PROTECTING YOUR CLIENT: READING FINANCIAL STATEMENTS WITH ... · Reporting Requirements – CCA/OCA CCA • auditor must be appointed annually • must present findings at annual
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PROTECTING YOUR CLIENT:
READING FINANCIAL
STATEMENTS WITH A
CRITICAL EYE
M. Elena Hoffstein
416-865-4388
ehoffstein@fasken.com
Jill H. McAlpine
416-218-1514
jill.h.mcalpine@ca.pwc.com
1
Discussion Topics
Reporting – evolving expectations and responses
Audited Financial Statements for Not-for-Profit Organizations
• Regulatory requirements
• Reporting frameworks
• Key concepts and components
• Selected topics
• Endowments and restricted contributions
• Controlled and related entities
• Communications with legal counsel
2
Reporting – Evolving Expectations and Responses
3
Reporting -
Evolving Expectations and Responses
Expectations:
• Transparency, accountability
• Regulatory and contractual compliance
• Resource allocation, performance and stewardship assessment – financial
management and organizational effectiveness
Responses include:
• CICA – “Improved Annual Reporting by Not-for-Profit Organizations”; new
accounting frameworks and standards; 20 Questions Series; NPO Director
Alerts; courses/seminars
• Imagine Canada – Ethical Code, Standards Initiative, Charity Focus
• CRA – T3010 online & searchable, donor education, new tools
• Voluntary Sector Reporting Awards
4
Audited financial statements
Requirements for an audit
Reporting frameworks
Key concepts
Components of financial statements
5
The Statutory Landscape for Non-Share Capital
Corporations
Governing Statutes
• Part I, CCA
• Part III, OCA
• CNCA
• ONCA
6
Reporting Requirements – CCA/OCA
CCA
• auditor must be appointed annually
• must present findings at annual general meeting;
OCA
• same as above
• Exemption from audit if company not a public company, if income is less
than $100K and all of the members consent to the exemption from audit
7
Reporting Requirements - CNCA
CNCA establishes two different types of not-for-profit corporations:
– soliciting corporations; and
– non-soliciting corporations.
• The type of reporting depends on (i) whether the corporation is a soliciting
corporation or a non-soliciting corporation; and (ii) the level of its gross
annual revenues.
• Must submit financial statements to Director
– A “soliciting corporation” is a corporation which received in excess of $10,000, in a financial year, in the form
of donations from third parties, (ie: not members, directors, officers or employees or related persons) grants
or financial assistance from the federal, provincial or municipal government, or donations from other soliciting
corporations;
– A “non-soliciting corporation” is a corporation which is not a soliciting corporation.
8
Reporting Requirements - CNCA
Type of
corporation
under CNCA
Gross Annual
Revenues (for
previous year)
May Dispense with
Public Accountant
Review
Engagement
Audit
Soliciting Less than or equal to
$50,000
Yes, if all voting members
consent. Members must sign a
waiver annually.
Default, unless the
majority of the
members vote for
an audit.
Optional
Soliciting Between $50,001 –
$250,000
No* Optional Default, unless two-thirds of
members voting for a review
engagement
(subject to the Director requiring
only a compilation report)
Soliciting More than $250,000 No* N/A Mandatory
(subject to the Director requiring
only a review engagement or as
an alternative a compilation
report)
9
Reporting Requirements - CNCA
Type of
corporation under
CNCA
Gross Annual
Revenues (for
previous year)
May Dispense
with Public
Accountant
Review
Engagement
Audit
Non-soliciting Less than or equal to
$1,000,000
Yes, if all voting
members consent.
Members must
sign a waiver
annually.
Default, unless
the majority of
the members
vote for an
audit.
Optional
Non-soliciting More than $1,000,000 No* N/A Mandatory
(subject to the Director
requiring only a review
engagement or as an
alternative a compilation
report)
10
Reporting Requirements - ONCA
• The ONCA establishes two classes of not-for-profit corporations; public
benefit corporations (i.e. similar to a “soliciting corporation” under the
CNCA) and non-public benefit corporations (i.e. similar to a “non-soliciting
corporation” under the CNCA).
• Charitable corporations are automatically considered to be public benefit
corporations.
• A non-charitable corporation will be considered to be a public benefit
corporation if it receives more than $10,000 in a financial year in the form of
donations or gifts from persons other than its members, directors, officers or
employees, or in the form of grants from the federal, provincial or municipal
government or agency thereof.
• No requirement to file financial statements with Ontario Ministry
• Financial statements much be provided to Public Guardian and Trustee if
corporation is a charity and is operating in Ontario
11
Reporting Requirements - ONCA
Type of Corp/Gross Annual
Revenue (GAR) of ONCA Corporation
Requirements for an auditor Audit/Review
Engagement
Public Benefit
Corporation (PBC) with
GAR of =
Less than $100,000 (s.
