4.2 The Difference Between Management Accounts and External Financial Statements

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1 : GETTING READY FOR YEAR-END 4.1 Introduction This part of the manual discusses the year-end accounting requirements that are particularly relevant for nonprofit bookkeepers and treasurers. Its aim is to provide an explanation of the steps required to assist the external accountant and auditor in preparing the financial statements, as well as provide a summary of the statutory regulations imposed under the Associations Incorporation Act (1981) and the Corporations Act (2001). Specifically, the chapter addresses the following issues: the difference between management accounts and external financial statements; whether your organisation is a reporting entity or a non-reporting entity; the difference between general purpose financial reports and special purpose financial reports; external reporting and audit requirements of incorporated associations and companies limited by guarantee; checklist of documents to provide your external accountant or auditor with at year-end; a sample agenda for an Annual General Meeting; and a summary of the forms required to be prepared and lodged with the regulatory authorities for incorporated associations and companies limited by guarantee. 4.2 The Difference Between Management Accounts and External Financial Statements So far, this manual has specifically dealt with the preparation of management accounts. Management accounts are typically prepared by a bookkeeper for internal reporting purposes. These accounts are usually prepared monthly and are specifically tailored to management s needs. In most cases, management accounts are prepared using computerised software accounting packages, such as MYOB or QuickBooks. Some bookkeepers export the reports produced by MYOB or QuickBooks into electronic spreadsheets such as EXCEL for manipulation, comparison of actual results to budget and the preparation of charts and graphs etc. This comparison of actual to budgeted results should be done on a monthly or quarterly basis or more frequently (eg. in preparation for periodic financial reporting to funding providers. And, in the event that an organisation is in receipt of multiple grants, and has multiple periodic reporting obligations, the results being compared may need to be separated by identifiable cost centres for ease of reporting. This was specifically illustrated in Part 2. The Standard Chart of Accounts presented in Part 1 of this manual was specifically developed to assist bookkeepers prepare an account list for internal reporting purposes. The management accounts are usually passed onto the external accountant at the end of the financial year so that the external accountant can prepare the external financial statements. In most cases, these accounts are audited and presented to members at the Annual General Meeting. Generic Training Manual 4-1

2 An annual financial report is required to be lodged with the Office of Fair Trading if your organisation is an incorporated association and with the Australian Securities and Investments Commission (ASIC) if your organisation is a company limited by guarantee. The primary purpose of the financial report is to provide information relevant to external users. The financial report usually consists of the following: a Profit and Loss Statement; a Balance Sheet, and a Cash Flow Statement. In some cases, an additional statement entitled a Statement of Changes in Equity is also prepared, showing the link between the Profit and Loss Statement and the Balance Sheet. The Profit and Loss Statement, Balance Sheet and Cash Flow Statement are collectively referred to as the financial statements. These financial statements must be prepared in accordance with accounting standards issued by the Australian Accounting Standards Board (AASB). Unlike management accounts which can be tailored to meet the specific needs of management, the format of external financial statements is generally similar in all organisations, as they must be prepared in accordance with the requirements contained in AASB accounting standards. The distinction between management accounts and external financial statements is summarised in Table 1 below. Table 1: Distinction Between Management Accounts And External Financial Statements Issue Management Accounts Financial Statements Users Types of Reports Format of Reports Frequency of Reports External Verification Users are within the organisation (i.e. management). Special purpose financial reports (usually prepared by the bookkeeper using a computerised accounting package). Flexible. Tailored to meet the needs of management. As requested by management (usually prepared monthly). Management accounts are not usually audited. Users external to the organisation (i.e. shareholders, lenders, creditors, customers, regulatory agencies, funding bodies etc.). General purpose financial reports (usually prepared by the accountant in accordance with AASB Accounting Standards). Generally standardised. Structure and content dictated by the contents of AASB Accounting Standards. Usually annually as per the requirements of the Associations Incorporation Act (1981) and the Corporations Act (2001). External financial statements may be subject to audit by an independent auditor. Generic Training Manual 4-2

3 4.3 The Notion of Differential Reporting The Australian financial reporting framework is based on the notion of differential reporting. In other words, the type and extent of financial information required to be included in an entity s financial report depends on whether an entity is classified as: a reporting entity; or a non-reporting entity. If an entity is regarded as a reporting entity, it must prepare a general purpose financial report. Conversely, if an entity is regarded as a non-reporting entity, it need only prepare a special purpose financial report. Diagram 1 below summarises the financial reporting obligations for both reporting and nonreporting entities. Diagram 1: Financial Reporting Obligations of Reporting and Non-Reporting Entities Is the entity a reporting entity? Yes No Must prepare a general purpose financial report (GPFR) Need only prepare a special purpose financial report (SPFR) Financial report must be prepared and presented in accordance with all AASB Accounting Standards and UIG Consensus Views Financial report must be prepared and presented in accordance with those AASB Accounting Standards and UIG Consensus Views in order to give a true and fair view Generic Training Manual 4-3

