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Module 10: Internal auditing in the public sector and notfor-profit sectors
Overview
Up to this point, you have learned about internal auditing and the role of internal auditors in private sector business organizations, the principles of good management, and ways to help managers apply those principles and achieve business objectives. In this final module, you study the unique features of governance and auditing in the public sector. This includes attest, compliance, performance, and comprehensive auditing, with an emphasis on internal audit. You also consider internal audit and governance issues in the not-for-profit sector.

Test your knowledge

Begin your work on this module with a set of test-your-knowledge questions designed to help you gauge the depth of study required.

Learning objectives
10.1 Roles, activities, and risks in the public sector Identify the roles, activities, and risks specific to the public sector in Canada. (Level 1) Governance in the public sector Outline public sector governance; explain how public sector auditors and audit committees can contribute to the effectiveness of governance. (Level 2) Legislative auditing Role of the Auditor General Explain the role of the Auditor General of Canada and its counterpart at other levels of government; explain the difference between the role of the Auditor General and internal auditors in the public sector. (Level 2) Internal auditing in the public sector Explain the standards and considerations for internal auditing in the public sector in Canada and internationally. (Levels 1 and 2) Comprehensive auditing Explain the characteristics and components of comprehensive auditing. (Level 2) Roles, activities, risks, and governance in the not-for-profit sector Outline the roles, activities, risks, and governance issues specific to the not-for-profit sector in Canada. (Level 2) Internal audit considerations for NFPs Develop the specific considerations that apply in the internal audit of not-for-profit organizations, including performance audits of NFPs. (Level 1) Module summary Print this module

10.2

10.3

10.4

10.5

10.6

10.7

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MU1 Module 10: Test your knowledge

1. Which of the following does comprehensive auditing not include? a. b. c. d. An An An An evaluation of compliance with management policies and procedures attestation to the fairness of financial statements evaluation of effectiveness, efficiency, and economy evaluation of the relevance of programs and business activities

2. How is efficiency normally best described? a. b. c. d. In terms of units produced By reference to the elapsed time for a process cycle By a ratio of resources consumed in relation to process outcomes By measuring resources consumed

3. Which of the following elements distinguishes performance auditing from financial statement auditing? a. Financial statement auditing relates solely to the financial controls of a commercial entity, whereas performance auditing seeks to determine the performance of notfor-profit organizations as measured in non-financial terms. b. Financial statement auditing is based on examining information related to an accountability relationship, whereas performance auditing seeks strictly to measure the relationship between expenses incurred and the performance of a not-for-profit organization. c. Financial statement auditing may attest to written assertions drafted by management, whereas performance auditing is based solely on the observation of facts contained in the records of the not-for-profit organization. d. Financial statement auditing must meet the same objectives and have the same scope from one audit to another, whereas performance auditing provides the auditor with discretion in establishing the audit objectives and scope. 4. In a comprehensive audit in the public sector, substantive information should be obtained with respect to different attributes of effectiveness. Which of the following statements best describes the management direction attribute? a. The extent to which the objectives of an organization (including its employees) are achieved. b. The extent to which the objectives of an organization (excluding its employees) are achieved. c. The extent to which the objectives of an organization (including its employees) are clear and understood. d. The extent to which the objectives of an organization (excluding its employees) are clear and understood. and its components and its components and its components and its components

5. Accountability is a relationship based on the obligation to demonstrate and take responsibility for performance in light of agreed-upon expectations. In what type of organization is accountability the most important? a. b. c. d. Manufacturing businesses Partnerships Government organizations Limited partnerships

Solutions

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MU1 Module 10: Test your knowledge solutions

1. a. Correct. The compliance portion of comprehensive audits assesses only compliance with laws and regulations and not with internal management policies and procedures. b. Incorrect. Attest audits of financial statements are included in comprehensive audits. c. Incorrect. The value-for-money or performance audit component of comprehensive auditing includes evaluating effectiveness, efficiency, and economy. d. Incorrect. Relevance is one of the 12 attributes of effectiveness that are assessed in comprehensive audits. 2. a. b. c. d. Incorrect. This only refers to output quantity without regard for inputs used. Incorrect. This refers to time without regard for quality. Correct. Efficiency is measured as a ratio of inputs to outputs. Incorrect. This ignores a measure of output.

3.

a. Incorrect. Financial audits are performed for commercial entities, public-sector entities, and not-for-profit organizations. Performance auditing is carried out in the public sector as well as not-for-profit entities and also includes measures of financial performance. b. Incorrect. Performance auditing is wider in scope than assessing only the relationship between expenses incurred and performance (and applies to publicsector entities as well as not-for-profit organizations). c. Incorrect. Performance auditing may consist of assessing assertions made by management about an entitys performance. d. Correct. The scope of financial statement auditing always involves determining whether the financial statements have been prepared in compliance with the applicable financial reporting framework. The scope of performance auditing can vary from audit to audit. a. Incorrect. The attribute of management direction measures the extent to which the objectives are clearly communicated and understood, not whether they are achieved. b. Incorrect. The attribute of management direction measures the extent to which the objectives are clearly communicated and understood, not whether they are achieved. c. Correct. The attribute of management direction measures the extent to which the objectives are clearly communicated and understood, not whether they are achieved. These objectives are those of the organization and its components, including its employees. d. Incorrect. The attribute of management direction measures the extent to which the objectives are clearly communicated and understood, not whether they are achieved. These objectives are those of the organization and its components, including its employees.

4.

5.

a. Incorrect. Accountability is more important in government organizations than in the private sector because those who manage public-sector entities are accountable to the taxpayers and ratepayers through their governing bodies and elected representatives. b. Incorrect. Accountability is more important in government organizations than in the private sector because those who manage public-sector entities are accountable to the taxpayers and ratepayers through their governing bodies and elected

representatives. c. Correct. Accountability is more important in government organizations than in the private sector because those who manage public-sector entities are accountable to the taxpayers and ratepayers through their governing bodies and elected representatives. d. Incorrect. Accountability is more important in government organizations than in the private sector because those who manage public-sector entities are accountable to the taxpayers and ratepayers through their governing bodies and elected representatives.

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10.1 Roles, activities, and risks in the public sector

Learning objective

Identify the roles, activities, and risks specific to the public sector in Canada. (Level 1)
Required reading

Reading 10-1, University Risk Management (Level 1)

LEVEL 1

Government services are complex. The reasons for this complexity are the extraordinary diversity in services offered by Canadas three levels of government, the multiple stakeholders and interests in such services, the ever-changing environment in which such services must be delivered, and the difficulty in measuring performance and accountability. Accountability in the public sector is the process whereby public sector entities, and the individuals within them, are responsible for their decisions and actions, including their stewardship of public funds and all aspects of performance, and submit themselves to appropriate external scrutiny Accountability is the obligation to answer for responsibility conferred. 1 Every level of government is faced with its constituents expectations of fiscal economy and improved delivery of public services at the same time. Those responsible for governing public services (legislators, board members, and senior management) must select the optimal services and delivery mechanisms within the confines of limited public resources and demonstrate that chosen services and delivery mechanisms are providing the best (most effective and efficient) means of achieving policy and fiscal goals. Governments that do not live up to the prevailing set of public expectations often do not stay more than a single term in office. The federal government, provincial governments, municipal governments, and a host of public service organizations are the guardians of public funds entrusted to them for delivering programs and services to benefit Canadians. An important part of the confidence that people have in our democratic institutions is their belief that public funds are spent wisely and effectively. There must be, and there must be seen to be, complete and accurate financial reporting, compliance with authorities, environmental stewardship, and value for money. The publics confidence in our various levels of government depends on clear and timely accountability by these governments for their performance. Downturns in the economy, increases in the national deficit, and overall financial constraints in the final decades of the past millennium have contributed to the growing demand for management accountability and better value for tax moneys expended by government at all levels. It is no longer acceptable for governments to incur large deficits and increase taxes to cover them. Elected officials and appointed directors of federal, provincial, and municipal governments, public sector organizations in health care, education, and social services, as well as government-owned or government-controlled corporations, have realized the need for better information on the performance of public-sector fiscal and program management and are seeking to have their auditors provide this accountability information. Governments operate through departments, agencies, and Crown corporations. Governance and accountability are more complex than in the private sector, where management is generally accountable primarily to the shareholders, through the board of directors. Where government agencies and Crown corporations have boards of directors (or equivalent bodies), management reports to those boards. The boards are accountable to the taxpayers and users of their services indirectly through the responsible minister and Parliament or the Legislature.

