sign all cheques. At the time of signing cheques the signatories should examine the original supporting documentation. Examples of supporting documentation include: • Approved invoices or reconciled statements; • Payroll records; • Details of petty cash expenditure together with supporting vouchers or receipts; or • Other documents, such as remittance advices/cheque requisitions with supporting invoices. Figure 3.5 indicates that 70% of organisations participating in our survey require a minimum of two people to sign all cheques. Are at least two people required to sign all cheques? Yes 70% No 30% Figure 3.5 - Number of cheque signatories required For the remaining 30% the risk of errors or irregularities such as those below occurring is substantially increased. Failure to adopt the above control procedures could lead to: • Excessive amounts being paid; • Cheques being paid for goods or services not supplied to the organisation; • Cheques being drawn in respect of invoices already paid and the funds diverted; • Fictitious payees going undetected; and/or • Fictitious documentation may go unnoticed. In addition to reviewing the supporting documentation as outlined above each of the signatories should then effectively cancel these documents to prevent subsequent re-use by marking "paid" across the documentation. The cheque signatories in 55% of surveyed organisations do not effectively cancel the supporting original documentation to prevent subsequent re-use - see Figure 3.6. Page 24
  27. 27. Financial Reporting & Corporate Governance in Not-For-Profit Organisations Do signatories cancel supporting documents at the time of signing cheques to prevent subsequent re-use? No 55% Yes 45% Figure 3.6 - % of organisations effectively cancelling supporting documentation to prevent re-use All cheques should be restrictively crossed "account payee only - not negotiable" at the time of issue. It is now possible with most business current accounts to have this pre-printed on all cheques. Despite this only 55% of not-for-profit organisations participating in our survey use restrictively crossed cheques - see Figure 3.7. Are all cheques restrictively crossed “account payee only - not negotiable”? No 45% Yes 55% Figure 3.7 - Use of restrictively crossed cheques 3.4 Cash & Cheque Receipts The area of cash and cheque receipts is a particular control risk for not-for-profit organisations - especially those that may receive unsolicited donations from the public. 75% of surveyed organisations keep a detailed record of amounts received, whether cash or cheque. These records are prepared at the time the post is opened - see Figure 3.9. Figure 3.8 sets out the typical income sources of Irish not-for-profit organisations. Page 25
  28. 28. Financial Reporting & Corporate Governance in Not-For-Profit Organisations Source of Funds 82% 82% 73% 64% 64% 64% 55% 36% 9% Corporate Donations Subscriptions Trading Bequests Events Investment State Sponsorship Donations Income Income Funds Figure 3.8 - Sources of income It is important that cheques and cash received are recorded when the post is opened. If no control total is kept it is easier for cheques or cash to be misappropriated. Do you record cheques and cash received in detail when the post is opened Yes 75% No 25% Figure 3.9 - Detailed recording of cheques and cash receipts Is the opening of the post and recording of remittances supervised by a responsible official, or at least carried out by two staff members? Yes 80% No 20% Figure 3.10 - Supervisory controls over cheque and cash receipts Page 26
  29. 29. Financial Reporting & Corporate Governance in Not-For-Profit Organisations As you can see from Figure 3.9 above 80% of organisations surveyed the opening of the post is supervised by a responsible official or performed by two or more people. It is important that the opening of the post and the recording of cheques and cash received be supervised by an executive, or at a minimum carried out by at least two staff members. Unsupervised, or without a second person involved, the capacity exists for the person opening the post to take some of the cheques or cash from the opened post and exclude these amounts from any detailed record maintained. Cheques and similar documents received should be restrictively crossed at the time of receipt. An un-crossed cheque that is lost or stolen may be cashed or deposited into a bank account other than that of the organisation. As a final control over cash or cheques received it is suggested that amounts received by post are lodged to the bank intact each day. A comparison of the amount of cash deposited with the original listing prepared when the post is opened makes it easy to identify, on a timely basis, if any amounts have been lost or stolen. 60% of organisations in our survey lodge remittances received by post and cash receipts intact each day - see Figure 3.11. Do you lodge remittances received by post and cash receipts intact each day? No 40% Yes 60% Figure 3.11 - Daily lodgement of cheques and cash receipts 3.5 Public Collections The aim of internal controls in respect of public collections is to ensure that the not-for-profit organisation has as much control as possible over what could be a widespread network of fund- raising efforts. Page 27
  30. 30. Financial Reporting & Corporate Governance in Not-For-Profit Organisations It is suggested that the following controls should be in place: • Collection boxes should be individually numbered and documented control exercised over the allocation and return. • All collecting boxes should be sealed so that any opening prior to recording is readily apparent. • Static collection boxes should be regularly opened and contents counted in the presence of at least two people authorised by the board for this duty. It is also a useful control to keep a diary showing not only where static collection boxes are situated, but also giving a history of their takings and the name of the person designated to empty them. • General public collections should be counted in the presence of the collector and a receipt from a duplicate pad given to them. • Collection money should be lodged on a timely basis into the organisation's bank account. 3.6 Fund-Raising Events The responsibilities of the board here are similar to those for public collections above - i.e. to make sure that the organisation is in control of the funds raised on its behalf so that it receives all the money to which it is entitled from such events. Page 28
