January 29, 1996

Introduction
Corporate directors are obliged to act in the best interests of the corporation. It is also generally accepted that directors should consider their corporation’s responsibility to others, including the corporation’s employees.

This paper will review the liability of directors of non-share capital (not-for-profit) corporations pertaining to employment matters. First, it will note obligations under the Day Nurseries Act. A summary of key requirements under the Employment Standards Act will be followed by review of liabilities that arise under the Income Tax Act.

Directors should always exercise prudence. The first step in reducing the risk of liability is to be aware of a corporate employer’s basic statutory and contractual obligations. Next, directors should be aware of the current state of the corporation’s fiscal affairs. With this information, directors may reasonably ensure that the corporation is in compliance with its current obligations, thereby restricting any practical personal exposure to liability.

Day Nurseries Act
Section 16 of the Day Nurseries Act empowers program advisors to enter and inspect day care centres. The program advisor may also review books of account, enrolment records and other records. This would include payroll information. It is an offence under the Act to obstruct a program advisor in the exercise of his or her duties. A person shall not supply false information or refuse to supply information which the Act empowers the program advisor to inspect.

Under section 21 of the Act, directors, officers and employees who “knowingly concur” in a contravention of section 16 by the corporation is guilty of a provincial offence and is liable to a fine of up to $5,000 or imprisonment of up to 2 years.

In the current environment, to the extent that program advisors are reviewing payrolls to make sure that there is money on hand to pay accrued liabilities, it would be prudent for the directors to satisfy themselves that money has been put aside in accordance with true information furnished to a program advisor.

Employment Standards Act
Record Keeping
Directors should ensure that the corporation keeps employment payroll records in accordance with the Employment Standards Act (ESA).
Under the ESA, an employer is required to keep for each employee:

• employee’s name and address,*
• employee start/anniversary date,*
• date of birth if employee is less than 18 years old,
• number of hours worked each day and week,
• wage rate and gross earnings for each pay period,
• vacations with pay or vacation pay,*
• amount of each deduction and purpose for each deduction, and
• net amount paid to each employee.

The above records marked with an “*” must be kept for 5 years after work is last performed by the employee. The other records must be kept for each employee for 2 years from the date the employee last worked for the employer.

Vacation pay accrues for employees as it is earned, not when it is paid. The payroll system should show, at any given time, how much vacation pay has accrued for each employee.

By ensuring that the proper records are kept, a director should, at the same time, be able to satisfy himself/herself that there are financial controls in place to account for payments to employees and remittances to Revenue Canada (discussed below). They will also be able to ensure that the employer has sufficient funds to meet the current payroll and accrued vacation pay.

Statutory Notice/Termination Pay under the Employment Standards Act
The Employment Standards Act requires the employer to give the following minimum written notice of termination/termination pay:

Different notice procedures and longer statutory notice periods apply to a “group” or “mass” termination of 50 or more within a four-week period. If the corporation does not have more than 49 employees, then even a closure of operations would not activate the special rules.

Statutory Severance Pay under the Employment Standards Act
The ESA also says that an employer must provide statutory severance pay if:

• the employer has an annual payroll of $2.5 million or terminates the employment of 50 or more employees within a six-month period, and
• the employee has 5 or more years of service.

Statutory severance pay is calculated based on a formula: 1 week of pay for each complete year of service plus 1/12 of a week of pay for each completed month in the last partial year, up to a maximum of 26 weeks’ pay.

Statutory severance pay is distinct from statutory termination pay. It cannot be converted into working notice.

In planning the affairs of the corporation, the directors should be aware of the above obligations in respect of termination pay and (if it applies) statutory severance pay. However, as will be explained in the next section, directors are not personally liable for termination pay and severance pay under the Employment Standards Act. Nor are they liable for pay in lieu of notice to which a former employee may be entitled under common law.

Directors of Non-Share Capital Corporations under ESA
The provisions covering the liability of directors under the Employment Standards Act do not apply to:

• corporations without share capital, formed under the Corporations Act;
• co-operatives, under the Co-operative Corporations Act; and
• corporations not carried on for gain or corporations similar to corporations without share capital and co-operative corporations.

Non-profit day care centres would probably fall into one of the above categories. Accordingly, the liability of directors of such corporations is covered by the Corporations Act. Accordingly, a director of a non-share capital corporation cannot be personally ordered to pay under the director’s liability provisions of the Employment Standards Act.

Under the Corporations Act, a director is liable for amounts the corporation owes to employees:

• for services the employees performed,
• while the director was on the board of the corporation,
• up to 6 months’ wages, and,
• up to 12 months’ accrued vacation pay.

Directors are liable only if the corporation has been sued for the debt within 6 months and the judgment has not been satisfied (or, within that period, has gone into liquidation or has been ordered wound up) and the director is sued within 6 months after he or she ceased to be a director. Liability extends only to the part of the obligation that the corporation cannot pay.

Directors of non-share capital corporations are not liable under the Corporations Act for termination pay and severance pay which the corporation may owe a former employee, because these payments do not relate to services performed. Similarly, common law damages for pay in lieu of notice are not considered payments for services performed. For this reason, a director would not be liable for any common law pay in lieu of notice that the corporation may owe a former employee who did not receive notice of the termination of employment in accordance with his/her contract of employment.

Withholding/Remitting Taxes and Premiums for CPP and EI
The Income Tax Act says that directors are liable for taxes the corporation failed to withhold and remit during period in which they were directors. The same provisions apply to Canada Pension Plan and Employment Insurance premiums. Directors are also liable for interest or penalties relating to such taxes or premiums.

In addition to a number of procedural hurdles limiting a director’s liability, a director is not liable under the Income Tax Act for the corporate failure to withhold and remit where the director “exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances.”

If the appropriate financial controls are in place, a director may reasonably and regularly verify that the corporation has deducted at source and remitted the required amounts to Revenue Canada.

The frequency of monitoring should increase where the corporation is in a tenuous financial position. Revenue Canada has produced information circulars (IC 98-2 Directors’ Liability) which a board of directors should review with professional advice and compare against its own practices.

Conclusion
While directors of non-profit corporations are exposed to potential personal liability, if they pay attention to the affairs of the corporation, the likelihood of being called upon to pay a debt of the corporation is remote.

In planning the affairs of the corporation, the directors should consider their statutory and common law obligations to their employees. At monthly directors’ meetings, the agenda should include a review of current and accrued financial obligations to employees and related obligations to Revenue Canada. If prudent management is followed, then the directors will know, well in advance, if the corporation is in danger of failing to meet its payroll.

In the unlikely event that the prudently managed non-share capital corporation ceases operations without notice, directors will not be liable for statutory termination pay, statutory severance pay or common law pay in lieu of notice which the corporation owes its employees.

Market research by the accounting profession reveals that most people have only a vague idea of the scope and objectives of an audit. Fewer people have any idea of the limitations of the process. As a result, the public is often understandably surprised and disillusioned when learning of corporate failures such as Livent Inc., YBM and Philips Services. The question “Where were the auditors?” is often asked.

With this article we hope to shed some light on the audit process. We will examine some of the factors that affect the nature and extent of audit testing and we will look at what communication you might reasonably expect from your auditor.

The Concept and Process of Auditing
What is the concept and process of auditing? During the 1960’s and 1970’s, audit professionals in many countries independently developed theories of auditing that could be applied to examination of many different areas, including financial statements. While practitioners may have differences of opinion as to the application of certain of the underlying concepts, the basic framework is generally accepted by auditors and the public. This framework has been codified in many countries around the world and is often called Generally Accepted Auditing Standards (“GAAS”).

The fundamental responsibility of an auditor of a not-for-profit organization is to obtain evidence to determine the degree to which assertions in the financial statement under audit compare to established generally accepted accounting criteria. The four concepts in the above statement that require an explanation are:

1. financial statement assertions
2. established generally accepted accounting criteria
3. obtaining evidence
4. comparison of financial statement assertions with established accounting criteria.

To comprehend the audit process it is important to understand each of these concepts and the relationship between them.

Financial statement assertions
A set of financial statements is created by management to communicate information to a variety of readers about a series of financial transactions occurring in a prior period, most often a year. The information in the financial statements contains certain assertions made by management. Assertions include:

• existence – that an asset or a liability of the organization exists at a given date
• occurrence – that a recorded transaction took place involving the organization
• completeness – that there are no unrecorded assets, liabilities or transactions
• ownership – that an asset is owned or a liability is owed by the organization at a given date
• valuation – that an asset or liability is recorded at an appropriate value
• measurement – that a revenue or expense transaction is recorded in the proper amount and in the appropriate period
• statement presentation – that an item is disclosed in accordance with generally accepted accounting principles (“GAAP”).

