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| Commentary on ECFA Standard 3 |
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Financial Statements
"Each member is required to submit complete and accurate financial statements as defined by ECFA policies."
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The financial statements (and the disclosure of the financial statements) are key components of transparency, both within the ministry and to donors and the public. This flows directly from biblical principles: "This is the verdict: Light has come into the world, but men loved darkness instead of light because their deeds were evil. Everyone who does evil hates the light, and will not come into the light for fear that his deeds will be exposed" (John 3:19-20 NIV).
Transparency serves to deter improper diversion of funds and other misdeeds. It also provides a defense to critics and a witness to both believers and nonbelievers. When Jesus was arrested, He said to the crowd, "Am I leading a rebellion, that you have come out with swords and clubs to capture me? Every day I sat in the temple courts teaching, and you did not arrest me" (Matthew 26:55 NIV). The openness of His public actions created a significant contrast to His middle-of-the-night arrest.
The Apostle Paul cites the fact that his deeds were done openly as one basis for his authority over the Thessalonians. "You are witnesses, and so is God, of how holy, righteous and blameless we were among you who believed" (1 Thessalonians 2:10 NIV). Being transparent with one another provides credibility and authority.
The annual audit by an independent certified public accounting firm, required for certain members, helps ensure—and is evidence of—financial accountability to an organization's constituencies. The independent auditor tests the data underlying the financial statements to form an opinion on the fairness of their presentation in accordance with accounting principles generally accepted in the U.S. The auditor's standard report provides reasonable assurance that the financial statements are free of material misstatements. Knowing they can rely on the accuracy of the organization’s financial statements, the board and management can make wise and perceptive policy decisions.
The annual review by an independent certified public accounting firm, permitted for certain members, provides limited assurance of the reasonableness of the financial statements presented. Although not as comprehensive as an audit, a review provides more assurance than a compilation. A review report states that: 1) the accountants do not express an opinion on the financial statements, and 2) based on their review, they are not aware of any material modifications that should be made to the financial statements.
The annual compilation by an independent certified public accounting firm, permitted for certain members, is the gathering of financial information and the development of financial statements for an organization. A compilation involves no assurance on the financial statements, as the accountant simply assembles the financial statements for the organization. The independent CPA’s participation with the financial statements will often help stakeholders feel that the statements are prepared with knowledge of applicable standards.
For compilations and reviews, the independent CPA must present the compiled or reviewed financial data according to GAAP or on the modified cash basis of accounting. If the modified cash basis of accounting is used, the financial statements must include the recognition of property and equipment as assets, depreciation as expense, and debt, other than trade payables and ordinary accruals, as liabilities.
Although obtaining financial statements prepared by a CPA firm is usually voluntary, it has become a common and expected practice among nonprofit organizations. Federal laws governing tax-exempt organizations do not require audits unless federal funds are provided. However, many boards and resource providers (such as donors, foundations, and financial institutions) see the involvement of an independent CPA firm as an essential and truly wise investment.
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Obtaining a quality audit, review or compilation of financial statements. Even with rigorous efforts by professional bodies governing the practice of Certified Public Accountants (including State Boards of Accountancy, State CPA Societies, and the American Institute of Certified Public Accountants) to improve quality and require reviews of CPAs, not all audits, reviews, or compilations are created equal. The quality of this work is directly impacted by:
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The experience level of personnel assigned to the engagement (a higher ratio of qualified partner and manager time will normally increase quality and some of the value-added benefits)
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The experience of assigned personnel with similar nonprofit organizations, the competencies of the personnel, as well as the extent of time devoted to nonprofit audit, review, and compilation and advisory services
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The emphasis and priority of the CPA firm on nonprofit audits
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The firm’s commitment to competency and continuity of the engagement team from year to year to provide audit, review, or compilation efficiency and a high level of knowledge about the organization that can result in cost-effective services
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Reasonable engagement fees that allow adequate time and attention to performing quality service and value-added benefits—unreasonably low fees may lower the services to the minimum requirements of professional standards
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Selection of a CPA firm. Some organizations routinely request proposals from other CPA firms to evaluate the cost of their audit, review or compilation. While it is important to be certain that the cost is reasonable in light of the quality and value of an audit, focusing too much on cost can be detrimental to the health of the audit and ultimately to the organization.
