Practice Note. 11(Revised) March 2011 THE AUDIT OF CHARITIES IN THE UNITED KINGDOM

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1 March 2011 Practice Note 11(Revised) THE AUDIT OF CHARITIES IN THE UNITED KINGDOM

2 The Auditing Practices Board (APB) which is part of the Financial Reporting Council (FRC), prepares for use within the United Kingdom and Republic of Ireland: Standards and guidance for auditing; Standards and guidance for reviews of interim financial information performed by the auditor of the entity; Standards and guidance for the work of reporting accountants in connection with investment circulars; and Standards and guidance for auditors and reporting accountants integrity, objectivity and independence with the objective of enhancing public confidence in the audit process and the quality and relevance of audit services in the public interest. The APB comprises individuals who are not eligible for appointment as company auditor, as well as those who are so eligible. Those who are eligible for appointment as company auditor may not exceed 40% of the APB in number. Neither the APB nor the FRC accepts any liability to any party for any loss, damage or costs howsoever arising, whether directly or indirectly, whether in contract, tort or otherwise from any action or decision taken (or not taken) as a result of any person relying on or otherwise using this document or arising from any omission from it. The purpose of Practice Notes issued by the APB is to assist auditors in applying auditing standards of general application to particular circumstances and industries. Practice Notes are persuasive rather than prescriptive. However, they are indicative of good practice, even though they may be developed without the full process of consultation and exposure used for auditing standards. This Practice Note replaces Practice Note 11: The audit of charities in the United Kingdom (Revised) which was issued in December # Financial Reporting Council 2011 ISBN

3 PRACTICE NOTE 11 (REVISED) THE AUDIT OF CHARITIES IN THE UNITED KINGDOM Contents Page Preface 3 Introduction 5 Legislative and regulatory framework 6 Charity governing documents Accounting and auditing requirements Reports to third parties Reporting direct to the charity regulators Special features of charities 10 Governance Operating structures and branches Sources of income Restricted funds Charity tax and trading income The audit of financial statements ISAs (UK and Ireland) 200 Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with International Standards on Auditing (UK and Ireland) Agreeing the Terms of Audit Engagements Quality Control for an Audit of Financial Statements The Auditor s Responsibilities Relating to Fraud in an Audit of Financial Statements Section A Consideration of Laws and Regulations in an Audit of Financial Statements 29 Section B The Auditor s Right and Duty to Report to Regulators in the Financial Sector Communication with Those Charged with Governance Communicating Deficiencies in Internal Control to Those Charged with Governance and Management Planning an Audit of Financial Statements 47 1

4 315 Identifying and Assessing the Risks of Material Misstatement Through Understanding of the Entity and Its Environment Materiality in Planning and Performing an Audit The Auditor s Responses to Assessed Risks Audit Considerations Relating to an Entity Using a Service Organisation External Confirmations Initial Engagements Opening Balances Analytical Procedures Auditing Accounting Estimates, Including Fair Value Accounting Estimates and Related Disclosures Related Parties Subsequent Events Going Concern Written Representations Special considerations Audits of Group Financial Statements (Including the Work of Component Auditors) The Auditor s Report on Financial Statements Section A The Auditor s Responsibilities Relating to Other Information in Documents Containing Audited Financial Statements 99 Summary Financial Information and Summarised Financial Statements 102 Appendices 1. Charity accounting and audit regulations in the United Kingdom Publications Example paragraphs for insertion into an engagement letter Illustrative example statements of trustees responsibilities The duty of the auditor to report matters of material significance to CCEW and OSCR Legislative background to auditor s reports on charities financial statements Definitions Some significant topics relevant to audits of charities 148 2

5 PREFACE This Practice Note contains guidance on the application of auditing standards issued by the Auditing Practices Board (APB) to the audit of charities in the United Kingdom. The Practice Note is intended to assist auditors in applying the requirements of, and should be read in conjunction with, International Standards on Auditing (ISAs) (UK and Ireland), which apply to all audits undertaken in the United Kingdom in respect of accounting periods ending on or after 15 December This Practice Note sets out the special considerations relating to the audit of charities which arise from individual ISAs (UK and Ireland). The Practice Note does not, and is not intended to, provide detailed guidance on the audits of charities, so where no special considerations arise from a particular ISA (UK and Ireland), no material is included. This Practice Note supersedes the guidance included in Practice Note 11 The audit of charities in the United Kingdom (Revised) issued by the APB in December 2008, and takes account of significant regulatory and other developments affecting charities since that date, including: new ISAs (UK and Ireland) which were published in October 2009; the Charities Accounts (Scotland) Amendment Regulations 2010; the Charities Act (Northern Ireland) 2008, where references to specific requirements are given in anticipation of these being commenced. The legal framework for charities is complex and different requirements exist depending on the charity s constitution, the part of the UK in which it is established and the type of activity it undertakes. The Practice Note contains guidance for auditors; the APB s intention is not to provide a comprehensive commentary on all aspects of law that may apply to a charity s operations, and the Practice Note should not be used as a substitute for appropriate consultation with legal advisers. The Practice Note is based on the legislation and regulations that have been published at 28 February Further changes to the legislative framework are anticipated but are not addressed in this guidance including: the introduction of a new form of charity, a Charitable Incorporated Organisation (CIO); consolidation of charity legislation in England and Wales in a new Charities Act; changes to the regulation of charities in Northern Ireland; and changes to reporting thresholds. 3

6 This Practice Note has been prepared with advice and assistance from staff of the Charity Commission for England and Wales (CCEW), the Office of the Scottish Charity Regulator (OSCR), and the Charity Commission for Northern Ireland (CCNI). 4

7 INTRODUCTION 1. The purpose of this Practice Note is to give guidance on the application of ISAs (UK and Ireland) to the audit of charities in the United Kingdom. The following paragraphs identify the special considerations arising from the application of the requirements of ISAs (UK and Ireland) to the audit of charities, and to suggest ways in which these can be addressed. Extracts from ISAs (UK and Ireland) are indicated by grey-shaded boxes below. This Practice Note does not contain commentary on all of the requirements included in the ISAs (UK and Ireland) and reading it should not be seen as an alternative to reading the relevant ISAs (UK and Ireland) in their entirety. In addition, where no special considerations arise from a particular ISA (UK and Ireland), no material is included. 2. Audits of charities required by legislation in the United Kingdom may only be carried out by a registered auditor, or other persons authorised by statute or to whom, in England and Wales, the Charity Commission (CCEW) may grant dispensation 1. Registered auditors are required to comply with ISAs (UK and Ireland) when conducting audits. This principle applies to charity audits, irrespective of their size, but the way in which the standards are applied needs to be adapted to suit the particular characteristics of the entity audited. 3. Where an audit is being performed on an entity within the Public Sector in the United Kingdom this Practice Note complements Practice Note 10: the Audit of Financial Statements of Public Sector Bodies in the United Kingdom (Revised). 4. Audit exemption thresholds are established in UK legislation and an independent examination will often be permitted instead of an audit. Guidance on the conduct of independent examinations in England and Wales has been published by CCEW 2 and best practice guidance on independent examination of Scottish Charities has been prepared by the Office of the Scottish Charity Regulator (OSCR) 3. An independent examination is significantly different from an audit: in particular the independent examiner must be an individual rather than a firm. Independent examiners of certain charities 4 must hold professional qualifications, as specified in the relevant legislation, but there is no requirement for the independent examiner to be a registered auditor. This Practice Note does not provide guidance on independent examinations. 1 The dispensation arises where a charity is audited under another statutory regime which is considered sufficiently similar to the audit requirements of the Charities Act 1993 or audited under arrangements which are sufficiently similar. CCEW can also give a dispensation from audit under the Charities Act 1993 in exceptional circumstances allowing an independent examination in place of an audit. 2 CC32 Independent Examination of Charity Accounts: Examiners Guide. 3 Independent Examination: Guidance for charities and independent examiners 4 Requirements for external scrutiny of financial statements are set out in Appendix 1. 5

8 LEGISLATIVE AND REGULATORY FRAMEWORK 5. The legal framework for charities is complex, and different requirements exist depending on the charity s constitution, the part of the United Kingdom in which the charity is established, or is active, and the type of activity which it undertakes. In addition, charities are affected by the whole range of national legislation applicable to business entities, such as employment, tax and pensions law and health and safety regulations. 6. The main laws that relate to a charity s financial statements and audit are: All company charities: the Companies Act 2006 (CA 2006) Charities in England and Wales; the Charities Act 1993 (as amended by the Charities Act 2006); All charities registered in Scotland with OSCR: the Charities and Trustee Investment (Scotland) Act 2005 (2005 Act (Scotland)); Non-company charities in Northern Ireland: the Charities Act (Northern Ireland) 1964; All charities registered in Northern Ireland with the The Charity Commission for Northern Ireland (CCNI): the Charities Act (Northern Ireland) 2008, as and when the relevant sections of the Act are commenced. 7. The legal requirements in relation to accounting and audit for charities in Scotland and Northern Ireland differ in some respects from those applicable in England and Wales, and it is important for auditors to understand what legislation applies. The legislation relating to accounting and audit applicable to each jurisdiction in the United Kingdom is summarised in Appendix 1 Charity accounting and audit regulations in the United Kingdom. 8. The regulatory framework is also complex. The primary regulators for charities (which are referred to as the charity regulators in this Practice Note) are: England and Wales: the Charity Commission (CCEW); Scotland: Office of the Scottish Charity Regulator (OSCR); Northern Ireland: The Charity Commission for Northern Ireland (CCNI). Appendix 1 to this Practice Note provides a summary of the regulatory framework for each of these jurisdictions. Additionally some charities may also be subject to other regulatory regimes, for example, housing associations 5 and higher and further education establishments. 5 Practice Note 14 deals with the audit of registered social landlords in the UK. 6

9 9. CCEW has powers under legislation to act for the protection of charity property where in the course of an inquiry it is satisfied that there has been misconduct or mismanagement in the administration of a charity, or that it is necessary to act for the purposes of protecting the property of a charity or to secure its proper application for the purposes of the charity. These powers include: issuing directions to the trustees; suspension of any trustee, officer, agent or employee; appointment of additional trustees; removal of a trustee, officer, agent or employee; freezing of property, restrictions on transactions or payments; and appointment of an interim manager. In Scotland, OSCR has similar powers under sections 28, 31 and 34 of the 2005 Act (Scotland). In Northern Ireland, CCNI will have similar powers under section 33 of the Charities Act (Northern Ireland) 2008, once that section has been commenced. 10. Charities with significant operations in Scotland but established in another jurisdiction are required to register separately with OSCR and to comply with the 2005 Act (Scotland) and regulations made thereunder. OSCR has prepared guidance on registration entitled Seeking charitable status in Scotland 6. The guidance includes a number of selfassessment questions to assist in determining whether registration with OSCR is required and, although it refers to English and Welsh charities, the principles apply to Northern Irish charities with operations in Scotland. OSCR introduced a bespoke monitoring programme for English and Welsh charities that are entered on the Scottish Charity Register in May In addition to relevant charities legislation and regulations, charities may be subject to other regulatory regimes. Examples of bodies which, when constituted as charities, may be subject to additional and/or different accounting and audit requirements include companies, registered social landlords, friendly societies, non-departmental public bodies (NDPBs), universities and further education colleges. Statements of Recommended Practice (SORPs) are issued in relation to a number of such sectors, and need to be taken into account in preparing charities financial statements. Charity governing documents 12. The governing documents of charities establish the purpose and constitution of each charity. They may also require an audit to be undertaken (which may supplement, but not 6 The full title is Seeking charitable status in Scotland: Guidance for England and Wales charities on registration with the Office of the Scottish Charity Regulator. 7

10 derogate from, a statutory requirement for an audit). There is no such thing as a standard charity; the governing documents of each charity are individual and will need careful consideration to identify matters relevant to the audit such as particular charitable objects and any special powers conferred on the trustees. 13. The terms of charities governing documents tend to be narrower than those for commercial entities, the objects of which are usually very generally phrased. This means that the auditor is much more likely to be faced with a situation where a charity has acted ultra vires or in breach of trust than would be the case with an entity in the commercial sector. 14. Any transaction by a charity that is undertaken outside its objects and powers is potentially a breach of trust. Such transactions require particular consideration. Noncompliance with the governing document is also likely to have financial implications for the charity, and thus needs to be taken into account in determining whether the financial statements give a true and fair view. Charities are broadly exempt from direct tax on their income where expenditure is applied for a charitable purpose and therefore if transactions are outside the objects, or they involve significant benefit to the donor (i.e. tainted donations), there may also be tax implications. In addition such transactions may give rise to a need to report the matter to the charity regulator. Accounting and auditing requirements 15. The financial statements of a charity which are prepared to give a true and fair view under the requirements of the Charities Act 1993, the 2005 Act (Scotland), or the Charities Act (Northern Ireland) 2008 (when the relevant sections are commenced) are required to be prepared in accordance with UK Generally Accepted Accounting Practice (UK GAAP) 7. Additionally, charitable companies comply with company legislation which requires accounts to be prepared in accordance with applicable law and regulations, and UK accounting standards. 16. UK GAAP comprises law and accounting standards issued by the Accounting Standards Board, including where applicable the FRSSE. Charities cannot currently apply International Financial Reporting Standards. 17. The Statement of Recommended Practice Accounting and Reporting by Charities (the Charities SORP) is an interpretation of UK accounting standards for the charity sector and is intended to apply to the accounts of all charities in the United Kingdom required to give 7 Trustees of small non-company charities in England and Wales and Scotland which are within the income thresholds defined by legislation may elect to prepare financial statements on a receipts and payments basis. Financial statements prepared on a receipts and payments basis are not required to give a true and fair view, but to be properly presented. 8

11 a true and fair view (unless a separate SORP exists for a particular class of charities 8 ). The Charities SORP issued in March 2005 by CCEW and other SORPs relevant to particular categories of charities are likely to be revised once the ASB proposals for the future of UK GAAP including the adoption of IFRS for SMEs are implemented and the proposed Public Benefit Entities standard is published. Since the publication of the Charities SORP, FRS 30: Heritage Assets, which has particular relevance to the recognition of some charity assets, has also been published and applies to accounting periods beginning on or after 1 April FRS 18 Accounting Policies requires an entity to adopt the most appropriate accounting policies to its particular circumstances for the purpose of giving a true and fair view in preparing financial statements. For charities it is normally necessary to follow the guidance set out in the Charities SORP in order to give a true and fair view, as required by legislation. A statement that the financial statements have been prepared in accordance with the relevant SORP, and details of any departures from the recommended practice and disclosures is also required. 19. Apart from any requirement for audit in the governing document, the statutory requirement for audit depends on the size of the charity, as defined in relevant legislation or regulations. Audit exemption thresholds are described in Appendix 1. For company charities the interaction between the thresholds established in CA 2006, the Charities Act 1993, the regulations made under the 2005 Act (Scotland) and the 2008 Northern Ireland Act need to be considered. Charities registered in both England and Wales and Scotland will report under both the English and Welsh legislation and the Scottish legislation. 20. A number of non-departmental public bodies are charities. The auditors of such bodies are responsible for expressing an opinion on both the view given by the body s financial statements and on whether the expenditure of the body is in accordance with the purposes intended by Parliament 9. Furthermore, for some bodies where the auditor is appointed by the Secretary of State, there may be a requirement in the auditor s terms of engagement for it to report to the sponsor department any significant matters arising out of the audit work, including losses incurred owing to failures of internal control, misconduct, fraud or other irregularity. Reports to third parties 21. In addition to the auditor s report on the financial statements, auditors of charities may be requested to provide additional reports in relation to grant-funded projects, giving 8 Where sector specific SORPs exist e.g. for Registered Social Landlords, and Further and Higher Educational Institutions, the specialist SORP takes precedence. 9 Practice Note 10 (Revised) provides guidance for auditors of public bodies on reporting on the regularity of expenditure. 9

12 assurance on matters such as the proper use of money and costs to completion. This Practice Note does not cover such additional engagements 10. Reporting direct to the charity regulators 22. In addition to the primary objective of reporting on financial statements, auditors of charities may have an additional statutory duty to report in certain circumstances to the relevant charity regulator. This duty is discussed in the section giving guidance on ISA (UK and Ireland) 250 section B: The Auditor s Right and Duty to Report to Regulators in the Financial Sector. SPECIAL FEATURES OF CHARITIES 23. There is a great diversity of charities in terms of constitution, activity and size. The smallest are local, single activity operations sometimes run by trustees with limited financial expertise, whereas the largest are international organisations with multiple activities, employing many full-time professional staff and operating sophisticated accounting systems. Despite this diversity there are special features of charities which will influence the planning and performance of all charity audits. Governance 24. Although the detail of regulation differs between different parts of the United Kingdom, the general principles governing the duties of trustees are the same regardless of what they are called in the charity s governing document 11. Trustees: have the general duty of protecting all the charity s property; ensure that all the charity s funds are properly applied; are responsible for the solvency and continuing effectiveness of the charity and the preservation of any permanent endowments; and must exercise control over the charity s financial affairs. Principles and guidance for governance in the charity sector is contained in a document Good Governance: a Code for the Voluntary and Community Sector which was published in October Trustee duties and responsibilities 12 include, but are not limited to: 10 Guidance has been provided by ICAEW in AAF 1/10 Framework document for accountants reports on grant claims. 11 Charity trustees are defined in legislation as the persons having the general control and management of the administration of a charity. 12 Comprehensive information regarding trustees duties and responsibilities is set out in guidance issued by the charity regulators. 10

13 where a particular function is delegated to staff or third parties, monitoring the performance of the delegated function and clearly setting out the scope and limits of the delegated authority; acting in accordance with the charity s governing document, in particular, the income and property of the charity must be applied for the purposes set out in the governing document and, in the case of any restricted fund, within the particular trusts attaching to that fund, and for no other purpose; acting reasonably and prudently in the charity s interests only and without regard to their own private interests; not deriving remuneration or benefit personally from the charity unless legally permitted to do so; maintaining proper accounting records and preparation of accounts required by the regulatory regime under which they operate; being able and willing to give time to the efficient administration of the charity and the fulfillment of its trusts. In addition, trustees are required to have regard to the regulators guidance on how charities meet the public benefit requirement. 26. Trustees may not profit out of transactions with the charity or receive any remuneration or benefit from it unless there is provision for this in the charity s governing document 13, or the transaction is authorised by the relevant public authority, (in England and Wales usually CCEW), or the statutory conditions relating to the supply of services by trustees, set out in paragraph 210 below are met. 27. It is possible for employees to be appointed as trustees if this is provided for in a charity s governing document or, in England and Wales, is otherwise authorised. Typically, the authority will draw a clear distinction between their functions as employees, conducting the operations of the charity in accordance with the trustees policy, for which they may be paid, and time spent acting as trustees, to which the remuneration authority would not usually extend 14. Similarly, professionally qualified trustees may only charge the charity for their firm s or their own professional services if the conditions set out above are applicable. 28. The Charities SORP and the Regulations in both England and Wales and Scotland require the accounts of a charity to disclose most transactions between the trustees and the charity, and trustee remuneration or benefits from the charity, whether authorised or 13 For charities registered in Scotland, the authorising provision would have to have been in force on 15 November In Scotland the authority applies to all services as there is no distinction drawn. 11

14 not. The disclosure requirements are widely drawn to include a person connected with a charity trustee and companies or institutions connected with the charity. 29. Charity trustees are usually unpaid and part-time, and governance structures can be very varied. In planning the audit, the auditor needs to understand the nature of the charity s governance and the influence that this has on the control environment of the charity (see ISA (UK and Ireland) 315) and on reporting to those charged with governance (see ISA (UK and Ireland) 260). 30. Charity trustees need to meet a fit and proper persons test in order to ensure that the charity is able to take advantage of charity tax reliefs. Consequently charities will take steps to ensure that their trustees meet this test and comply with the guidelines set out by HMRC. Operating structures and branches 31. Charities can adopt a variety of organisational structures including: a single centrally administered organisation; a centrally administered organisation with branches both in the UK and overseas; and a parent charity with a group structure including subsidiaries, joint ventures and associates. A charity may operate through branches to raise funds or carry out particular aspects of its charitable activities. The principles as to whether branches in the charity s wider structure are accounted for as part of the charity are set out in the Charities SORP and these apply whether operations are carried out in the UK or overseas. In England and Wales separate charities may in certain circumstances account as one entity where a uniting direction has been issued by CCEW. Such entities will normally be listed as subsidiary registrations by CCEW. 32. Some charities will use the term branches outside of its Charities SORP meaning to describe a network of charities which are administratively autonomous and as such are separate accounting entities. The constitutional provisions in such cases may require careful consideration. Audits of independent (or autonomous) branches are regarded as separate engagements where a separate opinion is required. 33. Sometimes charities enter into joint venture situations whereby two or more charities jointly control an entity, or undertake joint arrangements in partnership to carry out an activity. The structure adopted in such arrangements may be differentiated from participating interests in associates. The Charities SORP provides guidance on this issue and the accounting methods to be adopted. 12

15 34. The terms on which branches raise funds will also be relevant to determining the accounting policies of a charity. Local appeals may be for specific purposes, and where this is the case such funds will be restricted in the accounts of the main charity. The Charities SORP requires non-autonomous branches (see definition in Appendix 7 of this Practice Note) to be accounted for in the entity s financial statements and for consolidated financial statements to be prepared in group situations. Sources of income 35. Sources of income (other than trading income) giving rise to particular audit issues include: cash donations; legacies; gifts in kind and donated services; contractual income; and grants, for example from public authorities or other charities. Donations may be made tax-effectively, through gift aid, payroll giving, and gifts of land and shares. For most tax effective schemes, and especially for gift aid, there are detailed requirements relating to the procedures to be followed by donors and recipient charities, as well as detailed rules designed to prevent abuse (for instance the reciprocal benefit limits). The auditor considers the implications of the significance of these income streams and adapts the audit procedures accordingly. 36. The completeness of recorded donation income can be difficult to substantiate as such income will not always be supported by invoices or equivalent documentation. Where cash donations are received, the trustees need to make arrangements to institute appropriate controls, to the extent practicable, to ensure that all income is properly accounted for. Evidence concerning the effectiveness of such controls can be used in assessing the sufficiency of evidence about the completeness of the income shown in the charity s financial statements. 37. The use of autonomous branches, agents or loosely affiliated volunteer groups for fundraising needs to be considered when determining the appropriate method of income recognition for donations The Charities SORP states that income recognition is dependent on entitlement, certainty of receipt and the monetary value being measurable with sufficient reliability. 13

16 38. Trustees need to understand the terms attaching to legacies in order to consider the application of the charity s income recognition policies. The valuation of donations in kind also needs consideration. 39. An understanding of the conditions underlying contractual or grant income is necessary to determine the proper accounting treatment. As well as distinguishing whether the income is restricted or not, the nature of the terms and conditions may affect taxation considerations (for example, the Value Added Tax (VAT) treatment). 40. Income received under contract is unrestricted income while grants for the provision of a specific service normally represent restricted income. However the terminology used to describe funding arrangements can differ, particularly in relation to international charities, and an understanding of the nature of all significant funding arrangements is necessary to determine the proper accounting treatment. 41. Grants are often made for specific purposes and are subject to conditions, breach of which can have serious implications for the charity. Developments in the public sector mean that the auditor of a public authority donor may have, or seek, the right of access to the charity s records to follow through and verify the use made of the grant. In addition grants from public bodies are increasingly subject to claw back provisions requiring repayment if a charity breaches specified conditions. Restricted funds 42. Restricted funds are subject to specific trusts, which may be declared by the donor or created through legal process. They may be restricted income funds (which are expendable at the discretion of the trustees in furtherance of some particular aspect of the objects of the charity) or they may be endowments (where the assets are required or permitted to be invested or retained for future use see Charities SORP definition of restricted funds in Appendix 7). If restricted funds are used other than in the way specified, the trustees of the charity will have breached their duty. 43. The Charities SORP indicates that restricted funds are to be separately disclosed in the charity s financial statements. Consequently, the auditor considers whether restrictions are likely to exist as part of the planning process and when assessing the presentation of funds in a charity s balance sheet. The auditor also establishes whether it may be requested to issue a special donor report in respect of grants or restricted funds. Charity tax and trading income 44. Whilst charities do not enjoy a general exemption from direct taxation, there are significant tax exemptions available to charities both in relation to income and chargeable gains, as well as certain indirect taxes. The auditor needs to have an understanding of these statutory exemptions and extra-statutory concessions in order to identify activities that may fall outside their scope. Especially where income is receivable that does not fall within such reliefs, a charity can be exposed to significant tax liabilities. 14

17 45. Gift aid is an important source of income for many charities, and trustees need to ensure that the charity is complying with the strict rules set out by HMRC for its proper operation. In particular, the completeness of documentation and audit trails, and any transactions with, or benefits passing to, the donor or connected persons will need careful consideration. HMRC may consider the implications for operating gift aid where a charity s activities are not fulfilling the public benefit test, or where the trustees do not meet the fit and proper persons test The existence of trading activities can affect the charity s compliance with laws and regulations, potential tax liabilities and, in some cases, can give rise to matters to be reported to the relevant charity regulator as a result of the auditor s statutory duty to report. Trading by charities falls into two main categories primary purpose trading (also known as charitable trading) which is generally exempt from direct taxation; and trading to raise funds for charitable purposes, which is generally not exempt from direct taxation unless the trade falls within the exemptions available for small trades or the concessions made for charity fundraising events. 47. Primary purpose trading is the exercise of a trade in the course of the actual carrying out of a primary purpose of a charity, for example the charging of fees by a school which is established as a charity for the advancement of education. The tax exemption available on primary purpose trading also extends to trades where the work is mainly carried out by the beneficiaries of the charity and the remedial or educational value of the work to the beneficiaries can be demonstrated. 48. Charitable trading may also extend beyond primary purpose activities to incorporate ancillary trading. Ancillary trading, which contributes indirectly to the successful furtherance of the purposes of the charity, is treated as part of primary purpose trading for both charity law and tax purposes. An example of ancillary trading is the sale of food and drink in a restaurant or bar by a theatre charity to members of an audience. 49. Trading for fundraising purposes and other non-charitable trading activities, where undertaken directly by a charity on a substantial or regular basis, may be contrary to charity law and the profits may be liable to income or corporation tax. If a relevant power exists a charity may trade on a small scale for fundraising purposes. 50. Substantial permanent trading for fundraising purposes would also be incompatible with charitable status, and generally such trades would be hived off to a wholly-owned subsidiary company. Similarly, a failure to apply such income or gains for charitable 16 This requirement was introduced by Section 30 and Schedule 6 of Finance Act HMRC have issued detailed guidance on how HMRC applies this test. 15