To help clarify the concept of an assertion, take as an example the caption “cash” in a statement of financial position. As cash is classified as an asset, the reader is entitled to assume that the cash both exists and is owned by the organization. Existence and ownership are key accounting assertions relating to the asset category of cash. As another example, the assertions for “accounts payable” and “accrued liabilities” would be those of completeness, that all the liabilities that should be recorded have been recorded, and valuation, that the liabilities recorded are valued correctly (i.e. they are not over or under stated). The assertions for a revenue item such as membership fees would include: occurrence, that the revenue was earned by the organization; ownership, that the fees did not belong to another organization; and completeness, that all the revenue that was earned was recorded.

The assertions contained in financial statements come from the accounting process. Accounting paints a picture of past financial transactions and communicates this to the reader. The auditing process, on the other hand, uses generally accepted criteria to provide an objective opinion as to whether the financial statements accurately reflect the accounting assertions.

Established Generally Accepted Accounting Criteria
The criteria used to generate financial statements have been developed through a quasi-legislative process over the last forty years in a number of countries including Canada, the UK , the USA and Australia. The criteria are called GAAP – Generally Accepted Accounting Principles. GAAP in Canada at the present time includes:

• standards promoted by the Canadian Institute of Chartered Accountants’ (“CICA”) Accounting Standards Board
• common principles and practices that have gained general acceptance in the spirit of existing standards for those areas where the CICA’s Accounting Standards Board is silent.

Obtaining evidence
The auditor’s job, in short, is to provide a professional opinion on the relationship between the assertions in the financial statements and those embodied by generally accepted accounting principles. The auditor must obtain evidence to support his or her opinion on these financial statement assertions. Evidence can come in many forms including:

An auditor does not obtain all of these types of evidence for every financial statement assertion. For example, when attempting to verify an amount receivable the auditor may rely on direct confirmation from the debtor and evidence of payment made after the year end to provide assurance that the receivable both existed and was collectable. The auditor might decide that additional evidence would not be required to prove the assertions.

Comparison of financial statement assertions with established accounting criteria
The auditor obtains evidence and subsequently evaluates whether that evidence is sufficient and appropriate. The evidence gathered must be sufficient and appropriate to permit the auditor to express an opinion on the financial statement assertions. Techniques used to gather evidence include:

The auditor will not necessarily employ all these verification techniques to establish whether financial statement assertions agree with generally accepted accounting principles for every assertion. The degree to which an auditor collects evidence and applies verification techniques is based on the auditors professional judgment. The auditor must use judgment to minimize the risk of arriving at an incorrect conclusion. This brings us to the concept of audit risk.

The Audit Risk Model
Audit risk can be thought of as the risk that the auditor will fail to express a reservation in his or her opinion on financial statements that are materially misstated. A misstated financial statement is one where the accounting assertions are not in accordance with those prescribed by generally accepted accounting principles. Take, as an example, a statement of financial position with a caption for term deposits with a value of $100,000 where the organization did not have any term deposits. The assertion regarding the existence of these assets implied by the statements would be false. If this is not brought to the reader’s attention in the auditor’s report as a result of the auditor’s negligence then an audit failure would have occurred.

An auditor’s goal is to reduce the risk of audit failure to an appropriately low level. Auditors must use professional judgment in selecting appropriate verification techniques to reach their goal all within an acceptable level of risk. Auditing procedures are designed to minimize three types of risk:

1. Inherent risk
Inherent risk relates to the nature of the transactions, assets and liabilities being audited. Some financial statement items are inherently more susceptible to error or fraud. For example, cash is more susceptible to theft than prepaid expenses or goodwill. Inherent risk is generally identified during the planning process by obtaining or updating knowledge of the organization’s business and industry and significant events and transactions occurring during the year under audit.

2. Control risk
Control risk relates to the effectiveness of the organization’s internal controls and financial reporting. The organization has the responsibility for establishing sufficient internal control to prevent or detect, on a timely basis, errors resulting from problems in the processing of transactions and the maintenance of accounting records. If the auditor identifies effective internal controls and performs tests to provide evidence of the effectiveness of those controls then he or she can reduce the amount of verification on detailed balances and transactions. The auditor will typically only test internal controls where doing so would reduce the cost of performing the audit or where testing of detailed transactions and balances is not feasible.

3. Detection risk
Detection risk is the risk that the auditor will not identify misstatements in the financial statements. An auditor only reviews a sample of transactions and balances as to test all would be both impractical and prohibitively expensive. Therefore, it is possible for an auditor to fail to identify misstatements despite having performed audit testing. Inadequate verification (i.e. drawing the wrong conclusion from evidence obtained or failure to obtain evidence identified as necessary in the planning process) can also cause a failure to detect misstatements.

The impact of fraud
One of the underlying axioms of auditing in Canada is that the auditor can assume, in the absence of evidence to the contrary, that management will act in good faith (i.e. management will not deliberately act to defraud the organization). Consequently, auditors in Canada do not carry out audit procedures designed specifically to uncover the existence of fraud as part of every audit engagement. However, if the auditor, in the course of an audit, does uncover evidence of fraud or evidence indicating that a fraud might exist then the auditor would expand his/her verification procedures to determine whether a fraud has occurred and has created a misstatement in the financial statements.

Materiality
Financial statements are prepared by management using many judgmental evaluations. As a result it is not possible or economically feasible for an organization to produce financial statements that are absolutely precise. As an example, management estimates the collectability of accounts receivable and provides an allowance for doubtful accounts based, not on absolute certainty, but on management’s best estimate of the likelihood of collecting the accounts. Similar judgments are made when determining amounts of revenue unearned at a period end and in calculating over what period to amortize capital assets.

How precise should financial statements be? The concept of materiality is recognized in accounting literature. A misstatement in financial statements would be considered material if a person with a reasonable knowledge of the business and its economic activities would have reached a different opinion about the organization had he or she received a set of financial statements correcting for the material misstatement.

Auditors must recognize the concept of materiality in planning their audit. If an audit were designed to identify every possible misstatement in the financial statements, it would quickly become prohibitively expensive. Therefore, audits are generally designed to identify only material misstatements in the financial statements.

Setting materiality is a judgment call by the auditor. The auditor must consider both quantitative and qualitative measures in a arriving at a number. An appropriate level of audit materiality depends, in part, on the sensitivity of the readers to the accuracy of the financial statements. For many not-for-profit organizations a misstatement of 2% or more of gross revenue would be considered material. However, in many circumstances materiality is determined by qualitative rather than quantitative measures. For example, an organization having to return every dollar of unspent funding might consider an error of $1,000 material, even if their gross revenue is $650,000, if that error results in a dollar-for-dollar refund to the funding body.

Objectivity
Objectivity is critical to the audit process. Generally accepted auditing standards state that an audit must be performed by an auditor with an objective state of mind. An objective state of mind means that the auditor expressing an opinion must hold himself or herself free of any influence or relationship with the organization or any related party that might impair the auditor’s professional judgment or objectivity. A consequence of the objectivity standard is that audits generally may not be carried out by individuals who are directly involved with the not-for-profit organization in any capacity other than that of auditor. For example, a treasurer of a church congregation who is also a qualified auditor would not be permitted under professional regulations to perform the church’s audit. This is because a reasonable observer might view the treasurer-as-auditor’s judgment and objectivity as being impaired.

Reporting to users
Once the auditor has gathered sufficient and appropriate evidence, he or she will then conclude whether the assertions in the financial statements being audited are in accordance with GAAP. If the auditor concludes they are then he or she will issue an opinion without reservation . If, in the auditors opinion, the assertions are not in accordance with GAAP then the auditors report will state this, indicate what the differences are and, if possible, quantify the financial impact on the statements.

You will note that an auditor does not report on whether or not the organization is in good financial health. If an organization is in financial difficulty then the financial statements should reflect that; the auditor does not point it out separately. Except in the most serious circumstances an auditor’s job is not to comment directly on whether an organization is in financial difficulty. Rather, he or she will report whether the statements “tell it like it is” in accordance with GAAP.

During audits, issues are sometimes identified that may be of interest to management and Boards of Directors in discharging their responsibilities. At the conclusion of an audit the auditor may prepare a management letter to report on issues, including improvements in the safeguarding of assets, the improving of controls and increasing the efficiency and effectiveness of an organization’s financial systems. It is important to understand that preparation of the management letter is a by-product of the audit and is not an obligation of the auditor. An audit would not usually identify all matters that may be of interest to management in discharging their responsibilities. In other words, just because an auditor has not brought any recommendations to the attention of management does not mean that there is no room for improvement or that additional requirements are not needed for the safeguarding of assets. Organizations wanting a separate opinion as to the adequacy of internal control and procedures to safeguard assets would have to engage an auditor to expressly provide an opinion on that aspect of the organization.

In a formal management letter auditors will typically only comment on items they consider significant. An auditor will often communicate matters of lesser significance directly to persons responsible for financial systems (e.g. bookkeepers and accounting personnel) either orally or in writing during the audit. These items of a lesser nature are generally not communicated directly to an organization’s Board of Directors.