If an organization truly values the audit, review or compilation and desires the benefits that can come from an independent firm in helping it maintain best practices, anticipate and avoid problems, and assess its performance, then cost should be secondary to quality. Value is a correlation of both quality and cost.
Initial screening of potential CPA firms should be based solely on their industry experience, professional qualifications, the expertise of the engagement team, and its ability to provide the highest quality and best value of audit, review, or compilation services. Following that screening, the cost of the services can more truly be assessed as to “value,” leading to a selection that is prudent based on both quality and cost.
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Rotation of CPAs. The rotation of CPAs may not be the key to effectiveness of the services and in some cases may actually be counterproductive. Expertise in the respective industry coupled with objectivity may be the most important aspect. Recent studies have re-evaluated and questioned the benefits of frequent rotation. Frequent CPA changes do not guarantee the prevention of fraud.
The board, or a committee consisting of a majority of independent members, should annually assess the performance and effectiveness of the independent CPA firm and its engagement team. This should include but not be limited to: considering the CPA team's objectivity; assessing key risk areas; evaluating the strategy for the services—including its scope and the nature of testing, if appropriate; innovative thinking rather than reliance on prior results and assumptions; maintaining professional skepticism, and understanding relationships that could impair objectivity.
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CPA independence. The board should be certain that the CPA firm is independent and objective in performing its duties. The board should identify any threats to such objectivity and analyze the significance of such threats. Objectivity does not require that the CPA firm is completely free of all factors that might affect the ability to make unbiased audit decisions but rather that the CPA firm is free from those factors that rise to the level of compromising that ability.
Factors that may pose threats to independence and objectivity include: self-interest (CPA acts in his or her own emotional, financial, or other personal interest), self-review (CPA audits, reviews, or compiles his or her own work or the work of a colleague), and familiarity (CPA is influenced by a close relationship with a client). The following may constitute a conflict of interest for the CPA: a) performance of management functions, b) close family relationships, and c) financial involvement in other service providers or investments. If a CPA serves on the board or is an employee of an organization for which the CPA is providing services, the CPA is not considered by ECFA as independent with respect to the organization.
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Auditing standards. Auditing standards generally accepted in the United States of America (GAAS) are policies, guidelines, and procedures that an auditor is required to follow in performing an audit in order to be render an opinion on an organization's financial statements. This series of pronouncements is set forth by the American Institute of Certified Public Accountants (AICPA). Among many factors to be considered is the "scope" of the audit, which neither the organization nor the particular circumstances of its operations should limit.
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Accounting principles. Accounting principles generally accepted in the United States of America (GAAP) are those written principles established by the Financial Accounting Standards Board (FASB), the AICPA, and other published literature. These principles set forth how specific transactions should be reported; e.g., investments should be reported at fair value, while property and equipment should be reported at depreciated cost. In contrast to other forms of accounting, such as the modified cash basis, GAAP financial statements are prepared on the accrual basis. Certain standards and disclosures are additionally required.
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Review and compilation standards. Statements on standards for accounting and review services (SSARS) are policies, guidelines, and procedures that a CPA is required to follow in performing a compilation or review. This series of standards is set forth by the American Institution of Certified Public Accounts (AICPA). These standards establish the relationship, level of care, and procedures to be established by the CPA firm conducting the compilation or review services for an organization.
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Presentation of financial statements to satisfy ECFA requirements for GAAP presentation. According to FASB Statement No. 117, paragraph 6, a complete set of financial statements of a not-for-profit organization shall include:
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a statement of financial position as of the end of the reporting period (also referred to as a balance sheet)
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a statement of activities for the reporting period (also referred to as a statement of revenues and expenses)
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a statement of functional expenses required for Voluntary Health and Welfare Organizations and encouraged for all others as a separate statement, schedule, or note
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a statement of cash flows for the reporting period
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accompanying notes to the financial statements
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Summary.
Financial statements prepared by an independent CPA is a key element in informing donors and other constituencies about the organization's financial affairs. It requires independent, external attestation and provides a measure of assurance about the integrity of the organization and its worthiness to receive support.
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