1 First Nation Audit Engagements, Part 1: Understanding the Reporting Entity By BRUCE HURST, CGA This article is the first in a three-part series by Mr. Hurst on the subject of First Nation Audit Engagements to be carried on PD Net. First Nation Reporting Entity Why is the FRNE subject to an audit? Governance Applicable GAAP Contractual agreements with INAC Conclusion This article is intended to assist CGAs and CGA firms undertaking the audit of a First Nation including Tribal Councils and First Nation Political Organizations. Historically, a First Nation was referred to as an Indian Band, Band, or Band Council and much of the current literature refers to a First Nation by these terms. For the purposes of this article, any of these interchangeable names will be referred to as a First Nation Reporting Entity or FNRE. For most CGAs performing audit services, the audit of an FNRE will likely be one of the more significant audit engagements undertaken. As with all engagements, the CGA must have the specific expertise and adequate resources, and must undertake the proper planning of the engagement. However, due to the size of the engagement and the unique time constraints, it is critical that the CGA be familiar with the intricacies of the FNRE and the myriad of contractual obligations, rules, and regulations with which a typical FNRE must comply. Part 1 discusses the definition and nature of the First Nation Reporting Entity and the features that make it different from other audit clients. It considers issues that the CGA must be particularly aware of when embarking on such an audit, such as FNRE control of organizations, governance, contractual funding agreements, and GAAP reporting requirements. It is imperative that audited financial statements of the FNRE be in acceptable format and provided in a timely manner to the many interested parties relying on them. The financial consequences in terms of delayed or missed funding opportunities can be significant. In addition to auditors, many other CGAs serve as consultants or employees of an FNRE. They can provide assistance in preparing their client/employer for the annual audit and often play an important role in making the audit a smooth and cost-effective process. This article will also be of assistance to them in understanding the audit process. First Nation Reporting Entity The FNRE can take on many forms, but the most common structure is a First Nation government or Band as defined by the Indian Act. 1 The First Nation government is typically governed by a Chief and Council, who are normally elected by the First Nation membership. However, in some instances the Chief can be a hereditary position. 1 Indian Act, Section 2.(1) (a) to (c). Published under the authority of the Minister of Indian Affairs and Northern Development, QS BB-A1.
2 Control of entities A First Nation government is a multi-faceted organization. Like other governments, such as a municipal government, it delivers a variety of services and programs to its membership. It also might establish other entities such as societies, trusts, taxation authorities, school boards, unincorporated enterprises, incorporated companies, limited partnerships, and joint ventures to carry out a particular function or role for the benefit of its membership. The auditor is well advised in the planning phase of the engagement to be aware of all entities that make up the FNRE. Today s FNREs are very active in establishing new initiatives that are often assigned to any one of the above entities. By knowing in advance the existence of any new companies or societies, the auditor can factor the new entity into the audit plan and commit proper resources to it. It can be quite disruptive to embark on the audit fieldwork only to discover later that a new company was created during the year and there are insufficient staffing resources to carry out the audit. Up until 1996 all of the above-noted entities generally reported separately. After then, the Public Sector Accounting Board (PSAB) required that all entities controlled by the Chief and Council be consolidated into one reporting entity now commonly called the First Nation Reporting Entity. The overriding principle of this concept is that the band membership should be able to see in one reporting document the financial position and operating results of all organizations under the direct or indirect control of their elected officials. Special types of entities In certain instances Tribal Councils have been created. A Tribal Council is a First Nation entity established by a number of First Nations. It is usually governed by a board or council typically made up of a representative from each member First Nation. This is usually done to pool resources in order that the Tribal Council can provide advisory services and programs to its member First Nations. Tribal Councils might also provide non-financially driven services such as a political voice in negotiations on matters that affect the member First Nations. In some cases, the member First Nations might not have sufficient funding resources to provide services in certain areas. If all member First Nations pool their resources, there can be enough funding to justify the provision of these services. For instance, any one member First Nation might not have enough funding to support an economic development officer, but if resources are pooled there will be sufficient resources to hire the officer and provide administrative support services for the benefit of all member First Nations. In addition to funding provided by the member First Nations, Tribal Councils often receive funding directly from funding agencies. Similar to Tribal Councils, First Nation Political Organizations have been established to provide a political/advocacy voice and similar services on behalf of First Nation people. A good example would be the Assembly of First Nations or Treaty Negotiation organizations in British Columbia. By definition, the First Nation Reporting Entity is comprised of all entities it controls either directly or indirectly. First Nation Audit Engagements, Part 1: Understanding the Reporting Entity 2