4 4.3.1 What is a Reporting Entity? Paragraph 40 of SAC 1 Definition of the Reporting Entity defines a reporting entity as: all entities in respect of which it is reasonable to expect the existence of users dependent on general purpose financial reports for information which will be useful to them for making and evaluating decisions about the allocation of scarce resources. Put simply, a reporting entity is one which has many (and varied) users of its financial statements who require this report to be prepared and published so that they can make informed decisions about the entity. Whilst management is entrusted with the responsibility for determining whether the entity is classified as a reporting entity or not, usually the external accountant/auditor will have significant input into this decision. The primary question to ask in determining whether an entity is a reporting entity or not is: Who are the users of the reports? The more users, the more likely the entity is to be a reporting entity. Further guidance is included in paragraphs 20 to 22 of SAC 1 to assist when deciding whether or not an entity is a reporting entity. (a) Separation of management from economic interest (paragraph 20): The greater the spread of ownership/membership and the greater the extent of the separation between management and owners/members or others with an economic interest in the entity, the more likely it is that there will exist users dependent on general purpose financial reports as a basis for making and evaluating resource allocation decisions. Paragraph 20 refers to the extent of separation of the management committee or board of directors from the members. A nonprofit organisation with a large membership base is more likely to be a reporting entity. This is because, each member is unlikely to be able to access the management accounts and other financial information. Conversely, a small nonprofit organisation where members can request monthly management accounts be sent to them and directly participate in the decisionmaking of the organisation is likely to be considered a non-reporting entity. (b) Economic or political importance/influence (paragraph 21): Economic or political importance/influence refers to the ability of an entity to make a significant impact on the welfare of external parties. The greater the economic or political importance of an entity, the more likely it is that there will exist users dependent on general purpose financial reports as a basis for making and evaluating resource allocation decisions. Generic Training Manual 4-4

5 Hence, a large community service delivery organisation is more likely to be a reporting entity than a small community service organisation. (c) Financial characteristics (paragraph 22): Financial characteristics that should be considered include the size (for example, value of sales or assets, or number of employees or customers) or indebtedness of an entity. In the case of non-business entities in particular, the amount of resources provided or allocated by governments or other parties to the activities conducted by the entities should be considered. The larger the size or the greater the indebtedness of resources allocated, the more likely it is that there will exist users dependent on general purpose financial reports as a basis for making and evaluating resource allocation decisions. The larger the nonprofit organisation (measured in terms of revenue, assets, employees, members etc), the more likely they are to be considered reporting entities. Application to Nonprofit Organisations: Under SAC 1, most nonprofit organisations would typically be regarded as reporting entities because there are many external users of their financial statements. Importantly, it is up to the Board of Directors (or management committee) of the organisation to determine whether an entity is regarded as a reporting entity or not. Some of the factors that may be used to determine whether a nonprofit organisation is a reporting entity or not include: the number of members; the extent to which the members are involved in running the association, and how much this is left to the governing body; rights of access to books and records by members; extent of funding other than by members, and the information needs of external financiers (e.g. providers of grants, loans, etc.); extent of business activity and level of creditors; the size and nature of political or economic activity of the association; the size and number of donors; and number of employees and access of those people to financial information. In summary, the most common determining factor will be the size and involvement of the membership and the level and nature of the activity conducted. The fewer the members, the greater the likelihood that the nonprofit organisation will be regarded as a non-reporting entity. However, the determining factor is more likely to be whether all members can obtain the financial information they require without examining general purpose financial reports. Generic Training Manual 4-5

6 If the management committee is the only party that has access to the financial information, then the organisation is more likely to be a considered to be a reporting entity. Second, the decision-making of the nonprofit organisation also needs to be considered. If not all members of the organisation are able to be involved in the decision-making process, this will tend to indicate that the entity is more likely to be a reporting entity. Third, if the activities are limited, if they involve no external funding, involve only members and are operated with, for example, one bank account and one investment account, the nonprofit organisation is less likely to be a reporting entity. EXAMPLE: Victims of Criminal Violence Inc. is a small nonprofit incorporated association whose objects are the provision of support, education and advocacy services to victims of criminal violence on the north side of Brisbane. It had gross revenue of $125,000 for the year ended 30 June It has only one full-time staff member and three volunteers who assist with counselling. 95% of its revenue comes from a government grant with 5% from fundraising activities. No monies are generated from donations or bequests as the entity is not a deductible gift recipient (DGR). The Association has only 12 members, 7 of whom form part of the management committee. Each member can request monthly management accounts be sent to them. The Association has no external borrowings. Under the funding agreement, the granting agency receives quarterly management accounts, budgeted cash flow information and the year end financial report. On this basis, the Victims of Criminal Violence will be regarded as a nonreporting entity What if the Organisation is Classified as a Reporting Entity? If an entity (whether it be a company limited by guarantee, incorporated association, hospital foundation, etc) is regarded as a reporting entity, it will be required to prepare a general purpose financial report. In essence, a general purpose financial report is one that is in accordance with: all AASB Accounting Standards; all Urgent Issues Group (UIG) Consensus Views; and all other authoritative pronouncements of the Australian Accounting Standards Board. Generic Training Manual 4-6