Summary
In summary, an audit is a cumulative process that starts with planning and moves to gathering and evaluating of evidence. In determining the amount of evidence to be obtained in the verification procedures, the auditor must specifically assess the risk that a material misstatement in the financial statements will not be identified during the audit process. Once the auditor has obtained sufficient evidence and performed sufficient verification then he or she will draw a conclusion as to whether the financial statements are, in all material respects, fairly presented in accordance with generally accepted accounting principles. This opinion will be presented to readers in the auditor’s report.

Bibliography
The following sources were essential for the preparation of this article:

• Auditing: An Integrated Approach, W.M. Lemon, A.J. Arens & J.K. Loebbecke – 1997
• The CICA Handbook
• The IAASB Handbook http://web.ifac.org/publications
• CICA Report of the Commission to Study the Public’s Expectations of Audits – 1988
• The External Audit, R.J. Anderson – 1977
• The Philosophy of Auditing, R.K. Mautz & H.A. Sharaf – 1961

What constitutes allowable political activities for charitable organizations has been a contentious issue for the past twenty years. A recent court case has clouded the issue even more. Engaging in prohibited political activities can result in a charity being de-registered. Knowing where to draw the line on political activity is critical as de-registration will result in the confiscation of all of your charity’s assets.

In this article we will briefly discuss historical changes to what constitutes allowable political activity and review current Revenue Canada regulations and the recent court case.

A Historical Review
For many charities some degree of political activity is essential for meeting their objectives. In 1978 Revenue Canada issued Information Circular 78-3 in an attempt to define “political activities” for Revenue Canada’s purposes. There was tremendous opposition from the charitable community at the time. As a result, Circular 78-3 was withdrawn by Revenue Canada, albeit very reluctantly. It is interesting to note that the then-Prime Minister indicated that, regardless of the Information Circular being withdrawn, the position laid out in the Circular still represented both the law and Revenue Canada’s administrative policy.

The issue came to a head in 1985 when the Federal Court of Appeal upheld Revenue Canada’s refusal to register a legal services organization as a charity. Revenue Canada initially refused the registration because the organization had picketed the provincial legislature. In addition, the would-be-charity indicated that it would do so again given the same situation. The court concluded that the activities, while worthwhile and in line with the organization’s objectives, were political in nature and, therefore, not charitable.

In 1986 the Income Tax Act was amended retroactively to 1985 to allow registered charitable organizations to devote at least part of their resources and energy to “allowable” political activities. These amendments stand today. The Income Tax Act allows a registered charitable organization or foundation to devote no more than 10% of its resources to political activities so long as the activities are “ancillary and incidental” to the organization’s charitable purposes or activities. In addition, the political activities may not involve the direct or indirect support of or opposition to any political party or any candidate for office.

In 1988 the Federal Court of Appeal added some clarification to what constitute acceptable political activity. Three general points were made:

• “educating” the public is not of itself an acceptable political activity for a registered charity
• registered charities that “educate” the public must disseminate all points of view and not just those in line with the charity’s objectives
• an organization with a political objective in its corporate objects of incorporation is not eligible for charitable status.

Revenue Canada’s Current Position
In February 1987 Revenue Canada issued Information Circular 87-1 outlining allowable political activities for registered charitable organizations and foundations. The Circular divides charitable activities into three categories:

• charitable activities not subject to any limitation
• prohibited activities
• political activities that, when ancillary and incidental to a charities established purposes, are permitted within expenditure limits (i.e. under 10% of an organization’s resources).

The Information Circular does not define what constitutes “charitable activities not subject to any limitation”. Revenue Canada has left the area open to interpretation by stating that “a particular activity is fundamentally charitable or fundamentally political depending on the facts of a particular situation”. Political activities are viewed as those aimed at bringing about changes in law and policy. Revenue Canada generally accepts as charitable any work aimed at the relief of poverty, the advancement of religion, the advancement of education or the advancement of other purposes beneficial to the community. If you have a question about any of your organization’s activities and whether they are subject to limitation contact Revenue Canada’s Charities Division at 1-800-267-2384.

Revenue Canada is more helpful in defining what constitutes partisan politics and other prohibited activities. “A charity may not oppose or endorse a named candidate, party or politician. The charity’s resources may not be devoted directly to such activities, or devoted indirectly through provision of resources to a third party engaged in partisan political parties” [IC 87-1, para. 10].

Allowable political activities are defined in the Circular as “activities that cannot themselves be considered charitable activities but are subordinate to bona fide charitable purposes and which may be considered political” [IC87-1, para. 12]. Examples given include:

• publications, conferences, workshops and other forms of communication which are produced primarily in order to sway public opinion on political issues and matters of public policy
• advertisements designed to attract interest in or gain support for a charity’s position on political issues and matters of public policy
• public meetings or lawful demonstrations to publicize and gain support for a charity’s point of view on matters of public policy and political issues
• mail campaigns whereby a charity requests its members or the public to forward letters to the media and government expressing support for a charity’s view on a political issue or a matter of public policy.

Approved political activities are only permitted within specific expenditure limits. All registered charities must spend at least 80% of their receipted donation revenue on charitable activities in order to satisfy the disbursement quota. As many registered charities receive significant unreceipted funds (i.e. by way of government grants and investment income) meeting the disbursement quota is often a non-issue. Political activities are considered non-charitable and, therefore, the related costs must be classified as non-charitable expenditures.

In addition to the disbursement quota, all or substantially all of a registered charity’s resources must be used for charitable activities. The phrase “all or substantially all” in the Income Tax Act is understood to mean at least 90%. As a result, no more than 10% of the resources of the organization are allowed to be used for ancillary and incidental political activities. Note that the word “resources” refers to all the financial and physical assets of the charity as well as the services of its human resources.
Registered charitable organizations and foundations are expected to self-assess annually to determine whether their political activities are within the limits described above. The annual T-3010 Registered Charity Information Return must be filed but no special report of political activities is required. Charities are expected to keep sufficient financial and other records on hand to verify that all or substantially all of its resources have been used in charitable activities. These records must be kept back to 1986.

Note: Revenue Canada encourages use of the “all or substantially all” rule for allocating resources. If 90% or more of an expense is for charitable activities then the entire expense can be allocated as charitable. Conversely, if substantially all of an expense relates to political activities then the whole expense should be considered political.

Recent Developments
A recent decision of the Federal Court of Appeal has the potential for further restricting the definition of allowable political activities. In this case, Human Life International (“HLI”), a pro-life organization, had an extensive information program designed to convince the public of the merits of its pro-life position. HLI had neither lobbied for nor against legislation nor did it lobby or attack specific political candidates.

The Federal Court of Appeal held that “activities designed to sway public opinion on controversial social issues are not charitable activities”. The court did note that there are no previous legal cases to support this position. Most importantly, the term “controversial social issue” was not defined. It is not clear, for instance, whether advocacy for increasing public resources for licensed childcare would be taken as an activity designed to sway public opinion on a controversial social issue and therefore grounds for de-registration of a charity.

The court left the onus on the organization to prove that a specific activity is acceptable under the Income Tax Act. Consequently, if Revenue Canada revokes registration based on something it defines as a “controversial social issue” then it is up to the organization to defend its actions and prove that its activities were acceptable political activities and were carried on within resource limitations. This seems to give Revenue Canada significant power to interpret political activities as it sees fit.

We understand that the case will be appealed to the Supreme Court of Canada. In the interim, registered charitable organizations and foundations should review their political activities to ensure that they are within the guidelines issued by Revenue Canada Information Circular 87-1.

Reasons for creating a foundation associated with a charity
Wealth accumulation
A foundation makes sense where an organization wants to accumulate a financial cushion without jeopardizing funding. Donations and investment income not expected to be fully spent in the year can be generated by and, to the extent permitted by Revenue Canada regulations, kept in a foundation. Revenue expected to be fully spent in the year, such as program specific government funding, would be generated and spent by the charitable organization itself.

Fiscal prudence
A foundation can be used to help remove the temptation to dip into a surplus to cover funding shortfalls. By moving the financial cushion to a foundation the operating organization is forced to balance revenues and expenses annually.

Focused fundraising
Creating a foundation allows an organization to run two distinctly different fundraising campaigns. The charitable organization could, for example, focus on short-term funding such as securing government grants and conducting direct mail campaigns. The foundation could then be charged with long-term fundraising such as the securing of endowments, the use of insurance policies naming the charity as the beneficiary, soliciting bequests and fundraising for capital projects.

A foundation is often most effective when structured to be independent of the charity associated with it. If the foundation is not to some degree independent then the two organizations will have to combine or at least disclose each other’s significant financial information on preparation of the annual audited financial statements. The desired separation of the two organizations would be diminished by joint disclosure. To achieve independence the foundation should, as a minimum, have some Board Members who are not on the Board of the affiliated organization and have latitude as to how and when it can disburse its funds. The risk to the charity is that the foundation will have too much independence and, at some time in the future, not support its affiliate in the way originally intended. The risks and benefits of independence and the degree of independence granted in the incorporating documents must, therefore, be very carefully considered at the outset.

