PROTECTING YOUR CLIENT: READING FINANCIAL STATEMENTS WITH A CRITICAL EYE

Transcription

1 PROTECTING YOUR CLIENT: READING FINANCIAL STATEMENTS WITH A CRITICAL EYE Jill H. McAlpine jill.h.mcalpine@ca.pwc.com M. Elena Hoffstein ehoffstein@fasken.com

2 Discussion Topics Reporting evolving expectations and responses Audited Financial Statements for Not-for-Profit Organizations Regulatory requirements Reporting frameworks Key concepts and components Selected topics Endowments and restricted contributions Controlled and related entities Communications with legal counsel 1

3 Reporting Evolving Expectations and Responses 2

4 Expectations: Reporting - Evolving Expectations and Responses Transparency, accountability Regulatory and contractual compliance Resource allocation, performance and stewardship assessment financial management and organizational effectiveness Responses include: CICA Improved Annual Reporting by Not-for-Profit Organizations ; new accounting frameworks and standards; 20 Questions Series; NPO Director Alerts; courses/seminars Imagine Canada Ethical Code, Standards Initiative, Charity Focus CRA T3010 online & searchable, donor education, new tools Voluntary Sector Reporting Awards 3

5 Audited financial statements Requirements for an audit Reporting frameworks Key concepts Components of financial statements 4

6 The Statutory Landscape for Non-Share Capital Corporations Governing Statutes Part I, CCA Part III, OCA CNCA ONCA 5

7 Reporting Requirements CCA/OCA CCA auditor must be appointed annually must present findings at annual general meeting; OCA same as above Exemption from audit if company not a public company, if income is less than $100K and all of the members consent to the exemption from audit 6

8 Reporting Requirements - CNCA CNCA establishes two different types of not-for-profit corporations: soliciting corporations; and non-soliciting corporations. The type of reporting depends on (i) whether the corporation is a soliciting corporation or a non-soliciting corporation; and (ii) the level of its gross annual revenues. Must submit financial statements to Director A soliciting corporation is a corporation which received in excess of $10,000, in a financial year, in the form of donations from third parties, (ie: not members, directors, officers or employees or related persons) grants or financial assistance from the federal, provincial or municipal government, or donations from other soliciting corporations; A non-soliciting corporation is a corporation which is not a soliciting corporation. 7

9 Reporting Requirements - CNCA Type of corporation under CNCA Gross Annual Revenues (for previous year) May Dispense with Public Accountant Review Engagement Audit Soliciting Less than or equal to $50,000 Yes, if all voting members consent. Members must sign a waiver annually. Default, unless the majority of the members vote for an audit. Optional Soliciting Between $50,001 $250,000 No* Optional Default, unless two-thirds of members voting for a review engagement (subject to the Director requiring only a compilation report) Soliciting More than $250,000 No* N/A Mandatory (subject to the Director requiring only a review engagement or as an alternative a compilation report) 8

10 Reporting Requirements - CNCA Type of corporation under CNCA Gross Annual Revenues (for previous year) May Dispense with Public Accountant Review Engagement Audit Non-soliciting Less than or equal to $1,000,000 Yes, if all voting members consent. Members must sign a waiver annually. Default, unless the majority of the members vote for an audit. Optional Non-soliciting More than $1,000,000 No* N/A Mandatory (subject to the Director requiring only a review engagement or as an alternative a compilation report) 9

11 Reporting Requirements - ONCA The ONCA establishes two classes of not-for-profit corporations; public benefit corporations (i.e. similar to a soliciting corporation under the CNCA) and non-public benefit corporations (i.e. similar to a non-soliciting corporation under the CNCA). Charitable corporations are automatically considered to be public benefit corporations. A non-charitable corporation will be considered to be a public benefit corporation if it receives more than $10,000 in a financial year in the form of donations or gifts from persons other than its members, directors, officers or employees, or in the form of grants from the federal, provincial or municipal government or agency thereof. No requirement to file financial statements with Ontario Ministry Financial statements much be provided to Public Guardian and Trustee if corporation is a charity and is operating in Ontario 10