Risks
The CICA Handbook, paragraph PS 6410.18, addresses planning for performance audits in the public sector.

Such audits assess the extent to which the public sector entity provides value for the money contributed by stakeholders through taxes, user fees, and other revenues. As with internal audits of private commercial organizations, auditors of public organizations must deal with the types of risks faced by such organizations: a. The diversity, consistency, and clarity of the entitys objectives and goals If the entity has diverse or inconsistent objectives, the risk that its activities or programs are not operating with due regard for value for money increases. If the entitys objectives and goals are not clearly defined, there is an increased risk that they will not be understood by employees and that value for money will not be achieved. b. The complexity of operations An entitys operations become more complex as the variety and type of programs, functions, and activities increase and as decision making is decentralized. As the complexity of the operations of an organization increases, value for money may be more difficult to achieve. c. The complexity and quality of management information and control systems and external reporting Complex systems may be more difficult to develop, enhance, and maintain. Furthermore, if adequate management systems are not maintained, proper control may not be exercised. Users of accountability information may be relying on inadequate, incorrect, or incomplete information and may make decisions that result in a lack of due regard to value for money. d. The nature and degree of change in the environment or within the entity New public needs, budget cuts, or changes to key enabling legislation are some of the changes to the environment that the entity might experience. Changes within the entity include new initiatives, high turnover of staff, and a recent reorganization. Depending on how such changes are managed, there may be a lack of continuity or understanding of goals, operations, controls, or policies, thus increasing the risk that value for money will not be achieved. e. The program delivery method Programs in the public sector may be delivered by policy instruments such as expenditure, regulation, and revenue-raising; may provide goods or services directly or may redistribute income; and may be delivered directly or by using contractors. The amount of risk involved may vary depending on the complexity of the delivery method. f. The nature of transactions High volumes, large dollar values, and the complexity of transactions processed may indicate a risk that value for money may not be achieved. The auditor should identify all areas of the organization that are significant and/or high risk when establishing or assessing audit objectives and scope. In doing so, significance and risk are assessed together. The auditor should plan to examine significant areas where the risk is judged to be high. Areas that are significant in terms of achieving value for money, but where the risk is judged to be low, may also be selected because even if the risk is low, any occurrence of a lack of due regard to value for money can have a significant effect on the organization. Reading 10-1 describes risks specific to public universities. The reading also describes how ERM is applied to managing university risks.

1 IFAC Public Sector Committee,

Governance in the Public Sector: A Governing Body Perspective (New York: International Federation of Accountants, 2001), http://www.ifac.org/sites/default/files/publications/files/study13-governance-in-th.pdf, accessed April 25, 2012.

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10.2 Governance in the public sector

Learning objective

Outline public sector governance; explain how public sector auditors and audit committees can contribute to the effectiveness of governance. (Level 2)
Required reading

Online reading 10.2-1, The Role of Auditing in Public Sector Governance (Level 2)
LEVEL 2

This topic emphasizes the growing importance of governance and accountability, and establishes the need for both legislative and internal auditing and for audit committees in the public sector. Consider the similarities and differences of the governance issues between the public sector and the private sector (see Topic 3.7). Governance in a public-sector setting refers to the responsibilities and actions of governing bodies, the most senior authority levels in the public sector. These are legislatures, boards, trustees, councils, and directors. The stakeholders whose interests they represent are the tax-paying or fee-paying members of the public. Publicsector governing bodies are under close scrutiny from the public and the media because of the high expectations of value for public money spent. Many public institutions are perceived to be ineffective, resulting in a lack of public confidence not only in those specific institutions but in governments generally. Taxpayers are demanding improved performance of publicsector organizations while resisting any increases in taxation. They want accountability from those directing such organizations with respect to both the cost and the quality of services provided. They expect governing bodies to be well informed about the performance of public institutions in order to make correct decisions and to demonstrate their due diligence in fulfilling their responsibility to monitor managements performance. The fundamental need for comprehensive auditing is based on the growing importance of governance in the public sector.

Characteristics of effective boards

The CCAF/FCVI Inc. 1 (formerly called the Canadian Comprehensive Auditing Foundation) has developed a list of the characteristics of effective boards in its publication Comprehensive Auditing: An Introduction . If a board exemplifies these characteristics, it is considered to provide effective governance and accountability. Principles associated with effective governing bodies include the following: Being composed of people with the necessary knowledge, ability, and commitment to fulfil their responsibilities Understanding their purposes and whose interests they represent Understanding the objectives and strategies of the organization they govern Knowing and obtaining the information they require to exercise their responsibilities Once informed, being prepared to act to ensure that the organizations objectives are met and that performance is satisfactory Fulfilling their accountability obligations to those whose interests they represent by reporting on their organizations performance

Responsibility of governing bodies

Governing bodies allocate responsibility for performance to management. Management undertakes to use resources to develop systems, controls, and practices to accomplish objectives. Managers therefore have an obligation to answer for the responsibility that has been delegated to them.

Examples of governing bodies in the federal government of Canada are the members of the Canadian Wheat Board and the Ministry of Foreign Affairs, which report to Parliament through a minister. In British Columbia, there are boards of directors for a range of Crown corporations, including the Insurance Corporation of British Columbia (ICBC) and BC Hydro. Other public-sector organizations such as public universities, hospitals, and workers compensation boards have governing boards that are responsible to the provincial government. Management of government ministries and departments is made up of civil servants, but the president and deans of universities, the hospital administrators, and the management of Crown corporations are also examples of senior management in the public sector. In principle at least, the governing boards appoint senior management, which then hires the managers and other staff necessary for the organization to meet its legislated mandate.

Accountability relationships
Accountability relationships are between two parties, where one confers responsibility on the other and should receive an appropriate reporting (accounting) for the discharge of the responsibility. Each of the organizations mentioned previously should report (probably annually) to the level of government to which it is responsible. The report should include a financial summary and other reports on its achievements compared to its objectives. Among the objectives of comprehensive auditing is assessing whether there is a clear definition of the responsibilities delegated and the appropriate reporting of the outcomes of the unit in carrying out those responsibilities. Comprehensive audits (which include financial statement, compliance, and value-for-money components) focus on ensuring that the governing body has proper financial and operating information and that the organization is operating within its legislative mandate. The accountability hierarchy goes from the employees to management to the governing board to Parliament or the Legislature, and then ultimately to the voter. Each group has its role in the accountability process, being accountable to the next level up in that hierarchy. To the government auditor, the most important of these relationships are those between management and the governing board and between the governing board and Parliament. To be diligent and effective, governing bodies must be well informed about their organizations performance and must have confidence in the information that they receive about performance. Audit committees (and audit activities) can also contribute to effective governance in the public sector. Publicsector organizations such as councils, boards, and Crown corporations can benefit from the efforts of independent and effective audit committees and audit functions. Online reading 10.2-1, The Role of Auditing in Public Sector Governance, addresses the role of government auditing, both internal and external. The appendix provides a brief overview of the role of audit committees in the public sector and a short list of best practices for such committees.

The Canada Revenue Agency, for example, has considerable information available online regarding the minister, the board of management, and the structure and operational framework of the agency (not examinable).

1 CCAF/FCVI Inc. was established in the 1980s by the Auditor General for Canada to develop and expand the

practice of comprehensive auditing.

