Essentials of Accounting for Governmental and NotforProfit Organizations

1
Essentials of Accounting for Governmental and
Not-for-Profit Organizations

• Chapter 13
• Auditing Tax-Exempt Organizations
• And Performance Evaluation

2
Overview of Chapter 13

• Auditing GNP organizations
• Audit Reports
• The Single Audit Act
• Tax issues for nonprofit organizations
• Reporting Service Efforts and Accomplishments
  (SEA Measures)

3
Source of Auditing Standards

• AICPA GAAS Generally Accepted Auditing
  Standards
• GAO - GAGAS Generally Accepted Governmental
  Auditing Standards
• AICPA Audit and Accounting Guides
• Audits of State and Local Governments
• Not-for-profit Organizations

4
Government Auditing Standards

• The Yellow Book
• Issued by the GAO, incorporates AICPA auditing
  standards and provide extensions that are
  necessary due to the unique nature of public
  entities

5
Differences in Public Sector Audits

• Auditor knowledge of government accounting and
  auditing
• Public availability of audit reports
• Written evaluations of internal controls
• Distribution of audit reports and availability of
  working papers to federal authorities

6
Types of Engagements

• Financial Audits
• Provide reasonable assurance that financial
  statements are presented fairly in all material
  respects and comply with GAAP.
• Attestation Engagements Include Reporting on
• Internal controls
• Compliance with laws and regulations
• Prospective financial information
• Costs under contracts

7
Types of Engagements (contd)

• Performance Audits
• Economy and efficiency audits --
• involve aspects of appropriate acquisition, use,
  and safeguarding of resources
• Effectiveness (Program) audits --
• assess the degree to which mission objectives
  have been achieved while adhering to applicable
  laws and regulations
• Nonaudit Services
• Providing or explaining information
• Providing advice or assistance to management

8
Financial Statement Audits

• Auditors must first determine a level of
  materiality
• Financial statement audits involve
• examination of transactions on a test basis,
• forming judgments about internal controls and
  compliance with laws and regulations, and
• rendering an opinion about whether the financial
  statements are prepared fairly in accordance with
  GAAP.

9
Opinion Units

• Because of the various levels of reporting
  (government-wide, fund-type, and individual fund)
  the auditor must determine a level of materiality
  for each.

• A separate materiality evaluation is made for
• Governmental activities
• Business-type activities
• Each major fund
• Aggregate component units
• The aggregate of all remaining fund information

10
Opinion units (contd)

• One effect of reporting on opinion units is that
  some opinion units may receive unqualified
  opinions while others receive modified opinions.

• For example failure to report infrastructure
  assets could result in an adverse opinion
  regarding the governmental activities
  (government-wide statements) and an unqualified
  opinion for all other component units.

11
The auditor is required to prepare up to five
reports

• A report containing an opinion on the financial
  statements.
• A report discussing the evaluation and testing of
  internal control and compliance with laws and
  regulations.
• A report discussing significant deficiencies in
  internal controls.
• A report describing instances of fraud, illegal
  acts, or other material noncompliance.
• A report containing the views of responsible
  officials of the audited organization regarding
  any reported significant deficiencies.

12
Types of Audit Opinions on Overall Statements

• Unqualified --
• Statements appear to be in conformity with GAAP
  -- no ifs, ands, or but exception type of
  qualifying language.
• Qualified -
• Largely in conformity with GAAP except for some
  specified item(s).
• Adverse -
• Not in accordance with GAAP.
• Disclaimer -
• Not able to express an opinion, usually because
  auditor was precluded from doing some necessary
  procedure.

13
Purpose of Single Audit Act

• Before 1984, State and local governments and
  Not-for-profits receiving financial aid from
  several different federal agencies, had multiple
  audits.
• The initial Single Audit Act sought to impose one
  set of stringent audit guidelines so that only
  one audit would have to be conducted to satisfy
  multiple grantor agencies.

14
Single Audit Development

• The initial Single Audit Acts in OMB circulars
  A-128 and A-133 required a single audit if
  federal financial assistance was over 100,000.
• In 1996 A-133 was revised and replaced A-128 .
  The current threshold for a single audit is
  federal financial assistance EXPENDITURES of over
  500,000.
• If federal assistance gt 500,000 but is all from
  one agency, a program audit may be used instead
  of a single audit.

15
Supervision of Single Audits

• Cognizant agency
• Entities with 50 Million or more of federal
  awards are monitored by a cognizant agency --
  agency with largest grants normally selected
• Oversight agency
• Agency with largest grants receive audit reports
• Compliance supplement -- includes any special
  guidelines for particular grants

16
Risk-based Audit Process

• Must consider effect of pass-through entities and
  subrecipients
• Must identify MAJOR programs
• Group programs using risk-based approach
• Type A - larger programs (condidered major unless
  they are low risk)
• Type B - smaller programs and low risk large
  programs
• Type A programs receive closer auditing than Type
  Bs

17
Selecting Programs for Audit

• Generally, the auditor is required to express an
  opinion on compliance on major programs which
  must add up to 50 of the federal funds expended
  by the audited organization
• However, if the audited organization is
  determined to be low risk, the percentage is
  lowered to 25

18
Tax-Exempt Organizations

• Most nonprofits file IRS form 1023 Application
  for Recognition of Exemption to obtain favorable
  tax treatment for donors
• Local law governs exemptions from sales tax and
  property tax.
• Most NFPs must still file an IRS Form 990
  information return if gross receipts are over
  25,000.
• NFPs with over 1,000 of unrelated business
  income file Form 990-T.
• Other reports may be filed with the state.