12 Reporting Requirements - ONCA Type of Corp/Gross Annual Revenue (GAR) of ONCA Corporation Requirements for an auditor Audit/Review Engagement Public Benefit Corporation (PBC) with GAR of = Less than $100,000 (s. 76(1)(b) May, by extraordinary resolution* (80%), decide not to appoint an auditor May dispense with both an audit and a review engagement by extraordinary resolution (80%) Over $100,000 but less than $500,000 (s. 76(1)(a) May dispense with an auditor and have someone else conduct a review engagement. This requires an extraordinary resolution (80%) May elect to have a review engagement instead of an audit by extraordinary resolution (80%) Over $500,000 (s.68) An auditor must be appointed annually Audit is required 11

13 Reporting Requirements - ONCA Type of Corp/Gross Annual Revenue (GAR) of ONCA Corporation Requirements for an auditor Audit/Review Engagement NON-PBC corporation with GAR of = Less than $500,000 in annual revenues (s. 76(2)(b)) May, by extraordinary resolution (80%), decide not to appoint an auditor May dispense with both an audit and a review engagement by extraordinary resolution (80%) Over $500,000 (s. 76(2)(a)) May, by extraordinary resolution (80%), dispense with an auditor and have someone else conduct a review engagement May elect to have a review engagement instead of an audit by extraordinary resolution (80%) 12

14 Reporting Frameworks CICA Handbooks A c S B Type of Organization Canadian Publicly Accountable Enterprises Private Enterprises Not-for-Profit Organizations that are not GNFPOs (NFPOs) Reporting Framework IFRS (International Financial Reporting Standards CICA Accounting Handbook Part I) ASPE (Accounting Standards for Private Enterprises CICA Accounting Handbook Part II)) or IFRS ASNFPO (CICA Accounting Handbook Part III supplemented by ASPE) or IFRS P S A B Governments (including school boards) Government Business Enterprises (e.g., LCBO, OLG) Government Not-for-Profit Organizations (GNFPOs) Other government organizations (OGOs) PSAS (CICA Public Sector Accounting Handbook) IFRS PSAS or PSAS with PS 4000 series (CICA Public Sector Accounting Handbook) PSAS or IFRS 13

15 Is the Organization an NFPO or GNFPO NFPO (non-government) an organization organized and operated exclusively for social, educational, professional, religious, charitable or any other not-for-profit purpose members, contributors and other resource providers do not, in such capacity, receive any financial return directly from the organization and that is not a GNFPO GNFPO same as above except may be controlled by the government,and has counterparts outside the public sector (usually in the MUSH sector) includes government NFP organizations that currently report using CICA Handbook (e.g., schools, hospitals, colleges and universities) may include organizations that are directly or indirectly funded by the government or government agencies (but government funding does not necessarily translate into an organization that is a GNFP) 14

16 Audited Financial Statements Key Concepts Objective of financial statements Benefit vs. cost constraint Materiality Qualitative characteristics and trade-offs Understandability, relevance, reliability, comparability 15

17 Audited Financial Statements - Components Independent auditor s report Statement of financial position Statement of operations Statement of changes in net assets Statement of cash flows Notes to financial statements Supporting schedules cross-referenced to financial statements (if any) 16

18 Endowment & Restricted Funds 17

19 Endowments & Restricted Funds Audited Financial Statements Reporting objective Ability to carry out service delivery activities in future Financial flexibility Role of contributions in funding activities Management s stewardship of restricted assets Details of externally restricted (endowed and other restricted separately), internally restricted and unrestricted funds When How much For what purpose 18 18

20 Endowments Can be created by a donor either during lifetime (usually evidenced by a donor agreement setting out the terms of the gift) or on death (documented in a will) Can be internally created by the Board of a charity Involves the setting aside of capital (either cash or assets that are converted into cash and reinvested) in perpetuity Income can be expended on charitable programs or can be accumulated (subject to applicable provincial statutes) 19

21 Restricted Funds Endowments are a form of restricted funds Terms of restricted funds can require expenditure of the income and capital over a period of time Constraints can relate to restrictions on use or restriction as to a specific purpose (scholarship/research in a particular dept for example; real estate to be held for a particular use) Written agreement not needed for a court to determine whether donor intended restricted charitable gift. Will consider other written or oral evidence to determine intent such as correspondence, memo of discussions, fundraising material of charity 20

22 Unrestricted Gifts Gift at law to be applied towards the general charitable purposes of a charity. Not subject to any restrictions by the donor. Board may apply towards certain of its charitable objectives and also redirect the use. 21

