ACG 6685 Florida Atlantic University Audit of Charitable Organizations Paper Do CPA firms have a responsibility to perform audits of charitable organizatio

ACG 6685 Florida Atlantic University Audit of Charitable Organizations Paper Do CPA firms have a responsibility to perform audits of charitable organizations for reduced or lower than normal audit fees? If auditors perform audits of not-for-profits at discounted fees, what impact is this likely to have on the quantity and quality of audit effort the auditor puts into the audit? Other than audit fees, what other benefits do accounting firms accrue by auditing a charity? Discuss the issue of the level of risk an auditor may associate with performing the audit of a not-for-profit organization. use documents attached MA
AGE M E
T
fra u d
CPAs’ Role in Fighting Fraud
in Nonprofit Organizations
By Andrea McNeal and
j effrey Michelman
F
raud in the nonprofit sector ha
been th e object of increas in g
sc rutin y by the U.S. Congress,
notably th e U.S. Senat e …. in ance
Committee, a well a by ew
York St ate Attorney General
Eliot Spitzer. Recent studies indica te that frauds occur in non profits of all sizes and in every
area of the counu’y with astounding frequency. Furthermore. the
cost of the e fraud appears to be
increa in g at an alarming rate
(see Exhibit I ). With mall
organization uffering the mo t
ex treme losses from fraud and
embezzlements, mall , community-based nonprofits mu st be
e pec ially dili gent in enacting
fraud prevention and detection
meas ure s. Spec ifi ca lly , good
board governan ce and internal
control policies in these organiza tion s are imperativ e to preve nt or miti ga te th e nega ti ve
impacts of fraudulent activity
within the organization. Financial
officer and CPAs advi in g
nonprofits al 0 ha ve a role to
play in facilitating and en uring
effective internal controls.
often untrained or unqualified to properl y perfo rm the ove r si g ht function.
Combined, these factors can re ult in a
board that i unwilling or unable to a k
the tough questions necessary to detect
financial mi smanagement or fraud.
SOA requires public companies to estab-
Board Governance
The implication of the Sarbane -Oxley
Act (SOA) for all organizations are farrangi ng. Typica ll y, the boards of mall
nonprofit organizations tend to compri se
a few volunteer community members th at
kn ow each other well and have estabIi hed a leve l of tru st and rapport.
Additionally, nonprofit boards frequently experience a high turnover of member , and individual that volunteer are
60
Ii h an independent audit committee with
the presence of at lea t one “financia l
ex pert. ” For nonprofits that undertake
external audits, implementing this provision represents an opportunity to enhance
the oversight function and strengthen the
benefits received from the independent
audit. Many mall non profits, however,
lack the resources to conduct a full audit,
and therefore do not need a fonnal audit
committee.
The role of a CPA volunteer, even if
merely a an independent board member
providing check-signing oversight, may be
critically impoltant in both substance and
form. Small nonprofits should still consider retaining an independent accountant
to pelform a review or compilation of th e entit y’s f inan c ial
records to supplement any fraud
detection activities. Furthermore,
non profits that choose to forgo
an external audit should at least
establi h an independent finance
committee to oversee the organization ‘s financial employees and
transaction .
Gi ve n the hi gh turn over of
board member and officers, a
well as the vo lunteer nature of
these positions. small nonprofits
may ex peri ence difficulty findin g vo luntee rs with adequate
business and financial qualification . Furthermore, the turnover
of the e indi viduals makes continuity of oversight and fiscal initiati ve
more difficult.
onetheless, nonprofits hould
attempt to engage “finan c ial
ex pert ,” or at lea t financially
kno w ledgeable indi vidu al s, to
serve on the finance committee.
Active involvement of such indi vi duals in the oversight function
may provide additional scrutiny
and accountability for the financial officer and employees and therefore aid in
not only detecting, but also deterring,
fraudulent activity. Although nonprofits
may be stratified into perhap three categori e – those rece i ving no CPA services, those u ing CPA to complete a
rev iew, and tho e u ing a CPA to complete a full audit – the role of the CPA
remai n important in all three in tances.
JANUARY 2006 / THE CPA JOURNAL
Internal Control Issues
The ci a ic fraud tri ang le (Exhibit 2)
illu trates the three factor that are necessary fo r a fraud to occ ur: press ures o r
incenti ves, rati onalization. and oppoltunity. Although the convergence of these facto rs is what ult imate ly re ult in frauds,
organizatio ns can add ress the 0ppOltunity
compo ne nt, a nd thu s reduce the like lihood of fra udulent acti vity, by establishing
adequate internal controls.
