Internal Audit in NPOs (Non-Profit Organisation)- Consulting Service

Updated on March 04, 2024 03:44:36 PM

Community worldwide receives essential services and programs from nonprofit organisations (NPOs), which play a vital role in society. NPOs are faced with several unique challenges, including limited resources, complex operations, and a greater risk of fraud and abuse.

Internal audit in the (Non profit organisations)NPOs can be used to mitigate these risks and improve their operational efficiency. Providing recommendations for improvement, internal auditors assess the effectiveness of the organisation's internal control systems. Additionally, they examine the financial statements of the organisation and detect any potential fraud or irregularities.

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Accounting Standards on Internal Audit in the NPOs

Accounting standards are applicable to all enterprises (whether organised in corporate,co-operative or other forms) engaged in commercial or business activities, regardless of their profit-oriented or charitable or religious purposes.

Accounting standards are not applicable to enterprises that only carry out activities that are not business-related (such as collecting donations and distributing them to flood-affected people).

Even if a very small proportion of the activities of an enterprise is considered to be commercial, industrial or business in nature, the accounting standards would apply to all its activities including those which are not commercial, industrial or business in nature.

For example, where a NPO is engaged in the commercial activity of granting loans/credits to the small entrepreneur at nominal rates of interest or in the industrial activity of manufacturing clothes for rural or poor, Accounting standards formulated by ICAI would be applicable on such NPOs.

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Need of Internal Audit in NPOs

NPOs are no different from profit or commercial organisations. Their objectives and activities may be different but the day to day operations would more or less involve common activities like receipt and cash processing, tracking revenue and financial reporting to stakeholders.

The uniqueness of Not-for-Profit Organisations is that even a whiff of a scam can ruin the whole entity. An overwhelming majority of the public believes NPOs to be of a high standard of integrity that they will use donations as promised.

This is why internal audit in NPOs are crucial:

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Internal Audit of Funds in NPOs

An Internal Auditor must ensure the followings:

Utilisation of Funds

The entity generally sets some policies with the help of the Board or their own investment committee which can further be reviewed by the Internal Auditor in conjunction with state law.

Restricted Funds

The internal auditor should keep the following in mind when dealing with restricted funds:

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Internal Audit of Small or Used Items in NPOs

The completeness of donations often presents a high inherent risk, especially in case of small furniture or equipment belonging to organisations that do not capitalise their assets. The internal auditor should ensure if the NPO is using estimates.

Usually the reason for NPOs to not value its low-value assets could be the difficulties or estimate of their value. The Internal Auditor should obtain appropriate evidence to enable them to operate whether management accounting estimates are reasonable within the context of the financial statement as a whole.

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Internal Audit of Donations in NPOs

The risk associated with the cash donation is quite high because it is difficult to verify all the amounts given by donors. NPOs use various methods to raise funds for e.g, by fundraising events, door to door solicitation, TV campaigns endorsed by stars, corporate fundraising strategies, etc.The Internal Auditor should gather all information about the various methods used during the year to plan an audit strategy. The most important of all is gathering information about the internal control over cash and cheque receipts.

Cash Receipts

NPOs usually have storage of staff which leads to multiple responsibilities on a single person. This might be acceptable in certain areas but some duties should be set apart from others.

The following simple techniques can help in having effective internal control:

  • Cash receipts should be immediately recorded and deposited in banks.
  • Verification of the transactions that are approved by the authority before being recorded.
  • Examine the documented procedures for counting, reporting and preparing cash for deposit.
  • Cross checking records are well-maintained and easily traceable.
  • Verify that financial reports accurately represent cash receipt activities.
  • It is necessary for individuals who handle cash to be bonded.

Similarly, to other areas, the objective of Internal audit in NPOs is to ensure completeness, measurement, presentation, ownership, and existence of receipts. This can be achieved by ensuring the following

  1. Value of the donation received during the year is appropriate. (measurement)
  2. Cash donations received during the year were recorded. (completeness)
  3. Donations during the year were adequately disclosed in the Financial statements. (presentation)
  4. During the year, donations recorded were actually received and belong to the organization (occurrence, ownership, and existence).
  5. The value of donations received in kind was recorded if it could be reasonably estimated. (completeness)

The internal auditor needs to understand the process of issuing a donation receipt by the entity. The Internal audit of the receipt issuing process is an integral part of the internal control examination performed by the auditor with respect to donations.

It has been estimated that most organisations' receipts are not issued for up to 20% of donations. Thus, the internal auditor may not be able to express an opinion on completeness, measurement and existence of all donations.

The Internal auditor should enquire about the following policies and procedures to ensure reliability of receipts:

  • Control over numeric sequel.
  • Details of the entity like name, address, and registration number.
  • Controls over issuing of duplicates.
  • Procedures to ensure that the amount mentioned in receipts is correct.
  • Control over the date of issuance of receipt and date of donation.
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Classification of Expenses in NPOs

Classification based on natural categories would not provide the information needed to arrive at these ratios. General categories, such as, salaries, rent or electricity,etc. shows the expenditure of money but not the purpose for which it was spent.

Here are some common expense categories used in NPOs:

  • Program Expenses: The amount spent directly by not-for-profit organizations while carrying out its programs. Programs that can result in goods and services being distributed to beneficiaries, customers, or members that fulfill objectives or mission of the entity.
  • Administrative Expenses: The expenses associated with the management and administration of the organization. It also includes salaries of administrative staff, office rent, utilities, office supplies, and general overhead.
  • Fundraising Expenses: The expenses occur due to activities conducted for raising funds. These activities include marketing campaigns, donor outreach, fundraising events, and grant application fees.
  • Management Expenses: Management expenses encompass costs associated with administrative functions vital for organizational operation. Proper management ensures effective governance, financial accountability, and efficient support for delivery enabling NPOs to achieve their missions and serve their beneficiaries while maintaining transparency and sustainability.