One of the drawbacks of having a foundation is that you will need to recruit more volunteers to be on the Board of Directors of the foundation (all Ontario not-for-profit organizations must have at least three Board members). It is often possible for the foundation Board to meet only every three or four months to reduce volunteer time and make it easier to recruit additional Board members.

The Articles of Incorporation of a foundation should be general enough to permit the donation of funds by the foundation to a variety of organizations. This ability increases the perception of independence. In addition, it avoids the problems of the funds in the foundation being frozen in the event that the affiliate subsequently ceases to exist or loses its charitable registration number.

A group of like-minded organizations in a specific region could consider setting up a joint foundation to accumulate funds to be used by all the affiliated charities. This would permit the group to conduct joint direct mail and other fundraising campaigns where the benefits of economies of scale for both volunteer and non-volunteer resources can be realized. Unfortunately political philosophy is often the single biggest obstacle to setting up joint foundations.

Setting up a foundation
Creation of a foundation tied to an existing registered charity or charities need not be difficult. As stated earlier, care must be taken at the outset to ensure that the objectives of the foundation are appropriately designed to meet the needs of the sister organization(s). Following incorporation and appointment of a Board of Directors the foundation should apply for a registered charitable number from Revenue Canada. Once the charitable number has been obtained the foundation can start to raise and accumulate funds as intended.

Does your centre qualify for charitable status?
Childcare centres incorporated without share capital under the Ontario Corporations Act are all not-for-profit organizations. Not-for-profit status does not automatically qualify centres for federally registered charitable status. Centres must apply to Revenue Canada to become a registered charity for income tax purposes. Registration involves filling out forms, meeting specific tests and criteria and is best done with the help of someone knowledgeable with the process.

Most not-for-profit childcare centres are deemed charitable organizations in Ontario. Being a charity in Ontario has nothing to do with being a registered charity for federal income tax purposes. Being a charity in Ontario only brings you under the purview of the Public Trustee of Ontario and the Charities Accounting Act.

Benefits of Registration
Being a registered charity will enable your centre to issue donation receipts for donations of money and, in some cases, gifts-in-kind. Donation receipts may not be issued for regular childcare payments by parents. Donation receipts may only be issued for voluntary donations over and above regular childcare fees.

Donations to childcare centres generally make up a very small portion of total revenue. For example, many childcare centres routinely receive $20,000 or more a month from parent fees and related subsidies. These same centres are often fortunate to receive $2,000 a year in donations (less than 1% of total revenue). The ability to issue donation receipts will often not significantly increase the amount of donation revenue received. If your Board is considering charitable registration then it should first estimate the increase in revenue expected from being able to issue donation receipts for non-fee donations. This estimate will give you an idea whether or not registration is worthwhile.

Registered charities are automatically eligible for a refund of approximately 70% of HST paid. If your centre is currently not eligible (i.e. a not-for-profit organziation that is not a registered charity and has government funding more than 40% of gross revenue on average for the past two years) and if the recovery would be significant then you might consider registration.

If your organization is interested in using gambling or gaming for fundraising then you may find it advantageous to obtain registered charitable status in order to be given access to Bingo, Nevada ticket, and other revenue sources. Non-charitable organizations will find it difficult to become registered charities solely to obtain resources from gambling.

Some municipalities offer property tax rebates to registered charities that either own or rent property used to deliver their charitable services. This is generally a municipally run program. Please contact your municipal offices for information in your area. Registered charities operating in the City of Toronto can go to http://www.toronto.ca/taxes/property_tax/tax_rebates.htm for information on the program in Toronto.

Costs of Registration
Obtaining registered charitable status can be costly. The process generally takes at least six months and can take up to several years. Some legal costs may be incurred during the process and there is no guarantee that Revenue Canada’s approval will be obtained. For more information on registration please go tohttp://www.cra-arc.gc.ca/tx/chrts/

Once you are registered you must annually complete a Charitable Organization Information Return (T3010) and file it with Revenue Canada. Some of the information you supply in the Information Return is then available to the public. Failure to complete and file this form within six months of your fiscal year end can lead to deregistration.
The costs to community based not-for-profit childcare centres of obtaining registered charitable status generally exceed the benefits. If your centre already has charitable status then you should ensure that annual reporting requirements are met to prevent deregistration.

Defining Risk
The Canadian Institute of Chartered Accountants’ publication Learning About Risk: Choices, Connections, and Competencies defines risk as “the possibility that one or more individuals or organizations will experience adverse consequences from an event or circumstance”. This definition is flexible enough to be useful in commercial and not-for-profit organizations alike.

The Board of Directors of a not-for-profit organization is responsible for establishing the objectives for the organization and then making sure that these objectives are met by management. Risk, then, is the possibility that an event or circumstance will cause an organization not to meet the objectives established by the Board of Directors.

The greater the probability that an event or circumstance will result in an organization’s objectives not being met, the greater the risk of the situation. Note that high risk does not relate to the magnitude of the consequence but rather to the probability that the event or circumstance will occur.

Risk suggests a negative or adverse consequence. The opposite of risk is opportunity. Opportunity is the possibility that an organization will benefit from an event or circumstance. Inability to identify and exploit opportunities would be considered a risk where that inability could prevent the organization from reaching its objectives.

The risks an organization must deal with can be internal or external. It is often easier for an organization to manage the internal risks. For example, an organization might identify as a risk the possibility of losing government funding. If poor internal policies such as inefficient program delivery or poor monitoring of results could result in the loss of funding then strengthening internal processes could mitigate this risk. However, an organization may be helpless when faced with a loss of government funding caused by a shift in political thought.

Managing Risk
For most not-for-profit organizations it is the Board’s responsibility to ensure that a framework is in place to manage risk. The four processes involved are:

1. Identifying conditions that must exist for an organization to achieve its objectives
2. Identifying factors that could interfere with these conditions
3. Assessing the probability of these factors occurring (i.e. determining risk)
4. Taking action by either accepting the risks (and perhaps putting in place systems for damage control should the adverse consequences occur) or reducing risk to an appropriate level.

A. Identification of Conditions Needed to Meet Objectives
The first step in the process of risk management is identifying the conditions that must exist for an organization to meet its objectives. We assume for purposes of this article that an organization has already clearly stated its objectives through a strategic planning or other similar process. The conditions that must exist in order for an organization to meet its objectives could include:

• provision of a quality of service to clients consistent with standards established by the Board of Directors
• provision of services that continue to be relevant to clients (i.e. adapting services to meet the changing needs of the organization’s clients)
• continued access to sufficient funding to provide the necessary resources, financial, personnel and otherwise, to meet established objectives
• management of resources including volunteers, cash, other financial assets and networking resources

B. Factors That Could Interfere With Meeting Objectives
Once your organization has determined the conditions that are critical to meeting its objectives, you need to determine the events or circumstances (“factors”) that could interfere with these conditions. Using the four conditions in the previous section, the following factors might be identified.

Factors that could result in failure to provide high quality services:

• Inadequate financial resources, which could limit the organization’s ability to recruit sufficiently experienced and capable staff
• Insufficient monitoring of the quality of service provided (e.g., failure to keep track of outcomes, measure complaints and/or undertake periodic internal evaluations.

Factors that could result in failure to offer services relevant to clients:

• No system in place to regularly monitor clients’ needs
• No system in place to regularly monitor the needs of principal or potential funders

Factors that could result in inadequate sources of funding:

• Lack of attention to the political climate and how it might affect government funding and/or private donations
• Inadequate management and/or volunteer skills with respect to grant writing
• Insufficient attention to the organization’s image and reputation within its fundraising community

Factors that could result in the organization’s failure to manage resources:

• Failure to set efficiency benchmarks (e.g., number of cases handled per caseworker, cost of meals per day per child) and to monitor actual results
• Failure to set annual/monthly budgets and regularly follow-up with a comparison of actual to budgeted results
• Failure to assess the degree of satisfaction experienced by volunteers as a result of their role in the organization
• Ability to obtain resources external to the organization through networking (i.e., ability to get resources at a nominal cost).

C. Assessing the Probability that Adverse Factors Will Occur
So far you have identified your organization’s objectives, the conditions that must exist in order for your organization to achieve its objectives and the factors that could interfere with these conditions. The next step is to assess the likelihood that these factors will occur.

Take as an example the ability of an organization to receive sufficient funds where the majority of funding comes from government sources, which in turn is contingent on the organization’s ability to write grant proposals. If the organization relies on one key staff person with the ability to write grant proposals it would be critical to assess the likelihood of that person leaving. Similarly, if your organization is dependent on a single source for the majority of its funding (e.g. receiving money from the Ministry of Health for provision of a mental health program) then what is the likelihood that the political climate will change and your organization will be faced with cutbacks in funding?