18 purposes only can result in loss of tax relief. The impact of a tax assessment, perhaps going back a number of years, may affect a charity s ability to conduct its business. 51. Charities enjoy no general exemption from VAT, which can apply to a range of goods and services supplied in the course of business. Certain primary purpose trading activities as well as trading for fundraising purposes can fall within the meaning of business activity for VAT purposes. Many areas in which charities operate, such as the supply of certain educational, health and welfare services, may be exempt from VAT, and a number of special reliefs also apply specifically to charities 17. Non-compliance or errors could have adverse financial consequences for the charity. 17 A number of specific exemptions and zero-rating treatments may be available in relation to supplies by and to a charity. 16

19 THE AUDIT OF FINANCIAL STATEMENTS ISAs (UK and Ireland) apply to the conduct of all audits. This includes audits of the financial statements of charities. The purpose of the following paragraphs is to identify the special considerations arising from the application of certain requirements to the audit of charities, and to suggest ways in which these can be addressed (extracts from ISAs (UK and Ireland) are indicated by grey-shaded boxes below). This Practice Note does not contain commentary on all of the requirements included in the ISAs (UK and Ireland) and reading it should not be seen as an alternative to reading the relevant ISAs (UK and Ireland) in their entirety. Where no special considerations arise from a particular ISA (UK and Ireland), no material is included. ISA (UK AND IRELAND) 200: OVERALL OBJECTIVES OF THE INDEPENDENT AUDITOR AND THE CONDUCT OF AN AUDIT IN ACCORDANCE WITH INTERNATIONAL STANDARDS ON AUDITING (UK AND IRELAND) This International Standard on Auditing (UK and Ireland) (ISA (UK and Ireland)) deals with the independent auditor s overall responsibilities when conducting an audit of financial statements in accordance with ISAs (UK and Ireland). Specifically, it sets out the overall objectives of the independent auditor, and explains the nature and scope of an audit designed to enable the independent auditor to meet those objectives. It also explains the scope, authority and structure of the ISAs (UK and Ireland), and includes requirements establishing the general responsibilities of the independent auditor applicable in all audits, including the obligation to comply with the ISAs (UK and Ireland). The independent auditor is referred to as the auditor hereafter. (paragraph 1) In conducting an audit of financial statements, the overall objectives of the auditor are: (a) (b) To obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, thereby enabling the auditor to express an opinion on whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework; and To report on the financial statements, and communicate as required by the ISAs (UK and Ireland), in accordance with the auditor s findings. (paragraph 11) 17

20 In all cases when reasonable assurance cannot be obtained and a qualified opinion in the auditor s report is insufficient in the circumstances for purposes of reporting to the intended users of the financial statements, the ISAs (UK and Ireland) require that the auditor disclaim an opinion or withdraw (or resign) 18 from the engagement, where withdrawal is possible under applicable law or regulation. (paragraph 12) The auditor shall plan and perform an audit with professional skepticism recognizing that circumstances may exist that cause the financial statements to be materially misstated. (paragraph 15) 52. A fundamental principle is that practitioners shall not accept or perform work which they are not competent to undertake. The importance of technical competence is also underlined in the Auditor s Code, issued by the APB, which states that the necessary degree of professional skill demands an understanding of financial reporting and business. Practitioners do not undertake the audit of a charity unless they are satisfied that they have, or can obtain, the necessary level of competence. The auditor s responsibilities in this respect are not related to the level of fee charged for the audit. For example, the same levels of rigour are required in respect of audits carried out on an honorary basis as for audits carried out for a commercial fee and the engagement partner has a responsibility for being satisfied and able to demonstrate that the audit engagement has assigned to it sufficient partners and staff with appropriate time and skill to perform the audit in accordance with all applicable Auditing and Ethical Standards ISAs (UK and Ireland) include a requirement for auditors to comply with relevant ethical requirements relating to audit engagements. In the United Kingdom, the auditor complies with the APB s Ethical Standards (ESs) and relevant ethical guidance relating to the work of auditors issued by the auditor s professional body. 54. Particular issues that the audit engagement partner of a charity has regard to when assessing possible threats to the independence and objectivity and the nature and extent of the safeguards to be applied include: self interest in addition to financial interests, the auditor needs to be aware of other interests in a charity which may affect the conduct or outcome of the audit. The auditor therefore ensures that none of the audit team is in any way dependent upon the charity or are involved in providing significant support to the charity. 18 In the ISAs (UK and Ireland), only the term withdrawal is used. 19 ES 4 (Revised), paragraph 5. 18

21 self-review auditors will often be asked to provide additional help and advice, often on a pro bono basis. The provision of this service is regarded in the same way as other non-audit services in assessing whether there is a threat to objectivity. The ESs include a small number of additional requirements that apply to the audits of listed companies 20. ES 1 establishes that an audit firm s policies and procedures will set out the circumstances in which these additional requirements apply to the audits of nonlisted clients (which may include some charities), taking into consideration the nature of the entity s business, its size, the number of its employees and the range of its stakeholders. 55. Where safeguards include the review by an engagement quality control reviewer, that reviewer will have sufficient knowledge of the charity regulatory framework to enable a meaningful review to be completed. 20 These are set out in paragraph 46 of ES 1 (Revised). 19

22 ISA (UK AND IRELAND) 210: AGREEING THE TERMS OF AUDIT ENGAGEMENTS Objective The objective of the auditor is to accept or continue an audit engagement only when the basis upon which it is to be performed has been agreed, through: (a) (b) Establishing whether the preconditions for an audit are present; and Confirming that there is a common understanding between the auditor and management and, where appropriate, those charged with governance of the terms of the audit engagement. (paragraph 3) The auditor shall agree the terms of the audit engagement with management or those charged with governance, as appropriate. (paragraph 9) Subject to paragraph 11, the agreed terms of the audit engagement shall be recorded in an audit engagement letter or other suitable form of written agreement and shall include: (a) The objectives and scope of the audit of the financial statements; (b) The responsibilities of the auditor; (c) The responsibilities of management 2b ; (d) Identification of the applicable financial reporting framework for the preparation of the financial statements; and (e) Reference to the expected form and content of any reports to be issued by the auditor and a statement that there may be circumstances in which a report may differ from its expected form and content. (paragraph 10) If law or regulation prescribes in sufficient detail the terms of the audit engagement referred to in paragraph 10, the auditor need not record them in a written agreement, except for the fact that such law or regulation applies and that management acknowledges and understands its responsibilities as set out in paragraph 6(b). (paragraph 11) 2b In the UK and Ireland, the engagement letter sets out the responsibilities of those charged with governance. 20

23 56. The same basic principles used in drafting engagement letters apply in relation to the audit of charities as to the audit of any entity. Practical considerations arising from the particular characteristics of charities are considered below. 57. The terms of the engagement are to be agreed with management or those charged with governance. In the case of a charity the auditor agrees the terms of the audit engagement with the trustees of the charity and address the letter of engagement to the trustees. 58. The auditor may consider checking that all the trustees receive a copy of the letter. If the trustees are not engaged in the day-to-day running of the charity, the auditor may wish to send a copy of the engagement letter to the chief executive or the persons responsible for its day-to-day management, together with a more detailed description of the audit work to be undertaken and any client assistance to be given. 59. Matters that will normally be included in an engagement letter for a charity are: the legislative framework under which the financial statements are prepared and the audit is conducted 21 ; the statutory duty to report to the charity regulators any matters of which the auditor becomes aware that may be of material significance to the respective regulators; access to information, recognising that not all charities are constituted as limited companies (for which the auditor s rights of access are enshrined in company law). 60. Trustees may issue other reports to stakeholders in addition to the annual report required by statute. For example, they may provide summary reports and financial statements, and periodic newsletters. Where this is the case, the engagement letter also sets out the auditor s responsibilities, if any, in respect of such other reports. 61. It is the responsibility of the trustees to identify the need for any additional reports required by funders and to instruct the auditor accordingly: it will not be practicable for the auditor to check the documentation relating to all funds received by the charity to identify any conditions requiring special reports. However, the auditor may consider it appropriate to enquire of the trustees whether any reports are required in addition to the auditor s report on the charity s financial statements. Separate engagement letters will be obtained for non-audit work undertaken on behalf of the charity or its trustees. 21 Scottish charity law requires the auditor or independent examiner to consider the Trustees Annual Report and to state whether or not the report meets the requirements of the regulations and an opinion, where they have formed one, that there is a material inconsistency between the annual report and the rest of the statement of account. Although there is some legal uncertainty, the Scottish Government has given a provisional view that the Annual Report is outside the scope of the true and fair view, and have said that they will clarify the legislation on this point when a suitable legislative vehicle is available. 21

24 On recurring audits, the auditor shall assess whether circumstances require the terms of the audit engagement to be revised and whether there is a need to remind the entity of the existing terms of the audit engagement. (paragraph 13) 62. ISA (UK and Ireland) 210 sets out a number of reasons as to why an engagement letter will be revised on a recurring audit 22. In the case of charities, these reasons are also applicable including changes in the legal and regulatory framework or a new SORP. Appendix 3 sets out example paragraphs for an engagement letter for the audit of: England and Wales: non-company (accruals basis); England and Wales: non-company (receipts and payments basis); England and Wales: company; Scotland: non-company (accruals basis); Scotland: non-company (receipts and payments basis); Scotland: company; Cross-border charity. 22 Paragraph A28 of ISA (UK and Ireland)

25 ISA (UK AND IRELAND) 220: QUALITY CONTROL FOR AN AUDIT OF FINANCIAL STATEMENTS Objective The objective of the auditor is to implement quality control procedures at the engagement level that provide the auditor with reasonable assurance that: (a) The audit complies with professional standards and applicable legal and regulatory requirements; and (b) The auditor s report issued is appropriate in the circumstances. (paragraph 6) The engagement partner shall be satisfied that the engagement team, and any auditor s experts who are not part of the engagement team, collectively have the appropriate competence and capabilities to: (a) (b) Perform the audit engagement in accordance with professional standards and applicable legal and regulatory requirements; and Enable an auditor s report that is appropriate in the circumstances to be issued. (paragraph 14). Staff capabilities, competence 63. Competence is emphasised in the Auditor s Code. As well as ensuring that the engagement team has an appropriate level of knowledge and experience of the charity sector (including the legislation, which is increasingly complex), the engagement partner also satisfies himself that the members of the engagement team have sufficient knowledge, commensurate with their roles in the engagement, of: (a) the Charities SORP; (b) the governing document of the charity; (c) the legal responsibilities and duties of charity trustees; (d) the regulatory framework within which charities operate to identify situations which may give them reasonable cause to believe that a matter must be reported to a charity regulator. Engagement Quality Control Reviews 64. International Standard on Quality Control (UK and Ireland) 1 Quality Control for Firms that Perform Audits and Reviews of Financial Statements and Other Assurance and 23

26 Related Services Engagements requires audit firms to establish policies and procedures which set out criteria to determine whether engagement quality control reviews shall be performed for non-listed entities. Guidance to ISQC 1 notes that one of the criteria that a firm considers when determining whether to require completion of an engagement quality control review includes the nature of the engagement, including the extent to which it involves a matter of public interest. What is a matter of public interest is difficult to define: factors that may apply to a charity include: the size of the charity; its national or local profile; its sources of funds (including the extent to which the charity receives public funds). 24

27 ISA (UK AND IRELAND) 240: THE AUDITOR S RESPONSIBILITIES RELATING TO FRAUD IN AN AUDIT OF FINANCIAL STATEMENTS Objectives The objectives of the auditor are: (a) (b) (c) To identify and assess the risks of material misstatement of the financial statements due to fraud; To obtain sufficient appropriate audit evidence regarding the assessed risks of material misstatement due to fraud, through designing and implementing appropriate responses; and To respond appropriately to fraud or suspected fraud identified during the audit. (paragraph 10) In accordance with ISA (UK and Ireland) 200, the auditor shall maintain professional skepticism throughout the audit, recognizing the possibility that a material misstatement due to fraud could exist, notwithstanding the auditor s past experience of the honesty and integrity of the entity s management and those charged with governance. (paragraph 12) When performing risk assessment procedures and related activities to obtain an understanding of the entity and its environment, including the entity s internal control, required by ISA (UK and Ireland) 315, 23 the auditor shall perform the procedures in paragraphs to obtain information for use in identifying the risks of material misstatement due to fraud. (paragraph 16) The auditor shall make inquiries of management, and others within the entity as appropriate, to determine whether they have knowledge of any actual, suspected or alleged fraud affecting the entity. (paragraph 18) Unless all of those charged with governance are involved in managing the entity, the auditor shall make inquiries of those charged with governance to determine whether they have knowledge of any actual, suspected or alleged fraud affecting the entity. These inquiries are made in part to corroborate the responses to the inquiries of management. (paragraph 21) 23 ISA (UK and Ireland) 315, paragraphs

28 65. The trustees of a charity are responsible for the prevention and detection of fraud in relation to the charity, even if they have delegated some of their executive functions to senior staff. They are expected to safeguard charity assets and reserves through the implementation of appropriate systems of control. The auditor of a charity is responsible for forming an opinion as to whether financial statements show a true and fair view and to this end the auditor plans, performs and evaluates audit work in order to have a reasonable expectation of detecting material misstatements in the financial statements arising from error or fraud. 66. Many charities receive funds which have restrictions placed upon them. These funds are held on trust and must be applied to the purpose for which they were given. The misappropriation or misapplication of funds constitutes a breach of trust, whether it was intentional or accidental. In planning, performing and evaluating the audit work the auditor considers the risk of material misstatement arising from breaches of trust. 67. The auditor considers the possibility that the charity s records of incoming resources to which it is legally entitled may be incomplete as a result of fraud. A common type of fraud against charities is the diversion of donations to bank or building society accounts which the charity does not control. Sources of audit evidence as to whether incoming resources from appeals and other non-routine sources have been fully recorded can involve the assessment and testing of internal controls, and comparison of donations actually received by the charity to past results for similar appeals, to budgets and to statistics for response rates for charities in general. In accordance with ISA (UK and Ireland) 315, the auditor shall identify and assess the risks of material misstatement due to fraud at the financial statement level, and at the assertion level for classes of transactions, account balances and disclosures. 24 (paragraph 25) When identifying and assessing the risks of material misstatement due to fraud, the auditor shall, based on a presumption that there are risks of fraud in revenue recognition, evaluate which types of revenue, revenue transactions or assertions give rise to such risks. Paragraph 47 specifies the documentation required where the auditor concludes that the presumption is not applicable in the circumstances of the engagement and, accordingly, has not identified revenue recognition as a risk of material misstatement due to fraud. (paragraph 26) 68. A list of fraud risk factors is contained in Appendix 1 to ISA (UK and Ireland) 240. Additional charity specific factors include: 24 ISA (UK and Ireland) 315, paragraph

29 (a) the limited involvement of trustees in key decision making or monitoring transactions, and limited engagement with charity staff; (b) widespread branches or operations, such as those established in response to emergency appeals in countries where there is no effective system of law and order; (c) reliance on volunteers and staff with limited management or supervision and a lack of segregation and rotation of duties; (d) transactions (income and expenditure) often undertaken in cash; (e) unpredictable patterns of giving (in cash, by cheque, and through donations in kind) by members of the public, both in terms of timing and point of donation; (f) informal banking or cash transfer methods used in areas remote from conventional banking systems; (g) inconsistent regulation across international borders; (h) international transfer of funds. 69. The auditor is not required to review or conclude on the adequacy of the approach taken by trustees to assess and address risks faced by their charity. However, where the trustees have produced documentation that sets out their assessment of the various risks facing the charity, and how they believe those risks are controlled and managed, the auditor has regard to that documentation (and any fraud register where maintained) when performing its own assessment of the risk of material misstatements to financial reporting resulting from fraud. 70. In assessing the risk of misstatement arising from fraud, the auditor also considers the extent of the trustees involvement in the day-to-day administration of the charity, their access to its resources and their ability, collectively or individually, to override any internal controls. Additionally, the auditor considers the arrangements the trustees have put in place to monitor work undertaken by third parties, for example custodianship of investments and fundraising. If the auditor has identified a fraud or has obtained information that indicates that a fraud may exist, the auditor shall communicate these matters on a timely basis to the appropriate level of management in order to inform those with primary responsibility for the prevention and detection of fraud of matters relevant to their responsibilities. (paragraph 40) The auditor shall include in the audit documentation communications about fraud made to management, those charged with governance, regulators and others. (paragraph 46) 27

30 71. The auditor will communicate fraud related matters to those charged with governance (i.e. the board of trustees) in all situations. Other appropriate levels of management for many charities will include the Chief Executive or equivalent. 72. All such communications are subject to tipping off provisions under anti-money laundering legislation. Where there is a suspected or actual instance suggesting dishonesty or fraud involving a significant loss of or major risk to charitable funds or assets, the auditor makes a report direct to a proper authority without delay, and without informing the trustees in advance if they are suspected of being involved (see also the guidance in the section on ISA (UK and Ireland) 250 section B). 73. In the case of charities, the proper authorities include the Serious Organised Crime Agency (SOCA) where there is a suspicion of money laundering (see ISA (UK and Ireland) 250A section) and the appropriate charity regulator. If the auditor has concluded that the presumption that there is a risk of material misstatement due to fraud related to revenue recognition is not applicable in the circumstances of the engagement, the auditor shall include in the audit documentation the reasons for that conclusion. (paragraph 47) 74. The auditor remains aware that, although charities are not profit-making entities, there is still a risk of fraudulent misstatement of income due to fraud. This presumption may not always be appropriate for some public sector bodies which are funded from central government directly by grant-in-aid income where reporting on expenditure and outcomes is also required. 28

31 ISA (UK AND IRELAND) 250: SECTION A CONSIDERATION OF LAWS AND REGULATIONS IN AN AUDIT OF FINANCIAL STATEMENTS Objectives The objectives of the auditor are: (a) (b) (c) To obtain sufficient appropriate audit evidence regarding compliance with the provisions of those laws and regulations generally recognized to have a direct effect on the determination of material amounts and disclosures in the financial statements; To perform specified audit procedures to help identify instances of noncompliance with other laws and regulations that may have a material effect on the financial statements; and To respond appropriately to non-compliance or suspected non-compliance with laws and regulations identified during the audit. (paragraph 10) As part of obtaining an understanding of the entity and its environment in accordance with ISA (UK and Ireland) 315, the auditor shall obtain a general understanding of: (a) The legal and regulatory framework applicable to the entity and the industry or sector in which the entity operates; and (b) How the entity is complying with that framework. (paragraph 12) The regulatory framework and charity governing documents 75. In the case of charities, the legal and regulatory framework includes trust law, and hence specific requirements as to the use of restricted funds and preservation of any permanent endowments (capital funds). 76. The legal framework for charities is complex, and different requirements exist depending on the charity s constitution, the part of the United Kingdom in which the charity is established and the type of activity which it undertakes 25. In addition, charities are affected by the whole range of national legislation applicable to business entities, such as employment, tax and pensions law and health and safety regulations. 25 The legal framework associated with accounting and audit is summarised in Appendix 1. 29

32 77. The trustees of a charity are responsible for ensuring that the necessary controls are in place to ensure compliance with applicable law and regulations, and to detect and correct any breaches that have occurred, even if they have delegated some of their executive functions to professional staff or advisers. The auditor shall obtain sufficient appropriate audit evidence regarding compliance with the provisions of those laws and regulations generally recognized to have a direct effect on the determination of material amounts and disclosures in the financial statements. (paragraph 13) The auditor shall perform the following audit procedures to help identify instances of non-compliance with other laws and regulations that may have a material effect on the financial statements: (a) (b) Inquiring of management and, where appropriate, those charged with governance, as to whether the entity is in compliance with such laws and regulations; and Inspecting correspondence, if any, with the relevant licensing or regulatory authorities. (paragraph 14) During the audit, the auditor shall remain alert to the possibility that other audit procedures applied may bring instances of non-compliance or suspected noncompliance with laws and regulations to the auditor s attention. (paragraph 15) CLASSIFICATION OF LAWS AND REGULATIONS 78. Laws and regulations relevant to the audit can be regarded as falling into two main categories: i. those recognised to have a direct effect on the determination of material amounts and disclosures in the financial statements; and ii. those which may be fundamental to the operating of the business, to an entity s ability to conduct its business, or to avoiding material penalties, so that compliance with such laws and regulations may have a material effect on the financial statements. 79. Laws and regulations which do not fall into either category need not be taken into account in planning audit work to be undertaken. However, the auditor is required to remain alert to the possibility of breaches of other requirements and to investigate any which come to its attention. 30

33 Laws and regulations generally recognised to have a direct effect on the determination of material amounts and disclosures in the financial statements 80. Laws and regulations which have a direct effect on the determination of material amounts and disclosures in the financial statements for unincorporated charities are contained in the relevant legislation and subordinate regulations 26 relating to the particular UK jurisdiction in which the charity operates. Where individual charities are subject to legislation other than specific charity legislation, for example charitable companies or charitable registered social landlords, there may be certain additional disclosure requirements. 81. The auditor also checks whether charities governing documents contain any special provisions as to the disclosure of information in the financial statements or reporting requirements for the auditor. Users of the financial statements of a charity reasonably expect that the transactions recorded within them are authorised by the governing document of the charity and in furtherance of the charity s objects. In order to give a true and fair view, due regard needs to be given to disclosure of any significant noncompliance with the governing document. 82. The auditor therefore familiarises itself with the charity s governing documents and in planning and conducting the audit: ensures that the audit procedures cover compliance with the governing document; considers any changes in the charity s activities to ensure that these comply with the governing document; and is alert to new or unusual transactions which may not be in accordance with the governing document. Laws and regulations where instances of non-compliance may have a material effect on the financial statements 83. The ISA (UK and Ireland) requires the auditor to carry out specified steps to help identify possible or actual instances of non-compliance with those laws and regulations which fall into the category of those where instances of non-compliance may have a material effect on the financial statements, for example, those laws and regulations where: (a) compliance is a pre-requisite of obtaining a licence to operate; or (b) non-compliance may reasonably be expected to result in the entity ceasing operations, or call into question the entity s status as a going concern. 84. Determination of those laws and regulations where instances of non-compliance may have a material effect on the financial statements of a particular charity requires 26 See Appendix 1. 31

34 consideration of its governing document, the activities it undertakes and any laws and regulations specifically applicable to those activities, as well as the requirements of charity law. To assist in identifying possible or actual instances of non-compliance with these laws and regulations, the auditor inspects any recent correspondence between the charity and the relevant charity regulator in accordance with the provisions of the ISA (UK and Ireland). 85. In addition, each charity is bound to comply with the terms of its governing document, which may, for example, take the form of a trust deed, a will, a constitution or the Articles of Association of a company. 86. The charity sector is diverse in terms of activities undertaken and hence the requirements of laws and regulations where instances of non-compliance may have a material effect on the financial statements of a charity are likely to be derived from the activities undertaken as well as arising from charitable status. For example charities providing residential care in England and Wales will be subject to the requirements of the Registered Homes Act 1984, as amended by the Registered Homes (Amendment) Act 1991, and those in England and Wales providing residential accommodation for children will be subject to the provisions of the Children Act Similarly, many care services in Scotland are regulated by the Scottish Commission for the Regulation of Care under the Regulation of Care (Scotland) Act Significant regulatory breaches can result in loss of registration and hence ability to undertake particular activities. Similar legislative requirements can affect charitable operations in different parts of the sector and in the different parts of the United Kingdom. 87. The auditor will therefore also consider the impact of that particular activity on the overall ability of the charity to operate effectively in terms of the charity s current objectives. Where a particular activity, whilst subject to laws and regulations, does not have a material effect on the financial statements of a charity then the auditor has no responsibility for considering whether such laws and regulations have been observed. 88. Breaches of laws and regulations which apply to a particular type of activity may also result in fines, the financial consequences of which may, in particular instances, be significant. Severe financial consequences may also arise from failure to comply with grant conditions or taxation law. Money laundering 89. Auditors in the UK have reporting obligations under the Proceeds of Crime Act 2002 and the Money Laundering Regulations 2007 to report knowledge or suspicion of money laundering offences, including those arising from fraud and thefts, to the Serious Organised Crime Agency (SOCA). 90. Any knowledge or suspicions of involvement of a charity s trustees in money laundering would normally be regarded as being of material significance to the charity regulators 32

35 and so give rise to a statutory duty to report in addition to making any necessary report required by legislation relating to money laundering offences. Reporting a matter to SOCA does not relieve the auditor of a duty to report that matter to charity regulators where the information is of material significance to the regulator s function. A tipping off offence is only committed where: (a) a disclosure is made that a money laundering disclosure has already been made or that a money laundering investigation is being contemplated or carried out; and (b) that disclosure is likely to prejudice any investigation which might be conducted Further guidance on the matters to be considered by the auditor is set out in Practice Note 12 Money laundering Guidance for Auditors in the United Kingdom (Revised). Reporting non-compliance with laws and regulations Unless all of those charged with governance are involved in management of the entity, and therefore are aware of matters involving identified or suspected non-compliance already communicated by the auditor 28, the auditor shall 29 communicate with those charged with governance matters involving non-compliance with laws and regulations that come to the auditor s attention during the course of the audit, other than when the matters are clearly inconsequential. (paragraph 22) 92. The ISA (UK and Ireland) provides guidance on action to be taken by the auditor when possible non-compliance with laws and regulations is discovered. The procedures described in paragraphs 18 to 29 of the ISA (UK and Ireland) apply to the audit of charities as to other entities, but there may be special reporting considerations, as set out below. (1) Reporting to those charged with governance 93. The ISA (UK and Ireland) requires the auditor to communicate its findings to the appropriate level of those charged with governance (in the case of a charity, the trustees), unless the auditor concludes that the suspected or actual instance of noncompliance ought to be reported to a proper authority and that it no longer has confidence in the trustees. In this case, the auditor makes a report direct to a proper authority, without delay and without informing the trustees in advance. 27 Section 333(A) of the Proceeds of Crime Act 2002 (as amended). 28 ISA (UK and Ireland) 260, Communication with Those Charged with Governance, paragraph Subject to compliance with legislation relating to tipping off. 33

36 94. In those cases where the trustees are not involved in the day-to-day management of the charity, having delegated this function to staff, and it is the latter who are suspected of involvement in the breach of law or regulations, the auditor may consider that it is appropriate to communicate with the trustees in the first instance. (2) Reporting to the addressees of the auditor s report on the financial statements 95. The auditor s report on a non-company charity s financial statements is usually addressed to its trustees. Although an actual or suspected breach of relevant law or regulations may already have been reported to the trustees as managers of the charity, the auditor s report on the financial statements is nevertheless required to include details of any fundamental uncertainty, or disagreement over disclosure of a suspected or actual instance of non-compliance having a material effect on the financial statements. (3) Reporting to third parties 96. ISA (UK and Ireland) 250 B deals with the reporting of actual or suspected noncompliance to third parties, in particular reporting to a proper authority in the public interest. The ISA (UK and Ireland) states that the auditor only reports to an authority with a proper interest to receive the information. In the case of registered charities this will be CCEW or OSCR as appropriate while for exempt charities this will be their principal regulator (for example, the Higher Education Funding Council for England in the case of English universities). 34