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10.3 Legislative auditing Role of the Auditor General

Learning objective

Explain the role of the Auditor General of Canada and its counterpart at other levels of government; explain the difference between the role of the Auditor General and internal auditors in the public sector. (Level 2)
Required reading

Online reading 10.3-1, Fact Sheets from the Office of the Auditor General of Canada (Level 2) Online reading 10.3-2 , OAG Legislative Auditing (Level 2)
LEVEL 2

For citizens to have confidence in how their government spends public funds, there must be clear and timely accountability for its performance. In Canada, the government reports on its performance to the House of Commons. Independent assessment of this information is provided by the Auditor General to hold the government accountable for its stewardship. A similar function is provided at other levels of government, and most provinces have a provincial Auditor General. The activities of the Auditors General are referred to as legislative auditing . As outlined in Online Reading 10.3-2, the Office of the Auditor General of Canada carries out three main types of legislative audits: Performance audits (referred to as value-for-money audits in the past) assess the extent to which the government unit has processes in place to measure effectiveness and directly assess the extent to which programs are run with due regard for economy, efficiency, effectiveness, and environmental impact. Such audits may include all the activities of a government department, agency, or Crown corporation, or they may include only a selected range of activities. There are three performance reports every year: an annual report (fall), a spring report, and a progress report on any of the changes implemented. Financial audits (also referred to as attest audits ) are annual audits of the financial statements of the Government of Canada and most Crown corporations and other federal organizations. They are similar to the audits of financial statements of businesses carried out by their external auditors. Financial audits in the public sector usually also include an opinion on whether the transactions examined conform to the laws and government regulations governing the entity being audited. This portion of the audit is compliance auditing. Special examinations of Crown corporations are a form of performance audit where the scope is set by law to include the entire corporation. Federal law requires that federal Crown corporations be subject to such audits every five years. The reports prepared at the end of each performance audit are issued to the responsible minister and then made public. Reports from financial audits are usually tabled in Parliament or the Legislature and also made available to the public. In this respect, they are more like external audits than internal audits. (Although reports on special examinations of Crown corporations are usually submitted directly to the Crown corporations board of directors, the directors are required to table them in Parliament and make them available to the public.) Because the staff of the Office of the Auditor General are government employees and not employees of the departments, agencies, or Crown corporations that they audit, they have greater independence compared with internal auditors. Consistent with its essentially external audit perspective, the Office of the Auditor General of Canada follows the auditing and assurance standards found in the CICA Handbook, not the International Standards for the

Professional Practice of Internal Auditing set by the IIA. The Office of the Auditor General of Canada and its provincial counterparts frequently contract out legislative audit engagements to public accounting firms. In addition, some provincial Crown corporations appoint external auditors to provide an opinion on their financial statements in the same way that private-sector business entities do.
Online reading 10.3-1 contains several fact sheets issued by the Office of the Auditor General of Canada to describe the mandate and work performed by that office.

The Canadian Council of Legislative Auditors (CCOLA) is composed of provincial Auditor Generals and the federal Auditor General where common matters are discussed twice annually.

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10.4 Internal auditing in the public sector

Learning objective

Explain the standards and considerations for internal auditing in the public sector in Canada and internationally. (Levels 1 and 2)
Required reading

Reading 10-2, International Audit Trends in the Public Sector (Level 1) Reading 10-3, The Guardians of Public Trust (Level 1) Reading 10-4, Expenditure Review Principles (Level 1) Online reading 10.4-1, Treasury Board of Canada Secretariats Policy on Internal Audit (Level 2)
LEVEL 1

Legislative auditing through the Office of the Auditor General is directed at providing accountability of publicsector organizations to the public, through Parliament or the Legislature. In recent years, more governments (in Canada and elsewhere) are requiring that government departments, agencies, and Crown corporations also create internal audit functions. While the larger public-sector entities are large enough to establish their own internal audit department, governments may supplement such services by creating centralized government internal audit units to provide internal audit services to government departments not large enough to justify their own internal audit department. In Canada, such centralized services usually come under the management of the Federal or Provincial Office of the Comptroller General. As for internal auditors in the private sector, the role of internal auditors in the various levels of government is to assess the risk management, controls, and governance processes of their organizations, with the aim of increasing their effectiveness and efficiency. The scope of the audit work, the methodologies used, and the reports and follow-up processes used by internal auditors in the public sector are similar to those used in the private sector. The differences are in the objectives of the public-sector organizations and the range of risks that they face. In addition, no single governance model applies to public sector organizations. Online reading 10.4-1 includes the Treasury Board of Canadas policies for internal audit for the Government of Canada. The website sets out the policy on internal audit. This policy requires that large departments and agencies establish both an audit committee and an internal audit function. Some small departments and agencies may also have established both an audit committee and an internal audit function. The Office of the Comptroller General performs audits of both large and small departments and agencies regardless of whether there is an audit committee and an internal audit function. The internal auditing standards for the Government of Canada states that the Government of Canada has adopted the IIA Standards , which must be followed unless they conflict with explicit government directives or guidelines. Reading 10-2 summarizes the results of a study of internal audit organizations and internal control systems in the federal governments of six member countries of the Organization for Economic Co-operation and Development (OECD), including Canada. In Reading 10-3, the IIA president describes the valuable contribution of internal auditors in the public sector a contribution that is not always understood by the public. Reading 10-4 provides principles for reference when reviewing government programs and activities. These are good general standards or criteria which could be used in an internal audit project plan for reviewing a specific government program or activity.

As an example, here is a federal government internal audit report (not examinable).

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10.5 Comprehensive auditing

Learning objective

Explain the characteristics and components of comprehensive auditing. (Level 2)

Required reading

Reading 10-5, Comprehensive auditing (Level 2) Reading 10-6, Assurance Recommendations PS 5400: Value-for-money auditing in the public sector (Level 2)
LEVEL 2

Comprehensive auditing
Comprehensive auditing is a type of audit that focuses on ensuring that the governing body has proper financial and operating information and that the organization is operating within its legislative mandate. Comprehensive auditing is, in some respects, a public-sector version of external and internal auditing combined. It consists of three components:

Attest audit of financial statements to determine whether financial statements are presented fairly in accordance with the Public Sector Accounting Standards or other legislated or regulated accounting frameworks. This is similar to an external audit in the private sector. Compliance audit to assess whether operations and expenditures are properly authorized and in compliance with relevant legislation and regulation Performance audit (previously called value-for-money audit) to assess the extent to which the public-sector entitys resources are managed with due regard for effectiveness, efficiency, economy, and environmental impact. This component also determines whether accountability mechanisms are in place for public sector managers to report to their governing bodies on performance. However, it is important to note that performance auditing does not pass judgment on the appropriateness of programs or on the decisions of an elected or governing body.
The last two components are similar to but not exactly the same as internal auditing, in both the private and public sectors. One important difference is that the compliance auditing portion of a comprehensive audit only includes compliance with relevant laws and regulations, and does not include compliance with internal management policies and internal controls.

Performance auditing
Performance auditing is a systematic, purposeful, organized, and objective examination of the management of government activities. It provides Parliament or the Legislature with an assessment of the performance of a public-sector entitys activities. Performance auditing also assesses whether public-sector organizations are managed with due regard for economy and efficiency, and whether procedures are in place to measure and report on the effectiveness of programs. As explained in Reading 10-5, attributes of effectiveness in the public sector include, for example, appropriateness, responsiveness, and protection of assets. The Office of the Auditor General of Canada also includes an assessment of the environmental impact in a performance audit. Performance audits can be carried out as a component of a comprehensive audit or as a separate audit engagement and can cover all the activities of a public-sector entity, one or more specific activities within a public-sector entity, or a government-wide functional area. The CICA Handbook Assurance contains assurance standards for the conduct of performance (or value-for-money) audits.

Reading 10-5 provides an overview of comprehensive auditing. Reading 10-6 was developed by the CICA as part of its Assurance Recommendations, when the term valuefor-money was used to describe such audits. The current term is performance audits.

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10.6 Roles, activities, risks, and governance in the not-forprofit sector

Learning objective

Outline the roles, activities, risks, and governance issues specific to the not-for-profit sector in Canada. (Level 2)
Required reading

Reading 10-7, Increasing Risk Awareness for Mission Critical Objectives of Not-for-Profit Organizations (Level 2) Reading 10-8, Not-for-Profit Audit Committees: Terms of Reference (Level 2)
LEVEL 2

Not-for-profit organizations (NFPs) are often audited either in the form of external or internal audits because of legal requirements and because members of an NFP generally want an independent report on the organizations finances and activities. In addition, those making donations or grants may want assurances that their funds are being spent wisely. This topic outlines the roles, activities, risks, and governance issues specific to the not-for-profit sector.

