External audit

Guide to Financial Management

External audit

Handling an external audit

1. Introduction

An external audit is an independent examination of the financial statements prepared by the organisation. It is usually conducted for statutory purposes (because the law requires it).

An audit results in an audit opinion about whether the financial statements give a ‘true and fair’ view of the:

  • state of affairs of the organisation and
  • operations for the period

2. Appointment

An external audit can be conducted either as part of the annual review of accounts or as a special review by a donor agency. It is conducted by a registered firm of accountants with recognised professional qualifications, such as CPA, ACA or ACCA.

Auditors are appointed by the Board of Trustees (or Annual General Meeting) or by a donor for a special audit. They are independent of the organisation engaging them. Being independent means that the auditor must not have been involved in keeping the accounting records and is not personally connected in any way with the organisation being audited.

To engage an audit firm:

  • Identify possible firms by asking other NGOs for recommendations, contacting your local Accountancy Regulatory Body (eg Institute of Certified Public Accountants of Kenya, ICPAK), or consulting your donor’s list of ‘approved auditors’ if they have one
  • Approach firms and ask them to quote for doing your audit. They should ask you for information about your organisation as a basis for their quote
  • Select your chosen firm based on good reputation, experience auditing similar organisations, independence, qualification and registration, and lastly cost
  • Sign the ‘engagement letter’ that the auditor should send you

3. Purpose

The purpose of external audit is to verify that the annual accounts provide a true and fair picture of the organisation’s finances; and that the use of funds is in accordance with the aims and objects as outlined in the constitution.

It is not the prime role of the audit to detect fraud, although this may of course come to light during the checks that take place.  Auditors have thus been described as ‘watchdogs not bloodhounds’.

4. What is involved?

Auditors only have a limited time in which to complete their work, so they concentrate on testing the validity of a sample of transactions and results rather than vigorously checking everything.

Although an auditor’s independence must be respected and observed at all times, they are nonetheless providing a service for a fee – you have a right to expect value for money.

The audit should be a positive experience and not one to be feared; it is an opportunity to receive feedback on strengths and weaknesses in systems. Use your auditor to discuss ways of improving your accounting systems and procedures and always encourage the submission of a Management Letter, which summarises findings, highlights weaknesses and makes recommendations for improvements.

5. The audit report

An audit results in a report which gives an ‘audit opinion’ about whether the financial statements give a ‘true and fair’ view of the state of affairs of the organisation and operations for the period.

  • ‘True’ means that the transaction did take place and that an asset exists.
  • ‘Fair’ means that a transaction is fairly valued and that assets and liabilities are fairly stated.

If the auditors do not agree that the accounts give a true and fair view, they can give a variety of other opinions...

  Auditor Opinion Comment
1

Unqualified

'The accounts give a true and fair view'

The opinion everyone wants to see
2

Qualified - disagreement

Except for the effects of ...., the accounts give a true and fair view'

There are specific misstatements, such as an incorrect accounting policy, debtors which are not recoverable, an undisclosed fraud or insider loan.
3

Qualified - limited scope

Except for the possible effects of ...., the accounts give a true and fair view

There are specific issues which are uncertain, such as particular documents not being available for review, an internal control flaw that could result in income not being recorded.
4

Adverse

'These accounts do not give a true and fair view'

There are so many misstatements in the accounts that they are overall wrong.
5

Disclaimer

'We are not able to express an opinion'

There are so many missing documents or explanations that we do not have enough information to form an opinion.

 

The auditor may only sign his report, after the Board has signed and approved the financial statements.

6. What does the auditor need?

An auditor will need a quiet place to work where the checks can take place without interruption. If individual staff members are to be interviewed, then a private room where confidential discussions can take place will also be required. Depending on the type of audit taking place, the auditor will usually give advance notification of the records needed.

Ensure that all the records are up-to-date and properly filed as this will facilitate the routine checks and cause minimal disruption for the organisation. This will also help to save on audit fees.

A list of records and other documentation which might be requested by the auditor follows.

A.
Primary records of account:
Bank Book and Petty Cash Book completely up to date to the year-end
File of invoices/vouchers for all items of expenditure
File or book of receipts for moneys received
Bank statements, paying in slips and cheque books
Wages book and records
General Ledger, if kept
B.
Summaries and reconciliation statements
A Trial Balance and/or a summary of all receipts and payments by budget category
Bank reconciliation statements for all bank accounts at the year-end date
Petty cash reconciliation statement at year end date
Stock sheets
C.
Schedules:
Schedule of Creditors (money owed by the organisation)
Schedule of Debtors (money owing to the organisation)
Schedule of Grants Due
Schedule of Grants Received in Advance
Fixed Assets Register
D.
Other information:
A letter from bankers to confirm balances [this will be requested by the auditors themselves]
Constitution of the organisation
List of Committee members and staff
Minutes of Board meetings
Donor agencies funding agreements and audit requirements