3 The First Nation reporting entity should comprise the organizations that are accountable for the administration of their financial affairs and resources to the First Nation s Council and are owned or controlled by the First Nation. 2 * For the most part, it is relatively straightforward for the FNRE and its auditor to determine which entities should be included. However, it is not always that simple to determine in some instances. The auditor must examine carefully the meaning of control in the context of whether or not a particular entity is part of the FNRE. As outlined in A Guide to First Nations Accounting and Reporting Standards, 3 the FNRE controls an organization in one or more of the following circumstances: A First Nation controls an organization when, without requiring the consent of others or changing existing legislative provisions, it has the authority to determine the financial and operating policies of that organization. This authority allows it to establish the fundamental basis for the conduct of the organization s financial affairs, as well as the deployment of its resources. (see PSAH, Section PS ) Evidence of control may be found in statutory provisions, including regulations and bylaws that provide the First Nation with the authority to determine the revenue-raising, expenditure, and resource allocation policies of the organization s governing board or its senior management. A First Nation may choose not to exercise its authority or actively participate in the implementation of its policies, or it does not need to be involved on a day-to-day basis; nevertheless, control exists by virtue of the First Nation s ability to do so. (see PSAH, Section PS ) The fact that an organization is governed by a publicly elected board is not, in itself, sufficient justification for excluding that organization from the FNRE. The governing board may only be responsible for implementing and administering financial and operating policies rather than for determining those policies. On the other hand, organizations with publicly elected boards that have the authority to determine their financial and operating policies would not be included in an FNRE. (see PSAH, Section PS ) One organization is presumed to control another entity when it has the right to appoint the majority of the voting members of the other entity s Board of Directors. If the Board of Directors is the same for both organizations, then one is presumed to control the other. (see CICA Handbook, Section ) In the absence of the right to appoint the majority of the voting members of another organization s Board of Directors, the FNRE would have to consider other characteristics of the relationship such as: a significant economic interest in the other organization; provisions in the other organization s charter or bylaws that cannot be changed without the FNRE s consent and that limit the other organization to activities that provide future economic benefits to the FNRE; or 2 A Guide to First Nations Accounting and Reporting Standards, Exposure Draft, February 2000, page 9, The Financial Reporting Entity, paragraph * This exposure draft was prepared by a joint Working Group of the Assembly of First Nations and CGA-Canada, but it was never officially adopted. The reference sources of information come largely from the CICA Public Sector Accounting Handbook. The document translated generic municipal government terminology into terminology appropriate to the First Nation community. It is therefore a useful reference source for this article. 3 A Guide to First Nations Accounting and Reporting Standards, Exposure Draft, February 2000, pages 9 and 10, The Financial Reporting Entity, paragraphs 3.02 to 3.06, 3.09 and First Nation Audit Engagements, Part 1: Understanding the Reporting Entity 3
4 the other organization s purpose is integrated with that of the reporting organization so that the two organizations have common or complementary objectives. (see CICA Handbook, Section ) Inclusion or exclusion of entities Certain organizations, for a variety of reasons, sometimes wish to remain autonomous and independent of Chief and Council. This situation can create tension between the parties, and often the diplomatic skills of the CGA are required to explain the logic and reasoning for the organization to be included in the FNRE financial statements and annual reports. Conversely, and of equal cause for concern, there are instances where an organization meets the criteria for inclusion in the FNRE, but the FNRE does not want the organization s financial results included in its financial statements. Usually this is because of the poor financial position of the organization, which in turn has a negative impact on the overall financial position of the FNRE. Again, the skills of the CGA are called upon to assist. The auditor must consider the impact of the exclusion of a controlled entity from the FNRE, and also the possibility of a qualification of the Auditors Report under such circumstances. The FNRE as a whole is subject to audit. It is possible, however, that one or more of the controlled entities have not been audited. The financial statements of the controlled entity(ies) might have been prepared on a Review Engagement or Notice to Reader basis. The auditor must assess whether or not this is appropriate, and should look at such situations in the context of the materiality of the controlled entity to the FNRE. Refer to Appendix 1 for an Organizational Chart of a Typical FNRE. Why is the FNRE subject to an audit? Governance First Nation Reporting Entities receive Federal and/or Provincial government funding either directly or indirectly from member FNREs, or other FNREs and related agencies. The Government of Canada and Provincial Governments are accountable for the public funds they administer. In order to ensure that public funding has been expended for the intended purposes, the recipients of public funding must be subject