Characteristics of NFPs
NFPs are defined in the Preface to the CICA Handbook Accounting , as entities, normally without transferable ownership interests, organized and operated exclusively for social, educational, professional, religious, health, charitable or any other not-for-profit purpose. A not-for-profit organizations members, contributors and other resource providers do not, in such capacity, receive any financial return directly from the organization. NFPs normally provide a positive benefit to members (golf clubs, cooperative apartments, or accounting organizations such as CGA-Canada), society (Cancer Society, Red Cross), or a mix of both (most religious groups). Their funding may come from membership fees, government grants, corporate and private donations, and/or gaming revenue.

Risks faced by NFPs

Following are some of the risks faced by the boards and managements of NFPs: Inadequate accounting records. The problem for smaller NFPs is similar to that of small businesses: a lack of staff, training in accounting, and formal documented procedures may result in the books and records of the NFP being inadequate to provide the information necessary either to manage the entity or to enable financial statements to be prepared and/or audited. Volunteer workers. Many NFPs rely on unpaid and unqualified volunteers to perform a range of functions from serving on boards of directors to acting as treasurer and keeping the accounting records. This may make it difficult for the NFP to be effective or efficient in its operations. Multiple stakeholders. The interests of those providing donations or grants do not necessarily coincide with those of the NFPs management or its board of directors. Board members may serve for personal interests rather than those of the NFP. Compliance with regulations. Untrained volunteers are less likely to have the knowledge and skills to ensure that the NFP complies with laws and regulations that apply to NFPs (such as issuing tax deductible donation receipts) or to ensure that the organization complies with restrictions stipulated by those providing donations or grants.

Control over cash donations. The major external audit issue for many NFPs is the lack of evidence that all cash donations have been received by the organization and entered into its records. This is a particular concern for organizations that receive many small donations for which they do not issue receipts. Examples include the Salvation Army Christmas kettles, Veterans poppy days, Scout apple days, and the 50/50 draws held by many minor sports teams at their games.

Governance issues for NFPs

There are a number of governance issues specific to NFPs: Although NFPs generally try to operate in a businesslike way, performance evaluation is more difficult because there is usually no single objective, making a profit is not usually a principal objective, and performance evaluation may be relatively subjective. The task of the board is to achieve the organizations objectives. It should seek to do so by the most effective, efficient, and economical means available. Boards (by whatever name they are known) are accountable to members, donors, and other stakeholders for the organizations performance. In theory, the directors should set the objectives, establish the values of the organization, assign accountability to board members and staff (if any), and monitor performance. Other issues include an inability to distinguish between board and staff responsibilities, time spent on trivial matters, short-term biases, reactive positions, and unclear lines of responsibility. Reading 10-7 discusses governance and risk management in not-for-profit organizations. Reading 10-8 describes the creation and functions of the audit committee in not-for-profit organizations.

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10.7 Internal audit considerations for NFPs

Learning objective

Develop the specific considerations that apply in the internal audit of not-for-profit organizations, including performance audits of NFPs. (Level 1)
Required reading

Reading 10-9, New rules for charities fundraising expenses and program spending questions for directors to ask (Level 1)
LEVEL 1

The internal audit process for an NFP is the same as for any other audit. However, there are considerations at different stages of the internal audit that are particular to NFPs.

Establishing an internal audit function

There are various circumstances where NFPs decide to have internal audit activities, performed by full-time staff, part-time staff, co-sourced internal audit resources (shared among several NFPs), or outsourced resources (on a continuing or ad hoc basis). Public accounting firm Grant Thornton has identified a number of factors that should be considered in determining whether an internal audit function should be established: Previously identified material weaknesses or significant deficiencies in internal control Instances of fraud, embezzlement, or theft Decentralized accounting functions Extensive federal, provincial, or local contracts Significant audit findings by government oversight agencies Lack of segregation of duties Inexperienced personnel in critical areas Desire by the board, audit committee, and/or management to strengthen internal controls 1

Accepting an outsourced internal audit engagement

Because of the relatively small size of NFPs and frequent reluctance of their board members to divert resources that could be used more directly to achieve the organizations objectives rather than on internal audits, it is more common in NFPs than in the business sector to outsource internal audit services to resources such as CGAs in public practice. Before accepting or continuing an internal audit engagement of an NFP, the same items need to be considered as for a business enterprise. These considerations include having the technical competence and, where appropriate, the independence necessary to perform the engagement. Bob Harvey explains this further in Auditing Not-for-Profit Organizations: Both auditing standards and professional ethics require that CGAs accept only those engagements that they are qualified to perform. This applies not only to the firm, but also to the audit seniors and support staff assigned to the engagement. Although this doesnt appear to be a serious problem for well trained and experienced auditors, every audit must be considered in light of this requirement. It applies to both new and continuing engagements and takes into consideration the auditors knowledge of the industry or the operating environment in which the NFP operates. When offered a new engagement, auditors should consider whether their firm has time available to assure a high level of client service and be able to meet client deadlines 2

Rules of professional conduct preclude the public accountant and any other partners in their firm or family members from being on the board of directors of the NFP for which they are conducting an assurance engagement. This includes not only annual audits of financial statements but also internal audits intended to provide assurance, in contrast to those intended solely as consulting engagements. These rules ensure that the public accountant providing assurance services does not exert management influence over the NFP. They do not preclude the auditor or other partner from being a member of an NFP they are auditing; however, the auditor would want to ensure that they do not vote at the annual general meeting.

Gaining an understanding of the NFPs activities

Gaining an understanding of the activities to be audited is the first step in the planning stage of an internal audit, whether in the business sector or for an NFP client (or, for that matter, when the internal audit department of an NFP begins an engagement). The knowledge to be acquired and means of obtaining such an understanding is the same for an NFP as for any organization, with the following particular considerations: Organizational goals and activities Nature of the NFPs affiliation with a larger organization, if applicable Major sources of funding (grants, donations, gaming funds, and so on) Applicable legislation and regulations (such as whether the NFP is a registered charity) Risks facing the organization (such as possible funding cuts) Program performance measurement indicators and evaluation methods Contractual or statutory restrictions on funds Integrity of the board and management To obtain such an understanding, the auditor can use several sources, such as previous audit reports, mission statements, publicity brochures, budgets, and agreements with donors and other providers of funding.

Expanded scope internal audits of NFPs (performance audits)

An internal audit of an NFP generally involves an audit of financial controls. This part of the internal audit is similar to an audit of financial controls in a commercial organization, but it is defined in relation to the particular circumstances of NFP organizations previously outlined. What is of most interest to an internal auditor is that reported financial information in an NFP organization contains no information about organizational performance. Measuring and auditing organizational performance requires matching expenditures in financial terms with performance measured in non-financial terms in short, to match value in nonfinancial terms with money. Although performance audits are commonly performed in the public sector as part of comprehensive auditing, they can also be performed in the NFP sector, where they are more commonly referred to as program evaluation, program management, or operational audits . A broad-scope internal audit of an NFP organization would include the audit of financial controls, but would also incorporate the elements of a performance audit designed to examine and report on the following: The and The The adequacy of management systems, controls, and practice, including those intended to control safeguard assets, to ensure due regard to economy, efficiency, and effectiveness extent to which resources have been managed with due regard to economy and efficiency extent to which programs, operations, or activities of an entity have been effective

Performance audits can be applied to any entity or portion of an entity, such as a program or management control system. The terms of the auditors mandate specify the audit and reporting requirement. Many performance audit mandates require the auditor to report on any deficiencies observed; others require the auditor to express an opinion with reasonable assurance that there are no significant deficiencies in the systems and practices examined. The auditor may also attest to written assertions prepared by management with respect to economy, efficiency, and/or effectiveness of their performance.