While every no nprofit faces its ow n
set of control challe nges a nd weaknesses, small community- based organi zatio ns
have c ha rac te r is ti cs th a t ma ke th e m
partic ul arl y uscepti ble to fraud . At the
fo refro nt of the proble mati c cha racteristi cs is the fac t th at th e e o rga ni zati o ns
a re no t o nl y ove rsee n, but ge ne ra ll y
a lso run , o le ly o r la rge ly by vo lun teers. The indi viduals respo nsible fo r carry ing o ut exec uti ve and fin a ncial dutie
often ha ve se pa rate full -time j o bs and
rece ive no compe nsati o n fo r ass umin g
th e e additi o nal re po n ibiliti es. As a
result, the vo lunteers may not be as full y
co mmitted to the ta ks at hand a they
should be, and may therefore fa il to exerc ise a n adequ ate leve l of care in pe rformin g th eir du tie . Additio nall y, the e
vo luntee rs m ay rece ive littl e o r no
instructio n o n the prope r pelfo rmance o f
the ir res po nsibilitie .
These defic ie nc ies in dedi cation a nd
trainin g can have di re conseq ue nces fo r
an y o rga ni zati o n, and ma ny good, honest vo lunteer may unknowingly pelform
th e ir duti es inco rrectl y. Furth e rm o re,
o me vo lunteers may negligentl y breeze
through tasks that deserve more attention,
resulting in fi nanc ial losses o r administrati ve diffi culties fo r the orga ni zati on. At
the far end of the spectrum, unscrupulo us
volunteers may ex ploit these weaknesses to the ir ad vantage, as exemplified in
the First Coast Soccer Assoc iat io n case
(discus ed in Exhibit 3). Indi viduals looking fo r fra ud o ppOltunities will always
choose organi zatio ns with the ex ploitable
combinati o n of hi gh po te nti al rewards
and a poorl y imple me nted inte rnal control tructure.
Because small non profi t organi zati ons
rely so heav il y on the integrity and ability of their vo lunteers, uch e nti ties must
o btain background check, both criminal
and fin ancial, on all board me mbers and
JANUARY 2006 / THE CPA JOURNAL
EXHIBIT 1
Facts About Nonprofit Fraud
In a 2004 study of 508 occupational fraud cases*:
•
12.2% of the frauds occurred in the not-for-profit sector.
•
The median loss of cases in not-for-profit organizations was $100,000, up from
$40,000 in a similar study in 2002.
•
Billing schemes were the most frequent form of fraud in not-for-profit organi-
zations, accounting for 46.6% of the cases.
•
45.8% of the frauds occurred in organizations with fewer than 100 employees,
with a median loss of $98,000.
In a 2003 survey of more than 300 not-for-profit CEOs**:
•
62% said their board had not discussed the Sarbanes-Oxley Act.
•
Only 20% indicated that their board had implemented any governance policy
changes as a result of the Sarbanes-Oxley Act.
•
77% said they have a separate audit committee.
•
Just 16% said they have a “whistle-blower” policy in place.
* Association of Certified Fraud Examiners, 2004 Report to the Nation on
Occupational Fraud and Abuse.
** Grant Thornton LLP, National Board Governance Survey for Not-far-Profit
Organizations (www.grantthornton.com).
EXHIBIT 2
The Fraud Triangle
Pressure/lncentive
Pressure on employees to
misappropriate cash or
other organizational assets.
Opportunity
Circumstances that allow an
employee to carry out the
misappropriation of cash or
other organizational assets.
Rationalization
A frame of mind or ethical
character that allows
employees to intentionally
misappropriate cash or other
organizational assets and
justify their dishonest actions.
Sources: Occupational Fraud Abuse, by Joseph T. Wells, CPA, CFE (Obsidian Publishing Co., 1997);
Fraud Examination, by W. Steve Albrecht (Thomson South-Western Publishing, 2003).
61
officer, or at least on anyone handling
cash or other liquid asset. In many cases,
mall nonprofits that have suffered at the
hands of fraud ters would have uncovered
previous financial transgre sions or possible fraudu lent motivations simply by
conducting thorough background and reference check on the perpetrators prior
to hiring them.
Some organization may wish to go one
tep further and obtain fidelity bond to
cover those volunteers that will handle cash.
While fidelity bond coverage can mitigate
financial losses suffered due to fraud, organizations mu t be aware that mo t policies
require the nonprofit to establish and maintain sound accounting policies and procedures, and may refu e to pay indemnities
if!hi requirement i not met Organization
hould aI 0 con ider implementing a program to provide a certain level of financial-literacy education to board members and
employee with financial re pon ibilities.
