Auditing Charitable Organizations in Hong Kong:
Key Insights and Best Practices
Charitable organizations play a significant role in addressing various social, environmental, and humanitarian challenges. As an auditor in Hong Kong, it’s essential to understand the intricacies of auditing these organizations under the Hong Kong Financial Reporting Standards (HKFRS). This blog post delves into the crucial aspects to consider when auditing charitable organizations and showcases the remarkable capabilities of our Audit Program 3.0, which can dramatically reduce time costs and generate customized illustrative documentation for audit engagements.
Part 1: Revenue Recognition in Charitable Organizations
Accurate revenue recognition is critical when auditing charitable organizations. Due to the unique nature of these entities, it’s important to comprehend the specific rules and guidelines governing revenue recognition for them. Key factors to consider include:
1. Identifying the sources of revenue: Charitable organizations typically derive revenue from various sources, such as donations, grants, fundraising events, membership fees, and sales of goods or services. Understand the different sources of revenue and the applicable recognition criteria for each.
2. Timing of revenue recognition: Assess whether revenue is recognized over time or at a specific point in time. For instance, donations may be recognized when received or when the organization obtains control of the donated assets, while grants may be recognized when certain milestones are met.
3. Deferred revenue: Verify that revenue is deferred when the organization receives payments in advance for services that have not yet been rendered, such as event ticket sales or prepaid membership fees.
4. Donation and grant accounting: Review the criteria for recognizing donations and grants, particularly when they come with stipulations or conditions. Ensure that revenue is recognized in accordance with HKFRS 15 and HKAS 20.
5. Sales of goods or services: Examine the revenue recognition policies for sales of goods or services, such as merchandise or educational programs, and ensure they align with HKFRS requirements.
Illustrative Example 1: Application of HKFRS 15 - Revenue Recognition
For example, Audit Program 3.0 would include the following audit documentation on the Revenue Recognition in Charitable organizations industry when applying HKFRS as follows. This documentation would typically be included in the Engagement Planning Meeting Minutes in Section C of the APM:
“Revenue Recognition for a Mid-Sized Charitable Organization under Hong Kong Financial Reporting Standards (HKFRS)
This discussion provides a detailed explanation of how a typical mid-sized charitable organization would recognize revenue under the Hong Kong Financial Reporting Standards (HKFRS). This explanation will cover the determination of the point of revenue recognition, the calculation of revenue, and the relevant documents within the business operations specific to this industry that would help the accounts team to know when to recognize revenue.
Revenue Recognition Criteria
Revenue recognition for a charitable organization is primarily governed by HKFRS 15 – Revenue from Contracts with Customers. According to HKFRS 15, an entity should recognize revenue when it satisfies a performance obligation by transferring a promised good or service to a customer. The amount of revenue recognized should be the transaction price, which is the amount of consideration to which the entity expects to be entitled in exchange for transferring the goods or services.
Application to Charitable Organizations
A mid-sized charitable organization may generate revenue from various sources, such as:
– Donations
– Grants
– Fundraising events
– Membership fees
– Sales of goods or services
The following sections describe the point of revenue recognition, the calculation of revenue, and the relevant documents for each of these revenue sources in the context of charitable organizations.
Donations
Point of Revenue Recognition: Donations are recognized as revenue when the organization obtains control of the donated assets, and it is probable that the economic benefits associated with the donation will flow to the organization.
Calculation of Revenue: The revenue recognized for donations is the fair value of the donated assets at the date of the donation.
Relevant Documents: Donation receipts, bank deposit slips, and donor correspondence.
Grants
Point of Revenue Recognition: Grants are recognized as revenue when the organization has met the conditions stipulated in the grant agreement, and it is probable that the economic benefits associated with the grant will flow to the organization.
Calculation of Revenue: The revenue recognized for grants is the amount of the grant that has been earned by the organization, based on the terms and conditions of the grant agreement.
Relevant Documents: Grant agreements, progress reports, and grant disbursement confirmations.
Fundraising Events
Point of Revenue Recognition: Revenue from fundraising events is recognized when the event takes place, and the organization has satisfied its performance obligations, such as providing entertainment or auction items.
Calculation of Revenue: The revenue recognized for fundraising events is the total amount of funds collected from event participants, net of any direct event expenses.
Relevant Documents: Event registration forms, ticket sales records, and auction bid sheets.
Membership Fees
Point of Revenue Recognition: Membership fees are recognized as revenue over the membership period, which is typically one year.
Calculation of Revenue: The revenue recognized for membership fees is the total amount of fees collected from members, allocated evenly over the membership period.
Relevant Documents: Membership application forms, membership renewal notices, and member payment records.
Sales of Goods or Services
Point of Revenue Recognition: Revenue from the sale of goods or services is recognized when the organization has transferred control of the goods or services to the customer.
Calculation of Revenue: The revenue recognized for sales of goods or services is the transaction price, which is the amount of consideration to which the organization expects to be entitled in exchange for the goods or services.
Relevant Documents: Sales invoices, sales contracts, and delivery receipts.
By considering the point of revenue recognition, the calculation of revenue, and the relevant documents for various revenue sources, a mid-sized charitable organization can ensure accurate and compliant revenue recognition in accordance with the Hong Kong Financial Reporting Standards (HKFRS).”
Part 2: Understanding the Design and Implementation of Internal Controls within the Revenue Recognition Business Process
Evaluating the design and implementation of internal controls related to revenue recognition is vital when auditing charitable organizations. Key areas to assess include:
1. Segregation of duties: Assess whether there is an appropriate division of responsibilities among employees involved in the revenue recognition process to minimize the risk of errors or fraud.