  31. 31. Financial Reporting & Corporate Governance in Not-For-Profit Organisations Records should be maintained for each fund-raising event, in sufficient detail to identify gross receipts, how they have arisen, and all costs incurred. In the case of events for which there is ticket income or gate money all tickets should be pre- numbered; a record should be kept of all persons who have been issued with tickets to sell, and of the ticket numbers allocated to each; details of which tickets have been sold should be noted; and a reconciliation should be performed of receipts against tickets sold. Similar records should be maintained for sponsored events. 3.7 Investments Investments (including stocks, shares, land and buildings) are normally held in order to generate income for the organisation and to protect its capital base. It is therefore vital to make sure that they are safeguarded. Typical investment controls include: • Ensuring that full records are kept of all investments held (including details of all those sold or purchased) by the organisation, and that these are kept in a secure place. • The formulation of an investment policy is the responsibility of the directors or trustees. The detailed implementation of that policy is often delegated to investment professionals, but the directors must, by insisting on the supply of suitable reports or otherwise, ensure that their policy is in fact being implemented. This will also allow them to review properly the performance of their investments. • Directors should normally take professional advice before selecting or disposing of investments. • Where statements of investment performance are sent to a nominated director they should be inspected at regular intervals by the board as a whole. • Controls should be put in place to ensure that all dividends or interest payments due are promptly received and all purchases and sales of investments are properly authorised and accounted for. • Wherever possible, investments should be diversified so as to ensure that the failure of one investment does not have a major impact on the organisation. 3.8 Bank Reconciliation Statements One of the most basic and most common control procedures any organisation performs is the preparation of a bank reconciliation statement on a regular basis. Most organisations prepare this reconciliation on a monthly basis and 94% of the organisations in our survey follow this best practice approach. Page 29
  32. 32. Financial Reporting & Corporate Governance in Not-For-Profit Organisations However, preparation of the statement is not sufficient in itself. To be an effective control tool the reconciliation should be reviewed by the financial controller, finance manager or other responsible official. 75% of the not-for-profit organisations surveyed require their bank reconciliation statement to be reviewed by a responsible official - see Figure 3.11. Is the monthly bank reconciliation reviewed by a director or senior official? Yes 75% No 25% Figure 3.12 - Requirement for review of bank reconciliation statement 3.9 Board Responsibility The board of directors or equivalent governing body has oversight responsibility for internal control, exercised through reports from and discussions with management, internal audit (if applicable), and the external auditors. The board should gain an understanding of the degree to which the internal and external auditors review the internal control procedures as part of their testing. It should also understand the risks to which the organisation is exposed and the internal control processes which management have established to manage and mitigate those risks. Indeed, in many cases the board of a not-for-profit organisation request an independent accountant or the external auditor to prepare a special report on the internal control and risk management systems. A well-designed and implemented internal control system provides the right environment for the efficient running of an organisation's operations. It can assist in ensuring compliance with applicable laws and regulations and will reduce the risk of the financial statements or management information being materially misstated. Page 30
  33. 33. 4. Financial Reporting
  34. 34. Financial Reporting & Corporate Governance in Not-For-Profit Organisations 4. Financial Reporting 4.1 Financial Statement Disclosure The purpose of a not-for-profit organisation's annual report or financial statements is to provide timely and regular information on the organisation, enabling the users of the report to gain an understanding of the organisation's operations and achievements and a full and proper appreciation of the organisation's transactions during the period and of its financial position at the period end. The Accounting Standards Committee's statement of recommended practice for charities sets out recommendations on the form and content of the annual report and the way in which the accounts contained in an annual report should be prepared. The Accounting Standards Committee's purpose in setting out these recommendations is to help improve the quality of financial reporting by charities and other not-for-profit organisations. It hopes that the recommendations, which are considered to be best practice guidance, will assist in reducing the diversity in the level and type of disclosure provided in the annual