Planning the performance component of an internal audit

Planning includes consideration of the audit mandate, audit objectives and scope, criteria, audit evidence, and

the audit plan. For the purposes of this topic, the clients may be members of an NFP or an elected or appointed governing body that delegates authority and responsibility to management to acquire and uses the NFPs resources. Management may consist of various combinations of elected and appointed officials who are responsible for the administration of the resources and are accountable to the members of the governing body. The auditor is an independent party who examines elements of managements performance and reports the results of the audit to the client.
Distinctive features of performance audits

Although in both financial statement audits and performance audits the auditor examines and reports information related to an accountability relationship between client and management, there are some important differences between the two types of audit. Performance audits have the following distinctive features: Audit mandates may provide the auditor with discretion in establishing the audit objectives and scope. Audit objectives and scope vary from one audit to another. Performance audits address a variety of matters that are not necessarily of a financial nature (for example, human resource management). There is no body of generally accepted criteria for performance audits analogous to GAAP for financial statement audits. The nature and sources of evidence may differ from those in financial statement audits. Multidisciplinary audit team members may be used to a greater extent than in financial statement audits. Audits may not relate to a standard time period, unlike financial statement audits, which generally relate to fiscal years of the entities audited. There is no generally accepted standard short-form report; auditors may use direct reporting, either by reporting deficiencies or providing an overall opinion, or they may attest to management assertions.
Audit mandate and reporting requirements

Audit mandates specify what is required of auditors and provide auditors with the authority to carry out their work and report. The amount of discretion an auditor has in establishing the objectives and scope of a performance audit varies. Some performance audit mandates embodied in the organizations by-laws, policies, or procedures provide only general direction about objectives and scope. In such cases, the auditor decides on audit objectives and scope for a particular performance audit. In contractual mandates, audit objectives and scope are usually specified by the client. In these cases, the auditor assesses the appropriateness of the audit objectives and scope before accepting the engagement. Performance audit mandates also have different reporting requirements. Many mandates require direct reporting about the entity. For example, auditors may report deficiencies or provide an opinion on whether there is reasonable assurance, based on specified criteria, or that there are no significant deficiencies in the system and practices examined. Auditors may be asked to attest to management assertions. When the mandate does not specify the reporting requirements, auditors may choose how the results of the audit will be reported, often in consultation with their clients. The reporting requirements affect the nature and extent of work that must be performed in the audit.
Audit plan

The results of audit planning are reflected in an audit plan. The audit plan documents the following key planning information and decisions: Auditors understanding of the entity Audit objectives Scope of the audit (that is, the entity or portion thereof and the matters and time period subject to audit) Planned criteria Probable nature, sources, and availability of evidence Resources required

Work schedule Reporting requirements and timing of the report As additional information becomes available during the audit, the audit plan may need to be modified. Including the preceding information in the audit plan provides evidence of compliance with performance (VFM) auditing standards on planning. The examination and reporting phases of a performance audit have been described previously for public-sector organizations. The same general considerations apply to a performance audit conducted as a component of a broad-scope internal audit of a private NFP. Reading 10-9 outlines important considerations for boards and internal auditors to consider when reviewing operations and expenses of not-for-profits. Most not-for-profit organizations in Canada are registered as charities, and compliance with CRA rules and regulations is important to retain the benefits of not-for-profit status.

1 Forward

Thinking, Grant Thornton, 2006.

2 Bob Harvey, Auditing Not-for-Profit Organizations (Vancouver: CGA-Canada, 1997), pages 1-2.

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Module 10 summary
Internal auditing in the public sector and not-for-profit sectors
Up to this point, you have learned about internal auditing and the role of internal auditors in private-sector business organizations, the principles of good management, and ways to help managers apply those principles. This final module covers the unique features of governance and auditing in the public sector, including attest, compliance, performance, and comprehensive auditing, with the emphasis on internal audit. You also consider internal audit considerations and governance issues in the not-for-profit sector.

Identify the roles, activities, and risks specific to the public sector in Canada.
The following are characteristics of the public sector: Complexity of government services because of their diversity, multiple stakeholders, everchanging environment, and difficulty measuring performance and accountability Requirement to be accountable for combining optimal service and delivery within confines of shrinking public resources Accountability: a relationship based on the obligation to demonstrate and take responsibility for performance in light of agreed-upon expectations, or not be voted back in Requirement for complete and accurate financial reporting, compliance with authorities and environmental stewardship, and value for money Growing demand for management accountability and value for tax dollars in the recent economic environment Comprehensive auditing which provides accountability information Risks facing the public sector are as follows: Diversity, consistency, and clarity of objectives and goals Complexity of operations Complexity and quality of management information and control systems and external reporting Nature and degree of change in the environment or within the entity Program delivery method Nature of transactions

Outline public sector governance; explain how public sector auditors and audit committees can contribute to the effectiveness of governance.
Governance in the public sector refers to the responsibilities and actions of the most senior authority levels in the public sector. These governing bodies are under close scrutiny by the public and the media due to increasing expectations of value for public money spent. Governing bodies are expected to be well informed about performance of public institutions in order to perform effectively, leading to the need for comprehensive auditing. See Topic 3.7 to review governance issues in the private sector.

Accountability relationships are between two parties: one confers a responsibility on the other and should receive an appropriate accounting for the discharge of the responsibility. Governing bodies must be well informed about their organizations performance and must have confidence in performance reports. Comprehensive auditing includes assessing whether there is a clear definition of the principal parties in such a relationship and how the accountability is discharged.

Explain the role of the Auditor General of Canada and its counterpart at other levels of government; explain the difference between the role of the Auditor General and internal auditors in the public sector.
Confidence in the government depends on clear and timely accountability by the government for its performance. The government reports on its performance to the House of Commons. Independent assessment of this information is provided by the Auditor General to hold the government to account for its stewardship. A similar function is provided at other levels of government. The role of the Auditor General differs from that of internal auditors in the following ways: Included in the work of the Auditor General is the provision of assurance with respect to public sector financial statements. The reports of the Auditor General are issued to the Parliament or Legislature and to the public, not just to the public-sector institutions management. The Office of the Auditor General has greater independence than internal auditors. Audits conducted by the Office of the Auditor General comply with the assurance standards set out in the CICA Handbook; audits conducted by government internal auditors generally comply with the IIA International Standards for the Professional Practice of Internal Auditing.

Explain the standards and considerations for internal auditing in the public sector in Canada and internationally.
Federal and provincial governments frequently require that larger government departments, agencies, and other public entities establish internal audit departments. Departments such as the Office of the Comptroller General may provide internal audit services to smaller government units. Such internal audit departments serve much the same purposes as internal audit departments in other sectors of the economy. The differences are in the objectives of the organizations and the risks that they face. Whereas the Office of the Auditor General of Canada follows the assurance standards of the CICA Handbook, public sector internal auditors generally follow the IIA Standards .

Explain the characteristics and components of comprehensive auditing.

Comprehensive auditing focuses on public-sector management accountability.

It includes a review of the accountability relationship between public-sector management and the appropriate governing body. It helps to add credibility to members of governing bodies and the performance results they report. Comprehensive auditing provides an objective assessment of three related, but individual, distinguishable components of public-sector accountability: Attest audits of financial statements (whether financial statements are presented fairly) Compliance audits (whether operations and expenditures are properly authorized and in compliance with relevant legislation) Performance audits (assessment of the extent all resources are managed with due regard for economy, efficiency, effectiveness, and environmental impact and whether procedures are in place to measure and report on effectiveness of programs) Performance audit policies are grouped as follows: General policies Auditing conduct policies Audit examination policies Audit reporting policies Audit follow-up policies Measurement of effectiveness is the most challenging aspect: government programs have many objectives and there isnt always reliable information for such measurement.

Outline the roles, activities, risks, and governance issues specific to the not-for-profit sector in Canada.
The following are characteristics of NFPs: Organizational goals: NFPs provide a service for no financial gain. Restriction on distribution of profits: members or donors are not allowed to receive financial return. Use of volunteers: heavy use of volunteers has implications for need for controls. Performance measurement: users of NFP statements are interested in cost of services, how costs are funded, and ability of NFP to meet its goals. Funding sources: NFPs usually receive income from donations, contributions, grants, fees, investment income, or in kind; there may be restrictions on how such funds are used. Reporting requirements/accounting methods: NFPs have unique accounting and financial statement requirements; they use fund accounting. Tax status: an NFP is exempt from paying tax and, if a registered charity, can give donation receipts for tax purposes; there is an obligation in return to expend 80% of the donations they receive. NFPs operate in a business-like way, but there is no bottom-line to evaluate performance.