7 As such, a general purpose financial report is very comprehensive, lengthy and more costly as the entity is complying with all accounting regulations What if the Organisation is Classified as a Non-Reporting Entity? If the management regards the entity as a non-reporting entity, it may elect to prepare a special purpose financial report. For non-reporting entities, who prepare special purpose financial reports, there is no requirement to prepare the report in accordance with all AASB Accounting Standards and UIG Consensus Views. Instead, non-reporting entities who prepare special purpose financial reports are only required to apply those Accounting Standards and UIG Consensus Views which are considered necessary to present a "true and fair" view. This is usually less expensive as compliance with all AASB Accounting Standards and UIG Consensus Views is not required. The external accountant/auditor will provide guidance as to which AASB Accounting Standards and UIG Consensus Views the nonprofit organisation must comply with in order to give a true and fair view. Some guidance on this issue can be taken from an ASIC document released in July This document entitled Reporting Requirements for Non-Reporting Entities" outlines the reporting obligations of non-reporting corporate entities. This document can be downloaded from the ASIC website at: Web Link : ASIC Guide: Reporting Requirements for Non-Reporting Entities key=reporting_for_non-reporting_entities_guide_pdf ASIC confirms that it expects non-reporting entities to: adopt the accrual basis of accounting as set out in AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors; comply with those AASB Accounting Standards and UIG Consensus Views which are deemed necessary by the Board of Directors to give a "true and fair" view of the operations and activities of the entity (particularly those accounting standards dealing with recognition and measurement); Generic Training Manual 4-7

8 specifically apply the following accounting standards regardless of whether the entity is a reporting entity or not: - AASB 101 Presentation of Financial Statements; - AASB 107 Cash Flow Statements; - AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors; and - AASB 1048 Interpretation and Application of Standards. comply with the disclosure requirements required under the Corporations Act (2001); and specifically disclose in their accounting policy note (Note 1) that the financial statements are special purpose, the purpose for which they have been prepared and the extent to which Accounting Standards and UIG Consensus Views have or have not been adopted. What is of over-riding significance is the fact that the financial statements provide a "true and fair" view. Sample Note 1 Disclosures in Financial Reports Whether an entity has prepared a general purpose financial report or a special purpose financial report must be disclosed in Note 1 Statement of Significant Accounting Policies. The following is a sample Note 1 for a reporting entity that has prepared a general purpose financial report. Note 1: Statement of Significant Accounting Policies This financial report is a general purpose financial report which has been prepared in accordance with Australian Accounting Standards, Urgent Issues Group Consensus Views and other authoritative pronouncements of the Australian Accounting Standards Board and the requirements of the [Associations Incorporation Act (1981) or the Corporations Act (2001).] The financial report has been prepared on an accruals basis and is based on historical costs and does not take into account changing values or, except where stated, current valuations of non-current assets. Cost is based on the fair values of the consideration given in exchange for assets. The following is a summary of the material accounting policies adopted by the Association in the preparation of the financial report. The accounting policies have been consistently applied, unless otherwise stated. Generic Training Manual 4-8

9 Conversely, the following is a sample Note 1 for a non-reporting entity that has prepared a special purpose financial report. Note 1: Statement of Significant Accounting Policies This financial report is a special purpose financial report which has been prepared for the sole use by the Committee Members. In the opinion of the Committee Members, the Association is not a reporting entity, as defined in Statement of Accounting Concept SAC 1 Definition of the Reporting Entity, as the Committee Members do not believe that users exist who are unable to command the preparation of reports tailored so as to satisfy, specifically all of their information needs. The Association has applied Accounting Standard AASB 1025 Application of the Reporting Entity Concept and Other Amendments. However, the financial statements have been prepared in accordance with all Australian Accounting Standards, Urgent Issues Group Consensus Views and other authoritative pronouncements of the Australian Accounting Standards Board and the requirements of the [Associations Incorporation Act (1981) or the Corporations Act (2001),] with the exception of the following: AASB 114: Segment Reporting; AASB 117: Leases; AASB 119: Employee Benefits; AASB 132: Financial Instruments: Presentation; and AASB 139: Financial Instruments: Recognition and Measurement. The financial report has been prepared on an accruals basis and is based on historical costs and does not take into account changing values or, except where stated, current valuations of non-current assets. Cost is based on the fair values of the consideration given in exchange for assets. The following is a summary of the material accounting policies adopted by the Association in the preparation of the financial report. The accounting policies have been consistently applied, unless otherwise stated. Generic Training Manual 4-9