Report to Stakeholders

This is an important issue for both the NPOs themselves and for the donors. If the NPO is to retail donors it must convince them that their contributions are having a substantial and beneficial effect. Not just donors but also the general public, revenue authorities, government and most importantly the people and communities who benefit from the services provided by an NPO need to be convinced as to how NPOs do this job.

Assessment

Donors like the contributions as much as possible to go into the actual charitable activity. Though individual donors may not have a say, grantors often state a maximum level of administration support with their grants. Evaluations and reports are required by grantors to assess impact, and most donors receive some type of communication that illustrates effectiveness.

They want to know about the impact their investments made - not just numbers to how many they have helped but how many lives were improved, how things have changed.

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Risk Assessment in NPOs

Organisations must assess risks from both internal and external sources. The internal auditor conducts an overall risk assessment to understand the strategy and key processes, and then identifies high-risk areas for further investigation. The auditor uses risk assessment to determine audit timing, intensity, and frequency.

Risk analysis usually takes the following forms:

  • Identify the appropriate risk factors designed to reflect management’s concerns.
  • Choose a format that is suitable for evaluating risk factors.
  • Assign audit frequency based on risk and importance of audit units.
  • An audit coverage plan indicates timings, planning, nature of the audit, etc.
  • This will aid in scheduling staff and other resources.
  • Develop a combination rule for each unit which will properly reflect its riskiness over several risk factors that have been identified and a method of setting audit priorities for the audit units.

Risk Types

  • Inherent Risk: The risk of a material misstatement in the financial statements is present regardless of internal controls. Restricting certain funds could lead to donors refusing to provide further funding, which is a high-risk area for cash donations.
  • Control Risk: The risk of not preventing or detecting a material misstatement through internal controls is known as Control Risk. NPO has the ability to manage risk by implementing strong internal controls, segregating duties, conducting regular audits, and ensuring proper supervision.
  • Detection Risk: Detection risk is the risk that an audit will not detect a material misstatement. It can be reduced by conducting thorough and effective audit procedures, such as transaction verification, document review, and assessment of internal controls.

Assessment

The Internal auditors are required to assess inherent risk and control risk on three levels: maximum or high risk, moderate or medium risk and low risk. If the inherent and control risks are high, the detection risk must be low in order to have a low overall audit risk. Consequently, the internal auditor must apply more detection procedures in order to have reasonable assurance that the financial statements are free of material misstatements.

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Internal Control System in NPOs

During the planning phase, the internal auditor must analyse the organisation's internal controls. The issue with NPOs is that there are limited numbers of staff personnel and there is a mix of paid staff and volunteers.

The internal audit team should be looked into the following aspects:

  1. Determining the material existence of assets.
  2. The accuracy of records and the reports to the governing body (usually the directors).
  3. The adequacy of internal control.
  4. Proper authorization of activities and expenditures.
  5. Examining the tax-exempt status and identifying any activities that could pose a threat.

An internal control system may be evaluated by assessing its capacity to achieve seven commonly recognized control objectives:

    • Authorization: All transactions are pre-approved by responsible personnel.
    • Completeness: All valid transactions are included in the accounting records.
    • Accuracy: All the transactions are accurate, consistent with the originating transaction data, and information is recorded in a timely manner.
    • Validity: All recorded transactions fairly represent the economic events that actually occurred, are lawful in nature, and have been executed in accordance with management’s authorization.
    • Physical Safeguards and Security: Access to physical assets and information systems are controlled and properly restricted to authorized personnel.
    • Error Handling: Detecting errors at any stage of processing should receive prompt corrective action and are reported to the appropriate level of management.
    • Segregation of Duties: Duties are assigned to individuals in a manner that ensures that no one individual can control both the recording function and procedures relating to processing transactions. Standard on Internal Audit (SIA) 120, Internal Controls provides detailed guidance in this regard.
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Revenue Recognition of NPOs

NPOs rely on donations, contributions, membership fees, and investment income as their main source of income. Fundraising can be done through the use of social media campaigns and crowdfunding.Commercial activities are generally prohibited, but if permitted, must be directly related to the NPO's mission. It is not accurate to assume that all NPOs are large or government-funded.

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Conclusion

In conclusion, Internal audits in NPOs are essential to ensure transparency, accountability, and financial protection. They help identify areas for improvement, mitigate risks, and ensure that donor funds are used effectively. By fostering a culture of continuous improvement, NPOs can strengthen their impact on the communities they serve. Through proactive internal audits, NPOs can foster a culture of continuous improvement and responsible governance results in ultimately strengthening their impact on the communities they serve.

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FAQs on Internal Audit in NPOs

How can you audit a non profitable institution?

An audit of a non-profit organisation (NPO) is a review of its financial records, budgets, and transactions to ensure accuracy and compliance with regulations. The auditor will also examine internal controls, donor restrictions, and program effectiveness. The goal of an audit is to ensure transparency, ethical conduct, and responsible resource utilisation, and to bolster accountability and mission alignment.

Is audit mandatory for NPOs?

Audit requirements for NPOs vary depending on factors such as size, funding sources, and legal structure. However, it is generally recommended that all NPOs conduct audits, especially those that receive public funds or large donations.

Do non profit organisations have internal auditors?

Yes, many NPOs have internal auditors or internal audit functions. Internal auditors help to ensure financial accountability, operational efficiency, and compliance with regulations. They also help to identify and mitigate risks, and to improve internal controls.

What are Internal controls for NPOs?

Internal controls for NPOs are procedures and policies that safeguard assets, ensure financial accuracy and promote accountability. They encompass measures to prevent fraud, manage risks and maintain compliance with laws and donor requirements.

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