reports and financial statements of not-for-profit organisations. The responsibility for the preparation of the annual report rests with the board of directors, board of trustees or equivalent body. Members of the board therefore should be aware of what disclosure requirements represent best practice for not-for-profit organisations. A summary of these has been provided in Figure 4.1. Requirement Disclosure Requirement Legal & • Organisation's name and address of principal office • Nature of the governing document (e.g. charter, trust deed etc.) and how the organisation is Administrative constituted (e.g. limited company, unincorporated association etc.) Information • Director/trustee details - names, methods of appointment, etc. • Director/trustee duty and responsibility to prepare the annual report and financial statements should be outlined and acknowledged • A summary of the organisation's investment powers and details of any specific restrictions imposed on the organisation by its governing document. Narrative • The principal objects of the organisation and its operating structures • A review of activities for the period including details of any funds that are in deficit Information • An acknowledgement by the board of its responsibilities for the internal control systems and a review of their effectiveness • A summary of the process applied by the board in reviewing the effectiveness of the internal control systems Individual Funds • The nature and purpose of each fund • The assets and liabilities of each fund • Details of any significant or unusual movements or transfers Financial • Revenue recognition policies • Categories and major items of expenditure Disclosures • Details of major items in support costs including directors' or trustees' remuneration • Costs of external scrutiny and advice • Departures from recommended practice Figure 4.1 - Best practice disclosure requirements in not-for-profit organisations' annual reports Page 33
  35. 35. Financial Reporting & Corporate Governance in Not-For-Profit Organisations Figure 4.2 sets out the extent to which the organisations participating in our survey comply with recommended best practice disclosures for not-for-profit organisations. Financial statement disclosures Directors Remuneration 30% Major Support Cost Items 80% Expense Categories 80% Unusual Movements/Transfers 60% Nature & Purpose of Fund 55% Assets & Liabilities by Fund 70% Review of Activities 80% Organisational Structure 55% Charitable Objects 75% Investment Powers 45% Director/Trustee Details 75% % Disclosing Figure 4.2 - Compliance with recommended best practice in annual report disclosure As you can see the key areas where there is a divergence from the recommended disclosure requirements are: • Disclosure of investment powers - Only 45% of organisations surveyed disclosed details of the investment powers of the organisation. The annual report should include a brief summary of the investment policies of the organisation and the performance of the investments against that policy. The annual report should also outline any specific restrictions that are imposed on the investment policy either by legislation or the governing document. It would also be useful for the annual report to outline the monitoring controls that the directors operate over the investment activities of the organisation. • Organisation structure - the annual report should contain a description of the organisation structure and details of how policy decisions are made. Where the organisation is part of a wider network of not-for-profit bodies then the relationship involved should also be explained. 44% of survey participants do not provide organisation structure disclosures. • Nature and purpose of individual funds - where applicable the annual report should disclose how each of the funds has arisen (including designated funds), the restrictions imposed and the purpose of each fund. An indication should be given as to whether or not sufficient resources are held in an appropriate form to enable each fund to be applied in accordance with its purpose. For example, if funding has been received that is to be spent on a particular relief project in the near future, it should be made clear in the notes to the annual report whether or not the assets held, or expected to be received, in the fund are liquid assets. 55% Page 34
  36. 36. Financial Reporting & Corporate Governance in Not-For-Profit Organisations of organizations surveyed disclose the nature and purpose of their individual funds. • Unusual movements or transfers - Explanations should be provided for material movements in each of the organisation's funds. In disclosing details of movements on funds, material transfers between different funds and allocations to designated funds should be separately disclosed, without netting off, and should be accompanied by an explanation of the nature of the transfers or allocations and the reasons for them; and • Director/trustee remuneration - Only 30% of not-for-profit organisations surveyed disclose details relating to directors remuneration. In many cases directors of not-for-profit organisations will act on a voluntary basis and not receive remuneration. In such incidences it is best practice to disclose that neither the directors nor any persons connected with them have received any remuneration. Where the directors, or people connected with them, receive remuneration detailed disclosures should be provided. If the not-for-profit organisation has made any pension arrangements for directors or persons connected with them, the amount of contributions paid and the benefits accruing must be disclosed in the notes to the annual report. If the not-for-profit organisation enters into a contract or arrangement with a related party of a director appropriate disclosures should be provided. Each related party transaction must be separately disclosed. The required disclosure includes the name of the transacting related party; a description of the relationship between the parties; a description of the transaction; the amounts involved; any outstanding balances with related parties at the balance sheet date and any provisions for doubtful debts from such persons; details of any amounts written off from such balances during the accounting period; and any other elements of the transactions which are necessary for the understanding of the financial statements. Page 35