10 4.4 Financial Reporting Requirements of Companies Limited by Guarantee Some nonprofit organisations are companies limited by guarantee. These organisations are regarded as public companies for the purposes of the Corporations Act (2001). Section 292(1) requires these companies to prepare a financial report at the end of each financial year. The financial report for a financial year (Section 295(1)) must include: (a) (b) (c) the financial statements; the notes to the financial statements; and the Directors' Declaration. Financial statements (Section 295(2)) are defined as: (i) (ii) (iii) a profit and loss statement for the year; a balance sheet as at the end of the year; and a statement of cash flows for the year. Furthermore, the Directors are required to make a declaration as part of the financial report (Section 295(4)), stating: (a) (b) (c) whether the company s financial statements comply with the AASB Accounting Standards; whether the company s financial statements give a "true and fair" view in accordance with Section 297. A true and fair view is regarded as having being achieved when the entity complies with AASB Accounting Standards; and whether, in the Director s opinion, there are reasonable grounds to believe that the company will be able to pay its debts as and when they fall due. There is no mention in the Corporations Act (2001) of the reporting entity concept. The reporting entity concept is an accounting concept, not a legal concept. Accordingly, a company limited by guarantee may be either a reporting entity or a non-reporting entity. Once again, this is a decision to be made by the Board of Directors in consultation with the external accountant. The auditor of the company will also be interested in the classification of the company as a non-reporting entity in forming an opinion under Section 307 of the Corporations Act (2001) and in particular, whether the entity s financial report complies with AASB Accounting Standards. Generic Training Manual 4-10

11 4.5 Financial Reporting Requirements of Incorporated Associations The format and manner in which the annual financial statements of incorporated associations are regulated is not uniform in the various Australian states. In Queensland, the financial reporting requirements of incorporated associations are governed by the Associations Incorporation Act (1981). According to the Section 59(1) of the Act: The members of the management committee of an incorporated association must ensure the association, within 6 months of the close of the financial year prescribed, or more frequently if the rules of the incorporated association so provide: (a) prepares a statement concerning the following particulars: (i) (ii) (iii) the income and expenditure of the incorporated association during its last financial year; and the assets and liabilities of the incorporated association at the close of the said year; and all mortgages, charges and securities of any description affecting any of the property of the incorporated association at the close of the said year. These financial statements are required to be audited and lodged with the Office of Fair Trading. However, like the Corporations Act (2001), the Associations Incorporation Act (1981) provides no specific mention as to which Accounting Standards must be complied with in the preparation of the financial statements. Once again, there is no mention in the Associations Incorporation Act (1981) of the reporting entity concept. Accordingly, an incorporated association may either be a reporting entity or a non-reporting entity. Once again, this is a decision to be made by the Management Committee in consultation with the external accountant and auditor. A copy of the Associations Incorporation Act (1981) can be found at the following address: Web Link : Associations Incorporation Act (1981) Generic Training Manual 4-11

12 4.6 Audit Requirements An audit can be defined as an independent examination of an organisation s financial records, transactions and supporting documents in order to express an opinion as to whether the financial statements comply with certain levels of quality, as specified in the Accounting Standards and present a true and fair view of the entity s performance and financial position. An auditor is engaged to provide an independent opinion as to whether the accounts have been drawn up to give a true and fair view Audit of Companies Limited by Guarantee As previously mentioned, companies limited by guarantee are regarded as public companies for the purposes of the Corporations Act (2001). According to Section 301 of the Corporations Act (2001), the accounts of a public company are subject to an annual audit. Sections 327A to 327C of the Corporations Act (2001) govern the appointment of auditors to public companies. According to Section 327A(1), the Board of Directors of a public company must appoint an auditor within one month after the day in which the company is registered. That auditor only holds office until the first Annual General Meeting (AGM). Consequently, at its first AGM, and at subsequent AGMs, where there is a vacancy, the company must appoint a registered company auditor (Section 327A(3)). The auditor holds office until: (a) (b) (c) he/she dies; is removed or resigns; or ceases to be capable of acting as auditor. Under the Corporations Act (2001), an auditor has a statutory duty to: conduct an audit and form an audit opinion (Section 307); conduct an audit in accordance with the auditing standards (Section 307A); retain audit working papers for seven years (Section 307B); complete the auditor s declaration (Section 307C); report to members on the annual report (Section 308); and report contraventions to ASIC (Section 311). According to Section 307, an auditor must form an opinion about: (a) whether the financial report is in accordance with this Act, including: (i) (ii) Section 296 (compliance with accounting standards); and Section 297 (true and fair view); and Generic Training Manual 4-12

