The changing nature of auditing in New Zealand
The audit of financial statements has changed fairly significantly over the past couple of decades.
This has occurred for a number valid of reasons including business and organisations getting more complex, accounting standards growing in number and complexity as a result, increased public expectations regarding transparency, as well as standard setters, regulators, professional bodies and auditors responding to calls for greater scrutiny by auditors as a result of various financial scandals and the Global Financial Crisis.
We have also seen an ongoing move towards globalisation in both accounting, and audit and assurance standard setting. In order to ensure that New Zealand standards were in line with global best practice and to ensure that New Zealand entities remain internationally comparable and relevant, New Zealand adopted the International Standards on Auditing as our applicable audit standards back in the mid-2000s.
Auditing is a standards-based activity. After being set for many years via the voluntary activity of the accounting professional body, we now have statutory audit standard-setting in New Zealand. Auditing standards in New Zealand are promulgated by the New Zealand Auditing and Assurance Standards Board. The NZAuASB, as it is known, is one of the two sub-boards of the External Reporting Board (known as the XRB), an independent Crown Entity established under the Financial Reporting Act 2013. This means the NZAuASB’s audit and assurance standards now have the force of law.
Accordingly, referring to “an audit” can now be a much more complex, involved, and expensive exercise than it was, say, 20 plus years ago. This can be quite significant when considering legal documents drafted with the requirement for an audit of financial statements within them. The impacts of this are potentially even more significant when the requirement for an audit is in relation to a small charity or not-for-profit (NFP) entity.
Go back 50 years and just about every incorporated society or charity had a requirement in its constitution or rules that went something along the lines of: “An audit of the annual accounts shall be performed by an auditor appointed by the governing body”. Some used more specific terms and referred to the balance sheet, profit and loss statement or income and expenditure statement. A few even referred to annual financial statements.
As regards who the auditor could be, this also varied. Some specified that this could not be a member of the organisation, others specified it be an accountant and some even went so far as to specify a Chartered Accountant, thereby ensuring a degree of qualification. (A wise de facto quality standard in my opinion. The author once investigated “an audit” performed by a friend of an NFP organisation’s chairperson, whose “qualification” for the role was that she had done Form 2 accounting 30 or so years previously. While she had managed to competently copy an up-to-date audit report, sadly, that was where the quality of her obviously absent audit skills ended. However, as most people only saw her audit report, they were none the wiser as to the complete lack of competent audit work supporting it.)
In many cases, I have observed over the years, the drafted requirements referred specifically to an “honorary auditor”. I am inclined to see these as similar to a unicorn – we all know what one looks like but we have not seen one for a while!
Some may see this as a tad uncharitable to the accounting profession. But when one considers the increased volume and complexity of auditing standards and the increased sophistication and complexity of many organisations and accounting standards, and the increased risk of getting it wrong, it is perhaps more understandable.
In addition, the main professional body, the Institute of Chartered Accountants in New Zealand (know known as Chartered Accountants Australia New Zealand or CA ANZ)) has been increasingly vigorous over recent years in reviewing the work of its Chartered Accountant members. This is to ensure that those performing audits are competent and comply with all relevant standards and are not exposing the profession to reputational risk. Put bluntly, you could say that its message to the accounting profession has been, if you are doing an audit, no matter how big or small the entity, then you must comply with all the relevant standards and do a good job. The members of the organisation or general public who may be relying on an independent auditor would expect nothing less, especially if there is subsequently found to be a problem with the organisation’s finances.
Additionally, whether the organisation is large or small, or whether the auditor is being paid at commercial rates or not, is irrelevant, as is the fact that maybe the accountant “only does few small audits for NFP entities”. If a problem is subsequently found and an audit was performed, there will be little sympathy for any excuses from the auditor. Hence, there is a strong rationale for the increased focus by CA ANZ on its auditor members. The words of the lead Institute Practice Reviewer from 20 years ago still ring in my ears relative to this topic – on the question of occasional auditors, his view was firmly: “You can’t be half pregnant. You are either auditing in full compliance with the audit standards or you shouldn’t be auditing at all.”
The changing reporting requirements for charities and NFPs in New Zealand
As well as auditing standards changing, there have recently been significant changes in the requirements for financial statements and auditing of charities. Similar changes are likely to be seen in regard to incorporated societies in future as well.
All registered charities (those registered with DIA Charities Services) are now required by law to prepare annual financial statements in accordance with one of four, size-appropriate sets of financial reporting standards that have been specifically developed for NFP Public Benefit Entities.