to audit and reporting to the relevant government authority. Although an FNRE is subject to audit due to the requirements of external parties such as funding agencies, most FNREs have written into their charter, bylaws, or policies the requirement to have their financial affairs subject to audit. This is simply good governance and common sense for an organization charged with the fiduciary responsibility of administering the resources of its members. The century-old Indian Act deals with how the Government of Canada, through its agent the Department of Indian and Northern Affairs DIAND (or more commonly known now as Indian and Northern Affairs Canada INAC), interacts with Indian Bands and Indian people. The Act was created under vastly different political, social, and economic circumstances, yet has had relatively few amendments to it. It covers a variety of areas including Council Elections, Membership, Land Management, Environmental Protection of Reserve Lands, Estates, and Management of Indian Moneys. Since it was designed to facilitate the interaction between government and First Nations people, it gives very little direction on how the Chief and Council interact with their members. First Nation Audit Engagements, Part 1: Understanding the Reporting Entity 4
5 The general direction of the First Nations community is towards self-government. As this evolves, the more advanced First Nations are replacing the Indian Act with modern agreements such as constitutions, treaties, and self-government agreements. Further, the role of INAC is changing. Up until the last two decades, INAC had direct control over funding and was very involved in program and service delivery. Today, INAC transfers more than 80% of its funding directly to First Nations communities for the delivery of programs and services intended to improve community well-being. It also uses funding arrangements that provide increased local decision-making authority and accountability to First Nations. In the wake of this transition, INAC s role has become more of a funding agency than a service provider. First Nations Councils are thus assuming governance roles and responsibilities similar to other levels of government in Canada. 4 As First Nations move increasingly towards self-government, they are becoming less and less associated with the Indian Act. At the same time, Councils are becoming more accountable to their membership, who are the primary users for which audited financial statements are prepared. Nowadays, all stakeholders, including other levels of government, funding agencies, financial institutions, suppliers of goods and services, business partners, and coexisting non-first Nations communities commonly look to the Chief and Council to have a legal and administrative framework in which to govern their First Nation. The auditor should be familiar with the Indian Act; however, in today s environment other information sources, such as First Nations governing doctrines, are of higher significance and have a greater impact on the audit engagement. For a more comprehensive discussion on governance, refer to the First Nations Governance Handbook A Resource Guide for Effective Councils, available at most INAC offices. Applicable GAAP It is not the intent of this article to discuss in detail the GAAP requirements associated with an FNRE. However, the CGA should be familiar with the GAAP reference sources and guiding pronouncements that apply to an FNRE. In the past few years there has been a movement towards government entities being more accountable to citizens (members, constituents, and so on). In light of this, considerable effort has been expended to define what an FNRE is, what should be included and excluded in the definition, and what accounting standards are most applicable to it. It has become very apparent to all involved in accounting and reporting for an FNRE that the standards for municipal governments are applicable to most of the entity, while the standards for not-for-profit organizations and for profit-oriented organizations are applicable to other parts of the entity. The challenge is to bring all of these issues together in one comprehensive guideline so that the activities of the First Nation can be reported in a manner that is usable and understandable by all stakeholders. The primary entity of the FNRE is the First Nation Government. The GAAP rules applicable to local governments are found in the CICA Public Sector Accounting Handbook as produced by the Public Sector Accounting Board of the Canadian Institute of Chartered Accountants (CICA). Specifically, the auditor should refer to Sections PS 1700 and 1800 for recommendations that apply to local municipal governments. 4 First Nations Governance Handbook A Resource Guide for Effective Councils, page 11, third paragraph. Published under the authority of the Minister of Indian Affairs and Northern Development, QS EE-A1. First Nation Audit Engagements, Part 1: Understanding the Reporting Entity 5
6 GAAP applicable to the not-for-profit components of the FNRE such as Societies, School Boards, and Taxation Authorities can be found in Sections 4400 to 4460 of the CICA Handbook. Where the above-noted specialized areas are silent on a particular matter, the standards of the CICA Handbook prevail. The commercial activities of the FNRE are accounted for in the Enterprise Fund (discussed in Part 2). The enterprises conducting the commercial activities are subject to the normal GAAP requirements outlined in all sections of the CICA Handbook. INAC publishes an annual reporting handbook for First Nations, Tribal Councils, and First Nation Political Organizations. 