13 (aa) (b) (c) (d) if the financial report includes additional information under paragraph 295(3)(c) (information included to give true and fair view of financial position and performance) whether the inclusion of that additional information was necessary to give the true and fair view required by section 297; and whether the auditor has been given all information, explanation and assistance necessary for the conduct of the audit; and whether the company, registered scheme or disclosing entity has kept financial records sufficient to enable a financial report to be prepared and audited; and whether the company, registered scheme or disclosing entity has kept other records and registers as required by this Act. This audit opinion must be presented in an audit report. The audit report is covered by Section 308. This section requires the auditor to provide a report stating whether or not, in the auditor s opinion, the financial report is properly drawn up: in accordance with Australian Accounting Standards and other mandatory reporting requirements (Section 296); and so as to give a true and fair view of the matters with which they are required to deal (Section 297). There are two types of audit opinions: unqualified (no issues of significance were discovered by the auditor); and qualified (the auditor has discovered an issue of some significance). A clean audit opinion is referred to as an unqualified audit opinion. A qualified audit opinion means that the auditor has found something which s/he disagrees with or something which is of concern. The auditor must explain the nature of the qualification in a separate paragraph in the audit report. A serious qualification is one where the auditor disagrees with the treatment or disclosure of an accounting transaction. The worst type of qualification is where the auditor is unable to express an opinion due to the severe uncertainty as to whether the entity will be able to continue as a going concern. This is referred to as an inability to form an opinion. If, in the auditor s opinion, the financial statements are not drawn up in accordance with a particular Accounting Standard, the audit report must give particulars of the quantified financial effect thereof on the financial statements (Section 308(2)). A sample audit report for a public company with an unqualified opinion is presented below. Generic Training Manual 4-13

14 INDEPENDENT AUDIT REPORT To the members of XYZ Limited: Scope The Financial Report and Directors' Responsibility The financial report comprises the Profit and Loss Statement, Balance Sheet and Statement of Cash Flows, accompanying notes to the financial statements, and the Directors Declaration for XYZ Limited for the year ended 30 June The Directors of the company are responsible for preparing a financial report that gives a true and fair view of the financial position and performance of the company and that it complies with Accounting Standards in Australia and the provisions of the Corporations Act (2001). This includes responsibility for the maintenance of adequate accounting records and internal controls that are designed to prevent and detect fraud and error, and for the accounting policies and accounting estimates inherent in the financial report. Audit Approach We conducted an independent audit of the financial report in order to express an opinion on it to the members of the company. Our audit was conducted in accordance with Australian Auditing Standards in order to provide reasonable assurance as to whether the financial report is free of material misstatement. The nature of an audit is influenced by factors such as the use of professional judgement, selective testing, the inherent limitations of internal control, and the availability of persuasive rather than conclusive evidence. Therefore, an audit cannot guarantee that all material misstatements have been detected. We performed procedures to assess whether in all material respects the financial report presents fairly, in accordance with the Corporations Act (2001) including compliance with Accounting Standards in Australia, and other mandatory financial reporting requirements in Australia, a view which is consistent with our understanding of the company s financial position, and of their performance as represented by the results of their operations, changes in equity and cash flows. Generic Training Manual 4-14

15 We formed our audit opinion on the basis of these procedures, which included: examining, on a test basis, information to provide evidence supporting the amounts and disclosures in the financial report; and assessing the appropriateness of the accounting policies and disclosures used and the reasonableness of significant accounting estimates made by the Directors. While we considered the effectiveness of management s internal controls over financial reporting when determining the nature and extent of our procedures, our audit was not designed to provide assurance on internal controls. We performed procedures to assess whether the substance of business transactions was accurately reflected in the financial report. These and our other procedures did not include consideration or judgement of the appropriateness or reasonableness of the business plans or strategies adopted by the directors and management of the company. Independence We are independent of the company, and have met the independence requirements of Australian professional ethical pronouncements and the Corporations Act (2001). In addition to our audit of the financial report, we were engaged to undertake the services disclosed in the notes to the financial statements. The provision of these services has not impaired our independence. Audit Opinion In our opinion, the financial report of XYX Limited is in accordance with: (a) the Corporations Act (2001), including: (i) (ii) giving a true and fair view of the company s financial position as at 30 June 2005 and of their performance for the year ended on that date; and complying with Accounting Standards in Australia and the Corporations Regulations 2001; and (b) other mandatory financial reporting requirements in Australia. Name of Firm Name of Partner Date Address Generic Training Manual 4-15

