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©2007, The McGraw-Hill Companies, All Rights Reserved
©2007, The McGraw-Hill Companies, All Rights Reserved
Essentials of Accounting for Governmental and Not-for-
Auditing; Tax-Exempt Organizations;
And Performance Evaluation
E as t
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)
Source of Auditing Standards
• AICPA – Statements of Auditing Standards (GAAS)
• GAO – Government Auditing Standards (GAGAS)
• AICPA Audit and Accounting Guides– Audits of State and Local Governments– Not-for-profit Organizations
The Yellow Book
Government Auditing Standards, issued by the GAO, incorporate AICPA auditing standards and provide extensions that are necessary due to the unique nature of public entities
United States Government Accountability Office
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
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
Types of Engagements (cont’d)
• Performance Audits– Economy and efficiency audits --
• involve aspects of appropriate acquisition, use, and safeguarding of resources
– 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
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.
• 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
Opinion units (cont’d)
• 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.
The auditor is required to prepare up to five reports:
1. A report containing an opinion on the financial statements.
2. A report discussing the evaluation and testing of internal control and compliance with laws and regulations.
3. A report discussing significant deficiencies in internal controls.
4. A report describing instances of fraud, illegal acts, or other material noncompliance.
5. A report containing the views of responsible officials of the audited organization regarding any reported significant deficiencies.
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
• Adverse - – Not in accordance with GAAP.
• Disclaimer - – Not able to express an opinion, usually because auditor was
precluded from doing some necessary procedure.
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.
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 > $500,000 but is all from one agency, a program audit may be used instead of a single audit.
Supervision of Single Audits
• Oversight agency – Agency with largest grants receive audit reports
• Cognizant agency– Entities with $50 Million or more of federal
awards are monitored by a cognizant agency -- agency with largest grants normally selected
• Compliance supplement -- includes any special guidelines for particular grants
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– Type B - smaller programs and low risk large
programs– Type A programs receive closer auditing than
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%
The Sarbanes-Oxley Act
• Signed into law in 2002 in response to scandals in the business sector
• Intended to improve corporate governance and limit the services accounting firms may provide to their audit clients.
The Sarbanes-Oxley Act cont’d
• While act only applies to corporations filing with the SEC, it has changed the way public accounting forms relate to all their clients, including governmental and NFP.
• The Act has influenced governing boards and many NFP Boards have begun to model themselves on corporate governance “best practices” initiated by SOx
Governmental Auditing Standards
• GAO standards for independence already prohibit auditors from performing many non-audit services.
• Like governmental accounting, governmental auditing follows a unique set of guidelines established by the GAO that require auditors to evaluate and report on the system of internal controls and compliance with laws and regulations.
Sarbanes-Oxley Act has changed the world
• As a result of heightened public awareness for the importance of accountability and independence, other provisions of the SOx Act are being voluntarily adopted by NFP organizations.
• Pressure to adopt these practices has come from funding foundations that have announced that SOx compliance will be a factor in the awarding of grants.
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 $1000 of unrelated business income file Form 990-T.
• Other reports may be filed with the state.
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
– Include religious, charitable, scientific, literary, educational, amateur sports organizations, orgs 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.
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.
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 entity’s 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
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
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
Performance Evaluation - Ratios
• To compare entities of varying size, it is useful to compute financial ratios– Not-for-profit Ratios– Governmental Ratios
A. Program Expense Ratio: Program Service Expenses Total Expenses
What proportion of each dollar is used on programs?
B. Fundraising Efficiency: Fundraising Expenses
How much does it cost to raise a dollar of contributions?
Not-for-profit Ratios (Cont’d)
C. 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?
Governments:Users of Financial Statements
• Citizen groups
• Legislative and oversight officials
Bond Markets and Financial Analysis
• The CAFR is a major data source for professional bond rating agencies such as– Moody’s, Standard and Poor’s, Fitch’s 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.
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
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
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
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.
Common ratios cont’d
• Other issues to consider– Population trends, – trends in assessed values, – economic trends, – debt limits and margins, – pension position,
– current issues in the news, etc.
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
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