Incorporating mandated training for indi-
EXHIBIT 3
Case Study: First Coast Soccer Association
Over a period of 22 months, Karen Edenfield was able to steal more than
$80,000 from a community’s children and their parents. As the volunteer treasurer
of a Jacksonville, Florida, youth soccer association, she managed the finances of
an organization that served more than 1,500 children and collected funds in
excess of $400,000 annually. In this role, Edenfield’s stated responsibilities included
maintaining the records of the organization’s funds, reconciling all of the association’s bank accounts, and paying the debts of the association in a timely manner.
During the last two years of her four years as treasurer, Edenfield wrote more
than 100 checks to herself, to cash, and to vendors for personal expenses.
Additionally, she set up a new “business” bank account for a fake company with
the same initials as a legitimate socce r association payee, in order to inconspicuously siphon funds from the organization. She then transferred the money from
this account to her personal account
Like many other frauds, the start of this embezzlement was motivated by personal financial difficulties, resulting from the recent loss of her previous job and
her husband’s previous businesses failures. A background check on Edenfield
would have revealed a history of financially questionable situations, including
numerous bad-check charges and a large tax lien levied against her husband
from a failed professional endeavor. However, the board of the association did not
Segregation of duties
may be difficult in small
organizations, but it is
especially crucial in
combating embezzlement
and fraud when many
transactions are
conducted in cash .
undertake such an investigation. Furthermore, although Edenfield was required to
submit frequent budgetary and accounting reports to the association’s finance
committee, the board members knew each other well and frequently exercised
only perfunctory oversight As a result, it took nearly two years for the board to
become suspicious enough to undertake a thorough examination of the organization’s finances.
Once under investigation, Edenfield admitted to the thefts, although the full
amount was never determined, due in large part to the organization’s poorly kept
financial records. Additionally, Edenfield told the authorities that the association’s
president had suggested that she make use of the organization’s funds, and had
showed her how to do so without drawing attention. Very shortly after Edenfield’s
sentencing, the president was charged with embezzling $5,000.
vidual with acce: to or oversight of the
nonprofit’ funds enhances the ability of the
organization’ volunteers to detect financial mi management
In addition, mo t mall nonprofit are
cash based, which can compound any i ues
or weaknes es present in the control environment. Marginally tempted employees
may find the acces ibility of ca h too
appealing and may engage in conduct that
they otherwi e would not. Con equently,
organization that receive much of their col-
62
Discussions with board members revealed that the occurrence and duration of
the fraudulent activity were facilitated by a systemic failure in the board governance process, due to two primary factors. First, parents, particularly those serving as board members, were often afraid to ask pointed questions for fear of a
retaliatory effect on their child’s soccer playing time. Second, cash payments to
many of the volunteers for their “service” had become an accepted form of practice within the organization.
JANUARY 2006 / THE CPA JOURNAL
lections and pay many vendors in cash need
control in place to verify and oversee the
cash recei pt and disbursement .
egregation of duties may be difficult in
small organizations, but it is especially crucial in combating embezzlement and fraud
when many tran actions are conducted in
cash. If nothing else, the duties of handling
and reconciling fund hould alway be
egregated, with one party re pon ible for
approving di bursements, another for physically receiving and distributing fund, and
a third for receiv ing bank statements and
performing the cash and bank reconciliation . Furthermore, checks should never be
igned in advance, and special authorization. such a dual signatures on checks,
should be required for cash di bursement
over a certai n dollar amount. While such
controls may not prevent a determined
fraudster. they decrease the opportunity for
di honest individual to embezzle the organization’s funds, and may therefore deter
many improprieties. Accordingly. organ izations mu t emphasize the importance of
adherence to uch control to employee
and board members. both during training
and throughout their tenure.
Responsibilities of the Accounting
Profession
Accounting profes ionals are in a unique
position to help small nonprofits fight fraud
(see Exhibit 4). Their ro le is threefold:
• A community members. CPA
hould get invol ved with the organization s they patronize and upport. By
attending board mee tin g. becoming
familiar with the organization’s policie .
and a king tough que tion s of those in
charge, they can bring an outside ource
of accountability to the individual
responsib le for the organization’ operation s and finances.
• By vo lunteerin g to se rve as board
member for small nonprofits. CPA can
provide some much – needed financial
expertise to the board governance function , and can faci litate the implementation of proper governance and internal
control policies throughout the organ ization.