16 4.6.2 Audit of Incorporated Associations In Queensland, the audit requirements of incorporated associations are governed by the Associations Incorporation Act (1981). According to the Section 59(1) of the Act: The members of the management committee of an incorporated association must ensure the association, within 6 months of the close of the financial year prescribed, or more frequently if the rules of the incorporated association so provide: (b) causes the financial affairs of the incorporated association to be audited by: (i) (ii) (iii) (iv) a person registered as an auditor under the Corporations Act (2001); or a member of CPA Australia or the Institute of Chartered Accountants in Australia; or a member of the National Institute of Accountants, other than an associate, who has satisfactorily completed an auditing component of a course of study in accountancy of at least 3 years duration at a tertiary level conducted by a prescribed University or other prescribed institution under Section 1280(2A) of the Corporations Act (2001); or a person who the chief executive considers has appropriate qualifications; and (c) presents the audited statement to the annual general meeting for adoption. Unlike the Corporations Act (2001), an auditor does not need to be a registered company auditor. An auditor of an incorporated association need only be a member of one of the three professional accountancy bodies. Note that paragraph (iv) of Section 59(1)(b) above allows a person who the chief executive considers has appropriate qualifications to be appointed as auditor. This is becoming increasingly popular according to the Office of Fair Trading. The audit requirements are similar to those of a company limited by guarantee. The auditor is required to express an opinion as to whether the financial statements are properly drawn up: in accordance with Australian Accounting Standards and other mandatory professional reporting requirements; and so as to give a true and fair view of the results of its operations and its cash flows. A sample audit report for an incorporated association with an unqualified opinion is presented below. Generic Training Manual 4-16

17 INDEPENDENT AUDIT REPORT To the members of DEF Inc. Scope The Financial Report and Directors' Responsibility The financial report comprises the Profit and Loss Statement, Balance Sheet and Statement of Cash Flows, accompanying notes to the financial statements, and the Committee Members Declaration for DEF Inc. for the year ended 30 June The Committee Members of the association are responsible for preparing a financial report that gives a true and fair view of the financial position and performance of the association, in accordance with Accounting Standards in Australia and in accordance with the Associations Incorporation Act (1981). This includes responsibility for the maintenance of adequate accounting records and internal controls that are designed to prevent and detect fraud and error, and for the accounting policies and accounting estimates inherent in the financial report. Audit Approach We conducted an independent audit of the financial report in order to express an opinion on it to the members of the association. Our audit was conducted in accordance with Australian Auditing Standards in order to provide reasonable assurance as to whether the financial report is free of material misstatement. The nature of an audit is influenced by factors such as the use of professional judgement, selective testing, the inherent limitations of internal control, and the availability of persuasive rather than conclusive evidence. Therefore, an audit cannot guarantee that all material misstatements have been detected. We performed procedures to assess whether in all material respects the financial report presents fairly, in accordance with the Associations Incorporation Act (1981) including compliance with Accounting Standards in Australia, and other mandatory financial reporting requirements in Australia, a view which is consistent with our understanding of the association s financial position, and of their performance as represented by the results of their operations, changes in equity and cash flows. Generic Training Manual 4-17

18 We formed our audit opinion on the basis of these procedures, which included: examining, on a test basis, information to provide evidence supporting the amounts and disclosures in the financial report; and assessing the appropriateness of the accounting policies and disclosures used and the reasonableness of significant accounting estimates made by the Committee Members. While we considered the effectiveness of management s internal controls over financial reporting when determining the nature and extent of our procedures, our audit was not designed to provide assurance on internal controls. We performed procedures to assess whether the substance of transactions was accurately reflected in the financial report. These and our other procedures did not include consideration or judgement of the appropriateness or reasonableness of the business plans or strategies adopted by the Committee Members and management of the association. Independence We are independent of the association, and have met the independence requirements of Australian professional ethical pronouncements. Audit Opinion In our opinion, the financial report of XYX Inc. presents a true and fair view in accordance with Accounting Standards in Australia and other mandatory professional reporting requirements, the financial position of DEF Inc. as at 30 June 2005 and the results of its operations and its cash flows for the year then ended. Name of Firm Name of Partner Date Address Generic Training Manual 4-18