19
Tax Code Types of nonprofits

• The tax code specifies several different classes
  of nonprofit organizations by purpose.
• The most common are 501(c)(3) organizations

20
501(c)3 Organizations

• Include religious, charitable, scientific,
  literary, educational, amateur sports
  organizations, organizations for prevent of
  cruelty to children or animals.
• Requires that no dividends be paid and no
  substantial political activity.
• 501(c)(3)s status allows donors to take a
  charitable deduction on their U.S. tax return for
  donations.

21
Form 990 Information Return

• Requires financial statement information similar
  to that required by GAAP.
• Also reveals information about compensation of
  highest paid employees and contractors.
• Taxpayer Bill of Rights 2 (1996) requires that
  990s must be made available to those who request
  it -- commonly posted to a web site.
• Also asks questions to make sure the organization
  is still operating in accordance with its exempt
  mission.

22
Unrelated Business Income Tax

• Tax-exempt organizations are required to pay tax
  (at the corporate rate) on income generated from
  a trade or business unrelated to the entitys
  tax-exempt purposes

• The purpose of the tax is to prevent nonprofits
  from having an unfair tax advantage over
  business enterprises with competing goods and
  services

23
Unrelated Business Income Tax

• Even unrelated business income will be exempt
  from income tax if
• Not carried on regularly
• Run by volunteers
• Involves sales of donated items
• Operated for convenience of employees and
  patrons.

24
Income Exempt from UBIT

• Some income is given specific exemption
• Royalties, dividends, interest and annuities
• Research revenues
• Income from public entertainment at a fair
• Revenues from labor, agriculture, or business
  trade shows
• Income from rental or exchange of membership
  lists

25
Performance Evaluation - Ratios

• To compare entities of varying size, it is useful
  to compute financial ratios
• Not-for-profit Ratios
• Governmental Ratios

26
Not-for-Profit Ratios

• A. Program Expense Ratio
• Program Service Expenses
• Total Expenses
• What proportion of each dollar is used on
  programs?
• B. Fundraising Efficiency
• Fundraising Expenses
• Contribution Revenue
• How much does it cost to raise a dollar of
  contributions?

27
Not-for-profit Ratios (Contd)

• Working Capital Ratio
• (Current Assets Current Liabilities)
• Total Expenses
• If multiply by 12 months
• How many months of operating expenses are
  available in working capital?

28
GovernmentsUsers of Financial Statements

• Citizen groups
• Legislative and oversight officials
• Investors
• Creditors

29
Bond Markets and Financial Analysis

• The CAFR is a major data source for professional
  bond rating agencies such as
• Moodys, Standard and Poors, Fitchs Investors
  Services
• Bonds are rated from Aaa to C
• Insured bonds are automatically rated Aaa
• The financial condition of state and local
  governments affects the cost of debt and/or bond
  insurance.

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Common ratios Debt balances

• Net debt per capita
• Shows average outstanding debt per citizen
• Net debt to fair value of property
• Shows of debt outstanding on taxable property
• Net debt to assets
• A measure of solvency can be computed
  separately for governmental and business-type
  activities

31
Common ratios Net Asset Balances

• Net assets/Expenses
• A measure of overall financial position
• Unrestricted net assets/ Expenses
• A more conservative measure of availability of
  resources to meet expenses

32
Common ratios Governmental fund statements

• Unreserved fund balance as of revenues (General
  Fund)
• Shows level of rainy day fund
• Governmental revenues per capita
• Shows the citizen tax burden
• Debt service to total expenditures Principal and
  interest payments/total expenditures of general,
  and debt service funds
• Shows of budget used up for debt repayment

33
Common ratios Enterprise Fund Statements

• Interest coverage revenue bonds
• (Total Revenues operating expenses) / interest
  expense.
• Shows degree of credit risk
• Operating ratio enterprise funds
• (operating expenses, excluding depreciation) /
  operating revenues. Useful even if the
  enterprise fund has no debt.

34
Common Ratios contd

• Other issues to consider
• Population trends,
• trends in assessed values,
• economic trends,
• debt limits and margins,
• pension position,
• current issues in the news, etc.

35
Service Efforts and Accomplishments Reporting

• Because the bottom line is not a good indicator
  of government performance, governments often
  provide non-financial performance measures.
• Examples include crime statistics, lane-mile of
  highways maintained, cost per student, etc.
• The GASB has reserved the authority to one day
  begin to issue standards governing SEA reporting

36
SEA Levels of Reporting

• Input resources dedicated to a problem
• Output the quantity of service provided
• Outcome the extent to which results are
  achieved or needs are satisfied
• Efficiency relate costs (inputs) to output
  measures
• Cost Outcome relate inputs to outcomes