37 ISA (UK AND IRELAND) 250: SECTION B THE AUDITOR S RIGHT AND DUTY TO REPORT TO REGULATORS IN THE FINANCIAL SECTOR Objective The objective of the auditor of a regulated entity is to bring information of which the auditor has become aware in the ordinary course of performing work undertaken to fulfil the auditor s audit responsibilities to the attention of the appropriate regulator as soon as practicable when: (a) (b) The auditor concludes that it is relevant to the regulator s functions having regard to such matters as may be specified in statute or any related regulations; and In the auditor s opinion there is reasonable cause to believe it is or may be of material significance to the regulator. (paragraph 8) Where an apparent breach of statutory or regulatory requirements comes to the auditor s attention, the auditor shall: (a) (b) (c) Obtain such evidence as is available to assess its implications for the auditor s reporting responsibilities; Determine whether, in the auditor s opinion, there is reasonable cause to believe that the breach is of material significance to the regulator; and Consider whether the apparent breach is criminal conduct that gives rise to criminal property and, as such, should be reported to the specified authorities. (paragraph 12) 97. Although the title of ISA (UK and Ireland) 250 section B refers to reports to regulators in the financial sector, the requirements included in ISA (UK and Ireland) 250 section B apply in respect of the statutory duty and the discretionary right to report to charity regulators in England and Wales and Scotland. 98. The legislative basis for the charity auditor s statutory duty to report is: England and Wales: sections 44A and 68A of the Charities Act 1993 require the auditor to communicate to CCEW certain matters of which it becomes aware in their capacity as the auditor of a charity. The statutory duty to report to CCEW extends to charities excepted from registration but does not extend to exempt charities Exempt charities are excluded from the CCEW s supervision and monitoring, and consequently their auditors are not covered by this duty to report, However, there may be a duty to report to other authorities under which they are registered. There is, however, no disapplication of the reporting duty for exempt company charities. 35

38 Scotland: section 46 of the Charities and Trustee Investment (Scotland) Act 2005, which sets out the duty of the auditor of all forms of charity registered in Scotland to report to OSCR. OSCR has similar investigative powers to those of CCEW. Northern Ireland: sections 67 and 103 of the Charities Act (Northern Ireland) 2008 will require the auditor to communicate to CCNI certain matters of which the auditor becomes aware in its capacity as the auditor of a charity, once those sections of the Act are commenced. These provisions also establish the right to report a matter to the charity regulator which does not appear to fall within the scope of the duty to report but which the auditor has reasonable cause to believe is likely to be relevant to the charity regulator for the purposes of the exercise of any of its functions. The right to report, like the duty to report, applies to charitable companies and to non-company charities. 99. The Charities Act 1993, the 2005 Act (Scotland) and the 2008 Act (Northern Ireland) specify the matters which give rise to a duty to make an immediate report to the relevant regulator as those: (a) which relate to the activities or affairs of the charity or of any connected institution or body, and (b) which the auditor has reasonable cause to believe is, or is likely to be, of material significance for the exercise, in relation to the charity, of the relevant regulator s functions The auditor of a charity required to register in England and Wales and Scotland is required to report matters the auditor believes may be of material significance to the regulators to both CCEW and OSCR. In such circumstances a tipping off offence is only committed where there is knowledge or suspicion that a report has already been made and that disclosure is likely to prejudice any investigation which might be conducted following the report The Charities Act 1993, the 2005 Act (Scotland) and the 2008 Act (Northern Ireland), do not require the auditor to perform any additional audit work as a result of the statutory duty, nor is the auditor required specifically to seek out breaches of the requirements applicable to a particular charity. However, in circumstances where the auditor identifies that a reportable matter may exist, the auditor carries out such extra work, as considered necessary, to determine whether the facts and circumstances give it reasonable cause 31 For CCEW this is section 8 (general power to institute inquiries) or 18 (power to act for protection of charities) of the Charities Act 1993, for OSCR this is sections 28 (inquiries about charities), 30 (removal from the Register of a charity which no longer meets the test) and 31 (powers of OSCR following enquiries) of the 2005 Act (Scotland) and for CCNI it will be section 22 (general power to institute inquiries) or 33 (power to act for the protection of charities) of the 2008 NI Act once commenced. 36

39 to believe that the matter does in fact exist. The auditor s work does not need to prove that the reportable matter exists Where possible, it is CCEW practice to seek to resolve issues collaboratively with a charity. However, if the charity declines to co-operate or assist, under section 8 of the Charities Act 1993, CCEW has the power to institute inquiries with regard to charities or a particular charity or class of charities, either generally or for particular purposes. For the purposes of any inquiry instituted under this section, CCEW has powers to obtain information, which include the power to call for documents and require persons to give evidence. The charity s auditor may also be required to provide information. CCNI s powers will be similar in Northern Ireland under section 22 of the Charities Act (Northern Ireland) OSCR has similar powers and approach and under sections 28 and 29 of the 2005 Act (Scotland); the powers of investigation are extended to include a body that may be holding itself out as a charity CCEW s usual practice, when instituting an inquiry under section 8 of the 1993 Act, is to send a notice of this to the charity trustees. However, in rare cases this is not done as sending a formal notice of the institution of an inquiry to the trustees would have an adverse effect on the conduct of the inquiry. OSCR undertakes investigative inquiries under its inquiry and intervention policy and also sends a notice of this to the charity trustees. Criteria for determining the existence of a duty to report to the Charity Regulators 104. Determining whether a matter is reportable under the Charities Act 1993 or section 46 of the 2005 Act (Scotland) involves consideration both of whether the auditor has a reasonable cause to believe and that the matter in question is, or is likely to be of material significance to the charity regulators Material significance is defined by ISA (UK and Ireland) 250 section B as follows: The term material significance requires interpretation in the context of the specific legislation applicable to the regulated entity. A matter or group of matters is normally of material significance to a regulator s function when, due either to its nature or its potential financial impact, it is likely of itself to require investigation by the regulator Material significance does not have the same meaning as materiality in the context of the audit of financial statements. Whilst a particular event may be trivial in terms of its possible effect on the financial statements of an entity, it may be of a nature or type that is likely to change the perception of the regulator. For example, dishonesty by a trustee may not be significant in financial terms in comparison with the income of the charity but would have a significant effect on the relevant charity regulator s consideration of whether the person concerned should be allowed to continue to act as a charity trustee. 37

40 107. Matters which CCEW and OSCR have indicated are likely to be of material significance are set out on the charity regulators websites and in Appendix 5 of this Practice Note. Other sources of reference include CCEW s Directions and Guidance for independent examinations 32 and summaries of matters reported to regulators that are published from time to time The determination of whether a matter is, or is likely to be, of material significance to CCEW, OSCR or CCNI inevitably requires the auditor to exercise judgment. In forming such judgments, the auditor needs to consider not simply the facts of the matter but also their implications. In addition, it is possible that a matter, which is not materially significant in isolation, may become so when other possible breaches are considered, together with other reported and unreported breaches of which the auditor is aware The auditor of a charity bases a judgment of material significance to the charity regulator solely on the auditor s understanding of the facts of which it is aware without making any assumptions about the information available to the charity regulator in connection with any particular charity Minor breaches of trustees obligations, or isolated administrative errors that are unlikely to jeopardise the charity s assets or amount to misconduct or mismanagement would not normally be of material significance. ISA (UK and Ireland) 250 section B, however, requires the auditor of a regulated entity, when reporting on their financial statements, to review information obtained in the course of the audit and to assess whether the cumulative effect is of material significance such as to give rise to a duty to report to the regulator. In circumstances where the auditor is uncertain whether the auditor may be required to make a report or not, the auditor considers taking legal advice Where a situation is identified and the auditor, having considered the guidance provided in this section of the Practice Note and in Appendix 5, remains uncertain as to whether the matter is likely to be of material significance the auditor may wish to discuss the circumstances giving rise to its concern with the charity regulators. Whilst such discussions may help inform the auditor in reaching a conclusion as to whether a particular matter is likely to fall within the charity regulator s regulatory function, it is not used as a substitute for the auditor s own judgment. Such discussions do not remove the need to report where the matter is considered to be reportable On completion of any investigations, the auditor ensures that the facts and circumstances, and the basis for the conclusion that these are, or are likely to be of material significance to the charity regulator, are adequately documented such that the 32 CC 32: Independent Examination of Charity Accounts: Examiners Guide. Examples of matters to be reported to the Charity Commission are set out in Appendix 5 of this Practice Note. 38

41 reasons for the auditor s decision to report may be clearly demonstrated if the need to do so arises in future Whilst confidentiality is an implied term of the auditor s contract with a charity or other entity, in the circumstances described in section 44A Charities Act 1993, section 46 of the 2005 Act in Scotland and section 67 of the Act in Northern Ireland, it does not prevail. Subject to compliance with legislation regarding tipping off, in the circumstances leading to a right or duty to report the auditor is required to communicate information or opinions on a matter relating to the affairs of the charity or any connected institution or body. The defence afforded to the auditor from any potential breach of duty is given in respect of information obtained in the capacity as auditor In addition, an auditor who ceases to hold office, for any reason, is required by paragraph 35 of the 2008 Regulations (E&W) and Regulation 10(6) of the 2006 Regulations (Scotland) (as amended) to make a statement as to whether there are any matters concerning its ceasing to hold office which should be brought to the attention of the trustees and to send a copy of the auditor s statement to the charity regulator. (Note: regulations for Northern Ireland have not been made at the date of publication of this Practice Note 33 ). Conduct of the audit The auditor shall ensure that all staff involved in the audit of a regulated entity have an understanding of: (a) (b) (c) the provisions of applicable legislation, the regulator s rules and any guidance issued by the regulator, and any specific requirements which apply to the particular regulated entity, appropriate to their role in the audit and sufficient (in the context of that role) to enable them to identify situations which may give reasonable cause to believe that a matter should be reported to the regulator. (paragraph 11) 115. The auditor includes procedures within the planning process to ensure that members of the audit team have sufficient understanding (in the context of their role) to enable them to recognise breaches, and that such matters are reported to the audit engagement partner without delay so that a decision may be made as to whether a duty to report arises. 33 Similar powers are included in the Charities Act (Northern Ireland)

42 Connected entities 116. The auditor needs to be aware that the duty to report extends to any institution or body corporate connected with the charity The charity auditor decides whether there are any matters to be reported to CCEW, OSCR or CCNI relating to the affairs of the charity in the light of the information that the auditor receives about a connected entity for the purpose of auditing the financial statements of the charity. If the charity auditor is aware of possible circumstances that may fall due to be reported, it has a right and duty to do this under section 44A(3) of the Charities Act 1993, section 46 of the 2005 Act (Scotland) or section 67(3) of the Charities Act (Northern Ireland) At the planning stage of the audit, the auditor of the charity will consider whether arrangements need to be put in place to allow the auditor to communicate with the management to obtain further information direct from the management or auditor of the connected entity and to enable the auditor to ascertain whether the matter should be reported. An inability to communicate with the connected entity or its auditor does not preclude the duty to report. In such circumstances the auditor reports the circumstances and the fact that they have been unable to obtain further information, direct to the charity regulator. Discussing matters of material significance with trustees 118. The trustees are the persons principally responsible for the governance of the charity. In forming an opinion, the auditor will therefore normally seek to reach agreement with the trustees on the circumstances giving rise to a report and to understand whether they intend to make a report. However, ISA (UK and Ireland) 250 section B requires the auditor to bring the matter to the attention of the regulator as soon as practicable. Paragraph 14 of ISA (UK and Ireland) 250: Section B also states that: When the matter giving rise to a statutory duty to make a report direct to a regulator casts doubt on the integrity of those charged with governance or their competence to conduct the business of the regulated entity, the auditor shall make the report to the regulator as soon as practicable and without informing those charged with governance in advance. Additionally, in the case of money laundering suspicions, to ensure that tipping off does not occur the auditor cannot undertake to inform trustees in advance of every matter which it brings to the regulator s attention The trustees may wish to report the matters identified to the charity regulator themselves and detail the actions taken or to be taken. Whilst such a report from the trustees may 34 Connected includes any institution controlled by the charity or a body corporate in which the charity has a substantial interest (20% or more of the share capital or voting rights) (section 44A(6) of the Charities Act 1993 and section 46(5) of the 2005 Act (Scotland)). 40

43 provide valuable information, it does not relieve the auditor of the statutory duty to report directly to the charity regulator. Contents of a report to the charity regulators 120. ISA (UK and Ireland) 250 section B provides details of the information that is required to be included in a report to a regulator. CCEW and OSCR have indicated that a report should follow the format as set out in Appendix 5 of this Practice Note The report to CCEW or CCNI is required to be in writing. This can include making a report by . The auditor is not relieved of the duty to make a written report where an oral report has been previously made to CCEW or by any informal discussions of the issue with CCEW staff. Similarly, the auditor is not relieved of the duty to report on the basis that any other party has provided relevant information, whether written or oral, to CCEW In Scotland, there is no legislative requirement to make the report in writing but OCSR recommends that a written report or record of any verbal report is forwarded to OSCR Where trustees wish to make a submission to the charity regulators as to the circumstances and steps being taken to address a reportable matter, the auditor may attach such a memorandum or report prepared by the trustees to its report Where such additional information is provided the auditor refers to the additional information in the report, and indicates whether or not the auditor has undertaken additional procedures to determine whether any remedial actions described have been taken. Timing of a report 125. The duty to report arises once the auditor has concluded that there is reasonable cause to believe that the matter is or is likely to be of material significance to the relevant regulator s regulatory function. In reaching a conclusion the auditor may wish to take appropriate advice and consult with colleagues or lawyers The report is made without undue delay once a conclusion has been reached. Unless the matter casts doubt on the integrity of the trustees this will not preclude discussion of the matter with trustees and seeking such further advice as is necessary, so that a decision can be made on whether or not a duty to report exists. Such consultations and discussions are however undertaken on a timely basis to enable the auditor to conclude on the matter without undue delay. Information received in a capacity other than as auditor 127. There may be circumstances where it is not clear whether information about a charity coming to the attention of the auditor is received in the capacity of auditor or in some other capacity, for example as general adviser to the charity. Appendix 2 to ISA (UK and Ireland) 250 section B provides guidance as to how information obtained may be relevant 41

44 to the auditor in the planning and conduct of the audit and the steps that need to be taken to ensure the communication of information that is relevant to the audit. The auditor considers matters that are potentially of material significance to the regulator, and which arise in this context and if appropriate report these, in accordance with ISA (UK and Ireland) 250 section B. Failure to fulfil the statutory duty to report 128. Failure to comply with sections 44A or 68A of Charities Act 1993, section 46 of the 2005 Act (Scotland) or sections 67 and 103 of the 2008 Act (Northern Ireland) is regarded as a matter for the professional bodies to deal with pursuant to their own disciplinary procedures. For cases where the charity regulators have decided to make a complaint they have indicated that, within any legal restrictions that may apply, they will make available to those professional bodies any relevant information in its possession. Auditor s right to report to a Charity Regulator 129. In the case of charities in England and Wales and Scotland, the circumstances giving rise to a duty to report are equivalent to those applicable to regulated entities in the financial sector. The auditor also has a separate right to report where there is no statutory duty. This right in England and Wales is set out for non-company charities in section 44A(3) of the Charities Act Section 68A extends this section to company charities. This right is given by section 46 of the 2005 Act (Scotland) to auditors of charities registered in Scotland. Auditor s right to report in relation to charities in Northern Ireland 130. The statutory duty to report to the relevant charity regulator, and hence the statutory protection with respect to duties of confidentiality, do not yet extend to auditors of charities in Northern Ireland. 35 Until the statutory duty is commenced, the auditor considers whether a matter identified may be one that ought to be reported to a proper authority 36 in the public interest. Guidance on the factors to be taken into account when exercising the right to report in the public interest is set out in ISA (UK and Ireland) 250 section A. When considering whether to exercise the right to report to an appropriate authority, the auditor of a charity established in Northern Ireland will have regard to the examples of matters that would be of material significance to CCEW and OSCR which are included in Appendix 5 of this Practice Note. The auditor may need to take legal advice before making a decision on whether a matter should be reported in the public interest. 35 This right will be conferred by sections 67 and 103 of the Charities Act (Northern Ireland) 2008, once those sections of the Act are commenced. 36 At the time of publication of this Practice Note, this would normally be the Department for Social Development. 42

45 ISA (UK AND IRELAND) 260: COMMUNICATION WITH THOSE CHARGED WITH GOVERNANCE Objectives The objectives of the auditor are: (a) (b) (c) (d) To communicate clearly with those charged with governance the responsibilities of the auditor in relation to the financial statement audit, and an overview of the planned scope and timing of the audit; To obtain from those charged with governance information relevant to the audit; To provide those charged with governance with timely observations arising from the audit that are significant and relevant to their responsibility to oversee the financial reporting process; and To promote effective two-way communication between the auditor and those charged with governance. (paragraph 9) The auditor shall communicate in writing with those charged with governance regarding the significant findings from the audit if, in the auditor s professional judgment, oral communication would not be adequate. Written communications need not include all matters that arose during the course of the audit. (paragraph 19) 131. ISA (UK and Ireland) 260 stresses that communication shall be active, two-way communication between the auditor and those charged with governance. Effective communication is unlikely to be achieved when the auditor communicates with those charged with governance solely by means of formal written reports A charity s auditor notifies trustees of all breaches discovered in the course of its work 37 of duties relevant to the administration of the charity imposed by any enactment or rule of law on the trustees or managers or any professional adviser, regardless of whether the matter gave rise to a statutory duty to report to the charity regulators. Such notification normally takes place in the course of assessing the consequences of each particular breach; however, the auditor may also summarise such breaches in its report of audit matters to those charged with governance. 37 Subject to compliance with legislation relating to tipping off. 43

46 133. Those charged with governance include the directors (non-executive and executive) of a company. In relation to a charity this will include at a minimum the board of trustees who are collectively charged with governance. For larger charities where there are subcommittees of the board,.e.g. an audit committee, the sub-committee may be charged with specific tasks in order to assist the board meet its governance responsibilities Those charged with the governance of a charity have responsibilities at least as onerous as those of full-time, paid directors of commercial enterprises in relation to the security of a charity s income, assets and their proper application and, in the case of larger charities, are required by the Charities SORP to make a statement in their annual report concerning risks to which a charity is exposed and their management Where the trustees employ staff to whom certain executive functions are delegated, the auditor considers the persons to whom it would be most appropriate to address its reports. Whilst staff may play a central role in the direction and management of a charity, it must be remembered that such powers are delegated from the trustee body. 44

47 ISA (UK AND IRELAND) 265: COMMUNICATING DEFICIENCIES IN INTERNAL CONTROL TO THOSE CHARGED WITH GOVERNANCE AND MANAGEMENT Objective The objective of the auditor is to communicate appropriately to those charged with governance and management deficiencies in internal control that the auditor has identified during the audit and that, in the auditor s professional judgment, are of sufficient importance to merit their respective attentions. (paragraph 5) The auditor shall communicate in writing significant deficiencies in internal control identified during the audit to those charged with governance on a timely basis (paragraph 9). The auditor shall also communicate to management at an appropriate level of responsibility on a timely basis: (a) (b) In writing, significant deficiencies in internal control that the audit has communicated or intends to communicate to those charged with governance, unless it would be inappropriate to communicate directly to management in the circumstances; and Other deficiencies in internal control identified during the audit that have not been communicated to management by other parties and that, in the auditor s professional judgment, are of sufficient importance to merit management s attention (paragraph 10) The auditor s consideration of the system of internal control is undertaken as part of the steps necessary to form an opinion on the entity s financial statements. There is no statutory or regulatory requirement for a separate report on the design or operation of a charity s system of internal control. Nevertheless, the auditor s work may identify information on the systems which would assist the trustees in seeking to establish and maintain effective and efficient systems Findings from the audit to be communicated to those charged with governance and management include any significant deficiencies in the internal control systems identified during the audit. Guidance on internal controls is contained in a CCEW publication Internal Financial Controls for Charities (CC8). 45

48 138. Significant deficiencies in internal control may call into question the integrity or competence of management (for example, there may be evidence of fraud or intentional non-compliance with laws and regulations by management). In these situations, the auditor considers the need to make a report of matters of material significance to the Charity regulators see Appendix Whilst there is no requirement for charities to make a statement on internal control within the annual report, many charities do so as one way of demonstrating compliance with good governance codes and practice. The auditor reads this statement and considers any material inconsistency with knowledge gained from the audit. 46

49 ISA (UK AND IRELAND) 300: PLANNING AN AUDIT OF FINANCIAL STATEMENTS Objective The objective of the auditor is to plan the audit so that it will be performed in an effective manner. (paragraph 4) The auditor shall develop an audit plan that shall include a description of: (a) (b) (c) The nature, timing and extent of planned risk assessment procedures, as determined under ISA (UK and Ireland) The nature, timing and extent of planned further audit procedures at the assertion level, as determined under ISA (UK and Ireland) Other planned audit procedures that are required to be carried out so that the engagement complies with ISAs (UK and Ireland) (paragraph 9) 140. In developing the audit plan, the auditor considers the responsibilities as set out in statute and the letter of engagement to ensure that the scope of the audit plan is sufficient and includes, where appropriate, reports required by statute Particular issues the auditor considers, at the planning stage, include: the applicable reporting framework including: the legislative requirements, e.g. companies legislation or, in England and Wales the Charities Act 1993 or, in Scotland the 2005 Act (Scotland), or in Northern Ireland the 2008 Charities Act; the Charities SORP (or sector specific SORP where one applies); The governing document for the charity, which may also include specific reporting requirements; governance arrangements, including planning with the trustees the form and timing of communications; operating structures, branches and overseas operations including: 38 ISA (UK and Ireland) 315, Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment. 39 ISA (UK and Ireland) 330, The Auditor s Responses to Assessed Risks. 47

50 the extent to which the charity s activities (either of a fundraising or a charitable nature) are undertaken through branches or overseas activities and the impact this has on the auditor s required knowledge of the business (for example, taxation and employment law), the auditor s risk assessments and sources of audit evidence, and the structure and management of any related or connected entities, in particular the degree to which the entities are managed and controlled by the trustees and management of the charity; the charity s activities in the context of its stated objects and powers, including any limitations the charity s governing document, or terms and restrictions placed on material gifts or donations received; the likely impact on the financial statements of the charity of the activities of any related or connected entities (for example, a separate limited company set up to undertake commercial activities for the charity); the statutory duty to report matters to the charity regulators including whether members of the audit team have sufficient understanding (in the context of their role) to enable them to identify situations which may give reasonable cause to believe that a matter should be reported to the regulator; whether other auditor s reports are required for example special reports to funders of the charity, grant donors or EU agencies At an early stage in planning the audit, the auditor seeks agreement with the trustees for necessary access to third parties, when appropriate, and the timing and extent of the information required from them. The principal requirements are normally set out in the auditor s engagement letter. More detailed arrangements for obtaining access and information are likely to be one of the main subjects of discussion with the trustees, whether at a planning meeting or more informally, before the auditor completes the audit plan. 48

51 ISA (UK AND IRELAND) 315: IDENTIFYING AND ASSESSING THE RISKS OF MATERIAL MISSTATEMENT THROUGH UNDERSTANDING THE ENTITY AND ITS ENVIRONMENT Objective The objective of the auditor is to identify and assess the risks of material misstatement, whether due to fraud or error, at the financial statement and assertion levels, through understanding the entity and its environment, including the entity s internal control, thereby providing a basis for designing and implementing responses to the assessed risks of material misstatement. (paragraph 3) The auditor shall obtain an understanding of the following: (a) Relevant industry, regulatory, and other external factors including the applicable financial reporting framework. (paragraph 11a) The regulatory framework 143. As described in the introduction to this Practice Note the legal framework for charities is complex, and different requirements exist depending on the charity s constitution, the part of the United Kingdom in which the charity is established and the type of activity which it undertakes. The auditor needs to ascertain and understand the applicable law and regulations of the jurisdiction within which the charity operates. This involves keeping up to date with laws and regulations relating to charities generally, and to the client charity in particular The accounting requirements under which charities report depend on how they are constituted and the relevant national jurisdiction within the United Kingdom. The principal categories are set out in Appendix 1. The auditor shall obtain an understanding of the following: (b) The nature of the entity, including: (i) (ii) (iii) its operations; its ownership and governance structures; the types of investments that the entity is making and plans to make, including investments in special-purpose entities; and 49

52 (iv) the way that the entity is structured and how it is financed to enable the auditor to understand the classes of transactions, account balances, and disclosures to be expected in the financial statements. (paragraph 11b) 145. Knowledge of the charity s activities, governance, operating structure, sources of income and the existence of restricted funds is essential for ascertaining the risk of material misstatement arising from fraud, error, or non-compliance with applicable law and regulations and in order to plan and carry out audit work effectively and efficiently. Certain special features of charities are outlined in the introduction section of this Practice Note The auditor also needs to understand the charity s governing document. There are many different types of governing instrument or constitution which will determine the objects of the charity and the powers of its trustees, and the audit approach needs to be adapted accordingly. Particular issues include: any limitations in objectives placed on the charity by its governing document; or terms and restrictions placed on material gifts or donations received. The auditor shall obtain an understanding of the following: (c) (d) The entity s selection and application of accounting policies, including the reasons for changes thereto. The auditor shall evaluate whether the entity s accounting policies are appropriate for its business and consistent with the applicable financial reporting framework and accounting policies used in the relevant industry. (paragraph 11c) The entity s objectives and strategies, and those related business risks that may result in risks of material misstatement. (paragraph 11d) 147. The auditor reviews accounting policies and considers the application of the Charities SORP. Accounting policies adopted may have a significant effect on the recognition of assets and liabilities or their presentation within financial statements. Policies that may require particularly careful consideration include those for the recognition of: legacies receivable; grants receivable as voluntary income; grants receivable or payable on performance-related conditions; liabilities resulting from constructive obligations; 50

53 gifts in kind and donated services; and heritage assets. The auditor considers what steps have been taken by trustees and senior management in respect of cost allocations. Policies that affect the allocation of costs between charitable activities and income generation may have a significant impact on how costs are presented in the statement of financial activities The auditor also considers the key performance indicators used to monitor the performance of the charity especially those used by the trustees. The auditor shall obtain an understanding of internal control relevant to the audit. Although most controls relevant to the audit are likely to relate to financial reporting, not all controls that relate to financial reporting are relevant to the audit. It is a matter of the auditor s professional judgment whether a control, individually or in combination with others, is relevant to the audit. (paragraph 12) When obtaining an understanding of controls that are relevant to the audit, the auditor shall evaluate the design of those controls and determine whether they have been implemented, by performing procedures in addition to inquiry of the entity s personnel. (paragraph 13) 149. There is a wide variation between different charities in terms of size, activity and organisation. Smaller charities may be administered by volunteer staff or by third party administrators. Larger charities may directly employ professionally qualified, full-time staff. However, the responsibilities of trustees for ensuring that the charity has adequate internal controls and therefore is properly administered and its assets properly safeguarded apply irrespective of a charity s size or administrative arrangements, and the attitude, role and involvement of each charity s trustees are likely to be fundamental in determining the effectiveness of its control environment The maintenance of an effective system of internal control is at least as important, if not more so, for charities as it is for other entities, since it is a fundamental duty of charity trustees to protect the property of their charity and to secure its application for the objects of the charity. Failure to do so can render the trustees personally liable for any loss occasioned to the charity 40. Auditors of certain charities, for example registered friendly societies, registered social landlords and charitable non-departmental public bodies, are 40 Guidance leaflets entitled Internal financial controls for charities and The hallmarks of an effective charity have been published by the Charity Commission, and OSCR has published Guidance for charity trustees acting with care and diligence. 51