19 In the case of many nonprofit organisations, the auditor may find it difficult to verify cash receipts prior to their entry into the accounting system. For example, a nonprofit organisation may receive cash donations through the mail or undertake a series of fundraising events where cash is collected and banked without appropriate supporting documentation. For example, several nonprofits conduct fundraising events whereby they solicit cash donations on street corners or from door-to-door appeals. Cash proceeds from items such as cakes sold at fetes and carnivals and the proceeds from raffles conducted are virtually impossible to verify by the auditor because of lack of supporting documentation. Fundraisers and volunteers may also be geographically dispersed. For this reason, it is quite common for auditors to qualify the annual financial statements of nonprofit organisations (particularly small organisations) on these grounds. A sample audit opinion with this qualification is presented below. Qualification: Cash donations are a significant source of revenue for DEF Inc. The association has determined that it is impracticable to establish control over the collection of cash donations prior to their entry into its financial records. Accordingly, as the evidence available to us regarding revenue from this source was limited, our audit procedures with respect to cash donations had to be restricted to the amounts recorded in the financial records. We therefore are unable to express an opinion whether cash donations the association obtained are complete. Qualified Audit Opinion: In our opinion, except for the effects on the financial report of such adjustments (if any) as might have been required had the limitation on our audit procedures referred to in the qualification paragraph not existed, the financial the financial report of XYX Inc. presents a true and fair view in accordance with Accounting Standards in Australia and other mandatory professional reporting requirements, the financial position of DEF Inc. as at 30 June 2005 and the results of its operations and its cash flows for the year then ended. Name of Firm Name of Partner Date Address Generic Training Manual 4-19

20 4.7 When Does the Annual Report have to be Sent to Members? Companies Limited by Guarantee According to Section 314 of the Corporations Act (2001), the annual report of a public company limited by guarantee consists of the following documents: the financial report (subject to audit); the director s report; and the auditor s report. A summary of the components of an annual report for a company limited by guarantee is shown in Diagram 2 below. Diagram 3 presented later in this chapter illustrates the components of an annual report for an incorporated association. Diagram 2: What is included in an Annual Report for a Company Limited by Guarantee? Director s Report Financial Report + + Auditor s Report Director s Declaration + Financial Statements + Notes to the Accounts Profit & Loss Statement + Balance Sheet + Cash Flow Statement Also referred to as the Statement of Financial Performance or Income Statement Also referred to as the Statement of Financial Position Also referred to as the Statement of Cash Flows Generic Training Manual 4-20

21 According to Section 315(1) a public company must send the annual report to its members by the earlier of: (a) (b) 21 days before the AGM after the end of the financial year; or four months after the end of the financial year whichever is the earlier. According to Section 250N(2), a public company s annual general meeting must be held at least once in each calendar year and within five months after the end of its financial year. EXAMPLE: Assume that XYZ Limited (a company limited by guarantee) has a financial year ended 30 June. It has just prepared its financial report for the year ended 30 June According to Section 250N(2), XYZ Limited must conduct its Annual General Meeting no later than 30 November 2005 (i.e. within five months after the end of the financial year). Assuming that XYZ limited holds its AGM on 12 November 2005, it is required to send the annual report to its members by the earlier of: (a) 21 days before the AGM after the end of the financial year (22 October 2005); or (b) 4 months after the end of the financial year (30 October 2005). Hence, XYZ Limited must send its annual report to the members by 22 October In the case of public companies, Section 314 of the Corporations Act (2001) permits these organisations to send their members either a full annual report or a concise annual report. A concise annual report is an abbreviated version of the full annual report. It consists of a Profit and Loss Statement, a Balance Sheet, a Cash Flow Statement as well as the director s report, a statement by the auditor that the financial report has been audited (including whether the concise financial report complies with accounting standards) and a copy of the audit qualification (if relevant). The concise financial report must also contain a discussion and analysis by management on the principal factors affecting the organisations financial performance, financial position and financing and investing activities. Generic Training Manual 4-21

22 Finally, the concise financial report of a public company must also contain a statement confirming that it is a concise financial report and that the full financial report and auditor's report will be sent to the member free of charge if the member asks for them Incorporated Associations According to Section 59(1) of the Associations Incorporation Act (1981), the annual report of an incorporated association must be prepared within six months after the end of the financial year or more frequently if the rules of the incorporated association so provide. Under the Associations Incorporation Act (1981), there is no requirement for the association to send the annual report to members before the AGM. However, this may be provided for in the association s rules. According to Section 55, an incorporated association must hold its first general meeting within 18 months after the day the association is incorporated provided it is incorporated within six months before the date of the financial year. Section 56 provides that the association must hold subsequent AGMs: (a) (b) at least once each year; and within six months after the end of the associations previous financial year. As the timing of both events is the same, the incorporated association will have complied with the requirements of the Act provided the audited accounts are presented to members at the AGM no later than six months after the end of the association s financial year. EXAMPLE: Assume that DEF Inc. (an incorporated association) has a financial year ended 30 June. It has just prepared its financial report for the year ended 30 June According to Section 59(1)(a), DEF Inc. must have its financial report prepared before 30 December 2005 (i.e. within six months after the end of the financial year). The audited accounts must be presented at the AGM, which must also be conducted within six months after the end of the financial year. Generic Training Manual 4-22