The board of directors job is to get results and achieve the organizations objectives. They have total accountability for the organizations activities and total authority to exercise all the powers of the organization. In theory, directors make policy as follows: Setting objectives Establishing the values of the organization Assigning accountability for achieving the objectives in accordance with the values Delegating authority The reality, or what goes wrong: Time spent on the trivial Short-term bias Reactive stance Reviewing, rehashing, redoing Leaky accountability Evolution of NFPs: All-volunteer organization Volunteer/staff organization All-staff organization Governance approaches that work for all-volunteer organizations do not necessarily work well for volunteer/staff and all-staff organizations.

Develop the specific considerations that apply in the internal audit of notfor-profit organizations, including performance audits of NFPs.
The following are considerations that are particular to NFPs: Accepting the audit: Ensure technical competence in the area of NFP environment. Professional conduct rules preclude providers of assurance services, partner, or family member from sitting on the board of directors. Recognize the requirements of users of financial and other performance statements. Understanding the organizations activities: Nature of NFPs affiliation with a larger organization Major sources of funding The tax status and whether it is a registered charity Program performance measurement indicators and evaluation methods Contractual or statutory restrictions on funds Unfavourable characteristics: risk taking, aversion to controls Areas to consider and sources of information to obtain this knowledge Performance audits can be applied to the NFP sector. In this case, they are usually called program evaluation, program management or operational audits. Their main goal is to examine and report on the following: The adequacy of management systems, controls, and practices of the NFP entity The extent to which resources have been managed with due regard to economy and efficiency The extent to which programs, operations, or activities of the entity have been effective

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Module 10: Self-test

1. Multiple choice a. What does section PS 5400 of the CICA Handbook not require the auditor to do? 1. Follow a standard reporting format. 2. Describe the objectives and scope of the audit. 3. Comply with specified general and performance standards. 4. Identify criteria used. b. Contributions to an NFP organization have been constant for the past three years. The audit committee has become concerned that the president may have embarked on a scheme in which some of the contributions from many sustaining members have been redirected to other organizations. The audit committee suspects that the scheme may involve taking major contributions and depositing them in alternative accounts or soliciting contributions to be made in the name of another organization. Which of the following audit procedures would be most effective in detecting the existence of such a fraud? 1. Use generalized audit software to take a sample of pledged receipts not yet collected and confirm the amounts due with the donors. 2. Take a sample that includes all large donors for the past three years and a statistical sample of others. Next, request a confirmation of total contributions made to the organization or to affiliated organizations. 3. Take a discovery sample of cash receipts and confirm the amounts of the receipts with the donors. Investigate any differences. 4. Use analytical review procedures to compare contributions generated with those of other comparable institutions over the same period of time. If the amount is significantly less, take a detailed sample of cash receipts and trace to the bank statements. Solution 2. CASE STUDY T10-1: Educator overkill At the weekly internal auditing lecture, the instructor appears deeply distraught by the aerobatics of a pesky fly that has entered the classroom and she proclaims her determination to eliminate this unwanted distraction. Taking a sledgehammer from her audit bag, the impatient lecturer ends the flys meager existence with one swift blow from the sledgehammer. Decorum having been restored, the lecture is then resumed.
Required

In a performance (or value-for-money) audit, some of the key audit criteria are effectiveness, efficiency, and economy. Audit (evaluate) the effectiveness, efficiency, and economy of the lecturers actions. Solution 3. CASE STUDY T10-2: Municipality of Corniche

You are the internal auditor in the municipality of Corniche. A number of citizens have expressed their dissatisfaction with the roads maintenance department to the mayor. Municipal council has also expressed the view that the programs of the department do not seem to be working well,

especially considering the large budget of this area relative to other municipalities. The mayor has heard about performance audits and has asked you for a brief report, which she will use at an upcoming meeting with council.
Required

Prepare a short report for the mayor, using separate headings for each of the following issues: a. What does performance auditing mean for a department such as roads maintenance? b. What would the expected benefits be? c. What are the important planning and reporting issues (audit approach)? d. What areas would not be included in a performance audit? Solution 4. CASE STUDY T10-3: Renaissance politics

As a concerned citizen, you have recently become more politically active in your community and have established a reputation for plain speaking on issues of taxpayer rights and the need for municipal government to demonstrate greater accountability. As well, your organizational skills seem to have become well recognized over the last round of municipal elections as you managed the details of finances, door-to-door campaigning, speech writing, and purchasing of coffee and donuts at critical moments in the successful campaign of a municipal trustee. While you feel a sense of achievement relating to the recent political victory, you only wish you could find more hours in the day to keep up with the pressures of a hectic public accounting practice and a growing family. Bogged down as usual in traffic on the way to the office, you are mentally reviewing your meeting schedule for the day, and listening to the morning news and traffic report on the car radio. It comes as a surprise to you when, among other news stories, the announcer indicates that due to poor health, the long-sitting Member of Parliament for your riding a member of the Wait-and-See Party and cabinet minister in the Morriseau government has suddenly announced that she will be retiring for reasons of declining health to spend more time with her family. Since the Wait-and-See Party currently holds a narrow majority in the House of Commons, it is expected that the upcoming by election will be hotly contested. Finally, having arrived at the office, you grab a coffee, fire up your e-mail, peel the new urgent yellow stickies off your computer screen, and tap in the password for your flashing voice-mail. A pattern soon emerges. You have an urgent message from your friend Maurice, who is also the president of the local Renaissance Party, of which you are a member. According to Maurices excited voice message, an emergency party strategy meeting is to be held tonight at the River Oaks Inn, anticipating a by-election call by the Prime Minister. According to the voice-mail, it seems that you are the hands-down favourite to manage the campaign, if only you choose to accept the challenge. Maurice goes on to say: Adrian, I know I can count on you. We need capable professionals like you to support us. I know folks are going to want to begin framing platform issues regarding fair taxation, accountability of government, and some of the recent findings of the Auditor General. Because you are a CGA, I know you really understand this governance stuff, and I want you to do a presentation to the group tonight on what we have to know when we are successful in taking over this riding and shifting the balance of power in Ottawa. I want you to know I see a great future for you, Adrian. The neighbours are really going to get annoyed if you don't get the grass cut soon you reflect, and then begin to outline in your mind what needs to be said at tonights meeting.
Required

Prepare the required presentation. Be sure to discuss the complexity of government services, the nature of comprehensive auditing, and some of the characteristics of effective boards. Solution 5. CASE STUDY T10-4: Performance audit of the NRCC

You have been granted permission to proceed with an annual recruitment of summer interns from leading Canadian universities to join the Auditor Generals Office upon graduation. You have decided that the aptitude of the current flock of accounting and business majors in technology, coupled with their university research skills, are probably an excellent fit with plans to design and conduct a long overdue performance audit of the National Research Council Canada (NRCC) this fall. As part of this on-campus recruitment activity, you will be required to meet with students at several major centres across Canada and make presentations to them on prospects for a career with the Auditor General. Certainly, the role and responsibilities of the Auditor General will need to be explained. Experience with recent graduates has taught you that, while most seem quite knowledgeable about external auditing in the private sector, public-sector auditing is less well understood. Comprehensive auditing in comparison to auditing in the private sector should then likely be discussed. As well, students are often confused about the variety of terms used: internal auditing, comprehensive auditing, performance auditing, VFM auditing, compliance auditing, and the attest function. Some explanation, therefore, about the unique nature of the work the Auditor General performs would seem to be useful. As well, since you will manage the upcoming performance audit of the NRCC, to which several of the new graduates will be assigned, you see an opportunity to engage students in a discussion about this exciting first engagement and hope to discuss planning, the examination, reporting, and follow-up considerations for this audit.
Required

Prepare the required presentation for the prospective candidates. Solution

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Self-test 10 Solution 1
a. 1. Correct. Each content. 2. Incorrect. This 3. Incorrect. This 4. Incorrect. This b. 1. Incorrect. Listing sampling amounts as unpaid does not provide evidence about contributions previously paid or shifted to another organization. 2. Correct. The audit objective is to determine whether contributions have been wrongly directed to alternative accounts or solicited for other organizations. Consequently, an appropriate procedure is to send confirmation requests to donors. 3. Incorrect. Sampling cash receipts that have been recorded by the organization provides no evidence about unrecorded receipts or contributions diverted elsewhere. 4. Incorrect. Analytical procedures are of limited use. Also, the follow-up audit procedures only provide evidence that recorded receipts were also deposited. audit will have unique findings and reports will vary in style and is required by section PS 5400. is required by section PS 5400. is required by section PS 5400.