A Public Benefit Entity (PBE) is defined as a reporting entity whose primary objective is to provide goods or services for community or social benefit and where any equity has been provided with a view to supporting that primary objective, rather than for a financial return to equity holders.
Requiring compliance with specified PBE accounting standards is to ensure that we have consistent and comparable reporting in the sector of any entities such as registered charities receiving an income taxation benefit from the government on the public’s behalf. These registered charities are then required to file their annual financial statements on the public register (www.charities.govt.nz), to ensure appropriate public transparency.
As part of this significant legislative change, the requirement for audit was also considered. After considerable consultation and deliberation, legislators arrived at the conclusion that an independent audit carried out by an appropriately trained and qualified professional was important to provide public assurance that financial reporting standards had been followed and hence the financial statements could be relied upon as being materially fairly stated. However, there was considerable debate over the cost/benefit trade-off of independent assurance. As a result, the legislation contains a “bright-line” for where audit or a lesser alternative form of independent statutory assurance is required.
This kicks in at two levels:
- all registered charities with annual operating expenditure exceeding $500,000 are required to have a limited review engagement or an audit; and
- all registered charities with annual operating expenditure exceeding $1 million are required to have an audit.
Beneath these levels, it was determined that the cost of audit can sometimes outweigh the benefits, especially in the context of the stringent requirements on statutory auditors. Hence there should not be a statutory requirement for it. This is not to say that an audit is not a valuable service – there may be very valid reasons for requiring an audit below that level and this does not stop entities with annual operating expenditures below those levels from voluntarily choosing to procure independent assurance. However, the key point is that it needs to be a well-considered and positive choice and one that considers the cost/benefit equation of imposing such a requirement.
Who can audit in New Zealand now?
Given there is now a statutory requirement for charity auditing, it was also decided that this needs to be performed by appropriately-qualified audit professionals to ensure appropriate quality. Hence statutory audits in New Zealand now can only be performed by Qualified Auditors. This requires a certain level of audit specific skills and experience. A register of Qualified Auditors exists at https://charteredaccountantsanz.force.com/customer/find_a_ca.
(Note that Qualified Auditors differ from Licensed Auditors, which is another regulated subgroup able to perform the audit of FMC reporting entities, generally seen as the most complex of financial audits in New Zealand. FMC reporting entities are entities defined as such under the Financial Markets Conduct Act 2013 and include issuers of regulated products or listed issuers, banks, insurance companies, credit unions and the like.)
What about non-charity NFPs?
The registered charity population only accounts for approximately 28,000 of our estimated 113,000 NFP entities in New Zealand. Most of the non-registered charity population do not as yet have a statutory requirement for following PBE accounting standards, nor for being audited. This situation is partly expected to change with the Incorporated Societies Act overhaul, suggesting that, in future, all incorporated societies follow the same PBE accounting standards as charities. This makes good sense for consistency across the sector. However, the Incorporated Societies Bill proposes that an audit not be a statutory requirement and should be left to the decision of the members – again, a sensible suggestion. However, we will have to wait and see how reform in this area progresses through the parliamentary system.
Implications for lawyers involved with charities and NFPs
All of the above has an implication for lawyers who may be requested to assist with drafting or revising trust deeds, constitutions, rules or other governing documents of charities and NFPs.
- Lawyers should be reminded to check any templates they may be using to make sure that any audit requirements in any constitutions, rules or deeds are fit for current-day purpose.
- Lawyers should note that audits are more complex and hence more costly than has perhaps been the case in the past. Also, with a bright-line level set in legislation, there should now be serious consideration of the cost of imposing an audit on an entity below that statutory level. A practical option for entities not statutorily required to be audited may be to allow flexibility by drafting a requirement that allows the governing body or membership to choose if an audit or other form of independent assurance is necessary each year.
- Depending on the type of entity, there may be statutory requirements for following PBE accounting standards, and audit and assurance standards. Reference to the correct financial reporting requirements will be important.
- Consideration should be given to specifying who should perform any independent audit or other assurance. As noted above, in some cases, this will be required to be a statutory or Qualified Auditor. However, no matter what, it is important that any auditor specified has the requisite skills and experience for the job and is appropriately independent.
- Helpful information and guidance regarding financial reporting and audit and assurance requirements can be found on the External Reporting Board website www.xrb.govt.nz.
Craig Fisher FCA is an Audit Partner and Chairman of RSM. Mr Fisher is a specialist regarding not-for-profit and charitable entity issues. He is also a board member of the NZ Audit and Assurance Standards Board, as well as on the Council of the ADLS. He can be contacted at firstname.lastname@example.org.