Assign a risk factor of, for example, 0 to 10, to each of the critical factors that could interfere with achievement of an objective (0 representing the least likely factors and 10 the most likely factors). This will help you to determine which risks are most critical to your organization and will prepare you for the fourth step.

D. Taking Action to Mitigate Risks
At this point adverse factors that could prevent an organization from meeting its objectives have been identified and the likelihood that each of these events will occur has been estimated. It is now up to the Board of Directors to determine if it is able to live with the risks or if it must take action to decrease the likelihood of the factors occurring. The decision of whether or not to take action will depend on the cost associated with the action weighed against the likelihood of the adverse factor occurring coupled with the severity of the consequences.

For example, if one of the risks identified is that of an insecure political environment resulting in possible cancellation of an entire grant program, the organization needs to determine whether it wants to spend the resources required to influence the political environment or, instead, to try to diversify its funding sources. In all likelihood an organization would attempt to do the latter as the length of time required to affect a political solution to a funding problem is often too great and the outcome too uncertain.

As another example, if the consequences associated with failing to provide high quality service are considered critical, then the organization may want to develop benchmark performance measures against which quality of service can be compared. Reporting of results to management/the Board of Directors on a regular basis would hopefully flag whether the quality of service offered meets the established criteria or falls short. In this case the cost of developing benchmark performance measures must be weighed against the cost of losing clients and/or related funding from the poor quality of services.

Summary
Risk management by not-for-profit organizations is a part of continuing to be able to provide service to clients over the long term. Establishing a framework whereby your organization clearly:

• articulates its objectives
• identifies the conditions that must exist to achieve those objectives
• identifies adverse factors that could prevent your organization from meeting its objectives
• assesses the likelihood of these adverse factors occurring
• takes action to either accept the risks or implement standards to mitigate the adverse consequences

will go a long way to enabling your organization to efficiently and effectively carry out its mandate.

• All information must be relevant.
• Financial information must be understandable.
• The information presented must be reliable.
• Financial information must be timely to be useful.

Reported information must be relevant
The Finance Committee and/or Board of Directors should determine what financial information they require to monitor the organization=s financial progress. Information should include a summary of results of operations (revenues received and expenses incurred), financial position (assets and liabilities) and key statistical data such as present and expected enrolment to help the Board determine the financial outlook for the future. Specifically, monthly financial reports should at a minimum include totals for:

• Revenue from fees, grants and other sources.
• Salary and benefits expenses.
• Food costs, if significant.
• Other expense information as the Board considers necessary.
• A summary of significant assets at the end of the month including cash, accounts receivable, accounts payable (outstanding invoices) and grants not yet paid out.
• For childcare centres, enrolment statistics by age-group and/or room.

The above information should give you an idea of the organization’s current financial status and progress since the last Board meeting.
A comparison of actual with budgeted results is also very useful. Actual-to-budget comparisons will enable the Board to determine whether approved financial policies are being followed (Is the centre operating at a break-even level as directed by the Board?) and whether corrective action needs to be taken. The actual-to-budget analysis is most useful when accompanied by a brief narrative explaining significant variations.

Some Boards require monthly as well as year-to-date information for actual and budgeted revenues and expenses. The amount of detail reported is, of course, up to the Board of Directors.

Following is an example of a two page monthly report to a Board:

Other financial information such as uncollected parent fees and enrolment statistics should be reported in a format agreed upon by the Board of Directors.

Reported information must be understandable
Your monthly financial reports should neither be so summarized as to be superficial nor so detailed and voluminous as to be unintelligible. The ideal amount of information reported to the Board will be a function of the culture of the Board members together with the level of their involvement. Some Boards require reams of detail while other Boards prefer a simple one page summary assuming that all of the details have been taken care of by the staff. The ideal amount of information reported usually lies somewhere between these two extremes.

One strategy to determine the appropriate amount of information is to start with a fairly summarized report (e.g. the two page variety presented here) and then add information as requested by Board members. For example, if your Board wants details of advertising and professional development expenses reported each month then expand your initial summarized version of the report to include these amounts. If your Board requests a copy of the monthly bank reconciliation then attach that to the statement of financial position presented. You might want to revisit the content of monthly financial reports with each newly appointed Board of Directors.

Reported information must be reliable
Financial reports to Boards of Directors are only useful if the information is reliable. You do not have to have a monthly audit to achieve reliability. It is generally sufficient that the bank be reconciled to the accounting records each month and that the reconciliation be reviewed periodically by the Treasurer or another member of the Finance Committee. The Finance Committee or the Treasurer might also periodically (once or twice a year) make sure that amounts reported actually agree with those in the financial records.

While a bank reconciliation will help ensure that all cash transactions are reported, it will not guarantee that all transactions have been classified properly. For example, an invoice for play supplies for $2,571 may be inadvertently misclassified as a food expense. Significant misclassification errors should, however, be detected by a comparison of actual to budgeted amounts. If, in the above example, the monthly food budget was $2,500, the misclassification would result in the monthly food expense being twice that budgeted. Hopefully the Board would question this variance at the monthly meeting.

In summary, to help ensure that data reported is reliable you should:

• On a monthly basis reconcile all bank account balances with those reported to the Board of Directors.
• Compare actual to budgeted amounts and explain variations. This procedure will help determine whether significant expense or revenue transactions have been misclassified.
• Periodically (twice a year) compare amounts reported to the Board with those in the underlying accounting records.

Reported information must be timely
Reporting the results of operations and financial position on time is essential if corrective action is to be taken by the Board. For example, if you report September activity in January it may be too late to adjust salary expenses and/or fees to avert a pending financial crisis resulting from a drop in enrolment. Timely financial reports are essential!

Reporting financial information more than two months in arrears should raise warning flags for the Finance Committee and/or Board of Directors. Steps should be taken immediately to make sure that financial information reported is no more than one month old.

Given that your incorporated not-for-profit organization must have an annual audit you might as well ensure that it is as productive a process as possible. Following are a few suggestions to help.

Have the audit completed soon after year end
The auditor is presenting an opinion as to whether the financial statements of your organization represent fairly its financial position and changes in financial position for the year. It is generally helpful to get that opinion sooner rather than later. To ensure the audit is done on a timely basis call your auditor in advance of your year end and coordinate his/her efforts with those of the person responsible for your organization’s bookkeeping. Generally there should be no problems completing an audit within three months of the year end assuming that the books and records are ready for audit within six weeks of the year end. If the books and records are not ready within six weeks it may indicate an underlying problem in the organization with respect to timely financial reporting.

Request the same people each year
Maintaining continuity of audit personnel on the audit for at least two or three years in a row will reduce the amount of time required to explain to the auditors the unique characteristics of your organization and industry. Also, having the same person for several years gives you an opportunity to develop an ongoing relationship so that you can draw on their financial expertise throughout the year as the need arises.

Find an auditor who knows your industry
It is always helpful for your auditor to be familiar with your major funders and their reporting requirements. Auditors who are thoroughly knowledgeable about the characteristics of your industry will generally be in a better position to advise you on matters relevant to your organization such as how to maximize your revenue and use your financial resources as effectively as possible.

Accumulate a list of financial questions throughout the year and discuss your concerns with your auditor during the audit. This need not take long and could provide you with some valuable financial advice. Alternatively, call periodically throughout the year to resolve financial issues prior to year end.

Have the audit done at your premises wherever possible
Performing the audit at your organization will allow you to answer the auditor’s questions as they arise. This will avoid the annoying and all too frequent games of telephone tag that can occur during the audit process. Having the audit performed on site also reduces the inevitable hassles of sending additional information to and from the auditor’s office. It eliminates the inconvenience of being without your books and records for an extended period of time and also greatly reduces the risk of losing documents.

Discuss fees in advance
Attempt to obtain a firm fee quote and ask that any additional work that could possibly result in a fee increase be approved by you in advance of the work being performed. This will give you an opportunity to control the audit fees and to deal with problems in a cost effective manner (e.g. have the additional work performed by a bookkeeper as opposed to a chartered accountant).

To help reduce audit fees consider asking your auditor for a list of information that he/she requires from you prior to the audit being conducted. If necessary, request a planning meeting to ensure you understand their requirements. The information can then be prepared by you in advance of the year end audit visit.

Expect quality service
Finally, if you are unhappy with the relationship with your auditor and feel your organization is not being serviced appropriately then speak to your auditor. If you feel your needs are still not being met consider changing auditors. Select an auditor who you believe will provide superior service, has substantial knowledge of your organization’s specific field and with whom you think you can develop a productive working relationship.

The financial management framework
First it is helpful to put financial management into a framework. There are four main components in the financial management cycle:

• setting overall objectives
• establishing budgets
• regular monitoring of your financial position
• comparing where you are financially with where you want to be and adjusting appropriately.