23 Precatory Gifts/Donor Advised Funds Non binding requests by donor. No enforceable restrictions although moral obligation on charity receiving the gift to consider the expressed preference, desire, request of donor. Donor Advised Fund is a form of precatory gift. Too much control retained by donor may cause donation to not qualify as a gift thereby disqualifying it for charitable receipt under ITA. 22

24 Meaning of Income and Capital Many endowment agreements provide for distribution of income but no right to encroach on the capital. Generally no right to vary the agreement retained by the donor. Even if capital not to be retained in perpetuity, because of the ITA rules prior to the 2010 Federal Budget many gifts structured as gifts given subject to trust or direction that capital or property substituted therefore be retained for at least 10 years. This removed the gift from the requirement that 80% of the receipted gift had to be expended in the subsequent year. Income and capital are colloquially regarded as mutually exclusive terms fruit/tree analogy. Income - earnings, revenues. Capital - assets or property that is employed or invested to generate such returns - includes capital gains. 23

25 Endowments and Restricted Funds Audited Financial Statements Definitions for accounting purposes Contributions Endowment Restricted Financial statements Presentation and Disclosure Restricted fund method Deferral method Information about externally and internally (endowed and other) and unrestricted funds recognized in financial statements: Accounting policies Contributions by major source; Not assets Restrictions 24

26 Endowments and Restricted Funds Audited Financial Statements Deferral Method Deferral Method The Canadian Institute of Chartered Accountants 25

27 Endowments and Restricted Funds Audited Financial Statements Restricted Fund Method Restricted Fund Method The Canadian Institute of Chartered Accountants 26

28 Controlled & Related Entities Related Party Transactions 27

29 Controlled & Related Entities; Related Party Transactions: Relevance to Audited Financial Statements Impact an NFPOs resources and operations sustainability, flexibility, independence Government & private funders, regulators, creditors, potential partners Ministry of Health Information needs: Basic info, relationship, significance, resources, transactions Structuring organizations and operational arrangements 28

30 Controlled & Related Entities; Related Party Transactions: Relevance for Income Tax Purposes Concerns under the ITA Self dealing Private benefit ITA provisions include: Designation - charitable organization, public or private foundation Designated gifts non-arm s length charities inter-charity gifts Non-qualified investment Non-qualifying securities Associated charities Excess business holdings rules 29

31 Controlled & Related Entities; Related Party Transactions: Relevance for Income Tax Purposes T3010 tool for assessing compliance, identifying potential issues & monitoring, include Subordinate to a parent charity (A1) Directors/trustees & like officials (T1235) Compensation of directors and others (C8) Loan-backs (C13) Non-arm s length borrowing, loans, investments (Section D and Schedule 6) 30

32 Controlled and Related Entities Audited Financial Statements - Definitions Reporting controlled and related entities Control: continuing power to determine the controlled entity s strategic operating, investing and financing policies without the cooperation of others. Significant influence: the ability to affect [but not control] the entity s strategic operating, investing and financing policies Economic interest: the other NFPO holds resources that must be used to produce revenue or provide services for the reporting NFPO ; or the reporting NFPO is responsible for the liabilities of the NFPO in which it has an economic interest 31

33 Related Party Transactions Audited Financial Statements - Definitions Reporting related party transactions Related parties: one party has the ability to exercise, directly or indirectly, control, joint control or significant influence over the other. Two or more parties are related when they are subject to common control, joint control or common significant influence. Two not-for-profit organizations are related parties if one has an economic interest in the other. Related parties also include management and immediate family members Related party transaction: a transfer of economic resources or obligations between related parties, or the provision of services by one party to a related party, regardless of whether any consideration is exchanged. The parties to the transaction are related prior to the transaction. When the relationship arises as a result of the transaction, the transaction is not one between related parties. 32

34 Controlled & Related Entities; Related Party Transactions: Determination of Relationship Documents and factors to consider Governing documents Funder agreements Licenses Loan agreements Contractual or commercial relationships (joint venture, joint project, services agreements; economic dependence) International context: family service agreements Substance over form; factual & de jure Accounting and tax definitions/interpretations may differ Importance of dialogue between lawyers & accountants 33

35 Controlled and Related Parties Audited Financial Statements: Controlled Entities Controlled NFPOs: 1. Consolidate (combined financial statements), or Additional details for all 2. Specific disclosure w/o consolidation 1. Accounting policy total assets, liabilities, net assets 2. Description of revenues, expenses, cash flows relationship restrictions on resources 3. Description of controlled significant acctg policy differences organization s: purpose, reporting period if different intended community of significant subsequent events, or service, status under income tax legislation, 3. Exempt - One of large group, each individually legal form immaterial exempt from (1) and (2) disclose reasons for not reporting under (1) or (2) Controlled FPOs: 34