54 subject to specific reporting requirements in respect of internal controls. Where there is such a requirement, the auditor plans its work bearing in mind the need to report if a satisfactory system of control over transactions has not been maintained. Control environment 151. The role, attitude and actions of the trustees are fundamental in shaping the control environment of a charity. Factors to consider include: the amount of time committed by trustees to the charity s affairs; the skills and qualifications of individual trustees; trustees understanding of the charity and its legal and regulatory environment; the regularity and effectiveness of trustee meetings and the level of attendance at these meetings; the adequacy of minutes of trustee meetings; the independence of trustees from each other; the policy on dealing with trustee conflicts; the processes for managing trustee conflicts of interest; the supervision by the trustees of relatively informal working arrangements which are common when using volunteers; the degree of involvement in key decision-making or monitoring transactions and engagement with charity staff; the attitude of trustees to previously identified control deficiencies; the level of delegation by trustees to senior management and the formality of this delegation; and the committee structure of the organisation Other features of the control environment will depend on the size, activities, organisation and corporate governance structures of the charity but might include: a recognised plan of the charity s structure showing clearly the areas of responsibility and lines of authority and reporting. Where the charity does not have staff, and is administered entirely by the trustees, there can still be an agreed division of duties, provided there is adequate monitoring by the body of trustees as a whole; segregation of duties where charities have more than one member of staff (whether paid or not). In larger charities, such segregation could include involvement of staff from outside the finance department in certain transactions, for example in providing a first signatory for cheques; 52

55 supervision by trustees of activities of staff where segregation of duties is not practical; competence, training and qualification of paid staff and any volunteers appropriate to the tasks they have to perform; involvement of the trustees in the recruitment, appointment and supervision of senior executives; access of trustees to independent professional advice where necessary; budgetary controls in the form of estimates of income and expenditure for each financial year and comparison of actual results with the estimates on a regular basis; and communication of results of such reviews to the trustees on a regular basis so as to facilitate their review of performance and enable them to initiate action where necessary. The auditor shall obtain an understanding of whether the entity has a process for: (a) (b) (c) Identifying business risks relevant to financial reporting objectives; Estimating the significance of the risks; Assessing the likelihood of their occurrence; and (d) Deciding about actions to address those risks (paragraph 15) 153. The Charities SORP requires charities that are subject to a statutory audit to include a statement in the Trustees Annual Report confirming that the major risks to which the charity is exposed, as identified by the trustees, have been reviewed and systems have been established to manage those risks. In addition, companies legislation requires medium and large-sized charitable companies to disclose what key risks and uncertainties the charity faces. As a result of this, charities will often maintain a risk register. The auditor shall obtain an understanding of the information system, including the related business processes, relevant to financial reporting, including the following areas: (a) (b) The classes of transactions in the entity s operations that are significant to the financial statements. The procedures, within both information technology (IT) and manual systems, by which those transactions are initiated, recorded, processed, corrected as 53

56 necessary, transferred to the general ledger and reported in the financial statements. (c) (d) (e) (f) The related accounting records, supporting information and specific accounts in the financial statements that are used to initiate, record, process and report transactions; this includes the correction of incorrect information and how information is transferred to the general ledger. The records may be in either manual or electronic form; How the information system captures events and conditions, other than transactions, that are significant to the financial statements; The financial reporting process used to prepare the entity s financial statements, including significant accounting estimates and disclosures; and Controls surrounding journal entries, including non-standard journal entries used to record non-recurring, unusual transactions or adjustments. (paragraph 18) For charities it is particularly important that the systems in place are able to capture accurately any restrictions placed on income (whether imposed by the donor or as a result of the charity s fundraising initiatives). The charity also needs to ensure the documentation supporting the restrictions on the income is retained and easily accessible. This includes any deeds of covenant. The auditor shall obtain an understanding of control activities relevant to the audit, being those the auditor judges it necessary to understand in order to assess the risks of material misstatement at the assertion level and design further audit procedures responsive to assessed risks. An audit does not require an understanding of all the control activities related to each significant class of transactions, account balance, and disclosure in the financial statements or to every assertion relevant to them. (paragraph 20) 155. Some of the control activities which are special to charities are set out in guidance issued by CCEW Internal Financial Controls for Charities. In understanding the entity s control activities, the auditor shall obtain an understanding of how the entity has responded to risks arising from IT. (paragraph 21) 156. Many charities have websites which provide facilities for online giving. These may support a donation by credit card, sponsorship or legacy making. The auditor considers 54

57 whether adequate controls exist over the IT supporting these websites and the financial systems in respect of gifts made or pledged using these facilities. The auditor shall identify and assess the risks of material misstatement at: (a) (b) the financial statement level; and the assertion level for classes of transactions, account balances, and disclosures. (paragraph 25) There is a wide variation between different charities in terms of size, activity and organisation, so that there can be no standard approach to internal controls and risk. The auditor assesses risk and the adequacy of controls in relation to the circumstances of each charity Factors considered by the auditor in assessing whether there may be an increased level of risk of material misstatement include: evidence of failure to act in accordance with those objects and powers in the charity s governing document; the strength of the control environment; the complexity and extent of regulation; the significance of donations and cash receipts including whether donations are received over the internet or by credit card; the treatment of legacy income; the valuation of gifts in kind and donated services; difficulties of the charity in establishing ownership and timing of voluntary income where funds are raised by non-controlled bodies; lack of predictable income or a precisely defined relationship between expenditure and income which makes it difficult for the charity to ensure that income to which it is entitled is actually received; uncertainty of future income which can make consideration of future operations and viability of the charity difficult; restricted funds which require special considerations as to use and accounting; the extent and nature of trading activities; the complexity of tax rules (whether income tax, capital gains tax, VAT or business rates) relating to charities; 55

58 difficulties in identification and quantification of liabilities arising from constructive obligations 41 ; the sensitivity of certain key statistics, such as the proportion of resources used in administration and fundraising; the need to maintain adequate resources for future expenditure while avoiding the build up of reserves which could appear excessive to potential donors or be incompatible with the entity s charitable status; the valuation of heritage or unusual fixed assets Overseas activities may give rise to additional risks including: significant aspects of a charity s business may be conducted in conditions or locations which impede access to the accounting records; the transactions may be in a number of different and volatile currencies; conduit funding 42 ; or informal banking arrangements may be used; due to the location of the activities management may have reduced oversight and limited ability to monitor activities and transactions; governance, responsibility and accountability may be unclear regarding branches, joint ventures and the use of partners in overseas locations; the risk of a tax liability arising if HMRC consider that reasonable steps have not been taken to ensure overseas payments are being allocated to charitable causes only. In these circumstances the auditor will need to ensure that it is able to assess the full extent of the activities, and have the necessary understanding of the regulatory environment in which significant activities are carried out for example, in relation to taxation and employment law 43. As part of the risk assessment as described in paragraph 25, the auditor shall determine whether any of the risks identified are, in the auditor s judgment, a significant risk. In exercising this judgment, the auditor shall exclude the effects of identified controls related to the risk. (paragraph 27) 41 See also paragraph 148 of the Charities SORP. 42 Resources received and distributed by a charity as agent for another entity, usually another charity. The principal in the arrangement is the charity providing the resources who retains the legal responsibility for the charitable application of the funds. 43 The Charity Commission has issued guidance on charities working internationally. 56

59 If the auditor has determined that a significant risk exists, the auditor shall obtain an understanding of the entity s controls, including control activities, relevant to that risk. (paragraph 29) 160. Issues concerning the completeness of incoming resources, the existence of restricted funds and overseas operations are likely to give rise to significant risks affecting charity audits, and audit procedures in respect of these are commented on further in the section on ISA (UK and Ireland) 330 below. 57

60 ISA (UK AND IRELAND) 320: MATERIALITY IN PLANNING AND PERFORMING AN AUDIT Objective The objective of the auditor is to apply the concept of materiality appropriately in planning and performing the audit. (paragraph 8) When establishing the overall audit strategy, the auditor shall determine materiality for the financial statements as a whole. If, in the specific circumstances of the entity, there is one or more particular classes of transactions, account balances or disclosures for which misstatements of lesser amounts than materiality for the financial statements as a whole could reasonably be expected to influence the economic decisions of users taken on the basis of the financial statements, the auditor shall also determine the materiality level or levels to be applied to those particular classes of transactions, account balances or disclosures. (paragraph 10) The auditor shall determine performance materiality for purposes of assessing the risks of material misstatement and determining the nature, timing and extent of further audit procedures. (paragraph 11) 161. The auditor considers materiality in planning an audit and when assessing whether the accounts give a true and fair view from the point of view of the addressees of the report (in most cases, the trustees). The principles underlying this consideration of materiality are no different from those involved in the audit of other entities and are explained in the ISA (UK and Ireland) ISA (UK and Ireland) 320 indicates that materiality is considered at both the overall financial statement level and in relation to individual account balances, classes of transactions and disclosures. This can result in different materiality considerations being applied depending on the item of the accounts being considered, for example the degree of accuracy expected in the case of certain statutory disclosures, e.g. transactions with trustees are likely to be considered to be material. Also particular disclosures or expenditure categories may be sensitive and warrant extra attention, for example, costs of generating funds. Branches 163. The auditor clarifies with management which entities will form part of the financial statements being produced by the charity. Where a charity operates through branches or subsidiaries, their contribution to the results and financial position of the charity may not 58

61 be known at the time of planning the audit. In this case, the auditor considers how to decide the likely results of branches or subsidiaries by reference to procedures such as: discussion with management; consideration of problems or particular issues encountered in previous years to see whether there is an identifiable pattern suggestive of weak management or fraud, for example; consideration of prior year figures and any budgeted or preliminary results. The resulting best estimate is incorporated into the materiality calculation for the audit as a whole. Further guidance on consolidated financial statements is given in the section on ISA (UK and Ireland) 600 below. Restricted funds 164. Many charities receive funds subject to specific trusts, which must be accounted for separately (unless grouped together if, individually, they are comparatively small) in accordance with the Charities SORP. There is no presumption that the auditor will set a different monetary materiality level for such funds. However, the ISA (UK and Ireland) provides guidance 44 on the factors that may indicate that lower amounts than materiality could reasonably be expected to influence the economic decisions of users and which may result in different materiality considerations being applied to particular aspects of the financial statements. Lower amounts than materiality may also be considered in the evaluation of identified misstatements on the audit under ISA (UK and Ireland) 450 Evaluation of Misstatements Identified During the Audit Any breaches of the terms of trusts relating to restricted funds which come to the auditor s attention in the course of its work, regardless of materiality to the financial statements as a whole, need to be considered in terms of their significance to the auditor s report on the financial statements and brought to the attention of trustees, as a failure on their part to comply with the terms of trusts may place them in breach of their responsibilities The auditor also considers the disclosure of restricted funds which are subject to specific trusts as to their application, paying particular attention to: any funds that are in deficit; any income funds which are held in illiquid assets (including inter-fund loans) thereby preventing application of the fund; and any expenditure of the capital of a permanently endowed fund. 44 Paragraph A10 of ISA (UK and Ireland)

62 ISA (UK AND IRELAND) 330: THE AUDITOR S RESPONSES TO ASSESSED RISKS Objective The objective of the auditor is to obtain sufficient appropriate audit evidence regarding the assessed risks of material misstatement, through designing and implementing appropriate responses to those risks. (paragraph 3) The auditor shall design and perform tests of controls to obtain sufficient appropriate audit evidence as to the operating effectiveness of relevant controls if: (a) (b) The auditor s assessment of risks of material misstatement at the assertion level includes an expectation that the controls are operating effectively (that is, the auditor intends to rely on the operating effectiveness of controls in determining the nature, timing and extent of substantive procedures); or Substantive procedures alone cannot provide sufficient appropriate audit evidence at the assertion level. (paragraph 8) If the auditor has determined that an assessed risk of material misstatement at the assertion level is a significant risk, the auditor shall perform substantive procedures that are specifically responsive to that risk. When the approach to a significant risk consists only of substantive procedures, those procedures shall include tests of details. (paragraph 21) Completeness of incoming resources 167. The incoming resources of charities often involve a number of different sources, ranging from grants from government departments to occasional cash donations by members of the public in response to street collections. Whilst it is the trustees responsibility to safeguard the assets and incoming resources of the charity, the voluntary nature of some elements of its incoming resources raises considerations concerning the methods available to the trustees for the purposes of ensuring that all incoming resources to which the charity is entitled are correctly accounted for The amount of voluntary income cannot, in many cases, be determined in advance, nor can a charity be regarded as necessarily entitled to funds, even when the amounts can be predicted, before the charity is in receipt of them. Trustees of a charity cannot be held responsible for the security of money or other assets which are intended for its use until that money or assets are, or should be, within the control of the charity. Trustees should, 60

63 however, establish procedures to ensure appropriate recording and safeguarding as soon as such assets come within their control The Charities SORP reflects the position described in the previous paragraph. Discussing the criteria for recognising incoming resources, it states: Incoming resources both for income and endowment funds should be recognised in the Statement of Financial Activities when the effect of a transaction or other event results in an increase in the charity s assets. This will be dependent on the following three factors being met: (a) entitlement normally arises when there is control over the rights or other access to the resource, enabling the charity to determine its future application; (b) certainty when it is virtually certain that the incoming resource will be received; (c) measurement when the monetary value of the incoming resource can be measured with sufficient reliability The auditor considers the following factors when addressing the completeness of incoming resources: loss of incoming resources through fraud: the auditor considers the possibility that the charity s records of incoming resources to which it is legally entitled may be incomplete as a result of fraud. A common type of fraud against charities is the diversion of donations to bank or building society accounts which the charity trustees do not control. Sources of audit evidence as to whether incoming resources from appeals and other non-routine sources have been fully recorded can involve the assessment and testing of the sort of internal controls described in the section on ISA (UK and Ireland) 315, and comparison of donations actually received by the charity to past results for similar appeals and statistics for response rates for charities in general; recognition of incoming resources from third party fund-raisers: income recognition can be a complex issue where a charity obtains resources by means of fundraising organisations 45. The auditor considers the agreement (between the charity and the fundraiser) and other documents relating to the transaction to see whether all donations received in the charity s name have been transmitted to it or otherwise accounted for and that amounts have been accounted for gross where appropriate instead of having been netted off at source; 45 The Charities Act 1992 Section 59 requires there to be an agreement between the charity and the fundraiser in a prescribed form. 61

64 recognition of incoming resources from branches, associates or subsidiaries: if charities use branches, associates or subsidiaries to raise funds, the auditor considers the arrangements made by the main charity to determine at what point incoming resources are recognised; recognition of legacy income: legacy income is recognised on a receivable basis when there is sufficient evidence to provide necessary certainty that legacy income will be received and the value of the incoming resources can be measured with sufficient reliability (Charities SORP, paragraphs ). These criteria will normally be met following probate or confirmation and once the executor(s) of the estate have established that there are sufficient assets in the estate, after settling liabilities, to pay legacy income. Evidence that the executors have determined that a payment can be made may arise on the agreement of the estate accounts or some other notification that the payment will be made. Where notification is received after the year end but it is clear that the executor(s) have agreed prior to the year end that legacy income can be paid, then it is accrued (Charities SORP, paragraph 127). The certainty and measurability of the receipt may be affected by subsequent events such as valuations and disputes. The auditor therefore reviews information available up to when the accounts are approved for evidence relating to legacy income receivable at the balance sheet date. The auditor also considers the consistent application of legacy income recognition policies and the adequacy of their disclosure in accounting policy notes (Charities SORP, para 363(a)) and considers the implications for the audit report of policies that closely equate to recognition on receipt. Sources of audit evidence as to whether legacy income has been correctly recorded include probate information, estate accounts, correspondence from executors or solicitors, and legacy fundraising agencies. informal fundraising groups: where informal fundraising groups raise money or other resources for charitable purposes on a voluntary basis, without knowledge of any particular charity, criteria for recognising income are not met until the funds raised are notified to the recipient charity. In general, neither trustees nor the auditor has an obligation to estimate the extent of income from such sources before this point. Even if a legal entitlement on the part of the charity to the resulting income may arise under trust law, it would normally be inappropriate for the charity to account for income from such sources since its ultimate cash realisation, so far as the charity itself is concerned, cannot be determined with sufficient certainty; grants or contractual funding: in the case of grant or contractual funded charities, an examination of the grant applications or contract and correspondence can assist in confirming completeness of incoming resources. The auditor considers obtaining direct confirmation of the amounts receivable from the grant provider; and non-cash donations: satisfactory operation of internal controls may enable the auditor to obtain sufficient appropriate audit evidence as to the recognition and measurement of gifts in kind or donated services or facilities. The basis of any valuation of non-cash donations should be clearly stated in the notes to the financial 62

65 statements and consistently applied. The auditor considers whether the policy is reasonable in the circumstances and has been properly applied Analytical procedures may also be used as a source of audit evidence about the completeness of incoming resources. Whilst the degree of inherent uncertainty affecting donated incoming resources may restrict the reliance which can be placed on such techniques in respect of donations, they nevertheless provide a source of additional corroborative evidence to supplement that drawn from the auditor s consideration of relevant controls over completeness of incoming resources from donations. The auditor therefore undertakes substantive analytical procedures to assess whether such incoming resources are consistent with the auditor s knowledge of the charity and its activities over the period, and considers undertaking other audit procedures In the case of larger charities with more complex operations, there are specialist publications and sources of information which can be referred to for general information about charities as well as comparative figures and statistics. These sources include trade journals, umbrella organisations, and the charity regulators. Available statistics include responses to mail shots (i.e. donations received), and industry norms such as sales per square foot for trading operations in different areas. Restricted funds 173. Restricted funds (including endowments) which are subject to specific trusts as to their application may give rise to a significant risk of misstatement Audit procedures may include: consideration of internal control procedures put in place by the charity to identify restricted funds whether imposed by the donor or as a result of the charity s fund raising initiatives; consideration of the methods used in cost allocation to ensure that the expenditure is allocated in accordance with the terms or conditions attaching to restricted funds; comparison of expenditure (whether out of income or capital) with the terms of the restricted fund, and appeal documentation, bid submissions and related reports to donors; consideration of future funding to cover negative balances; consideration of the validity of transfers between funds; consideration of the ability of the fund to meet its obligations in view of the liquidity of its underlying assets; and consideration of whether the capital of an endowed fund has been expended without express authority. 63

66 Overseas operations 175. Overseas activities can be undertaken through a number of different structures including branches, joint ventures with other charities, projects managed by local agents or partners through to the grant funding of autonomous local organisations. The auditor of a charity is responsible for forming an opinion on the financial statements reflecting all of the charity s operations, wherever they are situated and however formally they are constituted Audit procedures on overseas operations may include: the auditor obtaining an understanding of how trustees control overseas operations. Management procedures may involve the vetting of applications, reviewing project reports received, setting thresholds for site visits to projects involving significant grant funding, confirmation of grant receipts, reviewing accounts and the local certification of expenditure; obtaining evidence from field officers reports as to work undertaken; comparison of accounting returns of expenditure with field reports and plans for consistency and reasonableness; analytical review of accounting returns received from overseas branches or local agents; consideration of any inspection or internal control visit reports undertaken by any internal audit function; consideration of audit work undertaken by local auditors, and consideration of any audit reports carried out on behalf of international donors for example government departments; and evidence from the audit work of another audit firm Where material assets are held or material funds are applied by overseas branches or subsidiaries the auditor may seek observational evidence by way of site visits. Such visits may provide valuable evidence of the existence of tangible fixed assets and of project work being undertaken by the charity. The auditor needs to be aware of the logistical arrangements which may be needed where site visits to remote areas are considered Where a charity makes a significant grant to an overseas organisation that is autonomous from the charity, the auditor seeks evidence to support receipt of funding by that organisation, and that the charity has exercised reasonable diligence in ensuring application of the funds for the purposes of the charity s objects in order that adverse tax consequences are not suffered Where the overseas operations are part of the charity, the transfer of funds by itself does not give rise to expenditure as such funds remain under the control of the charity. 64

67 However, an understanding of the structure of the charity will be needed in determining at what point expenditure is incurred, and audit evidence will be required to support material expenditure of money in the field In some cases it may be more cost effective to engage component auditors to undertake audit work on overseas operations. Guidance on ISA (UK and Ireland) 600 on group financial statements will apply in such situations and guidance in paragraphs 237 to 245 may be helpful. 65

68 ISA (UK AND IRELAND) 402: AUDIT CONSIDERATIONS RELATING TO AN ENTITY USING A SERVICE ORGANISATION Objectives The objectives of the user auditor, when the user entity uses the services of a service organization, are: (a) To obtain an understanding of the nature and significance of the services provided by the service organization and their effect on the user entity s internal control relevant to the audit, sufficient to identify and assess the risks of material misstatement; and (b) To design and perform audit procedures responsive to those risks. (paragraph 7). When obtaining an understanding of the user entity in accordance with ISA (UK and Ireland) 315, the user auditor shall obtain an understanding of how a user entity uses the services of a service organization in the user entity s operations, including: (a) (b) (c) (d) (e) The nature of the services provided by the service organization and the significance of those services to the user entity, including the effect thereof on the user entity s internal control; The nature and materiality of the transactions processed or accounts or financial reporting processes affected by the service organization; The degree of interaction between the activities of the service organization and those of the user entity; The nature of the relationship between the user entity and the service organization, including the relevant contractual terms for the activities undertaken by the service organization; If the service organisation maintains all or part of a user entity s accounting records, whether those arrangements impact the work the auditor performs to fulfil reporting responsibilities in relation to accounting records that are established in law or regulation. (paragraph 9) The auditor identifies whether the charity uses service organisations and assesses the effect of any such use on the procedures necessary to obtain sufficient and appropriate audit evidence to determine with reasonable assurance whether the financial statements are free of material misstatement. 66

69 182. Use of a service organisation does not diminish the ultimate responsibility of the trustees for conducting the affairs of the charity in a manner which meets their legal responsibilities, including those of safeguarding the assets, maintaining proper accounting records and preparing financial statements Similarly, an entity s use of a service organisation does not alter the auditor s responsibilities when reporting on its financial statements, but may have a significant effect on the nature of procedures undertaken to obtain sufficient appropriate audit evidence to determine whether a user entity s financial statements are free from material misstatement The auditor of a charity needs to consider the nature and extent of activity undertaken by service organisations to determine whether those activities are relevant to the audit, and what their effect is on audit risk Service organisations undertake a range of activities within the charity sector including: maintenance of accounting records, payroll services, fundraising, custodianship of assets, and investment management services. The user auditor shall determine whether a sufficient understanding of the nature and significance of the services provided by the service organization and their effect on the user entity s internal control relevant to the audit has been obtained to provide a basis for the identification and assessment of risks of material misstatement. (paragraph 11) In responding to assessed risks in accordance with ISA (UK and Ireland) 330, the user auditor shall: (a) (b) Determine whether sufficient appropriate audit evidence concerning the relevant financial statement assertions is available from records held at the user entity; and, if not, Perform further audit procedures to obtain sufficient appropriate audit evidence or use another auditor to perform those procedures at the service organization on the user auditor s behalf. (paragraph 15) 67

70 186. If the auditor is able to obtain a sufficient understanding of risk on which to base his planning of audit procedures by considering the charity s controls and information available to the charity, for example by reviewing a report produced in accordance with AAF 01/06 46, the auditor will not need to supplement that understanding and assessment by making further enquiries about the control arrangements of relevant service providers If the auditor is unable to obtain a sufficient understanding of risk by considering information and controls at the entity level, the auditor takes steps to obtain a more detailed understanding of the control arrangements of relevant service providers by such means as visiting the service organisation or requesting the service organisation s auditor or the entity s internal audit function to perform specified procedures. The feasibility of this approach will depend on whether the contractual arrangements between the trustees and the service provider entitle the trustees to obtain supplementary information when considered necessary Where controls are poor or absent, the auditor also considers whether the status of the charity s internal control arrangements should be the subject of a report to the relevant charity regulator For charities in England and Wales, the charity s governing document may set out powers for the trustees to delegate activities to outside service organisations, who may not be charities themselves. The auditor reviews such documents where practicable, or alternatively holds discussions with the trustees, to determine whether there is authority, or presumed authority, for outsourcing It is not uncommon for charities to share an accounting function. In such cases the auditor considers the control arrangements for allocation of costs between such connected entities Where investment management arrangements exist, the auditor considers how trustees set investment objectives and monitor performance. The auditor also discusses with the trustees how they ensure that the level of delegation is consistent with the charity s powers and that the investment powers are being properly exercised PN 15: The audit of occupational pension schemes in the United Kingdom (Revised) 47 sets out guidance on the auditor s considerations and sources of audit evidence in circumstances where investment management and custody functions are outsourced. This guidance may also be relevant to certain charity audits. 46 Assurance reports on internal controls of service organisations made available to third parties, issued by the ICAEW. 47 Paragraphs 245 to 247 of Practice Note 15 (Revised). 68

71 193. Certain arrangements may also involve a service organisation providing facilities and services direct to a charity s beneficiaries. Examples include: management of a recreational facility such as a sports centre, provision of services to beneficiaries such as the management of a care facility; and provision of ancillary catering facilities e.g. a museum restaurant. 69

72 ISA (UK AND IRELAND) 505: EXTERNAL CONFIRMATIONS Objective The objective of the auditor, when using external confirmation procedures, is to design and perform such procedures to obtain relevant and reliable audit evidence. (paragraph 5) The auditor shall consider whether external confirmation procedures are to be performed as substantive audit procedures. (paragraph 19 of ISA 330) 194. External confirmations can provide reliable audit evidence of the amounts recoverable from grant providers and sources of contractual income. However some sources of such income, for example, local authorities and some government funding bodies may not respond to confirmation requests and alternative procedures will be required to obtain appropriate audit evidence In deciding whether to request a bank report, the auditor considers the risks in relation to relevant financial statement assertions including bank-related information to be disclosed in the notes to the financial statements. For bank balances held in overseas locations the auditor considers the format of the request for information sent to the overseas bank to ensure that the request will be fully understood by the bank Where the auditor does not receive a response to a bank report the auditor considers alternative procedures and amends the audit plan accordingly. Additionally the auditor considers whether a failure of an overseas bank to reply to a request for information should be included in a report to those charged with governance. 70