A useful analogy for the financial management of a not-for-profit organization is that of taking a voyage. The first step is to figure out where you want to go (clearly setting out your objectives). If you don’t know where you want to go you will likely spend a great deal of time going nowhere. These objectives must be established by the Board and management of your organization and are commonly created through a strategic planning process. A common objective for childcare centres is that of providing affordable high quality childcare. Articulation of objectives can be a long and complicated process. However, it is critical that the organization spend the time and go through the process periodically to ensure a common focus and direction. It is also critical that overall objectives be documented, especially if there is little continuity of Board members from year to year.

Once you have decided where you are going you must chart your preferred course as there are usually several ways to reach an objective. To use the trip analogy again, you have to determine whether you want to take the scenic route, and perhaps run out of funds, or take the most economical route possible. Your centre should prepare a budget of financial resources estimating what you will need to spend to reach your objectives and, as importantly, how you expect to obtain the resources to get there. This could take the form of both an annual budget and a monthly cash flow forecast.

The next step is to periodically monitor where you are on the voyage. In the context of the financial management of an organization, this entails having an accounting system which permits you to determine where you are financially at regular (monthly) intervals. You may also need to obtain information such as current and estimated future enrolment levels to help you determine whether your budget is still a reasonable one.

Now that you know where you are and where you want to be you have to compare the two and change course as needed to reach your destination. For your childcare centre this involves comparing your actual financial position with that previously budgeted. Changes to revenue and expense patterns can then be made to help you work towards attaining your financial objectives at the end of your reporting period.

Increasing efficiency and effectiveness
We all know that there are more and less efficient ways of achieving objectives. Good control over the financial management framework can help you achieve your objectives with as little effort as possible. Failure to tend to the financial management process can result in your getting lost (going broke) along the way. Designing sensible internal financial controls helps to make the process as efficient and effective as possible.

What is internal control?
Internal control is the term used to describe policies and procedures designed by the Board and management to help ensure that the organization’s objectives are achieved. In a childcare setting internal controls include the policies and procedures developed to ensure that high quality care is delivered at the most affordable cost possible. Two signatures on each cheque, review of monthly bank reconciliations, preparation of an annual budget and presentation of a monthly financial report at each Board meeting are examples of internal control procedures designed to help a Board know whether finances are being efficiently managed. Establishment of a finance committee and monthly reports at Board meetings to discuss areas such as child development, upcoming meal plans and finances are examples of internal controls designed to provide the Board with information required to assess the quality of care being delivered.

Internal controls go beyond accounting and financial systems. Appropriate internal controls are essential if a Board is to monitor all facets of an operation including quality-of-care issues such as personnel management, child behavior management and program development. While our newsletter will focus on the financial aspect of controls, non-financial internal controls are just as critical for a Board to efficiently achieve its objectives (delivery of services).

Internal controls should be creative and need to be applied in the context of an organization’s culture. For example, some Boards may feel more comfortable with extensive and formal documentation of all aspects of policies and procedures. A voluminous manual may suit the culture of the organization. In other organizations such a manual may be seen as unnecessary and a less formal policy and procedure document may suffice. No single set of controls can be designed and applied to every organization. It is up to your organization to determine what is appropriate for its specific needs.

The Board of Directors sets the tone of internal control at the organization. If your organization wants to maintain a set of internal controls to keep financial management effective then the Board must be prepared to follow-up on a regular basis to ensure that the policies and procedures are being followed. Strong support at the Board level for appropriate controls generally results in effective financial management.

Limitations of internal control
There are inherent limitations to internal control and its ability to ensure that corporate objectives are met:

• Good financial management and internal controls are not possible if an organization does not have a clear idea of what it is attempting to achieve. Imagine trying to design an efficient vehicle not knowing what a journey involves. You may design an all-terrain vehicle when what you really need is a school bus. Once your organization has clearly articulated its purpose and goals then you can begin to design appropriate internal controls.
• Internal controls cannot prevent an organization from making operational and/or strategic errors and mistakes. They are designed to ensure that actions taken or not taken by management are followed up and reported to the Board. Internal controls are not designed to manage the organization. People manage.
• Internal controls can help minimize errors and irregularities but cannot eliminate them. Internal controls may cease to function as a result of human error. A purchase in excess of an amount budgeted may be made and not caught by an organization’s internal controls. Also, two or more people can deliberately decide to override controls.
• An organization must take into account the costs of implementing internal controls and compare the costs with the benefits. Costs include volunteer time. As internal controls can never provide absolute assurance that policies and procedures will be followed the Board must determine what constitutes an acceptable risk and controls must be designed accordingly. Once again, this requires judgment on the part of the Board and must take into account the culture of the organization.

Control systems
Internal controls can be classified into two broad categories or systems. The first category includes controls designed to collect, record and process financial data and prepare timely reports. People often do not think of data collection, processing and reporting as part of their organization’s internal control system. However, if you do not have an effective information collection, processing and reporting process then all the controls designed to ensure accuracy won’t be worth implementing. Controls in this category include:

• Assigning responsibility for various tasks such as the centre’s bookkeeping.
• Creating reports to be understood by Board members and management. Overly complex or simplistic reports will result in poor communication of financial data.
• Designing an appropriate attendance system to make staff aware of when children arrive and when they depart.
• Designing systems to ensure that data such as supplier invoices and accounts receivable are recorded accurately and on a timely basis.

The second category of internal controls includes those designed to enhance the reliability of the data reported. These procedures and policies include:

• proper authorization of transactions (prior authorization of major expenditures)
• adequate segregation of duties
• establishment of a finance committee
• proper controls over petty cash
• designing of appropriate forms
• controls to safeguard assets (two signatures required for all cheques)
• controls to verify financial records (monthly reviews and annual audits)

We have enclosed a financial management checklist with this newsletter for your information. You might find it useful to review the items listed and determine whether you feel there are areas in which your centre could do with improved controls. The next few newsletters will go into each of the areas in more detail. Making internal controls work
We conclude our overview with a brief discussion of some of the factors that can enhance the effectiveness of internal controls in place at your centre. Again, we will be going into this area in more detail in subsequent editions.
Good control factors include:

• Establishment of a finance committee of the Board to spearhead planning and monitoring of financial activities and reporting. The finance committee would report to the Board and take primary responsibility for managing financial resources throughout the year.
• Design of an effective organizational structure (i.e. who does what, who is responsible for what and to whom). An organizational structure with clear reporting responsibilities that take into account the culture of the organization is critical for effective financial management. A poor organizational structure with unclear reporting responsibilities will invariably result in controls being missed, misapplied or misinterpreted.
• Effective assigning of responsibilities. This includes clear articulation and documentation of job descriptions. This would also include articulation and clear documentation of responsibilities of various committees of the Board and the Board itself.
• Effective management controls including methods of financial planning and budgeting, reporting of actual results to the Board and follow-up of variances between budgeted and actual amounts.

Overview of the Changes and Some Practical Considerations for directors of charities [1]
By: Brian Iler and Ted Hyland, Lawyers Iler, Campbell, Klippenstein

On July 1, 1999, the Ontario Government substantially revised the powers and duties of some individuals and organizations holding and investing money, or other assets, for others, or for a charitable purpose.

Who is affected?
Not everyone who holds assets for others is affected. The revisions are to a statute called the Trustee Act (the “Act”), and affects only those who hold assets in trust for others called trustees.

Because the law imposes on charities the obligations of trustees for assets held by the charity, these changes apply to all organizations which are charities and do not contain in their incorporating ? or other documents setting up the charity ? specific rules for investment of the charity’s assets. If specific rules exist, they will govern where they conflict with the Act’s new rules.

As a general rule, directors of charities are considered to be trustees of the assets of a charity, even though the charity itself is clearly trustee of those assets. Accordingly, directors of charities are bound by the obligations set out in the Act – subject, again, to any contrary rule binding on them in the charity’s own incorporating documents.

The Reasons behind the Change
Prior to the amendments, the Act contained a very precise list of investment instruments in which trustees were authorized to invest trust property. These included government bonds, some publicly?traded shares, some mortgages, and deposits with financial institutions.

Underlying the former rules was the principle that a trustee’s principal task was to get the best return on investment, but not by placing the money invested at risk. This conservative approach conflicts with current mainstream investment wisdom, which encourages a broader and riskier approach, to maximize return on investment.

What Type of Investments are Now Allowed?
The old list of permitted investments has been abolished. Now, a charity may invest trust property in any form of investment in which a prudent investor would invest. What does that mean?

The Act provides some help, but not a lot: it says that, “in investing trust property, a trustee must exercise the care, skill, diligence and judgment that a prudent investor would exercise in making investments.”

This is the conventional legal statement of the duty or responsibility of a trustee. In fact, by deleting the “legal list”, the law is placing back on to directors of charities, in relation to investments, the duty to exercise the care, skill, diligence and judgment that a prudent investor would exercise in making investments. They can no longer rely on the “legal list” to avoid the responsibility to act prudently in making investment decisions.