76(1)(b)
May, by extraordinary resolution*
(80%), decide not to appoint an auditor
May dispense with both an
audit and a review
engagement by extraordinary
resolution (80%)
Over $100,000 but less
than $500,000 (s.
76(1)(a)
May dispense with an auditor and have
someone else conduct a review
engagement. This requires an
extraordinary resolution (80%)
May elect to have a review
engagement instead of an
audit by extraordinary
resolution (80%)
Over $500,000 (s.68) An auditor must be appointed annually Audit is required
12
Reporting Requirements - ONCA
Type of Corp/Gross Annual
Revenue (GAR) of ONCA Corporation
Requirements for an auditor Audit/Review
Engagement
NON-PBC
corporation with
GAR of =
Less than $500,000
in annual revenues
(s. 76(2)(b))
May, by extraordinary resolution
(80%), decide not to appoint an
auditor
May dispense with both
an audit and a review
engagement by
extraordinary resolution
(80%)
Over $500,000 (s.
76(2)(a))
May, by extraordinary resolution
(80%), dispense with an auditor
and have someone else conduct
a review engagement
May elect to have a
review engagement
instead of an audit by
extraordinary resolution
(80%)
13
Reporting Frameworks – CICA Handbooks
Type of Organization Reporting Framework
A
c
S
B
Canadian Publicly Accountable Enterprises IFRS (International Financial Reporting Standards
– CICA Accounting Handbook Part I)
Private Enterprises ASPE (Accounting Standards for Private
Enterprises – CICA Accounting Handbook Part II))
or IFRS
Not-for-Profit Organizations that are not
GNFPOs (NFPOs)
ASNFPO (CICA Accounting Handbook Part III
supplemented by ASPE) or IFRS
P
S
A
B
Governments (including school boards) PSAS (CICA Public Sector Accounting Handbook)
Government Business Enterprises (e.g.,
LCBO, OLG)
IFRS
Government Not-for-Profit Organizations
(GNFPOs)
PSAS or PSAS with PS 4000 series (CICA Public
Sector Accounting Handbook)
Other government organizations (OGOs) PSAS or IFRS
14
Is the Organization an NFPO or GNFPO
NFPO (non-government)
– an organization organized and operated exclusively for social, educational,
professional, religious, charitable or any other not-for-profit purpose – members,
contributors and other resource providers do not, in such capacity, receive any
financial return directly from the organization and that is not a GNFPO
GNFPO – same as above except
– may be controlled by the government ,and
– has counterparts outside the public sector (usually in the MUSH sector)
• includes government NFP organizations that currently report using CICA Handbook
(e.g., schools, hospitals, colleges and universities)
• may include organizations that are directly or indirectly funded by the government or
government agencies (but government funding does not necessarily translate into
an organization that is a GNFP)
15
Audited Financial Statements – Key Concepts
• Objective of financial statements
• Benefit vs. cost constraint
• Materiality
• Qualitative characteristics and trade-offs
• Understandability, relevance, reliability, comparability
16
Audited Financial Statements - Components
• Independent auditor’s report
• Statement of financial position
• Statement of operations
• Statement of changes in net assets
• Statement of cash flows
• Notes to financial statements
• Supporting schedules cross-referenced to financial statements (if any)
17
Endowment & Restricted Funds
18
Endowments & Restricted Funds
Audited Financial Statements
Reporting objective
• Ability to carry out service delivery activities in future
• Financial flexibility
• Role of contributions in funding activities
• Management’s stewardship of restricted assets
Details of externally restricted (endowed and other restricted
separately), internally restricted and unrestricted funds
• When
• How much
• For what purpose
18
19
Endowments
• Can be created by a donor either during lifetime (usually evidenced by a donor agreement setting out the terms of the gift) or on death (documented in a will)
• Can be internally created by the Board of a charity
• Involves the setting aside of capital (either cash or assets that are converted into cash and reinvested) in perpetuity
• Income can be expended on charitable programs or can be accumulated (subject to applicable provincial statutes)
20
Restricted Funds
• Endowments are a form of restricted funds
• Terms of restricted funds can require expenditure of the income and capital over a period of time
• Constraints can relate to restrictions on use or restriction as to a specific purpose (scholarship/research in a particular dept for example; real estate to be held for a particular use)
• Written agreement not needed for a court to determine whether donor intended restricted charitable gift. Will consider other written or oral evidence to determine intent such as correspondence, memo of discussions, fundraising material of charity
21
Unrestricted Gifts
• Gift at law to be applied towards the general charitable purposes of a
charity. Not subject to any restrictions by the donor.
• Board may apply towards certain of its charitable objectives and also
redirect the use.
22
Precatory Gifts/Donor Advised Funds
• Non binding requests by donor. No enforceable restrictions although moral
obligation on charity receiving the gift to consider the expressed preference,
desire, request of donor.