73 ISA (UK AND IRELAND) 510: INITIAL AUDIT ENGAGEMENTS OPENING BALANCES Objective In conducting an initial audit engagement, the objective of the auditor with respect to opening balances is to obtain sufficient appropriate audit evidence about whether: (a) (b) Opening balances contain misstatements that materially affect the current period s financial statements; and Appropriate accounting policies reflected in the opening balances have been consistently applied in the current period s financial statements, or changes thereto are appropriately accounted for and adequately presented and disclosed in accordance with the applicable financial reporting framework. (paragraph 3) The auditor shall obtain sufficient appropriate audit evidence about whether the opening balances contain misstatements that materially affect the current period s financial statements by: (a) (b) (c) Determining whether the prior period s closing balances have been correctly brought forward to the current period or, when appropriate, have been restated; Determining whether the opening balances reflect the application of appropriate accounting policies; and Performing one or more of the following: (i) (ii) (iii) Where the prior year financial statements were audited, reviewing the predecessor auditor s working papers to obtain evidence regarding the opening balances; Evaluating whether audit procedures performed in the current period provide evidence relevant to the opening balances; or Performing specific audit procedures to obtain evidence regarding the opening balances. (paragraph 6) 197. Special considerations will apply where a non-company charity changes its basis of accounting from a receipts and payments to an accruals basis, or where the financial statements become subject to an audit, having previously been subject to a report by an independent examiner. 71

74 198. When there has been a change in the basis of accounting procedures may include checking bank statements, the review of receipts and payments after the year end, and a physical check of any tangible fixed assets. For analytical procedures performed in the current year the auditor is likely to need to adjust the prior year management information prepared on a receipts and payments basis to enable a proper comparison. 72

75 ISA (UK AND IRELAND) 520: ANALYTICAL PROCEDURES Objectives The objectives of the auditor are: (a) (b) To obtain relevant and reliable audit evidence when using substantive analytical procedures; and To design and perform analytical procedures near the end of the audit that assist the auditor when forming an overall conclusion as to whether the financial statements are consistent with the auditor s understanding of the entity. (paragraph 3) The auditor shall perform risk assessment procedures to provide a basis for the identification and assessment of risks of material misstatement at the financial statement and assertion levels. Risk assessment procedures by themselves, however, do not provide sufficient appropriate audit evidence on which to base the audit opinion. (paragraph 5 of ISA 315) The risk assessment procedures shall include the following: (a) (b) Inquiries of management, and of others within the entity who in the auditor s judgment may have information that is likely to assist in identifying risks of material misstatement due to fraud or error. Analytical procedures. (c) Observation and inspection. (paragraph 6 of ISA 315) 199. A particular difficulty in applying analytical procedures to the audit of charities is that certain items in the financial statements can be very difficult to predict. For example, the level of income from donations and legacies cannot always be forecast with any great accuracy, as people s pattern of giving may change unpredictably. It is also difficult to establish a relationship between donations and other figures in the financial statements, as expenditure levels other than fundraising costs may not have any direct relationship with such income The usefulness of individual procedures depends on the scale and nature of activities undertaken, but examples of measures that can be adopted include: comparison of actual income and expenditure to prior years figures and trends; 73

76 comparison of actual to budgeted results; comparison of actual income to successful bids, legacy notifications and potential legacies reported in the minutes; comparison of actual expenditure to the auditor s own estimate of the expenditure that would be reasonable for the particular transaction under review; comparison of results of an individual branch to those of similar branches of the main charity; checking charity shops sales revenue between different periods (e.g. monthly) and to other shops operating in similar locations; analysis of efficiency ratios such as staff or administration costs as a percentage of benefits delivered or grants made, or the ratio of costs to income generated for material categories of fundraising; and comparison of actual donations received as a result of fundraising activities to the amount which could be expected on the basis of charity statistics, if any are available. 74

77 ISA (UK AND IRELAND) 540: AUDITING ACCOUNTING ESTIMATES, INCLUDING FAIR VALUE ACCOUNTING ESTIMATES, AND RELATED DISCLOSURES Objective The objective of the auditor is to obtain sufficient appropriate audit evidence about whether: (a) (b) accounting estimates, including fair value accounting estimates, in the financial statements, whether recognized or disclosed, are reasonable; and related disclosures in the financial statements are adequate, in the context of the applicable financial reporting framework. (paragraph 6). The auditor shall review the outcome of the accounting estimates included in the prior period financial statements, or, where applicable, their subsequent re-estimation for the purpose of the current period. The nature and extent of the auditor s review takes account of the nature of the accounting estimates, and whether the information obtained from the review would be relevant to identifying and assessing risks of material misstatement of accounting estimates made in the current period financial statements. However, the review is not intended to call into question the judgments made in the prior periods that were based on information available at the time. (paragraph 9). In identifying and assessing the risks of material misstatement, as required by ISA (UK and Ireland) 315, the auditor shall evaluate the degree of estimation uncertainty associated with an accounting estimate. (paragraph 10). The auditor shall determine whether, in the auditor s judgment, any of those accounting estimates that have been identified as having high estimation uncertainty give rise to significant risks. (paragraph 11). For accounting estimates that give rise to significant risks, in addition to other substantive procedures performed to meet the requirements of ISA (UK and Ireland) 330, 48 the auditor shall evaluate the following: (a) How management has considered alternative assumptions or outcomes, and why it has rejected them, or how management has otherwise addressed estimation uncertainty in making the accounting estimate. 48 ISA (UK and Ireland) 330, paragraph

78 (b) (c) Whether the significant assumptions used by management are reasonable. Where relevant to the reasonableness of the significant assumptions used by management or the appropriate application of the applicable financial reporting framework, management s intent to carry out specific courses of action and its ability to do so. (paragraph 15) Common areas of charity financial statements which are affected by accounting estimates or fair value adjustments include: the valuation of defined benefit pension schemes. Charities also have the specific complexities of allocating pension deficits/assets between funds and the effect of these deficits/assets on their free reserves; the need to recognise material grant commitments at their present value in the balance sheet; the basis of the valuation of investments whether financial or programme-related investments; the option to recognise tangible fixed assets and heritage assets 49 at valuation and the valuation methods used; the need to fair value the assets and liabilities acquired where acquisition accounting is applied (in this situation, the due diligence process may only provide limited information on the fair value of some assets such as land and buildings and heritage assets); the need to recognise gifts in kind (apart from second-hand goods donated for resale) at a reasonable estimate of their gross value to the charity and donated services and facilities at a reasonable estimate of the value to the charity of the service or facility received; the accrual of income in relation to legacy income; the allocation of costs between different expenditure categories in the Statement of Financial Activities (SoFA) The Charities SORP provides detailed guidance on appropriate accounting policies and measurement bases. In applying these policies and bases the use of estimates and estimation techniques will be necessary to determine the monetary value of assets and liabilities and to determine the allocation of costs within the SoFA. In order to comply with FRS 18 Accounting Policies and the Charities SORP, a charity s financial statements 49 FRS 30: Heritage Assets applies to accounting periods beginning on or after 1 April

79 discloses a description of the estimation techniques adopted, including underlying principles, that are significant The Charities SORP allows certain valuations to be undertaken by trustees or employees of a charity, provided that, in the case of property valuations, they are suitably qualified. In this situation, the auditor assesses the individual s relevant experience in accordance with the requirements of paragraph 8 of ISA (UK and Ireland) 500 and the associated guidance in relation to a management s expert Evidence to support accounting estimates may frequently be obtained as part of the auditor s review of the post-balance sheet period, for example by checking the subsequent expenditure of designated funds, or recoverability of accrued income in respect of, for example, tax claims, grant awards and legacies Evidence relating to cost allocations across the cost categories of the SoFA may sometimes be obtained through observation, for example, by observing the key duties of staff and internal departments to determine whether staff costs are reasonably allocated between the categories of charitable expenditure and the costs of generating funds. Where material estimates are required to allocate joint costs between the expenditure categories of the SoFA, the auditor considers the requirements of FRS 18 Accounting Policies, that the accounting policies adequately explain the estimation techniques adopted Where expenditure by a charity relates to a project which is of uncertain duration, because it is subject to external circumstances beyond the control of the trustees, it may be difficult to determine matters such as the expected useful economic life of fixed assets used in the project (for example, vehicles or other capital equipment used to provide emergency aid in a war zone may have an uncertain future, or the trustees may consider that the economic costs of redeploying equipment exceed its book value). The auditor uses its knowledge of the charity s activities and accounting policies to assess whether the periods for write-down of fixed assets are reasonable and in line with any estimate of service potential On occasion evidence obtained from post balance sheet review and observation may be insufficiently conclusive. Where such estimates are likely to be material the auditor reviews the process by which the estimate was arrived at and considers the basis of the calculation in terms of its reasonableness, justifiability and consistency. In so doing, the auditor will draw heavily on its knowledge of the charity in testing the consistency of principles adopted. Estimates of this nature may include: the quantification of future charitable commitments and constructive liabilities; valuations of gifts in kind received, particularly property; valuation of assets received for onward distribution; 77

80 valuation of fixed asset investments where no market price exists, e.g. unlisted securities and trading subsidiaries of the parent charity; valuation of heritage assets; valuation of intangible income derived from donated services or use of facilities; estimates of on-going service potential of fixed assets, in the absence of a cash flow, in an impairment review; impairment of programme-related investments made in furtherance of a charity s objectives, rather than for financial return; recoverability of loans made to beneficiaries in the furtherance of a charity s objects. The auditor shall review the judgments and decisions made by management in the making of accounting estimates to identify whether there are indicators of possible management bias. Indicators of possible management bias do not themselves constitute misstatements for the purposes of drawing conclusions on the reasonableness of individual accounting estimates. (paragraph 21) 208. In the charity sector management may be biased in their accounting estimates in order to achieve certain results for the year although bonuses based on results are not common. A management bias may arise from: a desire to meet trustee expectations on the results for the year; a desire to demonstrate growth; a need to meet covenant obligations attached to bank loans; wanting to avoid repayments of grant funds if they are not fully utilised. Management bias may also extend to those charged with governance. 78

81 ISA (UK AND IRELAND) 550: RELATED PARTIES Objectives The objectives of the auditor are: (a) Irrespective of whether the applicable financial reporting framework establishes related party requirements, to obtain an understanding of related party relationships and transactions sufficient to be able: (i) (ii) To recognize fraud risk factors, if any, arising from related party relationships and transactions that are relevant to the identification and assessment of the risks of material misstatement due to fraud; and To conclude, based on the audit evidence obtained, whether the financial statements, insofar as they are affected by those relationships and transactions: a. Achieve fair presentation (for fair presentation frameworks); or b. Are not misleading (for compliance frameworks); and (b) In addition, where the applicable financial reporting framework establishes related party requirements, to obtain sufficient appropriate audit evidence about whether related party relationships and transactions have been appropriately identified, accounted for and disclosed in the financial statements in accordance with the framework. (paragraph 9) If the auditor identifies arrangements or information that suggests the existence of related party relationships or transactions that management has not previously identified or disclosed to the auditor, the auditor shall determine whether the underlying circumstances confirm the existence of those relationships or transactions. (paragraph 21) In meeting the ISA (UK and Ireland) 315 requirement to identify and assess the risks of material misstatement, 50 the auditor shall identify and assess the risks of material misstatement associated with related party relationships and transactions and determine whether any of those risks are significant risks. In making this determination, the auditor shall treat identified significant related party transactions outside the entity s normal course of business as giving rise to significant risks. (paragraph 18) 50 ISA (UK and Ireland) 315, paragraph

82 209. The auditor considers the steps taken by the trustees to identify and record transactions with related parties and remains alert, in carrying out the audit, for evidence of such transactions which are not included in the information provided by the trustees Charity trustees, or those connected to them, may receive payment for providing goods or services to the charity where there is a clear benefit to the charity. The Charities Act 2006, the 2005 Act (Scotland) and the 2008 Charities (Northern Ireland) Act allow for trustees to be paid for providing goods or services to a charity if certain conditions are satisfied. These provisions do not allow payment for being a trustee or for any type of contractual employment within the charity unless explicit authority exists. The following conditions must be met before a trustee can be paid for providing goods or services: the amount of the remuneration must be set out in writing between the charity and the relevant person and must not be unreasonable for the services in question; it must be in the best interests of the charity for the services to be provided by the relevant person; if more than one person who is a trustee who is entitled to receive the remuneration, they must constitute a minority of the trustees; and the constitution of the charity must not contain an express provision prohibiting the relevant person from receiving the remuneration. Accounting disclosure is still required of any remuneration or benefit received by trustees or those connected to them notwithstanding that the payment is authorised and/or falls within the conditions set out above This apart, neither charity trustees nor persons connected with them should transact business with the charity (or with any company owned by the charity), other than meeting or reimbursing properly incurred expenses, except where the transaction, and any benefit (including remuneration) derived from it, is either expressly permitted by the charity s governing document or, in England and Wales, and Northern Ireland permission has been obtained from the relevant charity commission. In Scotland, the authorising provision within the governing document must have been in force on 15 November The Charities SORP provides further information and examples of related party transactions and disclosures required which includes remuneration or benefits paid to trustees or persons connected with them. The Charities SORP related party disclosures are also required by the 2008 Regulations (E&W). For charities registered in Scotland, the Charities SORP definition of related parties is extended in the 2005 Act (Scotland) section 68(2) The auditor considers the latest requirements of the Charities SORP, legislation and accounting standards when auditing related party transaction disclosures. Some 80

83 transactions with related parties do not need disclosing under the Charities SORP (for example, donations received from related parties where the donor has not attached conditions which would, or might, require the charity to alter significantly the nature of its existing activities, salaries paid to the senior management team), but will still be of interest to the auditor. The auditor shall inquire of management and others within the entity, and perform other risk assessment procedures considered appropriate, to obtain an understanding of the controls, if any, that management has established to: (a) (b) (c) Identify, account for, and disclose related party relationships and transactions in accordance with the applicable financial reporting framework; Authorize and approve significant transactions and arrangements with related parties; and Authorize and approve significant transactions and arrangements outside the normal course of business. (paragraph 14) 214. The controls management may have put in place to authorise and approve significant transactions might include: A register of interests being maintained by the charity, which clearly sets out the people and organisations connected with each trustee; Clear procedures being in place for trustees to declare any potential conflict during the relevant part of a trustee meeting, and for trustees to withdraw from the meeting while the relevant topic is being discussed; Procedures to ensure that all transactions and payments to a related party can only be authorised by the Board of Trustees; and Procedures to ensure annual declarations being obtained from all trustees where they set out all related party transactions of which they are aware In addition to those records or documents that normally may indicate the existence of related party relationships or transactions, the auditor inspects whatever documentation the auditor considers necessary for indications of the existence of related parties, for example, minutes of trustee meetings. If management has made an assertion in the financial statements to the effect that a related party transaction was conducted on terms equivalent to those prevailing in an arm s length transaction, the auditor shall obtain sufficient appropriate audit evidence about the assertion. (paragraph 24) 81

84 216. Possible assertions in charity accounts relate to: trustees taking on paid senior management team roles; services or goods being bought from a related party due to a lack of available suppliers in the general market. The auditor obtains comfort on such assertions by assessing the rigor of the process the charity has gone through prior to approving these transactions. Such a process may include the following: comparison to market indices; consideration of alternative sources of expertise, for example by obtaining alternative quotations; paying due attention to the sections of the Charities Act 2006 and the 2005 Act (Scotland) which allow trustees to be paid for certain services. 82

85 ISA (UK AND IRELAND) 560: SUBSEQUENT EVENTS Objectives The objectives of the auditor are: (a) (b) To obtain sufficient appropriate audit evidence about whether events occurring between the date of the financial statements and the date of the auditor s report that require adjustment of, or disclosure in, the financial statements are appropriately reflected in those financial statements in accordance with the applicable financial reporting framework; and To respond appropriately to facts that become known to the auditor after the date of the auditor s report, that, had they been known to the auditor at that date, may have caused the auditor to amend the auditor s report. (paragraph 4) The auditor shall perform audit procedures designed to obtain sufficient appropriate audit evidence that all events occurring between the date of the financial statements and the date of the auditor s report that require adjustment of, or disclosure in, the financial statements have been identified. The auditor is not, however, expected to perform additional audit procedures on matters to which previously applied audit procedures have provided satisfactory conclusions. (paragraph 6) 217. The Charities SORP indicates that the determination after the balance sheet date of the amount of a gift aid payment to a parent charity by a subsidiary undertaking, if the subsidiary had a present legal or constructive obligation at the balance sheet date, is an adjusting post balance sheet event. 83

86 ISA (UK AND IRELAND) 570: GOING CONCERN Objectives The objectives of the auditor are: (a) (b) To obtain sufficient appropriate audit evidence regarding the appropriateness of management s use of the going concern assumption in the preparation of the financial statements; To conclude, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the entity s ability to continue as a going concern; and (c) To determine the implications for the auditor s report. (paragraph 9) The auditor shall evaluate management s assessment of the entity s ability to continue as a going concern (paragraph 12). If the auditor concludes that the use of the going concern assumption is appropriate in the circumstances but a material uncertainty exists, the auditor shall determine whether the financial statements: (a) (b) Adequately describe the principal events or conditions that may cast significant doubt on the entity s ability to continue as a going concern and management s plans to deal with these events or conditions; and Disclose clearly that there is a material uncertainty related to events or conditions that may cast significant doubt on the entity s ability to continue as a going concern and, therefore, that it may be unable to realize its assets and discharge its liabilities in the normal course of business. (paragraph 18) 218. A charity prepares its accounts on a going concern basis unless it is being liquidated or has ceased operating or there is no realistic alternative but to liquidate or to cease its activities The Charities SORP reiterates the relevance of this concept in the preparation of charity accounts which are intended to show a true and fair view. Accounting standards require trustees, when preparing financial statements, to make an assessment of the charity s ability to continue as a going concern. Where material uncertainties may cast significant doubt on the charity s ability to continue as a going concern FRS 18 requires a disclosure 84

87 in the financial statements. The auditor evaluates the evidence that is given by the trustees to support their assessment Although the most significant factor ensuring the future viability of many charities is public goodwill, it is difficult, if not impossible, to value and cannot be included in the balance sheet, nor can the auditor rely solely on the existence of goodwill as evidence to support the going concern assumption The auditor has no duty to assess whether the charity s activities are for the public benefit in order to establish that the charity is a going concern. However, persistent failure by a charity to meet its public benefit requirement may have an implication for the auditor s assessment of going concern. Basis for preparation of financial statements 222. In considering factors relating to a charity s status as a going concern, it is necessary to take account of the particular circumstances of that charity which may affect its ability to continue its activities. The auditor considers the availability of future funding and whether uncertainties exist which require disclosure in the financial statements. The charity s purpose may also require consideration: some charitable activities are focused on a specific purpose, and once this is achieved, the charity may cease to operate Where the going concern basis within a charity group involves support between entities, the auditor considers the extent to which such support is within the charitable objects and powers. Circumstances where a charity may not be a going concern 224. The examples of indicators contained in the ISA (UK and Ireland) apply as much to charities as to commercial entities and include pointers such as an excess of current liabilities over current assets. Charity specific indicators include: inability to finance its operations from its own resources or unrestricted funds; decision by the trustees to curtail or cease activities; transfer to, or takeover by, another entity of the charity s activities; loss of essential resources or key staff; existence of tax liabilities which cannot be met from existing resources; deficits on unrestricted funds; loss of clients, for example where a public authority ends a practice or contract to refer (and pay for) clients to the charity; loss of operating licence (for example, for a residential care home); 85

88 significant changes in strategy of major funders, and significant decline in donations by the public; investigation by a charity regulator; loans made to subsidiaries which cannot be repaid; claw-back of grant received and gift-aid refunds; reliance on major donors; failure to meet reserves policy targets; persistent failure to meet the requirement for public benefit, leading to withdrawal of funding or tax liabilities. Where a charity fails to meet the public benefit requirement either in whole or in part, the auditor also considers the implication of actions taken, or likely to be taken, by the regulator, and assesses the implications on his opinion. The operations of charities 225. Assessment of the going concern basis can be complicated by the uncertainty as to future income streams to which many charities are subject. In considering projections of income the auditor considers the income sources, their regularity and predictability and the degree of risk attaching to such sources Restrictions placed on the use of particular funds held by a charity may be relevant to the consideration of its going concern status. An understanding of unrestricted and restricted income, and capital or permanently endowed funds is relevant both in relation to the consideration of balance sheet funds held at the year end and to the impact that such restrictions may have on the understanding of future cash flows. Factors the auditor considers may include: the nature and impact of the restrictions placed on the use of any material restricted income funds; the liquidity of assets held within restricted income funds; the nature of the restrictions placed on expenditure of any endowed funds, the impact such restrictions have on the ability to fund planned activities, the nature of any restrictions to be placed on future appeals or other projected income; and the operational ability to withdraw from projects or activities which have been subject to fund designations or restrictions Charities receiving grants of public funds (including lottery funds) are normally required to meet certain specified conditions. Expenditure outside grant conditions can lead to disallowance and repayment. Many charities rely on public authorities for grant support. 86

89 Where the financial effect of withdrawal of funding would be fundamental to a particular charity, the auditor assesses whether compliance with grant conditions has been achieved or otherwise obtains evidence about steps taken by the trustees to ensure compliance The timing of cash flows may also be relevant for certain categories of charities. Factors that can impact on a charity s cash flows include: reliance on annual votes of monies from governmental or central funding bodies, reliance on grant funding that reimburses expenditure only once incurred, or delays in the approval or payment of such funding; grant funding provided for specific projects but not for central administrative costs, or funding of long-term projects based only on short-term commitments as to funding receivable; the cash flow impact of any constructive liabilities accrued in the balance sheet, or on conditions being met for any contingent grants disclosed within contingent liabilities; and constructive obligations, such as grants payable or other funding commitments, that are recognised as liabilities but are payable over a number of years. Obtaining evidence, audit conclusions and reporting 229. In considering going concern, it may be helpful for the auditor to include the following points in discussions with trustees: the reliability of the budget and cash flow forecast for the coming year, based on past experience and the certainty of inflows and outflows; the nature of management information systems covering future income and expenditure; where the charity relies for a significant part of its funding on one or more major institutional donors or granting authorities such as local authorities, whether it would be practical to obtain a degree of comfort from such funders as to their future support for the charity; any shortfall of identifiable future income on forecast expenditure needing to be made up by voluntary donations of cash or other resources; lists of projects supported or awards made in the year and planned for the following year; the level of uncommitted reserves remaining available to the charity; any reliance on support by the charity s bankers, major donors, or public authorities; concentration on the provision of services to a particular category of beneficiaries or objects for which future funding or demand may be limited; and any special operating licences or similar conditions. 87

90 ISA (UK AND IRELAND) 580: WRITTEN REPRESENTATIONS Objectives The objectives of the auditor are: (a) (b) (c) To obtain written representations from management and, where appropriate, those charged with governance that they believe that they have fulfilled their responsibility for the preparation of the financial statements and for the completeness of the information provided to the auditor; To support other audit evidence relevant to the financial statements or specific assertions in the financial statements by means of written representations if determined necessary by the auditor or required by other ISAs (UK and Ireland); and To respond appropriately to written representations provided by management and, where appropriate, those charged with governance, or if management or, where appropriate, those charged with governance do not provide the written representations requested by the auditor (paragraph 6) 230. An important principle is that the auditor does not accept the unsupported representations of trustees or senior management of the charity where these relate to matters which are material to the financial statements. Moreover, representations cannot substitute for evidence that the auditor reasonably expects to be available. The auditor shall request written representations from management with appropriate responsibilities for the financial statements and knowledge of the matters concerned. (paragraph 9) The auditor shall request management to provide a written representation that it has fulfilled its responsibility for the preparation of the financial statements in accordance with the applicable financial reporting framework, including where relevant their fair presentation, as set out in the terms of the audit engagement. 51 (paragraph 10) Other ISAs (UK and Ireland) require the auditor to request written representations. If, in addition to such required representations, the auditor determines that it is necessary to obtain one or more written representations to support other audit evidence relevant to the financial statements or one or more specific assertions in the financial statements, the auditor shall request such other written representations. (paragraph 13) 51 ISA (UK and Ireland) 210, Agreeing the Terms of Audit Engagements, paragraph 6(b)(i). 88

91 231. Relevant information normally includes minutes of trustee meetings and correspondence with the charity regulators. Appendix 1 of ISA (UK and Ireland) 580 gives a list of requirements for written representations included in other ISAs (UK and Ireland). This includes the requirement in ISA (UK and Ireland) 250 section A and ISA (UK and Ireland) 550 to obtain written confirmation in respect of the completeness of disclosure to the auditor of: known events which involve possible non-compliance with laws and regulations, together with the actual or contingent consequences which may arise therefrom; and information provided regarding the identification of related parties and the adequacy of related party disclosures The trustees as a body are responsible for the contents and presentation of the financial statements. Consequently, discussion of the content of any written representation by the trustee body as a whole may be appropriate before it is signed on behalf of the trustees For charities where there are executive staff members, it is likely that in practice there are some representations that necessitate discussion with those persons. The auditor often finds it useful to attend the meeting at which trustees consider the financial statements and representation letter, to encourage discussion of significant items or matters, including unadjusted errors, arising in the course of the audit In addition to representations required by ISAs (UK and Ireland), the auditor of a charity also considers obtaining confirmation that: all income has been recorded; the restricted funds have been properly applied; constructive obligations for grants have been recognised; all correspondence with regulators has been made available to the auditor including, in England and Wales, any serious incident reports; and the trustees consider there to be appropriate controls in place to ensure overseas payments are applied for charitable purposes Timely communication by the auditor with the trustees on significant issues on which representations will be required is important in this sector, which relies primarily on unpaid (voluntary) trustees who are not involved in the day-to-day running of the affairs of the charity If there is a delay between the approval of the financial statements by the trustees and their receipt by the auditor for the approval of the audit report, the auditor considers 89

92 whether to obtain an update of the trustees representations, either by enquiry of the trustees about any changes to the charity s circumstances or by requesting the trustees to provide an updated representation letter. 90

93 ISA (UK AND IRELAND) 600: SPECIAL CONSIDERATIONS AUDITS OF GROUP FINANCIAL STATEMENTS (INCLUDING THE WORK OF COMPONENT AUDITORS) Objectives The objectives of the auditor are: (a) (b) To determine whether to act as the auditor of the group financial statements; and If acting as the auditor of the group financial statements: (i) (ii) To communicate clearly with component auditors about the scope and timing of their work on financial information related to components and their findings; and To obtain sufficient appropriate audit evidence regarding the financial information of the components and the consolidation process to express an opinion on whether the group financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework. (paragraph 8) The group engagement partner is responsible for the direction, supervision and performance of the group audit engagement in compliance with professional standards and applicable legal and regulatory requirements, and whether the auditor s report that is issued is appropriate in the circumstances. 52 As a result, the auditor s report on the group financial statements shall not refer to a component auditor, unless required by law or regulation to include such reference. If such reference is required by law or regulation, the auditor s report shall indicate that the reference does not diminish the group engagement partner s or the group engagement partner s firm s responsibility for the group audit opinion. (paragraph 11) If the group engagement team plans to request a component auditor to perform work on the financial information of a component, the group engagement team shall obtain an understanding of the following: (a) (b) Whether the component auditor understands and will comply with the ethical requirements that are relevant to the group audit and, in particular, is independent. The component auditor s professional competence. 52 ISA (UK and Ireland) 220, paragraph