But what does a prudent investor do?
First, except for investments placed in mutual funds (what constitutes an acceptable mutual fund is not defined in the Act), directors may not delegate their duty to make decisions on investments to others.

Second, directors must consider, at a minimum, these seven factors set out in the Act:

• general economic conditions;
• the possible effect of inflation or deflation on the investment;
• the expected tax consequences of investment decisions or strategies;
• the role that each investment or course of action plays within the overall trust portfolio;
• the expected total return from income and the appreciation of capital;
• the needs for liquidity, regularity of income and preservation or appreciation of capital; and
• an asset’s special relationship or special value, if any, to the purposes of the trust or to one or more of the beneficiaries.

Third, if there are other factors that are relevant in the circumstances or that are required by the incorporating documents of the charity, they must be considered.

Fourth, there are factors which the law prohibits directors from considering – social or political issues generally, although where two proposed investments are equally financially beneficial to a charity, and one is politically unpalatable, the directors may choose the other.

Fifth, although directors cannot delegate their investment powers to professional investment advisors, the Act does specifically permit them to consult such advisors in relation to the investment of trust property. Moreover, there is a provision in the amendments that saves them from liability for breach of trust as a result of relying on the advice, if a prudent investor would do so under similar circumstances.

Directors’ Liability: What if the Investments Lose Money?
According to the Act, the standard that directors must adhere to is mandatory and “objective”. This means that members of boards of directors of charities, irrespective of their background and experience in investing, will be held to the same standard. Someone with little or no background will not be held to a lower standard than someone with more experience.

However, the Act states that a director will not be liable for losses from investments if the investments were made according to a plan consisting of reasonable assessments of risk and return that a prudent investor would make under similar circumstances.

In the event that a court does find a director in breach of trust as a result of loss to the charity arising from the investment of trust property, the court may take into account the overall performance of the investments in assessing the damages payable by the director. It is important to note that this provision applies only to the assessment of damages and does not shield the director from scrutiny by a court of every investment decision, and from being held personally liable for bad decisions.

What Does it All Mean?
There are a number of immediately practical implications for boards of directors of charities that flow from the changes.

First, the board of directors of a charity will be responsible for the investment decisions, and each director will be personally liable for any losses suffered by the charity as a result of investment decisions that did not demonstrate the required standard of care, diligence and judgment of prudent investor.

The focus is now on each director to show that he or she acted as a prudent investor in the circumstances.

Second, because of the requirement to diversify (as the Act states, “to the extent appropriate to the requirements of the trust and general economic conditions”), the board of directors should consider whether it is appropriate to invest in only one type of asset.

Finally, the amendments make it perfectly clear that acting as a director of a charity holding substantial assets is a serious responsibility, with consequences for failure to meet the minimum duties placed on directors. Prior to assuming such obligations, an individual should consider whether the risk is one which she/he wishes to assume, and whether directors’ liability insurance is available to address that risk.

However, to make this decision even more difficult, the Ontario Public Guardian and Trustee, an official of the Ontario government, takes the position that even spending money on premiums for directors’ liability insurance may be a breach of the duties of directors of charities in certain circumstances!

A charity that does not have a policy for investing its accumulated funds would do well to establish one. Doing so will assist the board in fulfilling its duties. The policy should contain the criteria contained in the Act, as well as any other investment criteria contained in the charity’s incorporating or other constitutional documents. Having a policy will not, alone, be sufficient, however. In order to discharge its duties, the board must assess each investment decision in light of the criteria set out in the Act and must ensure that it develops a plan or strategy for investing the charity’s property.

[1] This article is intended to convey legal information to a general readership, and has not been prepared with a view to providing legal advice with respect to any of the issues discussed or to creating a solicitor?client relationship. Anyone contemplating making a decision with respect to the matters dealt with in this article should first personally consult a lawyer.

Following are a few early warning signs that, in our experience, generally precede financial difficulty. Any one or a combination of them can often be dealt with and rectified over a number of months. The trick is to identify financial difficulties and act promptly as a problem identified six months in advance can almost always be resolved.

Declining enrolment
The most obvious indicator of financial difficulty is one of persistent declining enrolment. Actual declines in enrolment are preceded by a shrinking waiting list. Boards should insist on a monthly report on the status of the waiting list as well as on actual enrolment levels.

Waiting lists must be tended. At least once a quarter every family on the waiting list should be contacted and families no longer needing care should be deleted. We know of one centre which closed its waiting list down at 120. Eighteen months later there was an unexpected vacancy in the toddler room. Not a single parent on the waiting list was still interested in care. It took the centre two months to fill the vacancy at a cost of $1,600 in foregone revenue.

Increasing Salary Costs As A Percentage of Fees
Centres typically have a fairly stable ratio of salaries to fees. For most centres this ranges between 70% and 90% with 80% being typical for multi-age programs. Increasing salary costs as a percentage of fees results from:

1. dropping enrolment levels without adjustment of staff costs;
2. rising staff costs resulting from factors such as maternity leave, increased use of casual staff and, in some cases overstaffing.

Regularly reviewing the percentage of staffing costs to parent and Metro fees can give you an indication of your centre’s financial health.

Declining Financial Cushion
A healthy childcare centre will generally have an accumulated surplus or financial cushion (the excess of current financial assets over liabilities) of between one and three months’ expenses. For example, if you have a centre with a $360,000 expense budget, an adequate financial cushion is in the range from $30,000 to $90,000. If your surplus declines below one month’s expenses then you have limited resources to carry you through financial difficulties such as losses in the summer or a sharp decline in enrolment.

Typically, centres build up their accumulated surplus when they are at or near full enrolment and steadily reduce this cushion when enrolment drops below 95% for an extended period of time.

If your accumulated surplus is below one month’s expenses then you should attempt to budget a small surplus on an annual basis until the cushion is built up again.

Increase in accounts receivable
Steady increases in accounts receivable from parents and Metro can be indicative of financial problems. Failure to monitor and collect parent receivables is a sign of a lack of attention to finances at the centre. Consistent lateness in receipt of subsidy from Metro almost always results from lack of attention to bookkeeping and financial matters in general.

Insufficient and/or late reporting of financial information
If you are receiving insufficient financial information to determine whether you are in financial health on a monthly basis and/or if the information provided is more than one month old you have no way of knowing whether problems await you further on in the year. A current financial report should be prepared for each Board meeting. Financial reports should ideally consist of a report on enrolment trends together with a brief financial statement showing performance for the past month, current financial position and a comparison of actual results with the budget approved by the Board earlier in the year.

1. Do you prepare an annual budget?
2. Is it prepared before the year starts?
3. Is it approved by the board?
4. Is it updated periodically?
5. Do you have a monthly cash flow forecast?
6. Is it used by the board in settling fee/expense policy?
7. Enrollment expectations are reviewed by the board at least quarterly?
8. Are you advised of changes in financial legislation (tax) and regulations?
9. Does your board/finance committee meet regularly and discuss financial matters?

Do you know where you stand today?
A. Cash

1. Are deposits made regularly?
2. Are parent names and period covered by fees deposited marked clearly in the deposit book?
3. Cancelled cheques are returned by bank
4. Are all bank accounts reconciled monthly to the accounting records? (not first to the cheque stubs).
5. Is the board is advised monthly of cash on hand.

B. Receivables

1. A monthly list of parent and metro receivables is prepared and shown to the treasurer.
2. Receivables from Metro Children’s Services, MCSS, GST, etc are monitored monthly?

C. Payables

1. A file of unpaid invoices is kept?
2. Bills are paid promptly?

D. Grants and government rebates

1. You know each month how much is owing to staff for salary grants received but not yet disbursed?
2. All grant forms for the last year have been submitted on time?
3. You are advised of new funding sources on a timely basis?
4. You know your eligibility status for GST rebates and, if eligible, you have received a rebate in the last year?

Are your assets safe?

1. Purchases of significance are approved in advance?
2. Two signing officers sign all cheques and review supporting invoices.
3. Bank accounts are reconciled monthly and someone other than the bookkeeper reviews the reconciliation.
4. Parent receivables are promptly followed up at the board level on a regular basis.
5. All Revenue Canada remittances have been submitted on time?
6. All payroll payments have been made on time?
7. Your last T4 and EHT returns were filed on time?

Corporate Governance

1. You have had an audit within the last year?
2. Filings with Consumer and Corporate affairs are up to date?
3. You have filed a tax return/charity information return within the last year?

Setting up a Finance Committee
Your Board of Directors should tailor the design of a Finance Committee to suit its needs. As there are no legal requirements under Ontario or Canadian Incorporation statutes to have a Finance Committee, your Board can design and set the terms of reference for the Committee as it sees fit. Following are some suggestions to consider when setting terms of reference and assigning responsibilities.