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Self-test 10 Solution 2
CASE STUDY T10-1: Educator overkill

The lecturer has been effective, but not efficient or economical. Effectiveness is the extent that programs achieve their intended results. Since the lecturers declared goal was to eliminate the unwanted distraction caused by the fly, you observe that this goal was clearly achieved. You may conclude that the lecturer was effective. Efficiency entails achieving the optimal output from the use of goods, people, and money. It can be seen to be similar to a ratio of inputs to outputs. Through analysis, a reasonable standard of input to achieve the outcome of eliminating a fly might be determined to be the deft application of a light instrument such as a fly swatter. Comparing the aggressive swinging of a sledgehammer to this standard, you would conclude that there was an opportunity for the lecturer to have been more efficient. You could say that this example illustrates overkill in its truest sense. Economy entails obtaining the required quantity and quality of goods and services on a timely basis at the lowest long-term cost. You must ask, What is a reasonable standard of cost to incur to eliminate a fly? A fly swatter might cost $1. Similarly, todays newspaper might cost $1. Yesterdays newspaper, however, or the college/university tabloid may have been readily available to the instructor at no cost. Comparing the cost of the sledgehammer, say $20 (as determined by inspection of the local hardware store flyers door crasher special), would lead you to conclude the lecturer had not been economical in dispatching the fly. Furthermore, there may have been unintended ancillary costs relating to the use of the sledgehammer such as the cost of repairing damage to the overhead projector, the table, and so on.

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Self-test 10 Solution 3
CASE STUDY T10-2: Municipality of Corniche

Performance Audit of the Roads Maintenance Department August 20X1

Performance auditing

Performance auditing assesses whether, in this case, the roads maintenance department is managed with due regard for economy, efficiency and environment, and whether procedures are in place to measure and report on the effectiveness of the road maintenance programs. Due to the concerns expressed by citizens and council, the focus would be on auditing the effectiveness of the department. Value-for-Money Auditing, in section PS 5400 of the CICA Handbook explains effectiveness as the achievement of the objectives or other intended effects of programs, operations, or activities. The audit would consider nonfinancial, as well as financial, activities such as the quality of work completed, responsiveness to taxpayer concerns, prioritization of projects, and staffing levels. It would result in a report to the mayor and council, including recommendations as to how the operations of the department may be improved.
Expected benefits

Effectiveness is an increasing area of concern in most of the public sector. Taxpayers, council, and the mayor need to know whether the department is managing its road maintenance programs with economy, efficiency, effectiveness, and regard for the environment. Specific benefits should include the following: Assistance to council and the mayor in assessing the extent to which financial, human, and physical resources are managed in this department in connection with economy, efficiency, and effectiveness Recommendations to increase economy, efficiency, and effectiveness of operations while considering the environmental impact An evaluation of the accountability relationships in the department, and recommendations to improve accountability in the use of resources An increase in the council and mayors understanding of the activities of the roads maintenance department An identification of areas or programs where budget cuts can be made, and other areas where additional resources are needed to improve performance An evaluation of whether services of the roads maintenance department are appropriate to the needs of the municipality and whether they are delivered in the most effective manner An opportunity for department managers to demonstrate their accountability, the quality of their management, and their program performance
Audit approach

Note: Your answers may vary in this area because a number of alternative approaches may be taken by the auditors. Specific audit procedures are not required. You should prepare an organized plan that contains some of the following key points.

Extensive planning would be required involving careful review with the council and the mayor to determine the exact purpose of the audit and the extent of the scope. Auditors and managers must work together to agree on the audit assurance required. Some preliminary research on performance audit techniques may be required. An audit team would then be determined. In addition to the internal auditors, the team would probably include specialists in the programs carried out by the roads maintenance department, such as civil engineers. These individuals could come from within the municipality, from other municipalities, or from outside consulting firms. An important part of the approach involves developing and defining criteria to be used for carrying out the audit and evaluating the programs of the roads maintenance department. These criteria would need to be accepted by both the auditors and management. The CCAF-FCVI Inc. has developed 12 attributes of effectiveness that should be reviewed as potential criteria for the audit. An audit report would be issued at the completion of the audit to the council and the mayor. The report would summarize the auditors findings and include recommendations for improvement. One of the current models for reporting and auditing effectiveness information recommends that management of public-sector organizations make representations on effectiveness, and that auditors give opinions on their fairness. This approach has already been successful in other public-sector organizations and may be appropriate here. Management of the department would provide information to the council and mayor to show accountability and to help them judge effectiveness. The auditors would then give an opinion on the reasonableness of the managers representations.
Areas not included

To avoid misunderstanding, it should be pointed out that a performance audit is not a financial audit. The financial statements, which report financial performance, will not be audited. Also, the purpose of a performance audit is not to measure the effectiveness of the departments programs themselves. Its purpose is to evaluate the accountability mechanisms and the reporting procedures. The audit would report where satisfactory procedures have not been put in place to measure and report on the effectiveness of programs. Management, not auditors, is responsible for measuring and reporting on its performance.

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Self-test 10 Solution 4
CASE STUDY T10-3: Renaissance politics

The following content may be covered: Government services are complex. This is a reflection of the extraordinary diversity in services offered by Canadas three levels of government, the multiple stakeholders and interests in such services, the everchanging environment in which such services must be delivered, and the difficulty in measuring performance and accountability. Every size and level of government is confronted with its constituents simultaneous expectations of fiscal economy and improved delivery of public services. Those responsible to govern public services must ensure the selection of the optimal services and delivery mechanisms within the confines of shrinking public resources, and are held accountable to demonstrate that chosen services and delivery mechanisms are providing the best (most effective and efficient) means of achieving policy and fiscal goals. Accountability is a relationship based on the obligation to demonstrate and take responsibility for performance in light of agreed-upon expectations. Governments that do not live up to the prevailing set of high public expectations often do not enjoy more than a single term in office. Parliament, provincial legislatures, municipal councils, governments, and a host of public service organizations are the guardians of public funds entrusted to them for delivering programs and services to benefit Canadians. An important part of the confidence that people have in our democratic institutions is their belief that public funds are spent wisely and effectively. There must be, and there must be seen to be, value for money spent, compliance with authority, and environmental stewardship. In a significant way then, confidence in our national government depends on clear and timely accountability by the government for its performance. Downturns in the economy, increases in the national deficit, and overall financial constraints in the final decades of the last millennium have contributed to the growing demand for accountability and better value for tax moneys expended by government at all levels. It is no longer acceptable for governments to incur large deficits and increase taxes to cover them. Elected officials and appointed governors of federal, provincial, and municipal government, public-sector organizations in health care, education, and social services, as well as government-owned or governmentcontrolled corporations realized the need for better information on the performance of public-sector fiscal and program management, and sought to have their auditors provide this accountability information. Comprehensive auditing has gained favour as a means of meeting these unique public sector challenges. Comprehensive auditing is concerned with accountability relationships between public-sector management and governing bodies. In Canada, the federal Auditor General, a Provincial Auditor, or the equivalent central audit function at each level of government usually performs comprehensive auditing. Canadians are clearly telling their elected representatives that they want the best possible value from the use of public funds they send to their federal government in Ottawa. Members of Parliament, in turn, look to the Auditor General to help them find out whether that value is being obtained by the government. CCCAF/FCVI Inc. has developed a list of the characteristics of effective boards. Parliament would be considered to provide effective governance and accountability if Members of Parliament exemplify the following characteristics: They have the necessary knowledge, ability and commitment to fulfil their responsibilities. They understand their purposes and whose interests they represent.