• Donor Advised Fund is a form of precatory gift.
• Too much control retained by donor may cause donation to not qualify as a
gift thereby disqualifying it for charitable receipt under ITA.
23
Meaning of Income and Capital
• Many endowment agreements provide for distribution of income
but no right to encroach on the capital.
• Generally no right to vary the agreement retained by the donor.
• Even if capital not to be retained in perpetuity, because of the ITA
rules prior to the 2010 Federal Budget many gifts structured as
gifts given subject to trust or direction that capital or property
substituted therefore be retained for at least 10 years. This
removed the gift from the requirement that 80% of the receipted
gift had to be expended in the subsequent year.
• Income and capital are colloquially regarded as mutually exclusive
terms – fruit/tree analogy.
• Income - earnings, revenues.
• Capital - assets or property that is employed or invested to
generate such returns - includes capital gains.
24
Endowments and Restricted Funds
Audited Financial Statements
Definitions for accounting purposes
• Contributions
• Endowment
• Restricted
Financial statements – Presentation and Disclosure
• Restricted fund method
• Deferral method
• Information about externally and internally (endowed and other) and
unrestricted funds recognized in financial statements:
– Accounting policies
– Contributions by major source;
– Not assets
– Restrictions
25
Endowments and Restricted Funds
Audited Financial Statements – Deferral Method
Deferral Method
© The Canadian Institute of Chartered Accountants
26
Endowments and Restricted Funds
Audited Financial Statements – Restricted Fund Method
Restricted Fund Method
© The Canadian Institute of Chartered Accountants
27
Controlled & Related Entities Related Party Transactions
28
Controlled & Related Entities; Related Party Transactions:
Relevance to Audited Financial Statements
Impact an NFPOs
• resources and operations
• sustainability, flexibility, independence
Government & private funders, regulators, creditors, potential partners
• Ministry of Health
Information needs:
• Basic info, relationship, significance, resources, transactions
Structuring organizations and operational arrangements
29
Concerns under the ITA
• Self dealing
• Private benefit
ITA provisions include:
• Designation - charitable organization, public or private foundation
• Designated gifts – non-arm’s length charities – inter-charity gifts
• Non-qualified investment
• Non-qualifying securities
• Associated charities
• Excess business holdings rules
Controlled & Related Entities; Related Party Transactions:
Relevance for Income Tax Purposes
30
T3010 tool for assessing compliance, identifying potential issues &
monitoring, include
• Subordinate to a parent charity (A1)
• Directors/trustees & like officials (T1235)
• Compensation of directors and others (C8)
• Loan-backs (C13)
• Non-arm’s length borrowing, loans, investments (Section D and
Schedule 6)
Controlled & Related Entities; Related Party Transactions:
Relevance for Income Tax Purposes
31
Controlled and Related Entities
Audited Financial Statements - Definitions
Reporting controlled and related entities
• Control: “continuing power to determine the controlled entity’s strategic
operating, investing and financing policies without the cooperation of
others”.
• Significant influence: “the ability to affect [but not control] the entity’s
strategic operating, investing and financing policies”
• Economic interest: the other NFPO “holds resources that must be
used to produce revenue or provide services for the reporting NFPO”; or
the reporting NFPO is “responsible for the liabilities” of the NFPO in
which it has an economic interest
32
Related Party Transactions
Audited Financial Statements - Definitions
Reporting related party transactions
• Related parties: “one party has the ability to exercise, directly or
indirectly, control, joint control or significant influence over the other.
Two or more parties are related when they are subject to common control,
joint control or common significant influence. Two not-for-profit
organizations are related parties if one has an economic interest in the
other. Related parties also include management and immediate family
members”
• Related party transaction: “a transfer of economic resources or
obligations between related parties, or the provision of services by one
party to a related party, regardless of whether any consideration is
exchanged. The parties to the transaction are related prior to the
transaction. When the relationship arises as a result of the transaction,
the transaction is not one between related parties.”