36 Controlled and Related Parties Audited Financial Statements: Significantly Influenced Entities & Economic Interest only NFPOs - Significantly influenced NFPOs - Economic interest w/o control of significant influence Description of relationship Nature and extent of interest (e.g., nature and purpose of assets Significantly influenced organization s flowing to reporting NFPO; or details purpose, intended community of service, of fund solicitation arrangement; status under income tax legislation, legal and/or details of responsibility for form liabilities Nature and extent of economic interest For-Profit Significantly influenced Equity method of accounting for investments & presentation and disclosure as per ASPE 35

37 Controlled and Related Parties Audited Financial Statements: Related Party Transactions Related party transactions Required disclosure: Description of relationship Description of transactions (including nil amounts) Recorded amount by financial statement category Measurement basis Amounts due to/from, terms and conditions Contractual obligations separate from other contractual obligations Contingencies, separate from other contingencies 36

38 Controlled and Related Parties NFPOs Reporting Decision Tree Controlled organizations Significantly influenced Economic interest only Related party transactions only The Canadian Institute of Chartered Accountants 37

39 Controlled and Related Parties For-Profits Reporting Decision Tree Controlled organization Significant influence Related party transactions only The Canadian Institute of Chartered Accountants 38

40 Communications with Lawyers Audited Financial Statements Purpose: Audit procedure re: litigation and claims Assess risk of material misstatement Lawyer s letter Management: prepares and instructs lawyer to communicate directly with auditor Auditor: sends and receives/assesses Financial statements presentation and disclosure Contingent losses Contingent gains 39

41 Jan 1978 CBA and CICA approved Joint Policy Statement (JPS) Two issues addressed: protect solicitor-client privilege ensure lawyer does not become involved in joint undertaking with auditor in preparation and certification of clients financial affairs Memorandum accompanying JPS highlights the following features of JPS 1.Lawyer response is determined by what is found in his records. No direction as it how such records are to be kept or what information is to be found in them 2.Distinction between claim and possible claim is important. 3.Not mandatory for lawyer to respond in accordance with the form letter but it is recommended that they do so 4.When lawyer does adopt the procedure laid down in JPS he/she obliges self to draw attention to claims of which he has record even though not mentioned in enquiry letter and to participate in conference with client and auditor if required. 40

42 Solicitor Client Privilege a key goal is protection of the privilege since 1978 Courts have adopted broader concept of solicitor-client privilege. Philip Services Corp (Receiver of) v. OSC (2005)77 OR (3d) 209 preservation of privilege is paramount and court should not interfere with this more than is absolutely necessary Case involved production of legal opinions that had been provided to auditor when he attended audit committee meeting Even though privileged documents are provided to auditor they are so provided for limited purpose to enable the auditors to comply with the full scope of their audit standards. Waiver of privilege can be narrow However also recognition that accurate financial statements are also in public interest. In cases where law firm knows client has omitted possible claim from enquiry letter lawyer should discuss with client to enable client to make proper disclosure Where law firm disagrees with client evaluation of a particular claim law firm should raise issue with client and ask client to arrange call with auditor 41

43 Solicitor Client Privilege What if client refuses to arrange conference or what if law firm becomes aware of error and advises client? JPS silent. However as a lawyer cannot waive the privilege, is prohibited from raising the matter with the auditor without client consent privilege is that of the client If law firm believes that in non disclosing to auditor, client is acting dishonestly, fraudulently or illegally Rules of Professional Conduct impose on law firm up the chain reporting or it may be law firm must withdraw from representing client JPS currently being adapted to respond to IFRS. There will be different accounting frameworks reporting standard for contingencies will change. In meantime Interim Guideline has been prepared which is intended to enhance JPS to assist lawyers in advising clients now following IFRS and to bridge gap until revised JPS comes into effect. 42

44 Disclaimer This handout and the corresponding presentation are for general information purposes only. They do not constitute a legal opinion or other legal advice. Readers are advised to consult a lawyer to obtain a legal analysis and advice before making a decision or taking other action regarding a specific matter. 43

45 THANK YOU Jill H. McAlpine M. Elena Hoffstein