5 This publication is a must-read for FNRE auditors as it outlines the reporting requirements for INAC. The handbook does not go into a great deal of GAAP detail, but it does outline the specific financial reporting requirements for the purposes of accountability of federal Transfer Payments. The previously referenced Guide to First Nations Accounting and Reporting Standards stresses in its Background that the Guide does not, in the opinion of the AFN-CGA-Canada Working Group, create new GAAP. It has, however, pulled together into one document the GAAP from all of the above-noted sources. In addition to the GAAP sources mentioned, the CGA Public Practice Manual (PPM) provides general guidance on audit issues that the CGA must be familiar with, and, depending on the province, may contain information pertinent to the auditing of First Nation entities. Contractual agreements with INAC Every First Nation that receives funding directly from INAC has a funding agreement with INAC. A contractual agreement will be entered into generally every year or every five years depending on the type of contract. Some First Nations receive their funding from an intermediary source such as a Tribal Council. The contractual arrangements with the Tribal Council would typically be very similar to an agreement that they would have entered into had they dealt with INAC directly. This article is not intended to go into the details of these contracts, but the following is a summary of two possible agreements: Comprehensive Funding Agreement a single-year agreement that is negotiated and renewed each year Canada First Nations Funding Agreement a multi-year (usually five years) agreement to be used by First Nations that are advanced enough in their administration to allow them, within certain parameters, to allocate the funding resources as they see fit First Nations having financial difficulties may be operating under a Remedial Action Plan with INAC either voluntarily or imposed. In this circumstance, the FNRE will likely have entered into a Comprehensive Funding Agreement. The auditor must be familiar with the specific terms and conditions of the Remedial Action Plan. 5 INAC Year-End Reporting Handbook for First Nations, Tribal Councils, and First Nation Political Organizations, Annex G Schedule of Federal Government Funding. Updated April 23, See INAC website (www.inac.gc.ca) for a downloadable PDF version. First Nation Audit Engagements, Part 1: Understanding the Reporting Entity 6
7 Conclusion Within each agreement the funding is categorized as follows: Contributions. These can be further categorized as Regular Contributions and Flexible Transfer Payments. Regular Contributions refers to funding that is restricted to specific purposes. Should the contribution not be fully expended for these purposes, it will likely be recovered at the end of the fiscal year. Flexible Transfer Payments provide more latitude in that if the intended program has fulfilled its intended purpose, the surplus generally can be allocated to other purposes within guidelines set out in the agreement. Capital Contributions. Similar to Regular Contributions the capital funding is restricted to use for a specified capital project. If a surplus remains at the end of the project, the FNRE can apply to have the surplus re-allocated to another capital project, but it cannot be allocated to any program other than a capital project approved by INAC. Grants. This type of funding is generally used for Band Support and can be used at the discretion of the FNRE. It is important that the auditor understand the nature of the applicable contractual agreement as it will have a bearing on determination of recoverable surpluses and proper allocations of funding among the various programs. Understanding what makes the audit of a First Nation different from other types of audits is essential for the CGA taking on such an engagement. Awareness of the unique requirements of this type of audit can go a long way to ensuring that it is conducted as smoothly, efficiently, and cost effectively as possible. Part 1 looked at the nature and structure of the First Nation Reporting Entity (FNRE), the circumstances under which an organization is controlled by the FNRE, and the CGA s role in assisting when difficulties arise with respect to the inclusion or exclusion of an organization within the FNRE. This Part also considered the way in which First Nation communities are increasingly moving towards self-government, with new types of agreements gradually replacing the old Indian Act. The GAAP requirements applicable to First Nation audits were also discussed and reference sources provided. Finally, Part 1 presented a summary of the contractual funding agreements an FNRE may be bound to. Part 2 discusses the different Funds common to First Nations and the financial and reporting requirements the auditor should be familiar with for each type of Fund. It also describes the audit approaches that can be used and highlights the areas specific to the FNRE that the auditor should be aware of in planning and executing the audit. Part 3 considers the various logistical issues that are characteristic of a First Nation audit and which add a special dimension to the audit engagement. Bruce Hurst has served as a Certified General Accountant since 1983, and is a graduate of the Canadian Credit Institute. In 1999, he obtained his Certified Financial Planner (CFP) designation and has completed the CGA in-depth tax program. With his extensive experience in managing and directing many of Reid Hurst Nagy's accounting and tax advisory functions, Mr. Hurst is a valued public practice reviewer and active member of the Ethics and Public Practice Committees for CGA-BC. Mr. Hurst played a lead role in the development of a comprehensive audit program for First Nations and served as a representative on the Technical Advisory Group on First Nations Financial Reporting. He and his firm have provided audit and consulting services to a wide range of First Nation related entities over the past 25 years. First Nation Audit Engagements, Part 1: Understanding the Reporting Entity 7
8 This article is the first in a three-part series by Mr. Hurst on the subject of First Nation Audit Engagements to be carried on PD Net. Appendices Appendix 1 Organizational Chart of a Typical FNRE Appendix 2 Further information First Nation Audit Engagements, Part 1: Understanding the Reporting Entity 8