33
Controlled & Related Entities; Related Party Transactions:
Determination of Relationship
Documents and factors to consider
• Governing documents
• Funder agreements
• Licenses
• Loan agreements
• Contractual or commercial relationships (joint venture, joint project,
services agreements; economic dependence)
• International context: family service agreements
Substance over form; factual & de jure
Accounting and tax definitions/interpretations may differ
Importance of dialogue between lawyers & accountants
34
Controlled and Related Parties
Audited Financial Statements: Controlled Entities
Controlled NFPOs:
1. Consolidate (combined financial statements), or Additional details for all
1. Accounting policy
2. Description of
relationship
3. Description of controlled
organization’s: purpose,
intended community of
service, status under
income tax legislation,
legal form
2. Specific disclosure w/o consolidation
• total assets, liabilities, net assets
• revenues, expenses, cash flows
• restrictions on resources
• significant acctg policy differences
• reporting period if different
• significant subsequent events, or
3. Exempt - One of large group, each individually
immaterial
• exempt from (1) and (2)
• disclose reasons for not reporting under (1) or (2)
Controlled FPOs:
35
Controlled and Related Parties
Audited Financial Statements:
Significantly Influenced Entities & Economic Interest only
NFPOs - Significantly influenced NFPOs - Economic interest w/o
control of significant influence
• Description of relationship • Nature and extent of interest (e.g.,
nature and purpose of assets
flowing to reporting NFPO; or details
of fund solicitation arrangement;
and/or details of responsibility for
liabilities
• Significantly influenced organization’s
purpose, intended community of service,
status under income tax legislation, legal
form
• Nature and extent of economic interest
For-Profit – Significantly influenced
Equity method of accounting for investments & presentation and disclosure as per ASPE
36
Controlled and Related Parties
Audited Financial Statements: Related Party Transactions
Related party transactions
Required disclosure:
• Description of relationship
• Description of transactions (including nil amounts)
• Recorded amount by financial statement category
• Measurement basis
• Amounts due to/from, terms and conditions
• Contractual obligations separate from other contractual obligations
• Contingencies, separate from other contingencies
37
Controlled and Related Parties – NFPOs
Reporting Decision Tree
Controlled organizations Significantly influenced
Economic interest only
Related party transactions only
© The Canadian Institute of Chartered Accountants
38
Controlled and Related Parties – For-Profits
Reporting Decision Tree
Significant influence
Controlled organization
Related party transactions only © The Canadian Institute of Chartered Accountants
39
Communications with Lawyers
Audited Financial Statements
Purpose:
•Audit procedure re: litigation and claims
•Assess risk of material misstatement
Lawyer’s letter
•Management: prepares and instructs lawyer to communicate directly
with auditor
•Auditor: sends and receives/assesses
Financial statements – presentation and disclosure
•Contingent losses
•Contingent gains
40
Jan 1978 CBA and CICA approved Joint Policy Statement
(JPS)
• Two issues addressed:
– protect solicitor-client privilege
– ensure lawyer does not become involved in joint undertaking with auditor in preparation and certification of clients financial affairs
• Memorandum accompanying JPS highlights the following features of JPS
1.Lawyer response is determined by what is found in his records. No direction as it how such records are to be kept or what information is to be found in them
2.Distinction between claim and possible claim is important.
3.Not mandatory for lawyer to respond in accordance with the form letter but it is recommended that they do so
4.When lawyer does adopt the procedure laid down in JPS he/she obliges self to draw attention to claims of which he has record even though not mentioned in enquiry letter and to participate in conference with client and auditor if required.
41
Solicitor Client Privilege
• a key goal is protection of the privilege
• since 1978 Courts have adopted broader concept of solicitor-client privilege.
• Philip Services Corp (Receiver of) v. OSC (2005)77 OR (3d) 209
• “preservation of privilege is paramount and court should not interfere with this more than is absolutely necessary”
• Case involved production of legal opinions that had been provided to auditor when he attended audit committee meeting
• Even though privileged documents are provided to auditor they are so provided for limited purpose to enable the auditors to comply with the full scope of their audit standards. Waiver of privilege can be narrow
• However also recognition that accurate financial statements are also in public interest.
• In cases where law firm knows client has omitted possible claim from enquiry letter lawyer should discuss with client to enable client to make proper disclosure
• Where law firm disagrees with client evaluation of a particular claim law firm should raise issue with client and ask client to arrange call with auditor
42
Solicitor Client Privilege
• What if client refuses to arrange conference or what if law firm becomes
aware of error and advises client? JPS silent. However as a lawyer cannot
waive the privilege, is prohibited from raising the matter with the auditor
without client consent – privilege is that of the client
• If law firm believes that in non disclosing to auditor, client is acting
dishonestly, fraudulently or illegally – Rules of Professional Conduct impose
on law firm “up the chain” reporting or it may be law firm must withdraw from
representing client
• JPS currently being adapted to respond to IFRS. There will be different
accounting frameworks reporting standard for contingencies will change.
• In meantime Interim Guideline has been prepared which is intended to
enhance JPS to assist lawyers in advising clients now following IFRS and to
bridge gap until revised JPS comes into effect.
43
Disclaimer
This handout and the corresponding presentation are for general
information purposes only. They do not constitute a legal opinion or
other legal advice. Readers are advised to consult a lawyer to obtain a
legal analysis and advice before making a decision or taking other
action regarding a specific matter.
44
THANK YOU
M. Elena Hoffstein
416-865-4388
ehoffstein@fasken.com
Jill H. McAlpine
416-218.1514
jill.h.mcalpine@ca.pwc.com
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