• e PAs hould give back to the nonprofit
ctor by acting in their professional capacity. They can offer to perform pro bono
or reduced-fee as urance engagements, or
volunteer their time and proficiency to provide financial literacy and internal control
traini ng to the organization’ board members and employee .
Andrea McNeal, MAcc , CPA , is an
accounting writer/e ditor with th e
Association of Certified Fraud £mminers
ill Austill, Texas. Jeffrey Michelmall, PhD,
CPA, CMA, is an associate professor of
accoullting and information systems at
th e Ulliversity of North Florida ill
Jacksoll ville, Fla .
EXHIBIT 4
ePAs’ Role in Good Board Governance
•
Volunteer to be treasurer.
•
Volunteer to chair the finance committee.
•
Make sure that the organization has purchased adequate directors’ and officers’ insurance.
•
Require fidelity bonding for individuals handling cash.
•
Require background checks on all employees handling cash or working with children.
•
Help identify high-risk areas of the organization.
•
Volunteer to perform pro bono or reduced-fee audits, reviews, or bookkeeping services.
•
Volunteer to provide financial literacy and internal control training to the organization’s board members and employees.
•
Become involved in hiring full-time staff as appropriate, particularly those employees involved in the finance function.
JANUARY 2006 / THE CPA JOURNAL
63
Technical focus > ASIC
audit fees
and maintaining
audit quality
Reduced audit fees can present problems in terms of quality.
Story Douglas Niven FCA
In recent months, many members of the
profession have raised concerns with
ASIC over significant instances of audit fee
reductions. There have also been reports of
low-balling where large reductions in audit fees
are offered by audit firms to companies to win
new clients.
Audit fee reductions may have been sought
through a tender process. In other cases,
an existing auditor may have been asked to
reduce fees or may have taken pre-emptive
action and offered a reduction in fees. There
are also some reports of firms approaching
non-clients with offers of reduced fees.
ROLE OF DIRECTORS
Many companies seek tenders for audit
services with a focus on audit quality. They
correctly focus on matters such as expertise
and experience of the engagement team,
industry knowledge, the availability of specialist
skills to deal with complex issues and auditor
independence. However, some tenders
focus on reducing fees and saving costs,
inappropriately assuming that audit quality is
only an issue for the audit firm.
While there may be some instances where
an effective but more efficient audit is obtained,
there could be pressures in some audit firms
to limit the impacts on margins. Fee reductions
can pose the risk that corners are cut and
audit quality is compromised. This should be a
concern to directors and audit committees.
High quality independent audits are a key
contributor to quality financial reports and
broader market confidence.
Directors have a duty to take all reasonable
steps to ensure compliance with the financial
reporting requirements of the Corporations Act.
Directors and audit committees should rely
on internal systems, processes, the CFO and
management, as well as their own diligence
and enquiries to meet this obligation. While
the external auditor gives an independent
opinion that follows after the directors’ opinion
on a financial report, directors and audit
committees also have an important role to play
in ensuring that the independent audit of the
financial report is of a high quality and market
confidence is protected.
Many companies have been under pressure
to reduce costs due to the global financial crisis
or other factors. Audit fees have sometimes
been caught up in the pursuit of general cost
reductions, perhaps with a view to sharing the
pain. However, audit fees are usually a small
proportion of costs and reductions generally
don’t have a significant impact on a company’s
bottom line.
In the current economic conditions external
auditors continue to be faced with more difficult
judgements in areas such as assessing going
concern, impairments of assets and fair values.
This increases the time spent on an audit and
might be expected to have led to increases
rather than reductions in audit fees.
While auditors may maintain audit quality
and absorb fee reductions into reduced
margins, audit committee chairs should ensure
that the Board is fully informed of any risks
associated with audit fees reductions that don’t
arise from selling a business unit or similar
changes in the company’s activities.
The old saying ‘pay peanuts and you get
monkeys’ can apply.
ROLE OF THE AUDITOR
While it is not ASIC’s role to interfere in the
commercial decisions by companies and their
auditors on the setting of audit fees, ASIC is an
audit oversight regulator and is concerned that
audit quality is maintained.
Many companies, audit committees and
audit firms have focused on the importance of
high quality audits and have decided that it is
not appropriate to participate in reducing audit
fees. The firms have applied their engagement
acceptance and continuance procedures and
determined that it is not appropriate to retain
clients seeking significant fee reductions.
However, some audit firms may have
offered discounted fees in order to maintain
or grow revenues, contribute to fixed costs,
occupy staff during lean times or to maintain
or build market share. …
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