94 (c) (d) Whether the group engagement team will be able to be involved in the work of the component auditor to the extent necessary to obtain sufficient appropriate audit evidence. Whether the component auditor operates in a regulatory environment that actively oversees auditors. (paragraph 19) 237. Charities may operate through a variety of different structures, which are established either formally as branches or associates, or informally, for example through an informal partnership arrangement. An associate may exist due to the parent charity being able to exert significant influence over another organisation, for example by virtue of their right to appoint a certain number of board members. The requirements of this ISA apply equally to these informal structures as it does to more conventional group structures where component auditors are engaged. In some cases it may be more cost effective for the auditor to undertake the audit work itself, in which case, guidance in paragraphs 175 to 180 under ISA (UK and Ireland) 330 will be more helpful Where the auditor uses the services of other auditors in the audit of a charity s financial statements, then the auditor advises the other auditors of the use that is to be made of their work and makes the necessary arrangements for the co-ordination of their efforts at the initial planning stage of the audit Some charities operate through local branches, subsidiaries or other units whose financial reports are audited or examined by component auditors. In these circumstances, the group auditor s planning of the audit of the charity as a whole includes the following considerations: the materiality of the results of the branches to the financial statements; the quality, nature and timing of information produced by the branches; the extent of the work undertaken by the component auditor, or other person making a report in connection with the branch or component financial reports and the level of sufficient appropriate audit evidence that is expected to be available from the other s work Where the charity is a limited company, there is a statutory obligation on any subsidiary undertaking which is a company incorporated in Great Britain, and on its auditor, to give to the auditor of the parent company such information and explanations as it may reasonably require for the purposes of its duties The auditor of a non-company charity in England and Wales has, under section 44(1)(d) of the 1993 Act, a right of access to books, documents and records which relate to the 92

95 charity. This access right extends beyond those records which are in the ownership of the charity and, under the 2008 Regulations, includes the records of any UK subsidiaries of the charity. However, this right will not extend to overseas entities with a separate legal constitution. In Northern Ireland, the auditor will have the same right of access under section 66(1)(d) of the Charities Act (Northern Ireland) 2008, when commenced. In Scotland this right applies to all legal forms of charity registered in Scotland and is given under Regulation 13 of the 2006 Regulations (Scotland) Where returns from the component auditors indicate a potential problem, such as modified opinions which in aggregate could cover a substantial part of the charity s transactions, the group auditor seeks to obtain authority from the trustees to discuss the issue with the auditor(s) involved to see whether, with additional procedures, it would be possible to obtain further evidence such that an unqualified opinion can be given on the group financial statements Where charitable groups have components overseas, there are added complications for the group auditor to ensure the results of the components (whose statutory accounts may not be prepared in accordance with the Charities SORP) are appropriately consolidated into the group financial statements (which are prepared in accordance with the Charities SORP). The group auditor: Obtains an understanding of the component business; Obtains an understanding of the accounting framework under which the component accounts will be prepared; Considers the need to get the component auditors to review the charity s conversion of the component financial statements into UK GAAP format; Considers the need for the component auditors to comment on UK GAAP specific areas (for example, asking the component auditors to specifically consider if the component has received any restricted funds). Depending on the local accounting framework, this may require details of the accounting requirements under the Charities SORP to be explained to the component auditors The auditor remains aware that overseas component auditors may not have a right of access to books, documents and records. Additionally, overseas component auditors may not be under any legal obligation to provide to the auditor of the parent charity such information and explanations as they may reasonably require for the purposes of their duties. If the component auditors are not able or prepared to provide this information and explanations and the component s results are significant to the group financial statements, then the auditor of the parent charity considers the impact on the group audit report. 93

96 245. Where the parent charity auditor has concerns over the competency of a component s auditor, this is communicated to those charged with governance. Where possible, this is done at the planning stage of the audit, so that alternative methods of obtaining sufficient appropriate audit evidence can be discussed (such as the use of internal audit or additional local procedures being carried out by the parent auditor). 94

97 ISA (UK AND IRELAND) 700: THE AUDITOR S REPORT ON FINANCIAL STATEMENTS Objectives The objectives of the auditor are to: (a) (b) Form an opinion on the financial statements based on an evaluation of the conclusions drawn from the audit evidence obtained; and Express clearly that opinion through a written report that also describes the basis for the opinion. (paragraph 7) The auditor s report on the financial statements shall contain a clear written expression of opinion on the financial statements taken as a whole, based on the auditor evaluating the conclusions drawn from the audit evidence obtained, including evaluating whether: (a) (b) (c) (d) Sufficient appropriate audit evidence as to whether the financial statements as a whole are free from material misstatement, whether due to fraud or error has been obtained; Uncorrected misstatements are material, individually or in aggregate. This evaluation shall include consideration of the qualitative aspects of the entity s accounting practices, including indicators of possible bias in management s judgments; In respect of a true and fair framework, the financial statements, including the related notes, give a true and fair view; and In respect of all frameworks the financial statements have been prepared in all material respects in accordance with the framework, including the requirements of applicable law. (paragraph 8) With respect to true and fair frameworks an unqualified opinion on the financial statements shall be expressed only when the auditor concludes that they have been prepared in accordance with the identified financial reporting framework, including the requirements of applicable law, and the financial statements give a true and fair view. (paragraph 11) 246. The auditor reviews and assesses the conclusions drawn from the audit evidence obtained as the basis for the expression of an opinion on the financial statements. Examples of points that the auditor considers as part of this assessment include: 95

98 the consistency of accounting policies adopted with the Charities SORP; the adequacy of analysis of incoming resources; the allocation of costs between SoFA expenditure headings; accounting treatment of heritage assets; capitalisation of expenditure on fixed assets; service potential of impaired assets; accounting for constructive obligations for grant payments. AUDITOR S REPORTS 247. The form and content of auditor s reports on the financial statements of charities follow the requirements established by ISA (UK and Ireland) 700. However, because of the complexity of the legal framework, the auditor needs to ensure descriptions of the legislative basis and responsibilities of the auditor and trustees are specific to the circumstances of the body audited Example auditor s reports are set out in the Bulletin Compendium of Illustrative Auditor s Reports on UK Private Sector Financial Statements issued by the APB which is supplementary to this Practice Note. This differentiates between reports on company and non-company charities in England and Wales, charities in Scotland, and cross border charities. Addressee of the report 249. Audit reports made under company legislation are addressed to members (in Scotland members and trustees) whilst reports made under charity law are made to the trustees. Statement of trustees responsibilities 250. ISA (UK and Ireland) 700 requires the auditor to include a statement that those charged with governance are responsible for the preparation of the financial statements and that the responsibility of the auditor is to audit and express an opinion on the financial statements in accordance with applicable legal requirements and ISAs (UK and Ireland) The responsibilities of the trustees will vary according to the constitution of the particular charity, for example the duties of trustees of charitable companies derive from both company and charity law. Some example wordings for trustees responsibilities are set out in Appendix The auditor needs to be aware that where charities are required to prepare accounts under both Scottish and English law, both sets of legal requirements must be adhered to. 96

99 Compliance with relevant legal and accounting requirements 253. The auditor s opinion on a charity s financial statements is expressed in the context of the particular legislation and accounting requirements applicable to the charity concerned The auditor is also aware that the trust deed establishing a charity may establish additional requirements concerning the contents of its financial statements (but cannot derogate from the statutory requirements). The auditor therefore assesses whether any such requirements are met. Where the auditor becomes aware of information which indicates that a transaction or transactions undertaken by the charity may have breached any terms of its trust deed, the auditor considers the implications for its reporting responsibilities following the guidance in the sections dealing with ISA (UK and Ireland) 250 section A As far as charitable companies 53 in England, Wales and Scotland 54 are concerned care needs to be taken to understand the interaction between CA 2006, the Charities Act 1993 (as amended by the Charities Act 2006) and the 2005 Act (Scotland). The effect of orders 55 made under company and charity law is that, for charitable companies claiming audit exemption under CA 2006, the legal requirements for audit (or independent examination) are provided in England and Wales by the Charities Act 1993 and in Scotland by the 2005 Act (Scotland). A small charitable company that is eligible for audit exemption under CA 2006 but does not claim this exemption continues to be audited under CA 2006 and in England and Wales no additional audit requirement arises under the Charities Act For charitable companies that do claim audit exemption and comply with section 475(2) to (4) of CA 2006, which requires a statement on the face of the balance sheet confirming that the company is entitled to audit exemption, the audit arrangements referred to in the auditor s reports are the Charities Act 1993 and the 2005 Act (Scotland) For charitable companies below the CA 2006 audit threshold and claiming exemption but above the Charities Act 1993/2005 Act (Scotland) threshold this could be achieved by a statement such as: 53 This guidance does not apply to groups see paragraph 11 of Appendix In Northern Ireland the special rules for the audit of small charitable companies provided by the Companies Act is currently retained. 55 Relevant orders are: The Companies Act 2006 (Commencement No. 6, Saving and Commencement Nos. 3 and 5 (Amendment)) Order 2008 The Charities Act 2006 (Charitable Companies Audit and Group Accounts Provisions) Order 2008 SI 2008 /

100 For the year ending (dd/mm/yyyy) the company was entitled to exemption from audit under section 477 of the Companies Act 2006 relating to small companies but as this company is a charity, it is subject to audit under the Charities Act 1993 / the 2005 Act (Scotland). a. The members have not required the company to obtain an audit of its accounts for the year in question in accordance with section 476 of the Companies Act 2006; b. The directors acknowledge their responsibilities for complying with the requirements of the Companies Act 2006 with respect to accounting records and the preparation of accounts. These accounts have been prepared in accordance with the provisions applicable to companies subject to the small companies regime. TRUSTEES ANNUAL REPORTS 258. Audits under companies legislation include consideration of whether the Trustees Annual Report is consistent with the financial statements The 2006 Regulations (Scotland) (as amended) require the auditor to include in their report a statement where they have identified that information contained in the Trustees Annual Report is inconsistent with the financial statements. Other matters 260. The auditor of a charity in England and Wales or Scotland is required to include an additional statement in the auditor s report on the financial statements if it concludes that: (a) the charity has failed to keep accounting records in accordance with the relevant Act; or (b) the financial statements are not in agreement with the accounting records; or (c) necessary information and explanations have not be made available to the auditor. 98

101 ISA (UK AND IRELAND) 720: SECTION A THE AUDITOR S RESPONSIBILITIES RELATING TO OTHER INFORMATION IN DOCUMENTS CONTAINING AUDITED FINANCIAL STATEMENTS AND SECTION B THE AUDITOR S STATUTORY REPORTING RESPONSIBILITY IN RELATION TO DIRECTORS REPORTS Objective The objective of the auditor is to respond appropriately when documents containing audited financial statements and the auditor s report thereon include other information that could undermine the credibility of those financial statements and the auditor s report. (paragraph 4) The auditor shall read the other information to identify material inconsistencies, if any, with the audited financial statements. (paragraph 6) If, on reading the other information for the purpose of identifying material inconsistencies, the auditor becomes aware of an apparent material misstatement of fact, the auditor shall discuss the matter with management. (paragraph 14) If, on reading the other information, the auditor identifies a material inconsistency, the auditor shall determine whether the audited financial statements or the other information needs to be revised. (paragraph 8) 261. As noted above, audits of charitable companies include consideration of whether the Trustees Annual Report is consistent with the financial statements. ISA (UK and Ireland) 720 section B applies in such circumstances. ISA (UK and Ireland) 720 section A applies to: Trustees annual reports of non-company charities, and Other information disclosed in the annual reports of all charities One of the fundamental principles set out in The Auditors Code is that auditors do not allow their reports to be included in documents containing other information if they consider that the additional information is in conflict with the matters covered by their report and they have cause to believe it to be misleading The auditor reads the other information contained in the annual report in the light of the knowledge it has acquired during the audit. The auditor is not expected to verify any of the other information. The auditor reads the other information with a view to identifying 99

102 whether there are any apparent misstatements therein or matters which are inconsistent with the financial statements. It is important to ensure that the trustees are aware of the auditor s responsibilities in respect of the other information, as set out in ISA (UK and Ireland) 720 section A and the extent of those responsibilities may usefully be outlined in the engagement letter An annual report may include: statements by the patron, president, chairman of the trustees and/or chief executive of the charity; an operating and financial review; an investment policy and performance report; a statement of grant making policies; a statement of reserves policy; a statement of achievements against objectives; a risk management statement by trustees (based on the Charities SORP or expanded and based on the UK Corporate Governance Code for listed companies); a treasurer s report; financial summaries; and projections of future expenditure based on planned activity. Additional care will be needed where, for example, the annual report and the financial statements are prepared at the same time but by different personnel, so that their content is largely independent. The Charities SORP requires that where the charity is subject to a statutory audit, the charity trustees state in their report that the major identified risks to which the charity is exposed have been reviewed and that systems have been established to manage such risks. Whilst this is not mandatory for charities that are not subject to statutory audit, some will choose to make such a statement The ISA (UK and Ireland) requires an auditor who becomes aware of any apparent material misstatements or inconsistencies in other information published together with the audited financial statements to seek to resolve them. Whilst the auditor is not expected to verify any risk management statement made by trustees the auditor is likely to become aware of the steps taken by the trustees to identify and manage identified financial risks through its work in assessing audit risk under ISA (UK and Ireland) 315. The auditor may also become aware of non-financial risks during the course of the audit If, after discussion with the trustees, any material misstatement or inconsistency identified by the auditor in relation to a corporate governance or risk management statement 100

103 remains in a Trustees Annual Report, the auditor considers reporting this in the opinion section of the auditor s report. As this does not give rise to a qualified audit opinion on the financial statements, the auditor s comments may be included under the heading other matter as illustrated in the APB Bulletin on Auditor s Reports on Financial Statements in the UK Charity trustees may request the auditor specifically to review a corporate governance or risk management statement made by them in their annual report or contained in other information presented with the financial statements. Providing guidance on a review of this nature is beyond the scope of this Practice Note. 101

104 SUMMARY FINANCIAL INFORMATION AND SUMMARISED FINANCIAL STATEMENTS 268. Many charities publish financial information in a format different from the statutory financial statements. This is usually in the annual report, impact statement, or annual review, but may also occur in other instances such as fund raising literature or local branch literature. In this connection it should be noted that the auditor s report on the full financial statements is not reproduced in conjunction with any accounts other than the complete financial statements reported on by the auditor The accounting requirements of the legislation do not extend to such summarised information. Trustees of charities which are not limited companies may therefore produce summarised financial statements on an extra-statutory basis, whilst in the case of charitable companies the specific provisions of section 435 of the Companies Act 2006 concerning non-statutory financial statements apply The Charities SORP distinguishes between summary financial information, and summarised financial statements. The table below sets out the differences: Characteristics of: Summarised financial statements Includes a summary of the Statement of Financial Activities (SoFA) and balance sheet The summary is derived from statutory accounts. A financial statement that purports to be a SoFA or balance sheet or summary thereof. Represents the entire finances of a charity or a charity group. Summary financial information Draws information from only parts of the accounts. May be based on interim accounts or other financial information as well as statutory accounts. Makes no reference to either of these primary statements. Represents analysis, e.g. of a particular activity or region. Non-company charities 271. The Charities SORP (paragraphs 371 to 376) sets out general principles for the preparation of summarised financial statements Summarised financial statements are to be accompanied by a statement, signed on behalf of the trustees, indicating: that they are not the statutory accounts but a summary of information relating both to the SoFA and the balance sheet; 102

105 whether or not the full financial statements from which the summary is derived have as yet been externally scrutinised; where they have been externally scrutinised, whether the audit report is modified; where the audit report is modified, sufficient details should be provided in the summarised financial statements to enable the reader to appreciate the significance of the report; where accounts are produced only for a branch of the charity, it must be clearly stated that the summarised financial statements are for the branch only and have been extracted from the full accounts of the reporting charity (giving its name); details of how the full annual accounts, the external scrutiny report (as applicable) and the Trustees Annual Report can be obtained; the date on which the annual accounts were approved; and for charities registered in England and Wales, whether or not the annual report and accounts have been submitted to CCEW. There is no statutory requirement for the auditor of a non-company charity to report on summarised financial statements. However, if the full financial statements have been externally scrutinised the Charities SORP requires a statement from the external scrutiniser giving an opinion as to whether or not the summarised financial statements are consistent with the full financial statements to be attached When a report on summarised financial statements is to be provided in addition to a report on the full financial statements, the auditor carries out procedures to establish that the summarised financial statements are consistent with the full financial statements Matters which may give rise to an inconsistency include: information which has been inaccurately extracted from the annual financial statements and Trustees Annual Report; the use of headings in the summarised financial statements that are incompatible with the statutory headings in the full annual financial statements from which they are derived; information which, in the auditor s opinion, has been summarised in a manner which is not consistent with the annual financial statements (for example, if the summary is unduly selective); and the omission from the summarised financial statements of information which is not specifically required by any regulations but which, in the auditor s opinion, is necessary to ensure consistency with the annual financial statements (for example, omission of information relating to an exceptional item or a non-adjusting subsequent 103

106 event which the auditor considers fundamental to a reader s understanding of the charity s results or financial position) If the auditor s report on the full financial statements was modified, the auditor considers whether the trustees statement accompanying the summarised financial statements gives enough details to enable the reader to understand the significance of the auditor s report. The auditor will also include an explanatory paragraph in its report on the summarised financial statements If the auditor is not satisfied, after discussion with the trustees, that the description given in the trustees statement describes the auditor s report adequately, the principle of association in The Auditors Code published by the APB indicates that the auditor will not issue a report to be included with the summarised financial statements in respect of which it considers that any qualification or explanatory paragraph in the original audit report is inadequately described If, in the auditor s opinion, the summarised financial statements are inconsistent with the full financial statements the auditor states this fact in the auditor s report. An example of the auditor s statement on summarised financial statements is set out at the end of this section. In addition, either where trustees publish inconsistent summarised financial statements, or the auditor s statement on these is to be qualified, the auditor considers whether this is a matter reportable to the relevant charity regulator in accordance with ISA (UK and Ireland) 250 section B Charities may issue other summary financial information which is not based on the full financial statements approved by trustees. This may include, for example, interim figures on a fundraising appeal or on a project. Whilst the Charities SORP requires a statement by the trustees to accompany such financial information, there is no requirement for the auditor to review such information and it will only do so if the auditor s name is to be associated with it in any way, in accordance with the principles discussed in the section on ISA (UK and Ireland) 720 section A. However the auditor may find it useful to refer to these documents as part of the process of obtaining knowledge of the charity in accordance with ISA (UK and Ireland) Where a charity prepares summary financial information which does not purport to be summarised financial statements, then the trustees may ask the auditor to prepare a form of report other than that specified in this Practice Note and the Charities SORP. The form of such wording is beyond the scope of this Practice Note. Charitable companies statutory summary financial statements 280. All companies have the option under CA 2006 section 426 to provide summary financial statements instead of copies of the full accounts and reports to the members of the company under companies legislation. Section 427 sets out the form and content for statutory summary financial statements prepared by unquoted companies, and includes 104

107 the requirements of the auditor. Bulletin 2008/3 contains a summary of the requirements of CA 2006 for the contents of the summary financial statement for different types of company and for the auditor s statement thereon. Industrial and Provident Societies 281. There are no statutory provisions in respect of summary financial information or statements produced by industrial and provident societies. However the Charities SORP generally applies to all charities in the United Kingdom and therefore the principles applying to non-company charities are applicable. 105

108 Illustrative example (non-statutory summarised financial statements): Independent auditor s statement to the trustees of xyz charity We have examined the summarised financial statements [for the year ended...] [set out on pages...]. Respective responsibilities of the trustees and the auditor The trustees are responsible for preparing the [summarised financial statements] [summarised annual report] in accordance with applicable United Kingdom law and the recommendations of the Charities SORP. Our responsibility is to report to you our opinion on the consistency of the summarised financial statements [within the summarised annual report] with the full annual financial statements and the Trustees Annual Report. [We also read the other information contained in the summarised annual report and consider the implications for our report if we become aware of any apparent misstatements or material inconsistencies with the summarised financial statements.] We conducted our work in accordance with Bulletin 2008/3 issued by the Auditing Practices Board. Opinion In our opinion the summarised financial statements are consistent with the full annual financial statements and the Trustees Annual Report of XYZ charity for the year ended... Or Qualified opinion In our opinion the summarised financial statements are not consistent with the full annual financial statements and the Trustee s Annual Report of XYZ charity for the year ended... in the following respects.... Statutory auditor Date Address 106

109 APPENDIX 1 CHARITY ACCOUNTING AND AUDIT REGULATIONS IN THE UNITED KINGDOM (UPDATED FOR THE COMPANIES ACT 2006) The information set out in this Appendix is an overview of the legal framework only, and is likely to be amended over time. Reference should also be made directly to the relevant legislation and regulations as considered necessary. THE REGULATORY FRAMEWORK England and Wales 1. In England and Wales the Charities Act 1993 as amended by the Charities Act 2006 (the 1993 Act ) provides the primary legislative framework for charity regulation by CCEW. In particular CCEW is responsible for the registration, supervision and regulation of charities that are not exempt. A public register of charities is maintained. All charities must register with CCEW unless: gross income in the financial year is 5,000 or less; or the charity is excepted from registration and gross income in the financial is 100,000 or less; or the charity is exempted from registration by order or regulation. 2. Under the 1993 Act as amended, CCEW may by order require any person to furnish them with any information in their possession which relates to any charity and is relevant to the discharge of their functions. These powers extend to all charities whatever their legal form. Certain types of charity may also be monitored by other bodies, for example, by the Higher Education Funding Council for England in the case of universities in England. Excepted charities 3. Excepted charities are regulated by CCEW. They are called excepted charities because they have been excepted from registration with CCEW by order or regulation. However, with effect from 31 January 2009 excepted charities with a gross income of more than 100,000 in a financial year must register with CCEW. 4. Examples of excepted charities include charities connected with churches and chapels belonging to various Christian denominations, armed forces charities wholly or mainly concerned with the promotion of efficiency of the armed forces and Scout and Guide groups. 107

110 5. In addition, a number of previously exempt charities became excepted on 1 June 2010 including the University of Wales, Student Unions in England and Wales, the Colleges of the Universities of Oxford, Cambridge and Durham, Eton and Winchester Colleges, the Church Commissioners and the Representative Body of the Welsh Church. 6. Excepted charities are required to prepare annual accounts and are subject to the same audit or examination requirements as registered charities. If registered, they must also prepare an annual report and annual return and file them and their accounts with CCEW. Even if unregistered, they can be required under s.46 of the Charities Act 1993 to prepare an annual report and to file it together with their annual accounts. Exempt charities 7. Exempt charities in England and Wales are excluded from CCEW s supervision and monitoring. From 2010 onwards, principal regulators are being appointed for different classes of exempt charities, to promote compliance with charity law. Exempt charities do not register with CCEW, nor do they submit accounts and annual returns. However, they do have the same status and tax benefits as other charities and must comply with general charity law and they can seek advice and apply for Schemes and most enabling orders. Most exempt charities are listed in Schedule 2 of the Charities Act 1993 and are generally subject to their own statutory and regulatory provisions. Examples include English universities, many maintained schools, and many national museums and galleries. 8. Where no suitable principal regulator can be identified for a class of exempt charities, that class of charities will lose its exempt status and become excepted. A number of previously exempt charities became excepted on 1 June 2010 and are listed in paragraph 5 above. 9. Registered charitable societies within the meaning of the Friendly Societies Act 1974 or the Industrial and Provident Societies Act 1965 in England and Wales are also currently exempt charities under Schedule 2 of the 1993 Act. However, it is anticipated that these classes of charities other than those which are registered providers of social housing will become excepted some time in The 1993 Act requires the accounts of exempt charities to be prepared on a true and fair basis. The accounting, reporting and audit requirements placed on exempt charities will also be dependent on how such charities are constituted and any specific statutes or regulations applying to them. For example, if constituted as companies then reporting rights and duties will apply. Scotland 11. In Scotland the main primary legislation is the Charities and Trustee Investment (Scotland) Act Supervision of charities registered in Scotland is carried out by OSCR. OSCR s statutory functions are to: 108

111 maintain the Scottish Charity Register (including granting charitable status); encourage, facilitate and monitor compliance with the 2005 Act (Scotland); and identify and investigate apparent misconduct, following which it has the power to take remedial action. Northern Ireland 12. CCNI was established in 2009 and is in the process of assuming responsibility for the registration and monitoring of charities from the Charities Branch of the Voluntary and Community Unit of the Department for Social Development. The old regulatory framework under which charities operated is provided primarily by the Charities Act (Northern Ireland) 1964 and the Charities (Northern Ireland) Order 1987, are in the process of being replaced by new provisions in the Charities Act (Northern Ireland) Some of the 2008 Act s provisions have been commenced, such as those which established CCNI. However, at present, under section 3 of the Charities Act (Northern Ireland) 1964 the Department for Social Development may, with the consent of the Attorney-General, require any person having in his possession any documents relating to a charity to give the documents (or copies) to the Department if it has reason to believe that the charity s property may have been concealed, misapplied or withheld. The legislation is widely drawn and would cover both audit clients documents held and auditor s own working papers. 13. The new 2008 Act will provide for audit requirements in Northern Ireland and these are the same as those which apply to charities in England and Wales. The relevant sections of the Charities Act (NI) 2008 have not been commenced, and until they are, section 3 of the Charities Act (Northern Ireland) 1964 is the effective statutory requirement which applies to auditors. Therefore, there are no statutory provisions relating to auditor s rights to information and explanations at this time. As full access to information is fundamental to the proper conduct of an audit in accordance with ISAs (UK and Ireland, an auditor who is unable to obtain all the information and explanations it considers necessary for the purposes of forming an opinion will qualify the auditor s report accordingly. Similarly no legislation covers auditor s reports to trustees at present. Friendly and Industrial and Provident Societies 14. There are relatively few remaining charitable friendly societies the Financial Services Authority regulates those that remain. The primary legislation relating to charitable societies is the Friendly Societies Act 1974, although new registrations under this Act are not permitted. Societies can be incorporated under the Friendly Societies Act 1992 but the purposes defined in Schedule 2 of this Act are unlikely to be charitable. A charitable 109