23 4.8 What Should I Give the External Accountant or Auditor? As previously mentioned, the bookkeeper is usually entrusted with the responsibility of preparing monthly management accounts. At the end of the nonprofit organisation s financial year, the annual financial statements are prepared. These financial statements are usually required to be audited and presented to members at the Annual General Meeting. The following checklist is designed to summarise the forms and documents that the bookkeeper should provide the external accountant or auditor with at year-end. Table 2 Checklist of Forms and Documents to be Provided to the External Accountant/Auditor at Year-End Item Document Yes No N/A 1 Print out of the Profit and Loss Statement for the 12 months 2 Print out of the Balance Sheet at year-end 3 Print out of the Trial Balance at year-end 4 Bank statements for the entire 12 months for all bank accounts maintained 5 Monthly bank reconciliations 6 Petty cash vouchers and petty cash summary 7 List of investments at year end including supporting evidence (eg. share certificates, term deposits detailing amount invested, maturity date and interest rate) 8 Schedule of accounts receivable at year-end (aged debtors print out) 9 Details of any prepayments made during the financial year 10 Details of stock on hand at the end of the financial year (eg. stocktake records) as well as details of any stock write-offs during the financial year 11 Fixed asset register (including details of any assets purchased during the financial year) 12 Depreciation schedule 13 Schedule of accounts payable at year-end (aged creditors analysis) 14 Details of employees, including number of employees at year-end, their salary and details of annual leave and long service leave entitlements Generic Training Manual 4-23

24 Table 2 (Continued) Checklist of Forms and Documents to be Provided to the External Accountant/Auditor at Year-End Item Document Yes No N/A 15 Copies of loan contracts, lease agreements or hire purchase agreements entered into by the nonprofit organisation 16 Details of tied funds or restricted funds (in the case of DGRs) 17 Details of all non-monetary donations and supporting documentation as to their market value 18 Names of Board/ Committee Members and the number of board meeting held during the financial year (including details of board attendance) as well as details of appointment/resignation of committee members/directors during the financial year 19 Minutes of Meeting of Management Committee/Directors during the financial year 20 Register of Members 21 Details of amounts paid to committee members/directors during the financial year 22 Copies of any resolutions passed during the financial year (including amendments to the Constitution/rules) 23 Investment statements (eg. dividend statements, managed fund distribution statements etc.) 24 Details of any grants received during the financial year (provide copies of supporting documentation) 25 Copies of the gift receipts for significant donations made by donors during the financial year 26 Copies of each BAS/IAS lodged with the Australian Taxation Office during the financial year showing the amount of GST paid and received as well as PAYG withholding tax 27 Copies of the all PAYG Payment Summaries provided to each employee as well as the annual PAYG Reconciliation Statement showing the gross wages paid to employees during the financial year as well as PAYG withholding tax deducted 28 Permits for raffles, bingos and art unions 29 Details of any other legal correspondence relating to the organisation such as legal claims etc. Generic Training Manual 4-24

25 TIP: Given the number of documents that need to be passed over to the external accountant/auditor, it is strongly recommended that the bookkeeper place this information in a lever arch folder. Dividers (or tabs) can be inserted into the folder with each section marked. It is also useful to place a copy of last year s audited financial statements at the front. Remember that it has been one year since the external accountant/auditor has seen your accounts. This will serve as a useful reminder and re-acquaint them with your financial statements. Remember, anything you can do to make the task easier and simpler and for the auditor should result in significant time and cost reductions for the auditor. Hopefully, this will ultimately be passed onto the nonprofit organisation in the form of a reduced audit fee. 4.9 Audit Engagement Letter When an auditor is engaged to conduct an audit, they will usually provide the nonprofit organisation with an engagement letter. The purpose of the engagement letter is to formally document the terms of the audit engagement (preferably before the commencement of the audit). The engagement letter ensures there is a clear understanding by the association s management committee and the auditor of the extent of the auditor s duties and responsibilities and is designed to avoid uncertainty and misunderstandings with respect to the engagement. The engagement letter also documents and confirms the acceptance of the appointment as well as the objective and scope of the engagement. It also highlights the extent of the auditor s responsibilities to the entity and the form of any reports. The Auditing and Assurances Standards Board (AUSAB) has issued AUS 204 Terms of Audit Engagements which provides a standard engagement letter for use by auditors. A copy of a sample audit engagement letter (adapted for an incorporated association) is reproduced on the following pages. Generic Training Manual 4-25