They understand the objectives and strategies of the organization they govern. They know and obtain the information they require to exercise their responsibilities. Once informed, they are prepared to act to ensure that the governments objectives are met and that performance is satisfactory. They fulfil their accountability obligations to those whose interests they represent by reporting on the governments performance. The Auditor General plays an important role in the functioning of the Canadian parliamentary system and influences the attitude of the government and public servants toward effective management of and accounting for public funds. The Auditor General helps Parliament perform its role within the framework of our parliamentary system of government. In terms of considering our election platform, we should examine the findings of the Auditor General to critically evaluate the opportunities for the Renaissance Party to achieve improvements in the effectiveness of Parliaments governance.

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Self-test 10 Solution 5
CASE STUDY T10-4: Performance audit of the NRCC

A possible solution to this question might resemble the following: Overview of presentation To acquaint you with the exciting career opportunities that await you at the Office of the Auditor General of Canada, I have prepared a presentation that includes a discussion of the following issues: The role of the Auditor General Public sector audits Advantages and limitations of comprehensive auditing The performance audit of National Research Council Canada Conclusion: The auditor as an agent of constructive change Role of the Auditor General Canadians are telling their elected representatives that they want the best possible value from the use of public funds they send to their federal government in Ottawa. Members of Parliament, in turn, look to the Auditor General to help them find out whether that value is being obtained by the government. Parliament, the government, and the public service are the guardians of public funds entrusted to them for delivering programs and services to benefit Canadians. An important part of the confidence that people have in our democratic institutions is their belief that public funds are spent wisely and effectively. There must be, and there must be seen to be, value for money spent, compliance with authority, and environmental stewardship. In a significant way then, confidence in our national government depends on clear and timely accountability by the government for its performance. The Auditor General plays an important role in the functioning of the Canadian parliamentary system and influences the attitude of the government and public servants toward effective management of and accounting for public funds. The Auditor General helps Parliament perform its role within the framework of our parliamentary system of government. Public sector audits Comprehensive audits are a public-sector version of external and internal auditing combined, and are concerned with accountability relationships between public-sector management and governing bodies. In Canada, the federal Auditor General, and provincial auditors reporting to their respective legislatures, perform comprehensive audits. Comprehensive audits have a number of components and always include an evaluation of accountability. A comprehensive audit provides an objective assessment of public-sector accountability. It typically includes three main components: a financial statement attest audit, a compliance audit, and a performance audit.

Attest auditing determines whether financial statements are presented fairly in accordance with the Public Sector Accounting Standards or other legislated or regulated accounting frameworks. This is similar to an external audit in the private sector. Compliance auditing assesses whether operations and expenditures are properly authorized and in compliance with relevant legislation and regulation. Performance auditing (previously called value-for-money or VFM auditing) assesses whether public-sector organizations are managed with due regard for economy, efficiency, and environment, and whether proper procedures have been established to measure and report on the effectiveness of programs. It is often viewed as the most important component of comprehensive auditing because it focuses on performance, now generally understood

to mean the following: Economy: obtaining the required quantity and quality of goods and services on a timely basis at the lowest long-term cost Efficiency: achieving the optimal output from the use of goods, people, and money Effectiveness: the extent to which programs achieve their intended results Environmental impact: determine which environmental effects may result from the programs and related projects, activities, and operations Internal audits are performed in both the public and private sectors, whereas a comprehensive audit is a style of audit normally used in the public sector only. Reporting to senior management, internal auditors are auditors whose goal is to assist management and the board of directors. Internal audits evaluate the completeness and effectiveness of management processes to identify opportunities to improve organizational achievement in future. Three alternative approaches may be taken to the performance component of comprehensive auditing: Reporting on management systems and practices In this approach, the focus of the comprehensive audit is on the quality of management systems and practices. These are examined with a view to using them as an indicator of the extent to which the organization pays due regard to economy, efficiency, and effectiveness (resembles internal audit methodology). Attestation to management reports on performance Using this approach, the auditor concentrates on delivering an opinion on the completeness and integrity of managements reporting to the organizations governing body or stakeholders on the performance (effectiveness) of the organization. The reporting framework or principles would guide managements reporting and the audit. Audit reporting on performance In the third approach, the audit function itself provides a performance report where management has not provided one to the governing body. A reporting framework or principles would guide the auditor in developing the performance (effectiveness) report for the organization. Advantages and limitations of comprehensive auditing Public-sector managers, elected officials, governing bodies, and the general public can all benefit from a comprehensive audit. Comprehensive auditing offers a number of important advantages. For example, this style of auditing does the following: Objectively assesses how well the organization is currently pursuing economy, efficiency, and effectiveness Identifies major deficiencies in management control practices and systems Recommends how to get more value for money Provides information and makes recommendations for better internal and public accountability Adds credibility to the assertions of public-sector administrators about the quality of their stewardship and management

Promotes confidence in public-sector institutions Helps members of governing bodies discharge responsibilities to stakeholders by confirming the degree to which they have demonstrated diligence and effective governance To maintain perspective, you should also be aware of the following potential limitations of comprehensive auditing: Comprehensive auditing does not pass judgment on the appropriateness of programs or on the decisions of an elected or governing body. Comprehensive auditing cannot identify every strength and weakness in an organization, though it should detect the major ones. A comprehensive audit does not automatically improve administration. Improvement can occur only if management takes concrete action on the findings and recommendations. The audit report does not always result in savings to the organization, although it normally identifies improvements in managerial processes that could lead to savings, or improvements in efficiency of greater value than the cost of the audit. Comprehensive auditing is often mistaken for consulting services in the value-for-money area. When these services are provided under the audit label, they can mislead the reader and create unjustified expectations. Engagements that are not designed to serve an accountability relationship or that do not meet the standards for independence, objectivity, and competence should not be referred to as audits. The performance audit of NRCC The NRCC, as you are likely aware, has developed a global presence with acknowledged scientific expertise and perspective. In terms of audit scope and methodology, each of the Auditor Generals performance audits is tailored to the nature of the organization and focuses on different aspects of value for money. The breadth and depth of knowledge that we will need to obtain in preparation for the audit is, to me, always impressive; for example, we will need to quantify what NRCC does in terms of dollars, staff counts, operating locations, and the identification of its objectives, as well as its uniqueness. A significant dilemma for the design of this performance audit of NRCC is that the results of research are difficult to demonstrate and may take many years to appear. Reporting on specific development results of NRCCs program will be difficult because of the uncertain nature of the research process. In some projects, years of unsuccessful trials still lead to a successful result eventually. In some cases, measurable results may not appear for 10 years or more after the initial project grant. Like many research agencies, NRCC has found it difficult to measure the impacts of its activities, especially in the short term. The scope of the audit will be defined in relation to the outcomes that the Auditor General expects to see at NRCC, such as performance in accountability, awareness of costs, and demonstrated orientation towards results. Before the examination begins, we will establish some expectations. The NRCC should do the following: Account for its funds and for the results it achieves Provide the board of governors with timely, reliable, and relevant financial and program information to assist them in decision making and in accounting to Parliament Manage with due regard to economy and efficiency You should review some samples of Auditor General reports to appreciate the nature of opportunities for

improvement that can be identified, as well as the style of the communication. Follow-up of the previous audit, you should note, is routinely considered in each audit. Conclusion: The auditor as an agent of constructive change To acquaint you with the exciting career opportunities that await you at the Office of the Auditor General of Canada, I have discussed four issues: The role of the Auditor General Public sector audits Advantages and limitations of comprehensive auditing The performance audit of NRCC Auditing can be an innovative, collaborative process, and a mutually beneficial exercise that leads to new and appropriate accountabilities. Our hope in the upcoming audit of the NRCC, which you may be involved in, is that the audit process will be a force for positive, constructive change, and that the final report will identify opportunities to help NRCC improve the way it manages and reports on its activities to Parliament. Thank you for your time and attention. I would be happy to hear any questions that you may have.