2. Authorization and approval: Verify that contracts, pricing changes, and discounts are authorized and approved by the appropriate personnel.
3. Revenue recognition policies and procedures: Review the organization’s policies and procedures for recognizing revenue to ensure they comply with HKFRS requirements.
4. Periodic review and reconciliation: Confirm that revenue transactions are periodically reviewed and reconciled to supporting documentation, such as donor correspondence, grant agreements, or sales invoices.
5. Monitoring and review: Examine the organization’s process for tracking and updating revenue-related estimates, such as deferred revenue or grant milestones, to ensure accurate recognition.
Understanding the nuances of revenue recognition and internal controls in charitable organizations can help auditors provide valuable insights and support to their clients.
Illustrative Example 2: System Notes on Internal Controls in Revenue Business Process
For example, Audit Program 3.0 would include the following illustrative audit documentation when understanding the internal controls in the revenue business process of a client operating in the Charitable Organizations industry when applying HKFRS as follows. This documentation would typically be included in section C5.1 of the APM:
“ Revenue Recognition Controls
Donations
Control Activity: Review and approval of donation recognition
Individual Responsible: Accounts Manager
Frequency: As donations are received
Type of Control: Authorization
Walkthrough:
1. Accounts Clerk receives the donation receipt or bank deposit slip and donor correspondence.
2. Accounts Clerk records the donation in the accounting system at the fair value of the donated assets on the date of the donation.
3. Accounts Manager reviews the donation entry and supporting documents for accuracy and completeness.
4. Accounts Manager approves the donation recognition by signing the donation receipt or bank deposit slip.
Grants
Control Activity: Review and approval of grant revenue recognition
Individual Responsible: Accounts Manager
Frequency: As grants are earned
Type of Control: Authorization
Walkthrough:
1. Accounts Clerk reviews the grant agreement and related progress reports to determine if the organization has met the conditions for grant revenue recognition.
2. Accounts Clerk calculates the grant revenue earned based on the terms and conditions of the grant agreement.
3. Accounts Clerk records the grant revenue in the accounting system.
4. Accounts Manager reviews the grant revenue entry and supporting documents for accuracy and completeness.
5. Accounts Manager approves the grant revenue recognition by signing the grant disbursement confirmation.
Fundraising Events
Control Activity: Reconciliation of event revenue
Individual Responsible: Accounts Manager
Frequency: After each fundraising event
Type of Control: Reconciliation
Walkthrough:
1. Accounts Clerk collects event registration forms, ticket sales records, and auction bid sheets from the Operations Manager.
2. Accounts Clerk calculates the total funds collected from event participants, net of any direct event expenses.
3. Accounts Clerk records the event revenue in the accounting system.
4. Accounts Manager reviews the event revenue entry and supporting documents for accuracy and completeness.
5. Accounts Manager performs a reconciliation of the recorded event revenue with the event registration forms, ticket sales records, and auction bid sheets.
6. Accounts Manager approves the event revenue recognition by signing the reconciliation report.
Membership Fees
Control Activity: Review and approval of membership fee revenue recognition
Individual Responsible: Accounts Manager
Frequency: As membership fees are received
Type of Control: Authorization
Walkthrough:
1. Accounts Clerk receives the membership application forms, renewal notices, and member payment records.
2. Accounts Clerk calculates the membership fee revenue to be recognized over the membership period.
3. Accounts Clerk records the membership fee revenue in the accounting system.
4. Accounts Manager reviews the membership fee revenue entry and supporting documents for accuracy and completeness.
5. Accounts Manager approves the membership fee revenue recognition by signing the membership application forms or renewal notices.
Sales of Goods or Services
Control Activity: Review and approval of sales revenue recognition
Individual Responsible: Accounts Manager
Frequency: As sales transactions occur
Type of Control: Authorization
Walkthrough:
1. Accounts Clerk receives the sales invoices, sales contracts, and delivery receipts.
2. Accounts Clerk records the sales revenue in the accounting system based on the transaction price.
3. Accounts Manager reviews the sales revenue entry and supporting documents for accuracy and completeness.
4. Accounts Manager approves the sales revenue recognition by signing the sales invoices or sales contracts.
Sales Receipts and Sales Posting Controls
Control Activity: Reconciliation of sales receipts and sales posting
Individual Responsible: Accounts Manager
Frequency: Monthly
Type of Control: Reconciliation
Walkthrough:
1. Accounts Clerk prepares a monthly report of sales revenue recorded in the accounting system.
2. Accounts Clerk prepares a monthly report of sales receipts collected and deposited in the bank.
3. Accounts Manager compares the sales revenue report with the sales receipts report to identify any discrepancies.
4. Accounts Manager investigates and resolves any discrepancies.
5. Accounts Manager approves the sales receipts and sales posting reconciliation by signing the monthly reports.
By implementing these internal controls on revenue recognition, sales receipts, and sales posting, the audit client can effectively prevent, detect, and correct misstatements in its financial statements. This documentation provides a detailed walkthrough of the process flows of these controls, enabling another auditor with no prior experience with this audit client to fully understand the client’s internal controls by just reading this documentation.”
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In conclusion, understanding revenue recognition and internal controls is crucial when auditing charitable organizations adopting HKFRS. By leveraging the power of Audit Program 3.0, Hong Kong auditors can streamline their work, enhance efficiency, and elevate audit quality to new heights. Experience the transformative impact of Audit Program 3.0 on your practice and watch your client relationships thrive.