112 incorporated society is not an exempt charity. A number of charities, primarily Registered Social Landlords, are constituted as industrial and provident societies. 15. The accounting requirements for industrial and provident societies are set out in the Friendly and Industrial and Provident Societies Act , which require accounts to be prepared giving a true and fair view. All industrial and provident societies are required to submit an annual return, including the accounts, which are public records. Similar provisions apply to charitable societies registered under the Friendly Societies Act In Scotland, charities which are registered under the Friendly Societies Act or the Industrial and Provident Societies Act are still subject to the provisions of the 2005 Act (Scotland) and 2006 Regulations (Scotland) (as amended). Registered Social Landlords in Northern Ireland register under the Industrial & Provident Societies Act (Northern Ireland) 1969, and are also required to register with the Department of the Environment. 56 The Friendly and Industrial Provident Societies Act 1968 is to be renamed the Co-operative and Community Benefit Societies Act

113 Primary legislation applicable to charities UK-wide England & Wales Scotland N. Ireland Companies Act 2006 or N. Ireland equivalent Charities Acts 1992, 1993 and 2006 The Charities and Trustee Investment (Scotland) Act 2005 Charities Act (Northern Ireland) 1964 and the Charities Act (Northern Ireland) 2008, as and when commenced Friendly Societies Acts 1974 to 1992 Trusts (Scotland) Acts 1921 and 1961 Industrial & Provident Societies Acts 1965 to 1978 or N. Ireland equivalent Housing (Scotland) Act 2001 Co-operatives and Community Benefit Societies Act 2003 Public Services Reform Act 2010 Housing Associations Act 1985 and Housing and Regeneration Act 2008 Housing Acts 1988 and

114 Principal secondary legislation England & Wales Scotland N. Ireland The Charities (Accounts & Reports) Regulations 2008 (SI 2008/629) The Charities (Exception from Registration) Regulations 1996 (SI 1996/180) The Charities (Exemption of Universities from Registration) Regulations 1966 (SI 1966/965) The Charities (Exception from Registration and Accounts) Regulations 1965 ( SI 1965/1056) The Charities (Exception of Voluntary Schools from Registration) Regulations 1960 (SI 1960/2366) and section 23 School Standards and Framework Act 1998 The Charities Act 2006 (Changes in Exempt Charities) Order 2010 (SI 2010/500) The Charities Accounts (Scotland) Regulations 2006 (SSI 2006/218) The Charities Accounts (Scotland) Amendment Regulations 2007 (SSI 2007/136) The Charities Accounts (Scotland) Amendment Regulations 2010 (SSI 2010/287)(From 1 April 2011) The Charities References in Documents (Scotland) Regulations 2007 (SSI 2007/203) The Charities Reorganisation (Scotland) Regulations 2007 (SSI 2007/204) The Charities (Northern Ireland) Order 1987 (1987/ 2048 (N.I. 19)) will be repealed as equivalent provisions in the Charities Act (Northern Ireland) 2008 are commenced. Regulations are expected to be made to provide the secondary legislative framework under which accounts and audits are to be governed. 112

115 The Charities Act 2006 (Changes in Exempt Charities) Order 2010 (SI 2010/502) The Charities Act 2006 (Commencement No.7, Transition and Transitory Provisions and Savings) Order 2010 (SI 2010/503) 113

116 ACCOUNTING AND REPORTING REQUIREMENTS Charitable company Industrial & Provident Society Unincorporated charity UK-wide UK-wide England & Wales 57 Scotland N. Ireland Accruals basis; true and fair view required Gross income no more than 250,000, option to prepare receipts and payments accounts Gross income less than 100,000, should prepare receipts and payments. For accounting periods commencing on or after 1 April 2011, this threshold will be 250,000. Accruals basis and true and fair view required where income 250,000 and more 58 Charities choose either annual receipts and payments or income and expenditure account. This will be amended as sections from the Charities Act (Northern Ireland) 2008 which deal with accounts are brought into operation. The Charities SORP and UK legal requirements 17. The Charities SORP (reissued in May 2008) applies to all charities in the United Kingdom whose financial statements are required to give a true and fair view, unless a more specialist Statement of Recommended Practice applies. Paragraph 5 of the Charities SORP states that, where a Statement of Recommended Practice exists for a particular 57 Registered charities with gross income of 25,000 or less, and excepted charities which are not registered, are not required to submit annual reports or accounts to the Charity Commission, unless requested to do so. All registered charities must prepare an annual report, even if they are not requested to submit it to the Charity Commission. 58 Legislation amending this threshold to this level comes into force from 1 April 2011, before which the level is 100,

117 class of charities, the trustees of charities in that class should adhere to that SORP instead. In the charity sector specialist SORPs exist for registered social landlords and higher and further education institutions. 18. Whilst the Charities SORP is generally compatible with the requirements of UK law, it is recognised that where necessary, its recommendations should be adapted to meet any statutory requirements relating to the form and content of accounts, such as are contained in companies legislation, the Industrial and Provident Societies Acts 1965 to 1978, or registered social landlord accounting regulations for England, Wales or Scotland. The recommendations of the Charities SORP should also be adapted to meet any special requirements of the charity s own governing document. 19. It is not envisaged that the requirements of different regimes will be incompatible. For example, there is a general requirement under companies and friendly societies legislation in the United Kingdom for financial statements to give a true and fair view. The aim of SORPs, including the Charities SORP, is to assist entities in achieving a true and fair view appropriate to their circumstances. Charitable Companies (United Kingdom) 20. Charitable companies are generally incorporated as companies limited by guarantee and the requirements of the Companies Act 2006 ( CA 2006 ) applicable to such companies apply throughout Great Britain. CA 2006 requires directors of companies to approve accounts only if they give a true and fair view of the assets, liabilities, financial position and of the net income or expenditure for the year. The accounts must be prepared in accordance with section 396 of the Act. Section 396 allows for the adaption of formats enabling Charities SORP compliant accounts to be prepared by charitable companies. Paragraphs 419 to 428 of the Charities SORP provide a detailed analysis of the impact of the Companies Act requirements on Charities SORP compliant accounts. 21. CA 2006 requires annual accounts to give a true and fair view, which means that charitable companies, however small, must prepare their accounts on an accruals basis. 22. Charitable companies registered in England and Wales are also subject to certain provisions of the 1993 Act. For example, an annual report must be prepared under the 1993 Act and group accounts must be prepared where the aggregate income of the group exceeds 500,000. Similarly, charitable companies registered in Scotland are also subject to the provisions of the 2005 Act (Scotland). Charitable companies will be subject to the provisions of the Charities Act (Northern Ireland) There are no special provisions for the audit of small company charities within CA 2006: a. In England and Wales, if a small company charity claims audit exemption under CA 2006, it will still need an audit or independent examination under the 1993 Act, if the relevant threshold in charity law is exceeded. Where small group accounts are 115

118 prepared there are further complications as these must meet the requirements of both CA2006 and the 1993 Act. b. In Scotland, any small company charity registered with OSCR, which claims audit exemption under CA 2006, will require either an audit or independent examination under the 2005 Act (Scotland), as determined by the relevant threshold in Scottish charity law. c. In Northern Ireland, if a small company charity claims audit exemption under CA 2006, it will still need an audit or independent examination under the Charities Act (Northern Ireland) 2008, if the relevant threshold in that Act is exceeded. 116

119 REQUIREMENTS FOR EXTERNAL SCRUTINY OF FINANCIAL STATEMENTS (The constitution of the charity may impose more demanding requirements than, but cannot derogate from, the following rules) Charitable companies England & Wales Scotland N.Ireland Independent examination where gross income is between 10,000 and 500,000 Where gross income is over 250,000, the examiner must be a member of a specified body Audit required where: Independent examination required where gross income is less than 500,000 The examiner must be a member of a specified body Audit required where: Audit required under the Companies (Northern Ireland) Order 1986 gross income is over 500,000 gross income is 500,000 or more or or gross assets are over 3.26 million and gross income is over 250,000 Audit must be undertaken by a registered auditor unless CCEW gives a dispensation gross assets are over 2.8 million (accounting periods commencing before 1 April 2011) or 3.26 million for accounting periods commencing on or after 1 April 2011) Audit must be undertaken by a registered auditor or by the Auditor General for Scotland 117

120 24. Section 1175 and Schedule 9 to CA 2006 removed from company law special rules about the audit of smaller companies that are charities. The effect is that if a small company charity claims exemption from audit under company law, it will still be subject to audit or independent examination under the 1993 Act or the 2005 Act (Scotland) if the relevant threshold set by charity law is exceeded. In Northern Ireland the special rules for the audit of small charitable companies provided by the Companies Act is currently retained. 25. In England and Wales, if CA 2006 requires the preparation of group accounts, then the group accounts must also be audited under CA 2006 provisions and no requirement arises for those group accounts to be prepared or audited under the 1993 Act. If group accounts are prepared on a voluntary basis under CA 2006 then the group accounts must also comply with the requirements of the Charities Act 1993 which are consistent with company law requirements. Group accounts prepared by a small company parent charity are subject to audit under the provisions of charity law even if audit exemption has not been claimed under CA In Scotland, under the 2006 Regulations (Scotland) (as amended), group accounts must be prepared where the consolidated gross income is 500,000 or more and these are always audited under the 2006 Regulations (Scotland) (as amended), even where they are also prepared and audited under CA The differences between an audit undertaken in accordance with CA 2006 and an audit undertaken in accordance with charity legislation include: to qualify for exemption from CA 2006 the directors must make the prescribed statement on the company balance sheet; CA 2006 requires that the auditor explicitly reports on the consistency of the annual report with the financial statements. Audit reports under charity law do not; CA 2006 audit report is signed by a senior statutory auditor. Audit reports under charity law can be signed in the name of the firm; CA 2006 permits the auditor to limit liability. There is no such provision in charity law. 27. A small company charity claiming audit exemption under CA 2006 may file abbreviated accounts without any audit report with Companies House. However, charity sector practice is to file the full statutory accounts with Companies House and to attach the audit or independent examination report, prepared under the 1993 Act or the 2005 Act (Scotland), with the accounts filed. Company charities must file their full statutory accounts and annual report with CCEW and/or OSCR and must attach the relevant audit or independent examination report to the accounts filed. Industrial and Provident Societies 28. In England and Wales, charitable Industrial and Provident Societies are exempt from audit if their turnover is less than 90,000. An audit exemption report is required if turnover is more than 90,000 and less than 250,000 and total assets are less than

121 million. An audit is required above this threshold (exemption not available if there is a subsidiary). In Scotland, all charitable Industrial and Provident Societies are also subject to the provisions of the 2005 Act (Scotland). They must prepare accounts on the accruals basis which must be audited where gross income is 500,000 or more or where gross assets are more than 2.8 million (this threshold increases to 3.26 million for accounting periods commencing on or after 1 April 2011). Below these thresholds, independent examination by a member of a specified body must be carried out. Non-company charities England & Wales Scotland N.Ireland Independent Examination where gross income is between 25,000 and 500,000 Where gross income is over 250,000 the examiner must be a member of a specified body Audit required where: or gross income is over 500,000 Independent examination required where gross income is less than 500,000 Where gross income is 100,000 or more, the examiner must be a member of a specified body. This threshold will increase to 250,000 for accounting periods commencing on or after 1 April 2011 Audit required where: or gross income is 500,000 or more [Will be governed by the provisions of the Charities Act (Northern Ireland) 2008] [Will be governed by the provisions of the Charities Act (Northern Ireland) 2008] gross assets are over 3.26 million and gross income is over 250, Audit must be undertaken by a registered auditor gross assets are over 2.8 million (accounting periods commencing before 1 April 2011) or 3.26 million (accounting periods commencing on or after 1 April 59 These limits apply to accounting periods beginning on or after 1 April

122 unless CCEW gives a dispensation 2011) and accruals accounts are prepared Audit must be undertaken by a registered auditor or by the Auditor General for Scotland 29. A charity s governing document may require an audit, even though the charity may be below the threshold and therefore only require an independent examination. In such circumstances the trustees may wish to approach CCEW/OSCR with a view to amending the requirement of the governing document to bring it in line with statutory provisions. Where the intention of the governing document is ambiguous in terms of the level of scrutiny required the trustees may seek the advice of the regulator or seek to amend the relevant clause in line with the requirements of charity law. OTHER ASPECTS OF LAW RELEVANT TO AUDITORS England and Wales Content of auditor s report 30. The 2008 Regulations set out the matters to be included in the audit report. In addition to giving an opinion on the state of affairs and incoming resources and their application and compliance with the Regulations, additional statements in the auditor s report are required where the opinion is formed that: proper accounting records have not been kept in accordance with section 41 of the 1993 Act; the statement of accounts does not accord with those records; any information contained in the statement of accounts is inconsistent in any material respect with any report of the charity trustees prepared under section 45 of the 1993 Act in respect of the financial year in question; or information and explanations considered necessary have not been provided. Access to information and explanations 31. Auditors or independent examiners have a right of access with respect to books, documents and other records (however and wherever kept) relating to the charity concerned and any subsidiaries. The auditor or independent examiner is entitled to require, in relation to the charity, information and explanations from past or present charity trustees, or from past or present officers or employees of the charity. 120

123 Other reporting rights and duties 32. The auditor is required by section 44 of the Charities Act 1993 to report to CCEW in writing if, in connection with an audit of a charity, the auditor becomes aware of a matter of material significance to CCEW s regulatory functions under sections 8 or 18 of the 1993 Act. A similar reporting duty is imposed on independent examiners. Detailed guidance on the audit implications of this duty is provided in the section of this Practice Note on ISA (UK and Ireland) 250 B. 33. In addition when an auditor ceases for any reason to hold office it must send to the charity trustees a statement of circumstances connected with its ceasing to hold office, which it considers should be brought to the trustees attention or, if it considers that there are no such circumstances, a statement that there are none. A copy of the statement should be sent to CCEW unless there are no such circumstances to report. Scotland Content of auditor s report 34. The 2006 Regulations (Scotland) (as amended) set out the matters to be included in the audit report. The auditor must give an opinion as follows: Where regulation 8 (of the 2006 Regulations (Scotland) (as amended)) applies, the statement of account complies with the regulatory requirements, gives a true and fair view of the state of affairs of the charity at the year end and of the incoming resources and application of resources during the year; Where regulation 9 applies, the statement of account complies with the regulatory requirements and properly presents the receipts and payments of the charity for the year and its statement of balances at the year end. In addition, the auditor is required to make a statement where the opinion is formed that: the accounting records have not been kept in accordance with the 2005 Act (Scotland) and 2006 Regulations (Scotland) (as amended); the statement of account does not accord with those records; any information contained in the statement of account is inconsistent in any material respect with any report of the charity trustees prepared under section 44(1)(b) of the 2005 Act (Scotland) in respect of the financial year; any information or explanation to which the auditor is entitled under regulation 13 has not been afforded to them. Access to information and explanations 35. The 2006 Regulations (Scotland) (as amended) provide that the auditor shall have the right of access at all times to the records of the relevant charity and shall be entitled to 121

124 require such information and explanations from the present or former trustees as they think necessary for the performance of their duties. Other reporting rights and duties 36. Where an auditor ceases to hold office for any reason, Regulation 10 of 2006 Regulations (Scotland) (as amended) states that the auditor must include in its notice of resignation a statement as to any circumstances connected with its resignation which it considers should be brought to the trustees attention, or a statement that there are none. If there are circumstances which it considers should be brought to the trustees attention, the auditor should send a copy of the statement to OSCR. 37. The auditor is required by section 46 of the 2005 Act (Scotland) to report to OSCR if, in connection with an audit of a charity, the auditor becomes aware of a matter of material significance to OSCR s regulatory functions under sections 28, 30 or 31 of the 2005 Act (Scotland). A similar reporting duty is placed on independent examiners. Guidance on the audit implications of this duty is provided in the section of this Practice Note on ISA (UK and Ireland) 250 section B. Northern Ireland 38. Once the sections of the Charities Act (Northern Ireland) 2008 which bring into operation the audit requirements which will apply to charities are commenced, regulations will be made which will set out the matters to be included in the audit report. 122

125 PUBLICATIONS APPENDIX 2 The Charities SORP Accounting and Reporting by Charities Statement of Recommended Practice (Charities SORP) was published in March 2005 (reissued in May 2008 to reflect legislative changes). This publication can be viewed and downloaded for free from CCEW s web site. The Charity Commission (CCEW) For charities registered in England and Wales, CCEW produces a range of publications and guidance which are available to download from its web site The web site provides information about the Charity Commission s role and regulatory activity, starting and managing a charity and a range of guidance material. A section of the web site is devoted to charity accounting and reporting requirements and guidance. Office of the Scottish Charity Regulator For charities registered in Scotland, further reading matter is available from OSCR. All of its publications are available on the website Northern Ireland The Charity Commission for Northern Ireland (CCNI) is preparing to invite applications for charities to register with CCNI. As CCNI s operations expand, its website, will contain updates and further information about the role and the duties of trustees. Information can also be obtained from: Northern Ireland Council for Voluntary Action s Governance and Charity Advice Service in the form of guidance notes. Charity regulators: England and Wales Charity Commission Direct PO Box 1227 Liverpool L69 3UG Textphone service for hearing and speech impaired callers [email protected] 123

126 Scotland The Office of the Scottish Charity Regulator 2nd floor Quadrant House 9 Riverside Drive Dundee DD1 4NY [email protected] Northern Ireland The Charity Commission for Northern Ireland 4 th Floor, Arthur Street, Belfast BT1 4GF [email protected] 124

127 APPENDIX 3 EXAMPLE PARAGRAPHS FOR INSERTION INTO AN ENGAGEMENT LETTER 60 England and Wales Non-company (accruals basis) The following paragraphs are for insertion into the auditor s standard letter of engagement for non-company charities in England and Wales which are preparing financial statements on an accruals basis: 1. As trustees of the charity, you are responsible for maintaining proper accounting records and an appropriate system of internal control for the charity. You are also responsible for preparing the annual report and financial statements which give a true and fair view and have been prepared in accordance with applicable accounting standards and the Charities Act 1993 ( the Act ) and regulations thereunder. 2. As trustees of a charity, you are under a duty to prepare an annual report for each financial year complying in its form and content with regulations made under the Charities Act You should also have regard to the Charities SORP, issued by the Charity Commission of England and Wales and any subsequent amendments or variations to this statement. 3. Under the Charities Act 1993 we have a statutory responsibility to report to you as trustees whether in our opinion the financial statements comply with the requirements of regulations made under that Act and whether they give a true and fair view of the state of affairs of the charity at the end of the financial year and of the incoming resources and application of the resources of the charity in that year. In arriving at our opinion, we are required to consider the following matters, and report on any in respect of which we are not satisfied: whether proper accounting records have been kept by the charity and proper returns adequate for our audit have been received from branches not visited by us in accordance with section 41 of the Charities Act 1993; whether the charity s balance sheet and income and expenditure account are in agreement with the accounting records and returns; 60 These example paragraphs take account of changes introduced by the Companies Act 2006 and the Charities Act As a result, they are appropriate for accounting periods beginning on or after 6 April

128 whether we have obtained all the information and explanations which we consider necessary for the purpose of our audit; and whether the information given in the trustees annual report is consistent with the financial statements. 4. Under the Charities (Accounts and Reports) Regulations 2008 and the Charities SORP you are required to report as to whether you have given consideration to the major risks to which the charity is exposed, and to the systems designed to manage those risks. We are not required to audit this statement, or to form an opinion on the effectiveness of the risk management and control procedures. 5. We have a statutory duty to report to the Charity Commission of England and Wales (the Commission) such matters (concerning the activities or affairs of the charity or any connected institution or body corporate) of which we become aware during the course of our audit which are (or are likely to be) of material significance to the Commission in the exercise of their powers of inquiry into, or acting for the protection of, charities (The Charities (Accounts and Reports) Regulations 2008). 6. From time to time we may have to rely on oral representations by management which are uncorroborated by other audit evidence. Where they relate to matters which are material to the financial statements, we will request that you provide written confirmation of them. In particular, where misstatements in the financial statements that we bring to your attention are not adjusted, we are required to obtain your reasons in writing. Non-company (receipts and payments basis) Alternative paragraphs for a non-company charity in England and Wales which prepares accounts on a receipts and payments basis: 1. New paragraph: In accordance with the Charities Act 1993 section 42(3), where the charity s gross income in any financial year does not exceed 250,000, the charity s trustees may elect to prepare a receipts and payments account and a statement of assets and liabilities [as its annual statement of accounts]. [You have elected to prepare such an account and statement.] 2. References in paragraphs 3 and 6 above will be to the account and statement rather than to statement of account/financial statement. 3. The statutory requirement to report on the major risks does not apply, so paragraph 4 is dropped. 126

129 Charitable company Alternative paragraphs for a charity in England and Wales which is incorporated under the Companies Act 2006, does not exceed the small company thresholds (as defined by the Companies Act 2006) and has elected for audit exemption under the Companies Act For all paragraphs, the term charity can be replaced with charitable company. 1. References in paragraph 1 above to the Charities Act 1993 are replaced with Companies Act Paragraph 2 above is replaced with As trustees of a charity, you have a duty under the Companies Act 2006 to prepare a directors report for each financial year and also an annual report complying in its form and content with regulations made under the Charities Act You should also have regard to the Statement of Recommended Practice Accounting and Reporting by Charities (revised 2005) ( Charities SORP ), issued by the Charity Commission for England and Wales and any subsequent amendments or variations to this statement. 3. In the first section of paragraph 3 above replace you as trustees with the members. In the first section, also replace comply with the requirements of regulations made under that Act with have been properly prepared in accordance with the Companies Act In the first bullet point delete in accordance with section 41 of the Charities Act Alternative paragraphs where the charity is incorporated under the Companies Act 2006, and exceeds the small company thresholds (as defined by the Companies Act 2006) or is below the small company threshold but has not elected for audit exemption: 1. The changes applicable for company charities which do not exceed the small company thresholds as defined by companies legislation will also apply to these charities. 2. In addition, in paragraph 3 Under the Charities Act 1993 is replaced with Under the Companies Act Scotland Non-company (accruals basis) Alternative paragraphs for non-company charities registered in Scotland preparing accounts on an accruals basis: 1 References in paragraphs 1 and 2 above to the Charities Act 1993 are replaced with Charities and Trustee Investment (Scotland) Act References in the first section of paragraph 3 above to the Charities Act 1993 are replaced with Charities and Trustee Investment (Scotland) Act In the first bullet 127

130 point of paragraph 3 above, section 41 of the Charities Act 1993 is replaced with section 44 of the Charities and Trustee Investment (Scotland) Act In paragraph 4 above, Charities (Accounts and Reports) Regulations 2007 and the Charities SORP is deleted so that the paragraph reads Under the Charities SORP you are required to... 4 References in paragraph 5 above to the Charity Commission are replaced with OSCR. In addition, the reference at the end of the paragraph to (The Charities (Accounts and Reports) Regulations 2008) is replaced with (section 46 of the Charities and Trustee Investment (Scotland) Act 2005). 5 New paragraph Scottish charity law requires the auditor or independent examiner to consider the Trustees Annual Report and to state whether or not the report meets the requirements of the regulations and an opinion, where they have formed one, that there is a material inconsistency between the annual report and the rest of the statement of account. Although there is some legal uncertainty, the Scottish Government has given a provisional view that the annual report is outside the scope of the true and fair view, and have said that they will clarify the legislation on this point when a suitable legislative vehicle is available. This engagement letter has been produced on that basis. Non-company (receipts and payments basis) Alternative paragraphs for a non-company charity in Scotland which prepares accounts on a receipts and payments basis: 1. In paragraph 1, replace You are also responsible for preparing the annual report and financial statements which give a true and fair view and have been prepared in accordance with applicable accounting standards and the Charities and Trustee Investment (Scotland) Act 2005 and regulations there under. with In accordance with the Charities and Trustee Investment (Scotland) Act 2005 and regulations there under, where the charity s gross income in any financial year does not exceed 100,000 61, the charity s trustees may elect to prepare a receipts and payments account, a statement of balances, notes and annual report. You have elected to prepare such a statement of account. 2. Reference in paragraph 2 to the Charities SORP is not applicable so the whole of the second sentence is removed. 3. In paragraph 3 the opinion expressed as the financial statements comply with the requirements of regulations made under that Act and whether they give a true and fair view of the state of affairs of the charity at the end of the financial year and of the incoming resources and application of the resources of the charity in that year. is replaced with 61 Reference to 100,000 to be replaced with 250,000 for accounting periods commencing on or after 1 April

131 the statement of account properly presents the receipts and payments of the charity for the financial year in question and its statement of balances as at the end of that year. 4. In paragraph 3 above, the second bullet point is replaced with whether the accounts and statement are in agreement with the accounting records and returns Charitable company Alternative paragraphs for a charity in Scotland which is incorporated under the Companies Act 2006: 1. For all paragraphs, the term charity can be replaced with charitable company. 2. References to Charities and Trustee Investment (Scotland) Act 2005 are replaced with Companies Act 2006 and the Charities and Trustee Investment (Scotland) Act For large companies, in paragraph 3, the auditor has a duty to report to both the trustees and the members. So the first sentence is amended from to report to you as trustees to read to report to the members and to you as trustees. 4. In paragraph 3 replace that Act with the Charities and Trustee Investment (Scotland) Act 2005 and have been properly prepared in accordance with the Companies Act Cross-border charity Alternative paragraph for a charity registered in England and Wales and which has operations in Scotland: The relevant changes noted above for Scotland need to be combined with the English and Welsh requirements. For example, paragraph 1 should read As trustees of the charity, you are responsible for maintaining proper accounting records and an appropriate system of internal control for the charity. You are also responsible for preparing the annual report and financial statements which give a true and fair view and have been prepared in accordance with applicable accounting standards, the Charities Act 1993 ( the Act ) and regulations there under and the Charities and Trustee Investment (Scotland) Act 2005 and regulations thereunder. 129

132 ILLUSTRATIVE EXAMPLE STATEMENTS OF TRUSTEES RESPONSIBILITIES APPENDIX 4 The general duties of trustees in relation to financial reporting are set out in Appendix 1, but these need to be adapted to the circumstances of individual entities. Examples are given below of statements for: 1. a trust which is subject only to the regulation generally applicable to charities in the country where it is based (England and Wales, or Scotland, or Northern Ireland); 2. a charitable company which is subject to the requirements of the Companies Act 2006 (this example also illustrates wording appropriate to consolidated accounts); 3. a public sector entity. 1. Statement of trustees responsibilities The trustees are responsible for preparing the Trustees Annual Report and the financial statements in accordance with applicable law and United Kingdom Accounting Standards (United Kingdom Generally Accepted Accounting Practice). The law applicable to charities in [England and Wales/Scotland/Northern Ireland] requires the trustees to prepare financial statements for each financial year which give a true and fair view of the state of affairs of the charity and of the incoming resources and application of resources of the charity for that period. In preparing these financial statements, the trustees are required to: select suitable accounting policies and then apply them consistently; observe the methods and principles in the Charities SORP; make judgments and estimates that are reasonable and prudent; state whether applicable accounting standards have been followed, subject to any material departures disclosed and explained in the financial statements; and prepare the financial statements on the going concern basis unless it is inappropriate to presume that the charity will continue in business. The trustees are responsible for keeping proper accounting records that disclose with reasonable accuracy at any time the financial position of the charity and enable them to 130