  37. 37. Financial Reporting & Corporate Governance in Not-For-Profit Organisations 4.2 The Directors/Trustees' Report The directors' or trustees' report is the main narrative section of the annual report. It should contain: • An explanation of the objectives of the organisation and a description of the way in which the organisation is structured and managed. The policies that have been adopted in order to try to achieve these objectives should also be explained. If there have been any significant changes in the objectives, organisation or policies since the last report, this should be made clear. The purpose of this part of the report is to explain what the organisation is trying to achieve and how it is going about it. • A review of the development, activities and achievements of the organisation during the period. This review should bring the reader up-to-date on the organisation's progress and achievements. It should also explain the important events that have occurred during the year and how the organisation has responded to them. It will be in this part of the report that information enabling the reader to judge the effectiveness of the not-for-profit organisation will usually be provided. • A review of the transactions and financial position of the organisation, and an explanation of the salient features of the accounts. This review should enable the reader to appreciate the significance of any surpluses or deficits disclosed in the financial statements and the purposes for which the organisation's assets are being held. It will also put the charity's current financial position in the context of its future plans and commitments, particularly with regard to on-going items of expenditure, projects not yet completed and obligations not yet met. The purpose of this part of the report is to help ensure that the financial statements are properly interpreted. Page 36
  38. 38. Financial Reporting & Corporate Governance in Not-For-Profit Organisations Other information which, if not included in the financial statements, could usefully be provided in the directors' report includes details of voluntary help, donations-in-kind and other intangible income received during the accounting period, and an indication of the extent to which the organisation is dependent upon certain donors. 4.3 Internal Control Disclosures As we have seen throughout this report organisations are recognising, more and more, their responsibility to explain their actions and the decision-making process which has resulted in these actions. Many not-for-profit organisations now include sections in their annual reports dealing with their corporate governance arrangements, measures taken by the organisation to ensure that management decisions are subject to appropriate oversight, and that internal control procedures are properly designed, implemented and maintained. The annual report should include an acknowledgement by the board of its responsibilities for: • Establishing adequate internal control systems; and • Reviewing the effectiveness of such systems. 75% of the annual reports of not-for-profit organisations participating in our survey include such an acknowledgement - see Figure 4.3. Do the financial statements include an acknowledgement by the board that is responsible for internal control systems and for reviewing their effectiveness? Not specified 10% No 15% Yes 75% Figure 4.3 - Acknowledgement of internal control responsibilities In addition to acknowledging their responsibilities the board should also include a statement in the annual report summarising the process that they have applied in reviewing the effectiveness of the system of internal controls. In 65% of not-for-profit organisations surveyed the board does not include a statement in the annual report describing the process that they have applied in reviewing the effectiveness of the internal controls - see Figure 4.4. Page 37
  39. 39. Financial Reporting & Corporate Governance in Not-For-Profit Organisations Does the annual report summarise the process the board has applied in reviewing the effectiveness of the system of international control? Not specified 5% Yes 30% No 65% Figure 4.4 - Inclusion of internal control effectiveness review disclosure 4.4 Board Responsibility The board of directors or equivalent body is responsible for ensuring that the organisation's annual return and financial statements meet the related statutory or regulatory responsibilities. They are hold oversight responsibility for the internal control systems of the organisation. Given the increased interest in, and awareness of, the issue of public accountability and related duties of care it is important for the directors of all not-for-profit organisations to ensure that their organisation adopts best practices across the board - including recommendations in the areas of financial reporting, disclosure of information and assessing the effectiveness of internal control systems. Page 38
  40. 40. 5. Not-For-Profit Contacts in PricewaterhouseCoopers
  41. 41. Financial Reporting & Corporate Governance in Not-For-Profit Organisations 5. Not-for-Profit Contacts in PricewaterhouseCoopers For more information, or to discuss how our Not-for-Profit practice may be of benefit to your organisation, please contact: Dublin Teresa Harrington Maurice Cavanagh Partner Senior Manager Tel: (01) 704 8558 Tel: (01) 704 8570 Cork Joe O'Shea Derry Keohane Partner Senior Manager Tel: (021) 427 6631 Tel: (021) 427 6631 Galway Alan Luby Ann Lavin Senior Manager Senior Manager Tel: (091) 764 620 Tel: (091) 764 620 Kilkenny Siobhan Collier Brendan O'Neill Senior Manager Manager Tel: (056) 21998 Tel: (056) 21998 Limerick Ken Johnson David O'Malley Partner Partner Tel: (061) 212 346 Tel: (061) 212 354 Waterford Martin Freyne Jim Harty Partner Senior Manager Tel: (051) 874 858 Tel: (051) 874 858 Wexford Billy Sweetman Sharon O'Leary Senior Manager Senior Manager Tel: (053) 52404 Tel: (053) 52408 Page 41
  42. 42. 6. PricewaterhouseCoopers Not-For-Profit Practice in Ireland
  43. 43. Financial Reporting & Corporate Governance in Not-For-Profit Organisations 6. PricewaterhouseCoopers' Not-for-Profit Practice in Ireland Not-for-profit organisations are similar to commercial businesses. They face many of the same risks and opportunities. However, aside from ensuring the continuing operation of their activities there are a number of matters of critical importance to them - not least of which is public interest and accountability. Larger or more complex not-for-profit businesses have paid careful attention to these issues and have, with our assistance, developed suitable governance structures and controls to safeguard their assets and reputation. The services that we provide to not-for-profit organisations include: • Corporate Governance Review - This review of governance and management arrangements provides an organisation's board of directors with an assessment of the existing corporate governance structures. The resulting report sets out recommendations to improve governance structures; suggests practical measures that can be adopted to increase accountability and transparency across the organisation; and highlights steps to that should be considered to enhance the quality and frequency of management information supplied to the board. • Risk Management & Internal Control Evaluation - We work with the board and management of not-for-profit organisations to identify and measure the risks that they are facing. We assist in managing and mitigating these risks by evaluating the adequacy of the risk reporting and internal control procedures within the organisation. This service provides the board and management with assurance on strategic and operational areas such as financial reporting, treasury management, statutory compliance and commercial activities. • Strategic Planning - The not-for-profit sector is becoming a more and more complex environment. As a result of changes in corporate governance practices, companies legislation, the economic environment and cost increases directors of not-for-profit organisations are experiencing increased pressure to renew and restructure their organisations to address the challenges of this new environment. We work with the directors to help them to understand the issues facing their organisation; to develop strategic responses and action programmes; and to determine what changes are required to their operating structures and working practices. • Investment Planning & Review - We provide comprehensive investment planning and review services designed to help maximise the performance of an organisation's investment portfolio. We work with the directors and management team to develop investment strategies that are integrated with and appreciative of the balance between the social objectives and the commercial realities that not-for-profit organisations have to face. We guide clients through the challenges of investment planning today: the proliferation of new investment vehicles, insurance products and retirement plans, changes in laws and regulations, and a volatile economy. The result is a plan based on independent, timely, accurate investment advice that helps avoid pitfalls and promotes long-term financial viability and security for the organisation. Page 45
  44. 44. Financial Reporting & Corporate Governance in Not-For-Profit Organisations • Executive Search & Selection - We help our client's management team to define the role and competencies required; profile the ideal candidate and determine where they may be found; and comprehensively assess candidates before a shortlist is presented. In addition to our search and selection services we provide a range of complementary services including management development and training, executive remuneration planning, and reward systems. • VAT Planning - We provide a range for VAT services for not-for-profit organisations including compliance advice and support, tax authority liaison, optimising refund positions, cash-flow planning, and advice on the VAT implications of transactions. • Accounting Services - We offer accounting, company secretarial and payroll services to our not-for-profit client base including the preparation of management accounts and providing accounting support on a tempory or secondment basis. PricewaterhouseCoopers are the market leaders in providing professional services to not-for-profit organisations. We will continue to develop and introduce new services that will strengthen our client-service offering in this area. Page 46
  45. 45. Researched & written by Teresa Harrington Tel: 01 704 8558 e-mail: Partner Mark Lynch Tel: 01 662 6440 e-mail: Senior Manager Sheila Grey Tel: 01 704 8585 e-mail: Research Assistant This report aims to provide guidance only, and does not purport to deal with all possible questions and issues which may arise in any given situation. Should a reader encounter particular problems they are advised to seek professional advice that we at PricewaterhouseCoopers would be pleased to provide. All reasonable care has been taken in the preparation of this booklet. No responsibility is accepted by the authors, PricewaterhouseCoopers, for any errors, omissions or misstatements it may contain, or for any loss or damage howsoever occasioned, to any person relying on any statement or omission in this report.