Remember that it is critical for your Board to document in writing the role and responsibilities of the Finance Committee. Documentation will provide for continuity over time and give new Finance Committee members a clearer understanding of their responsibilities.

Who should sit on the Committee
As the Finance Committee will be a sub-committee of the Board of Directors, it is important that members of the Board form the committee. You could recruit non-Board members to provide advice on an ongoing basis provided non-Board member participation is not prohibited in the by-laws of your organization. This is also a way to recruit and train future Board members.

We recommend having at least three members on your Finance Committee to foster discussion. Recruiting Board members with non-financial experience can provide fresh points of view and varied experiences. We believe it is as important to have Finance Committee members who question the way things are done as it is to have members with preset notions of how finances should be managed.

The staff person responsible for your organization’s finances should be asked to attend most Finance Committee meetings. This will help ensure that the Committee receives accurate information and is advised of changes in the organization’s financial circumstances on a timely basis.

You could also invite your auditor to at least one Finance Committee meeting each year. The Committee should review the findings of the annual audit and discuss any concerns and/or suggestions regarding internal control at that meeting.

What the Finance Committee should review
The Finance Committee should review and be responsible for reporting to the Board all aspects of the financial management framework including:

• establishing budgets to meet the organization’s objectives
• regular monitoring of the financial position of the organization
• comparing where you are financially with where you planned to be and recommending appropriate adjustments to the Board.

The Finance Committee should also look at areas of internal control and ensure that you get the most from your financial resources.

The terms of reference for your Finance Committee could include the following:

Monitoring the Budgeting Process
The level of Finance Committee involvement in the budget preparation process will depend on the financial capabilities of your organization’s staff. Some Committees will primarily provide a supervisory role whereas others will find themselves preparing the annual budgets. In either case the Finance Committee should be responsible for presenting the annual budget to the Board once it is completed.

Regular reports comparing actual financial results with budgeted forecasts should be made by the Committee to the Board throughout the year. The Committee should periodically (at least quarterly) review the critical underlying budget assumptions (enrolment, fees charged, number of staff and salaries paid, etc.) and recommend appropriate budget adjustments to the Board.

The Committee should make recommendations to the Board for fee increases where necessary and report if and when funds are available for salary increases. While it would generally not be appropriate for the Finance Committee to recommend individual raises to the Board (this is usually left up to the Personnel Committee), it would be their responsibility to determine how much in total is available for raises on an annual basis.

Monitoring day-to-day record keeping
The Finance Committee should determine whether the day-to-day internal controls of the organization are functioning as expected. This review should be done at least once a year. If circumstances change during the year then an interim review may be appropriate. For example, if parent fees receivable steadily increase over several months it would be appropriate for the Finance Committee to review whether the organization’s policies of debt collection are being followed and determine whether the policies themselves are effective. The Finance Committee could also consider having staff report on the status of financial reporting systems on a quarterly basis. Consider using a financial management checklist to help this process.

The Finance Committee should approve significant changes in day-to-day accounting systems such as implementing new accounting software and reallocation of record keeping duties (e.g. hiring a bookkeeper).

Financial reporting
The Finance Committee should:

• review internal financial statements on a regular basis to make sure that the statements make sense and that financial trends are brought to the attention of the Board of Directors.
• review the annual audited financial statements prior to presentation to the Board of Directors and discuss the statements with the auditor if necessary. Items to be discussed with the auditor could include:
  • any changes in accounting policies and practices
  • recommendations for improving internal controls
  • observations the auditor might have regarding the financial efficiency and future financial viability of the organization.
• recommend to the Board of Directors the selection of an auditor for the following year together with the anticipated fees.
• present the financial statements and a brief annual financial report to the members of the organization at the Annual General Meeting.
• review funding submissions to various government bodies prior to submission, including municipal budgets (e.g. the Metro Children’s Services budget), the grant utilization forms required by the Province of Ontario and Pay Equity reports if applicable. Consideration should also be given to reviewing T4 Summaries, annual employee health tax and income tax/Charity Information Returns and other reports as required by various levels of government. The level of detail of the Committee’s review will depend on the financial expertise of staff at your organization. Remember that no matter how expert your committee members and staff are, the Board is responsible for ensuring the ongoing financial viability of the organization.

Keeping assets safe
At least annually the Finance Committee should review financial policies to ensure safety of assets. The Committee should review whether the policies governing the signing of cheques, use of organization credit cards and purchase of investments (T-Bills, GICs) continue to be appropriate and have been adhered to throughout the year.

Frequency of meetings
The Board and members of the Finance Committee should determine the frequency of the Committee’s meetings. We recommend that the Committee meet at least quarterly. These meetings should not, however, replace the review and discussion of financial information at the monthly Board meetings. Following is a sample agenda:

February

• Review T4s, etc.
• Review the annual audited financial statements
• Review budget assumptions for the period to June 30

May

• Review the organization’s summer budget
• Review prepared grant utilization forms, corporate tax returns and other government reporting forms as applicable

August

• Re-review budget assumptions for the fall
• Compare actual results for the summer with those budgeted

October

• Review the following year’s municipal subsidy budget if applicable
• Prepare a budget of revenue and expenses and monthly cash flow for the upcoming fiscal year
• Discuss financial reporting and any related concerns with the auditor if appropriate.

• Assemble payroll information for T4/T4-A preparation

FEBRUARY

• Final date for T4/T4A submission is month end
• Review monthly cash flow assumptions and adjust monthly cash flow forecast if necessary (*)

MARCH

• Annual financial statement should be finalized and approved by the board (*)
• If eligible, prepare application for GST rebate (*)
• Complete and submit EHT annual return by March 15

APRIL

• Prepare cash flow forecast for summer period

MAY

• Prepare Worker’s Compensation return if applicable

JUNE

• Final date for filing of Revenue Canada returns (T2/T3010/T1044) is June 30 (*)
• Annual General Meeting held before month end (*)
• Update/finalize summer period cash flow forecast
• MCSS grant utilization forms due (DOG/WEG) (*)(**)
• Provincial Annual Return and Special Notice filings due (*)

JULY

• Review summer cash flow forecast assumptions and adjust budget if necessary

AUGUST

• Enjoy well deserved rest!

SEPTEMBER

• Assemble information for Metro Children’s Services budget (Metro Toronto only)(**)
• Update monthly cash flow forecast for changes in enrolment/service levels (*)

OCTOBER

• Complete Metro Children’s Services budget by month end (**)

NOVEMBER

• Assemble information for next year=s monthly cash flow forecast

DECEMBER

• Finalize and obtain board approval for next year’s monthly cash flow forecast (*)
• Review staff salaries and fees charged (*)

NOTES:
* This schedule assumes a budgeting process based on a calendar year. If your budget is for a different period, for example from April to March, then you should adjust the items marked with an asterisk accordingly.
** Applies to childcare centres only.

Focus on the primary objective of your organization
Providing quality childcare at an affordable price is the primary objective of most licensed childcare centres. Most, if not all, of the major decisions your board must make can be analyzed in terms of a trade-off between benefits and costs; the benefit being quality childcare and the cost being affordability. You might find it useful to step back and focus on this objective when the decision making gets stuck.

Clear and honest communication
Clear and honest communication between board members, staff and parents is critical to quality care. In an environment of financial stress the worry of being laid off is always present. If staff do not believe they are receiving clear and honest communication then unrest and dissension can develop. This will raise tension in the centre and may reduce the quality of care provided. Consequently, your board should ensure that lines of communication between the board and the supervisor, and the supervisor and the staff are not only honest and clear but are perceived to be honest and clear by all groups. This is a quality of care issue.

Deal with the significant
When discussing financial plans and necessities in an environment of cost cutting it is crucial that your board focus on the significant. For example, if your monthly cash flow shows you are short a significant amount of cash each month (say $3,000) and cost reduction is the only remedy then you must focus on reducing significant costs. Staff salaries and benefits are generally the only category that even come close to significant levels of expenditure. Focusing the discussion on reducing expenses for play supplies, food or trips will serve only to reduce the quality of care provided and will not resolve the real issue, a cash flow crisis. In short, keep the board focused on significant items and attempt to avoid the trivial.

Consider giving staff responsibility for all expenditure decisions up to annual or monthly amounts approved by the board. This could reduce discussion of a lot of detail at the board level.

Focus on the future
Focus on the future trends and developments and try not to get buried in analyzing the past. Enrolment trends are the most significant indicator of future financial health. Have your board focus on enrolment trends at each meeting. Update your monthly cash flow forecast for the remainder of the year for changes in your estimates and discuss what you need to do in the future to achieve your objectives.

There are many excellent books to provide a starting point for volunteer board members wanting to read more about efficient and effective not-for-profit governance.

In summary, focusing on the overall objective of your childcare centre, ensuring there is an environment of honest and clear communication and focusing on significant items only will help your board run the organization in an efficient and effective manner.