133 ensure that the financial statements comply with the Charities Act 1993, the Charity (Accounts and Reports) Regulations 2008 and the provisions of the trust deed 62. They are also responsible for safeguarding the assets of the charity and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities. The trustees are responsible for the maintenance and integrity of the charity and financial information included on the charity s website. Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions Statement of trustees responsibilities charitable company The trustees (who are also directors of [name of charity] for the purposes of company law) are responsible for preparing the Trustees Annual Report and the financial statements in accordance with applicable law and United Kingdom Accounting Standards (United Kingdom Generally Accepted Accounting Practice). Company law requires the trustees to prepare financial statements for each financial year which give a true and fair view of the state of affairs of the charitable company [and the group 64 ] and of the incoming resources and application of resources, including the income and expenditure, of the charitable [company/group] for that period. In preparing these financial statements, the trustees are required to: select suitable accounting policies and then apply them consistently; observe the methods and principles in the Charities SORP; make judgments and estimates that are reasonable and prudent; state whether applicable UK Accounting Standards have been followed, subject to any material departures disclosed and explained in the financial statements; and prepare the financial statements on the going concern basis unless it is inappropriate to presume that the charitable company will continue in business. The trustees are responsible for keeping proper accounting records that disclose with reasonable accuracy at any time the financial position of the charitable company and enable them to ensure that the financial statements comply with the Companies Act They are 62 For Scottish charities, the references should be supplemented by the Charities and Trustee Investment (Scotland) Act 2005, the Charities Accounts (Scotland) Regulations 2006 (as amended) and the provisions of the charity s constitution. 63 Only required if the accounts are included on the entity s website. 64 In England and Wales group accounts prepared by small company parent charities are prepared under the accounting provisions of the Charities Act. 65 For Scottish charities, the references should be supplemented by the Charities and Trustee Investment (Scotland) Act 2005 and the Charities Accounts (Scotland) Regulations 2006 (as amended). 131

134 also responsible for safeguarding the assets of the charitable company [and the group] and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities. In so far as the trustees are aware: there is no relevant audit information of which the charitable company s auditor is unaware; and the trustees have taken all steps that they ought to have taken to make themselves aware of any relevant audit information and to establish that the auditor is aware of that information. 66 The trustees are responsible for the maintenance and integrity of the corporate and financial information included on the charitable company s website. Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions Statement of trustees responsibilities public sector entity accounts Law applicable to Public Sector entities in England and Wales/Scotland/Northern Ireland requires the trustees to prepare financial statements for each financial year which give a true and fair view of the charity s financial activities during the year and of its financial position at the end of the year. In preparing those financial statements, the trustees are required to: select suitable accounting policies and then apply them consistently; make judgments and estimates that are reasonable and prudent; state whether applicable accounting standards and statements of recommended practice have been followed, subject to any material departures disclosed and explained in the financial statements; and prepare the financial statements on the going concern basis unless it is inappropriate to presume that the charity will continue in operation. The trustees are required to follow the accounts direction issued by the Secretary of State/ Scottish Ministers, and are responsible for ensuring that proper accounting records are maintained which disclose with reasonable accuracy at any time the financial position of the charity and which enable them to ensure that the financial statements comply with (applicable law, regulations and trust deed). They are also responsible for safeguarding the assets of the charity and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities. 66 These two bullet points are required if subject to audit. 67 Only required if the accounts are included on the entity s website. 132

135 The trustees have a responsibility to ensure that the entity s system of internal control complies with the obligations placed on the entity by the relevant Secretary of State/Scottish Ministers. Where an Accounting Officer has been appointed the financial statements must include a statement of the scope of their responsibilities in respect of the internal controls and the financial statements along the following lines: X has been designated as Accounting Officer for the charity. His/her relevant responsibilities as Accounting Officer, including his/her responsibility for the propriety and regularity of the public finances for which he/she is answerable and for the keeping of proper records, are set out in Managing Public Money issued by the Treasury. If the entity is required to comply with the Companies Act the annual report must contain a statement to the effect that: (a) so far as the Accounting Officer (or equivalent) is aware, there is no relevant audit information of which the entity s auditor is unaware; and (b) the Accounting Officer (or equivalent) has taken all the steps that he/she ought to have taken to make him/herself aware of any relevant audit information and to establish that the entity s auditor is aware of that information. 133

136 APPENDIX 5 THE DUTY OF AUDITORS TO REPORT MATTERS OF MATERIAL SIGNIFICANCE TO THE CCEW AND OSCR Introduction CCEW and OSCR value the objectivity and independence that auditors bring to their work and the assurance that the audit process provides makes an important contribution to maintaining public trust and confidence in charities. Auditors in both England and Wales and Scotland have a common statutory duty to report matters of material significance to charity regulators. This important duty will be a key contribution to the ability of charity regulators to take timely action and so they have agreed a common list of matters of material significance to assist the auditor in reporting important matters on a timely basis. The sooner the charity regulators are made aware of a matter the sooner it can be considered and, where appropriate, regulatory action taken to protect a charity, its beneficiaries and its charitable assets. Guidance The Charities Act 1993 section 44, as amended by the Charities Act 2006, places a duty on the auditor of both a non-company charity and a company charity to report matters of material significance to the Commission. Section 46 of the Charities and Trustee Investment (Scotland) Act 2005 places a similar duty on the auditor of a Scottish charity to report matters of material significance to OSCR. The duty to report arises where the auditor, in the course of their audit, identifies a matter, which relates to the activities or affairs of the charity or of any connected institution or body, and which the auditor has reasonable cause to believe is likely to be of material significance for the purposes of the exercise by the Commission of its functions under section 8 or 18 of the Charities Act 1993 or the exercise by OSCR of its functions under sections 28, 30 or 31 of the Charities and Trustee Investment (Scotland) Act Reporting a matter to SOCA does not relieve auditors of a duty to report that matter to charity regulators where the information is of material significance to their function. A tipping off offense is not committed where a disclosure is not likely to prejudice an investigation. Subject to compliance with money laundering legislation regarding tipping off, in the circumstances leading to a right or duty to report, the auditor is entitled to communicate to charity regulators in good faith information or opinions relating to the business or affairs of the entity or any associated body without contravening the duty of confidence owed to the entity. In addition, in England and Wales, the Charities Act 1993 provides additional statutory protection for the auditor as no duty, for example confidentiality, is regarded as contravened merely because of any information or opinion contained in the report. Similarly, in Scotland, the 2005 Act (Scotland) provides that no obligation as to secrecy or other restriction on disclosure of information however imposed prevents an auditor from exercising the auditor s duty to report matters of material significance to OSCR. 134

137 The reporting of a matter of material significance is a separate report from the auditor s report on the accounts. The Charities Act 1993 and the Charities and Trustee Investment (Scotland) Act 2005 require the report to be made immediately the matter comes to the auditor s attention and in England and Wales the Charities Act 1993 requires that this is done in writing. There is no requirement under Scottish law for a report to be made in writing but it is recommended to do so. It is not part of the reporting duty to require the auditor to perform any additional scrutiny work as a result of the statutory duty nor is the auditor required specifically to seek out reportable matters. The auditor does however include procedures within the planning processes to ensure that members of the audit team have sufficient understanding (in the context of their role) to enable them to identify situations which may give reasonable cause to believe that a matter should be reported to the regulator. Where a matter comes to light relating to a previous financial year which would give rise to a duty to report, then the auditor still makes a report. In order to recognise whether a situation is likely to be of material significance to a regulator s function an understanding is needed of those matters which either due to their nature or potential financial impact are likely to require evaluation and, where appropriate, investigation by the regulator. Both CCEW and OSCR will always consider the following to be of material significance and hence reportable: matters suggesting dishonesty or fraud involving a significant loss of, or a major risk to, charitable funds or assets; failure(s) of internal controls, including failure(s) in charity governance, that resulted in a significant loss or misappropriation of charitable funds, or which leads to significant charitable funds being put at major risk; matters leading to the knowledge or suspicion that the charity or charitable funds have been used for money laundering or such funds are the proceeds of serious organised crime or that the charity is a conduit for criminal activity; matters leading to the belief or suspicion that the charity, its trustees, employees or assets, have been involved in or used to support terrorism or proscribed organisations in the UK or outside of the UK; evidence suggesting that in the way the charity carries out its work relating to the care and welfare of beneficiaries, the charity s beneficiaries have been or were put at significant risk of abuse or mistreatment; significant or recurring breach(es) of either a legislative requirement or of the charity s trusts; 135

138 a deliberate or significant breach of an order or direction made by a charity regulator under statutory powers including suspending a charity trustee, prohibiting a particular transaction or activity or granting consent on particular terms involving significant charitable assets or liabilities; and the notification on ceasing to hold office or resigning from office, of those matters reported to the charity s trustees. These matters are considered central to the integrity of a charity and as such will require evaluation and where appropriate investigation by the regulators. CCEW and OSCR consider all such reports to have a very high intelligence value. Both take a risk based and proportionate approach to inquiry work when deciding whether to open an inquiry. The duty to report applies to the auditor who must make a report whether or not the matter has already been notified to other regulators or agencies and whether or not the trustees have already advised the charity regulators, for example, by making a serious incident report to CCEW under separate requirements applying to trustees. Where auditors make a report, they may not have all the information but should be prepared to provide as much relevant information as possible about the matter(s) they are reporting. Matters which CCEW and OSCR have indicated are likely to be of material significance are set out on the charity regulators websites. Other sources of useful information relevant to the particular jurisdiction are available from the charity regulator s websites including: statements of results of inquiries are published by CCEW following the completion of each formal inquiry and identify particular issues that have lead to the inquiry; Back on Track an annual report published by CCEW on the themes and wider issues arising from its compliance work; Appendix 5 of CCEW s Directions and Guidance for Independent Examinations which provides independent examiners with basic guidance as to the type of issues that they may encounter during an examination which will require their consideration; annual returns (in Scotland, supplementary monitoring returns 68 ) which signpost a number of the areas that the relevant regulator considers significant; and inquiry reports published by OSCR under section 33 of the 2005 Act (Scotland). The auditor s right to report to charity regulators under the Charities Act 1993 Act and the Charities and Trustee Investment (Scotland) Act 2005 The auditor also has a broad discretionary right to report matters that they believe may be relevant to the work of the charity regulators but they are not under a duty to report such matters. 68 Completed by charities with gross income over 25,

139 CCEW and OSCR consider such reports to have considerable intelligence value and welcome these submissions. Given the broad discretion permitted it is not appropriate to list instances for reporting but the auditor may usefully review matters which were not considered material relating to the statutory duty and matters upon which trustees are requested to provide additional information as part of the annual return process. Matters falling within this discretionary category are likely to be indicative of significant risks to charitable funds or their proper application and would therefore normally be relevant to the work of the regulators. Where such a matter arises, the auditor may discuss the matter with the trustees to identify whether it remains a matter of concern and whether the trustees have taken or are taking action which can reasonably be expected to remedy or mitigate the effect on the current or future years. Although the auditor enjoys a discretion as to whether to make a report of a matter relevant to the work of CCEW and OSCR, it is recommended that the auditor documents any relevant matters identified in the course of the audit and documents the basis of any decision not to report a matter falling within this discretionary category. Ceasing to hold office In addition to the duty to report matters of material significance, regulations under the Charities Act 1993 and the Charities and Trustee Investment (Scotland) Act 2005 provide that Where an auditor appointed by charity trustees ceases for any reason to hold office he shall send to the charity trustees a statement of any circumstances connected with his ceasing to hold office which he considers should be brought to their attention or, if he considers that there are no such circumstances, a statement that there are none; and the auditor shall send a copy of any statement sent to the charity trustees under this paragraph (except a statement that there are no such circumstances) to... CCEW and/or OSCR. Matters that may require consideration in relation to this duty include: disagreement over opinions expressed or to be expressed in an auditor s report; disagreement over any disclosure made or to be made to the Commission in respect of a matter of material significance; disagreement over any accounting policy, assumption, financial judgment or disclosure made in the accounts or in the preparation of the accounts; concerns over any matter which is believed to give rise to a material risk of a loss of charitable funds; and lack of co-operation or obstruction in the context of an audit. 137

140 Cross border charities Where a charity registered in England and Wales also operates in Scotland it will need to be registered with OSCR as well as CCEW. For such cross border charities neither regulator is considered to be the principal regulator and both will have an interest in receiving reports. The auditor therefore makes a report to both regulators who will determine which regulator takes forward the issues raised by the report. Reporting gateways To ensure reports are handled efficiently and immediately, the auditor makes reports to the regulators as follows: to CCEW by [email protected] to OSCR by [email protected] Within the body of the , or in an attachment thereto, the following information is requested: the auditor s name and contact address, telephone number and/or address; the charity s name and registration number (if applicable); whether the auditor is reporting a matter of material significance, or is exercising his right to report; under which of the eight headings of reportable matters the report is being made; a description of the matter giving rise to concern and the information available on the matter reported, where possible providing an estimate of the financial implications; where the trustees are attempting to deal with the situation, a brief description of any steps being taken by the trustees of which the auditor has been made aware; if the report concerns terrorist, money laundering or criminal activity confirmation that the auditor has already notified the Serious Organised Crime Agency and/or the Police as appropriate; if the report concerns the abuse of vulnerable beneficiaries details of whether the auditor has contacted the Police and/or Social Services. In England and Wales the Charities Act 1993 requires the report to be in writing and therefore a hard copy of any report made orally is also forwarded to: Charity Commission Direct PO Box 1227 Liverpool L69 3UG 138

141 In Scotland, there is no legislative requirement to make the report in writing, but it is recommended that a written report or record of any verbal report is forwarded to: OSCR 2 nd Floor Quadrant House 9 Riverside Drive Dundee DD1 4NY 139

142 LEGISLATIVE BACKGROUND TO AUDITOR S REPORTS ON CHARITIES FINANCIAL STATEMENTS APPENDIX 6 The Companies Act In respect of periods beginning on or after 6 April 2008 charitable companies which do not exceed the Companies Act 2006 audit threshold 69 may elect to take advantage of the audit exemption conferred by section 477 of the Companies Act However, charitable companies which are eligible for audit exemption under the Companies Act 2006 but are above the lower threshold for audit contained within charity law must receive an audit under charity law 71 if they elect not be audited under the Companies Act This is explained further in paragraphs 2 to 7. English and Welsh charity legislation 2. The Charities Act 2006 (Charitable Companies Audit and Group Accounts Provisions) Order 2008 applies charity audit provisions under the Charities Act 1993 to charitable companies that are not being audited under the Companies Act However, charitable companies will be subject to the audit requirements of the Companies Act 2006 if the charitable company exceeds the Companies Act 2006 audit exemption thresholds or it is below the Companies Act 2006 audit exemption thresholds but no election has been made for audit exemption under that legislation. Scottish charity legislation 4. The Charities and Trustee Investment (Scotland) Act 2005 and the Charities Accounts (Scotland) Regulations 2006 (as amended) apply to all charities entered on the Scottish Charity Register including those also registered in other jurisdictions. 5. The audit requirements of the Charities and Trustee Investment (Scotland) Act 2005 and The Charities Accounts (Scotland) Regulations 2006 (as amended) are in addition to the audit requirements of the Companies Act As a result, charitable companies on the Scottish Charity Register will be audited under both sets of legislation unless the 69 Any charitable company with income in excess of 6.5 million or gross assets in excess of 3.26 million must be audited under the Companies Act It should be noted that if a charitable company decides to elect for audit exemption under the Companies Act 2006 then a statement to this effect is required on the charity s balance sheet. 71 In England and Wales The Charities Act 1993 as amended by The Charities Act In Scotland Charities and Trustee Investment (Scotland) Act 2005 and The Charities Accounts (Scotland) Regulations 2006 (as amended). 72 This will affect charitable companies that are below the small company thresholds (as set out in the Companies Act 2006) but which are above the thresholds in the Charities Act At the time of writing these thresholds are: income in excess of 500,000 or income in excess of 250,000 and gross assets in excess of 3.26 million. 140

143 charitable company has elected for audit exemption under the Companies Act Where such an election has been made, the audit is undertaken solely under the Charities and Trustee Investment (Scotland) Act 2005 and the Charities Accounts (Scotland) Regulations 2006 (as amended). 6. Scottish charity law requires the auditor or independent examiner to consider the Trustees Annual Report and to state whether or not the report meets the requirements of the regulations and an opinion, where they have formed one, that there is a material inconsistency between the annual report and the rest of the statement of account. Although there is some legal uncertainty, the Scottish Government has given a provisional view that the annual report is outside the scope of the true and fair view, and have said that they will clarify the legislation on this point when a suitable legislative vehicle is available. 7. The Office of the Scottish Charity Regulator has confirmed that it will not take any action if a charity files an auditor s report that does not make a specific reference to the inclusion of the Trustees Annual Report within the scope of the audit. Northern Ireland charity legislation 8. In Northern Ireland, the audit threshold for a charitable company has been set by section 65 of the Charities Act (Northern Ireland) However, at the time of writing, section 65 has not been brought into operation. Regulations will be made when the section is brought into operation which will set out detailed audit requirements. It is expected that the regulations will apply to charitable companies which are not being audited under the Companies Act Illustrative examples 9. APB publishes illustrative examples of charity auditor s reports in a Compendium Bulletin. The latest version of this Compendium Bulletin is 2010/2 in which Examples 29, 30, 32 and 33 address charitable companies and Examples 35 and 36 address noncompany charities. Examples 31 and 34 relate to charitable company groups. Particular features of the examples not relating to charitable company groups are set out in the table below. 73 At the time of writing the threshold is gross income in excess of 500,

144 England & Wales only Charitable company (unless Companies Act audit thresholds have not been breached and Trustees elect not to be audited under the Companies Act 2006) Charitable company not exceeding the Companies Act audit thresholds, audited under the Charities Act Non-company charity Scotland only Charitable company not electing for audit under the Companies Act 2006 Charitable company not exceeding the Companies Act audit thresholds, audited under the Charities and Trustee Investment (Scotland) Act 2005 Non-company charity Audit requirement Accounts drawn up under Address to Companies Charities Companies Charities members Act 2006 Act 1993 Act 2006 Act 1993 or S43 S42 trustees? Charities and Trustee Investment (Scotland) Act 2005 S44 (1) (c) Charities and Trustee Investment (Scotland) Act 2005 S44(1)(b) P P Members P P Trustees P P Trustees P P P P Members and trustees P P P Trustees P P Trustees 142

145 Dual registered England & Wales and Scotland Charitable company not electing for audit under the Companies Act 2006 Company, not exceeding the Companies Act audit thresholds, where Trustees elect not to be audited under the Companies Act 2006 Non-company charity P P P P Members and trustees P P P P Trustees P P P P Trustees 10. In order to avoid excessive length, differing requirements under each type of legislation are set out in the footnotes to the illustrative auditor s reports. The auditor will need to select the appropriate disclosures for the charity using the table above and the footnotes to the individual examples. 11. The examples do not deal with the special features of the auditor s report associated with: charities adopting the FRSSE; charities preparing their accounts on a receipts and payments basis; Industrial and Provident Societies; Friendly Societies; audit reports by auditors appointed by CCEW; National Health Service charities; exempt charities. Charitable company groups add further complexities. In England and Wales if the Companies Act requires the preparation of group accounts then the group accounts must be audited under Companies Act provisions and no requirement arises for those group accounts to be audited under the Charities Act Group accounts must be prepared and audited under the Charities Act 1993 where the aggregate gross income of the group for the financial year exceeds 500,000 unless there is a requirement for group accounts to be prepared under the Companies Act. If group accounts are prepared on a voluntary basis under the Companies Act then the group accounts must still be audited under Charities Act provisions irrespective of whether an audit is undertaken under the Companies Act. This will affect the wording in the auditor s opinion which will refer to the Charities Act provisions in addition to the Companies Act. 143

146 APPENDIX 7 DEFINITIONS Abbreviations and frequently used terms in this Practice Note are set out below: Branches Entities or administrative bodies set up, for example, to conduct a particular aspect of the business of the charity, or to conduct the business of the charity in a particular geographical area and which are included within the individual accounts of a charity. For the purpose of the Charities SORP a branch is: simply part of the administrative machinery of the charity, or a fund shown in the accounts as a restricted or endowment fund. This may include: a separate trust which is administered by or on behalf of the charity and whose funds are held for specific charitable purposes which are within the general purposes of the charity; in England and Wales, a separate trust (or legal entity) not falling within the above which CCEW has united by a direction under section 96(5) or 96(6), Charities Act Charity Charitable purposes Charity Regulators Any institution, corporate or not, which is established for charitable purposes and is subject to the control of the High Court in the exercise of the Court s jurisdiction with respect to charities. When referred to in the context of CCEW and HMRC UK-wide matters, this means purposes that are exclusively charitable according to the law of England and Wales. Charitable purposes for Scottish Registered Charities are as defined within the Charities and Trustee Investment (Scotland) Act 2005 The principal regulators for charities in the UK are, for: England and Wales The Charity Commission for England and Wales; Scotland Office of the Scottish Charity Regulator; Northern Ireland The Charity Commission for Northern Ireland. 144

147 Charitable company A company: formed and registered under the Companies Act 2006; and established for exclusively charitable purposes. Charity trustees The persons having the general control and management of the administration of a charity, regardless of what they are called. For example, in the case of an unincorporated association the executive or management committee are its charity trustees, and in the case of a charitable company it is the directors who are the charity trustees. Charities SORP Statement of Recommended Practice Accounting and Reporting by Charities, originally issued by CCEW under the auspices of the Accounting Standards Board in March CA 2006 The Companies Act Directors Excepted charity The ISAs (UK and Ireland) which are considered in sections of the Practice Note use the word directors to describe the persons who are legally responsible for a reporting entity s affairs, including the preparation of its financial statements. The equivalent persons for a charity are its trustees and the directors of a charitable company are, by virtue of their office, its trustees. This Practice Note therefore uses the term trustees rather than directors. One which does not have to register with CCEW, but in most other respects is fully within its jurisdiction. Under section 3(5) of the Charities Act 1993, the following charities fall into this category: any charity which is excepted by an Order or by Regulations, any charity which has neither: any permanent endowment, nor the use or occupation of any land, and whose annual income from all sources does not amount to more than 5000, places of worship registered under the Places of Worship Registration Act

148 Exempt charities FSA Gift Aid Management NDPB Non-company charities Exempt charities in England and Wales are specifically excluded from CCEW s supervision and monitoring. Exempt charities do not register with CCEW, nor do they submit accounts and annual returns. These are charities listed in Schedule 2 to the Charities Act 1993 as amended by Chapter 3 of the Charities Act 2006 (every institution listed is not necessarily a charity; the Act grants exempt status only so far as they are charities ). The Financial Services Authority. Tax relief for certain payments made to charity. References in the Practice Note to management are to those persons, who may include trustees, who have executive responsibility for the conduct of the entity s operation. Care needs to be taken to identify the legal position of senior staff. Many charities call their salaried chief executive director which is not to be confused with the term of company director in company law. In most cases, whilst accountable only to the trustee body and having responsibility for the execution of that body s policy, a salaried chief executive is not a trustee and therefore holds a position whose legal status is significantly different from that of a company director. A non-departmental public body is an entity that has a role in the process of government but is neither a government department nor forms part of a department. It is established at arm s length from departments and may carry out executive, regulatory, administrative or commercial functions (see also Practice Note 10). Non-company charities mean charities other than those which are formed and registered under the Companies Act 2006 or to which the provisions of that Act apply. The term includes charities incorporated by Royal Charter or by special Act of Parliament. Charities incorporated under general legislation other than the Companies Act 2006, such as Industrial and Provident Societies Acts, are referred to separately as appropriate. OSCR Office of the Scottish Charity Regulator Act (NI) The Charities Act (Northern Ireland) Order (NI) The Charities (Northern Ireland) Order Act (Northern Ireland) The Charities Act (Northern Ireland)

149 2005 Act (Scotland) The Charities and Trustee Investment (Scotland) Act Regulations (Scotland) (as amended) 2008 Regulations (E&W) Restricted funds The Charities Accounts (Scotland) Regulations 2006 (as amended). The Charities (Accounts and Reports) Regulations Restricted funds are defined in Appendix 3 to the Charities SORP as: funds subject to specific trusts, which may be declared by the donor(s), or with their authority (e.g. in a public appeal), or created through legal process but still within the wider objects of the charity. [They] may be restricted income funds, which are expendable at the discretion of the trustees in furtherance of some particular aspect(s) of the objects of the charity. Or they may be capital (ie endowment) funds, where the assets are required to be invested, or retained for actual use, rather than expended. Serious Incident Reports Information provided to CCEW by the trustees of a charity about serious incidents which have caused or could cause harm to their charity including any necessary declaration made by them as part of their Charity s Annual Return concerning the reporting of such matters. SOCA Serious Organised Crime Agency. Contact details SoFA A Statement of Financial Activities. A charity s SoFA shows all the incoming resources becoming available during the year and all its expenditure for the year, and reconciles all the changes in its funds. The SoFA should account for all the funds of the charity and should be presented in columns representing the different types of funds. 147

150 APPENDIX 8 SOME SIGNIFICANT TOPICS RELEVANT TO AUDITS OF CHARITIES TOPIC PARAGRAPH NUMBERS SECTION Branches Introduction 68 ISA (UK&I) ISA (UK&I) 320 ISA (UK&I) 600 Charity Governing Documents Introduction ISA (UK&I) ISA (UK&I) ISA (UK&I) ISA (UK&I) 402 ISA (UK&I) 700 Cash Donations and Donations in Kind Completeness of Income Introduction ISA (UK&I) 240 ISA (UK&I) 520 ISA (UK&I) 545 Introduction ISA (UK&I) 240 ISA (UK&I) 315 ISA (UK&I) 330 Grant Income Overseas Operations Restricted Funds Introduction ISA (UK&I) 315 ISA (UK&I) 505 ISA (UK&I) 570 ISA (UK&I)300 ISA (UK&I) 315 ISA (UK&I) 330 ISA (UK&I) 600 Introduction ISA (UK&I) 320 ISA (UK&I) 330 ISA (UK&I)

151 Trading Activities Introduction Trustees Responsibilities Trustees Report on Risks , Introduction ISA (UK&I) 240 ISA (UK&I) 250 ISA (UK&I) 260 ISA (UK&I) 315 ISA (UK&I) 550 ISA (UK&I) 580 ISA (UK&I) 240 ISA (UK&I) 315 Taxation 30, Introduction ISA (UK&I) 315 ISA (UK&I)

152 The APB is part of the Financial Reporting Council Limited a company limited by guarantee. Registered in England number Registered Office: 5th Floor, Aldwych House, Aldwych, London WC2B 4HN

153 urther copies, 8.00, post-free, can be obtained from: CODE: UP/APBD-BI11256 Further copies, 15.00, post-free, can be obtained from: FRC Publications 145 London Road Kingston upon Thames Surrey KT2 6SR Telephone: Fax: or ordered online at: