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August 1991

Auditing museum collections. (Auditing) (column)

by Glazer, Alan S.

    Abstract- The Financial Accounting Standards Board (FASB) has issued an exposure draft (ED) aimed at standardizing accounting methods for works of art, historical treasures and similar assets. The ED details an auditor's responsibilities regarding the audit of financial statements of museums and similar institutions. It states that a museum can only retroactively recognize its collection as an asset if: adequate inventory and accession records exist, purchased and contributed items are appraised properly, and the values of items are reasonable.

Responsibilities Relating to

Contributions and Collections

The AICPA Audit and Accounting Guide, Audits of Certain Nonprofit Organizations, provides examples of procedures the auditor should consider in auditing gifts of "securities, materials, facilities, and other nonmonetary items" and of "collections of works of art and similar items."

With respect to contributed collection items, the suggested procedures include:

* "Obtaining a listing of recorded amounts, including name of donor, type of donation, gross valuation, amount paid in cash (in the case of a bargain purchase), and the net contribution, recorded by source or activity."

* "For other items other than donated securites, obtaining reasonable assurance that the values placed on the donated items are comparable to prices paid for similar items recently acquired, are consistent with appropriate market rates, or are based on a reasonable appraisal or other expert valuation. (See SAS 11, Using the Work of a Specialist.)"

* "Reviewing receiving reports and other evidence supporting the donated items to obtain reasonable assurance that they were properly recorded."

* "With respect to donated collections (such as works of art, books, and botanical specimens), reading the organization's correspondence and any newspaper clippings (the nonprofit organization may keep a file of such items) for gifts of this nature, physically inspecting such gifts, and obtaining reasonable assurance that, if applicable, they have been properly recorded and disclosed."

* "Requesting confirmation from donors regarding the description and quantities of donated items and any restrictions imposed on them."

With respect to collections of works of art and similar items (again, presumably whether recognized as assets or not), the Guide presents examples of auditing procedures that the auditor should consider:

* "Evaluating the procedures for recording accessions and deaccessions and inspecting approvals or acknowledgments to donors of the acquired items."

* "Obtaining reasonable assurance that the valuation basis on the balance sheet is appropriate and that such basis is disclosed."

* "Evaluating the procedures for controlling the collections and for periodically conducting a physical inventory of them. If the value of the collection is included in the financial statements, the auditor should consider observing the physical inventory or otherwise obtaining reasonable assurance that the collections exist."

With regard to the second item, if the collection is not recognized, the appropriate valuation basis would be zero, and the accounting policy note would state that the value of the collection has been excluded from the balance sheet.

If collection items are not recognized as assets or revenues, most of the relevant suggested procedures relate to the museum's controls over collection items and contributions of such items. The objective of performing those procedures when the collection is not recognized is presumably not to obtain evidence to corroborate, directly or indirectly, a recorded amount, because no amount has been recorded. Instead, the objective would appear to be to help the auditor understand the museum's internal control structure. To do this, the auditor may seek evidence that museum management has policies and procedures in place to enable it to meet one of its key responsibilities, namely the safeguarding of the collection, its most valuable economic resource and its raison d'etre.

The relevant authoritative auditing literature, SAS 55 (written after the Guide), requires the auditor to understand the entity's control environment. The necessary understanding of the control environment does not include a requirement to test control procedures that are part of the control environment (or any other control procedures, for that matter), but merely to obtain knowledge about the design of relevant policies, procedures, and records, and whether they have been placed in operation by the entity. What is sometimes referred to as a "transaction review" or "walk-through" of relevant custodial controls would probably be adequate for the auditor to gain the requisite level of knowledge about controls over the collection as part of understanding the control environment.

Additional Responsibilities When

Contributed Collection Items are

Recognized Currently

As indicated, if a museum recognizes contributions of collection items, the auditor should seek assurances that the values used are based on "a reasonable appraisal or other expert valuation." Museum management, not the auditor, has the responsibility to determine the appropriate values. That responsibility may be discharged in many cases by considering the appraised value the donor has used for federal income tax purposes and the related appraiser's certification, together with the expertise of the museum's curatorial staff and, if necessary, outside appraisers retained by the museum.

Such valuations can, of course, do no more than approximate a "true" fair value--what a willing buyer would pay a willing seller in an arm's- length exchange transaction. The fact that valuations are based on estimates, however, need not per se preclude the auditor from issuing a clean opinion. SAS 57, Auditing Accounting Estimates, acknowledges that fair values in nonmonetary exchanges are examples of accounting estimates whose measurements or valuation in the accounts is uncertain, pending the outcome of future events.

Whenever possible, the auditor should seek outside (third-party) corroborative evidence of recorded values. In addition, of course, he or she must obtain assurance that such valuations are provided by individuals who are in fact "experts." Traditionally, when such "expert" valuations are necessary, the auditor seeks evidence that they are within an objectively verifiable range that is sufficiently narrow to support a belief that the total dollar value of the financial statement element results in a materially accurate presentation (i.e., that the financial statements taken as a whole are not materially misstated).

Significant problems may exist concerning the reliability of appraisals of contributed collection items. Accordingly, even if museum management makes a diligent and systematic effort to arrive at an estimated fair value for current contributions of collection items, and even if this is done through an established process involving external experts at one or more stages in the process, the auditor may not be able to obtain the necessary assurance to conclude that the estimated value of current period contributed collection items is reasonable. An inability to obtain the necessary assurance would lead the auditor to conclude that he or she should qualify the opinion or disclaim an opinion because of a scope limitation and should include an explanatory paragraph.

Responsibilities When

Collections are Recognized


If the museum has not recognized its collection as an asset from the date of its founding, the auditor's ability to evaluate the reasonableness of management's estimates of the value of the collection will depend on a combination of: 1) the adequacy of the museum's records of purchased and contributed items; 2) the valuation basis used by management to value the collection at the time it first recognized the collection as an asset; and 3) the procedures used by management to apply the valuation basis chosen. Each of these variables affects the auditor's report and is discussed below.

If purchased acquisitions are valued at their cost, records of those values may exist in archives, in minutes of acquisition committee or trustee meetings, or in accession records. Of course, significant effort may be needed to extract the cost data from those sources, and, in some cases the data may not exist (in which case estimates of fair values would be the only attribute that could be measured).

Contributed items may be valued at their fair value at the time they were donated or bequeathed. Records of the fair value of some or all contributed items, however, may not exist anywhere in the museum's records. In older museums, gifts received may have been valued only for purposes of establishing donor classification, may have occurred before appraised fair values were needed by donors for tax purposes, or may not have been valued through a diligent and systematic process. If original cost or appraised value is the basis of valuation and if the data cannot be found or reconstructed, an audit scope limitation would be present, leading to a qualified opinion or a disclaimer of opinion. If accession or inventory records of the collection itself did not exist or if the auditor could not obtain reasonable assurance that the inventory records were complete (apart from whether the records contained information about values), an additional scope limitation would probably exist because the auditor would likely not be able to obtain assurance about the completeness of the collection recognized on the balance sheet.

The remainder of this discussion on reporting assumes that a museum currently recognizes its acquisitions of contributed items as revenues and its collection as an asset, and that the valuation is based on appraisals, either at the time of contribution or, in the case of items previously not recognized as assets, at the time of initial recognition. In those circumstances, the form of the auditor's report depends on the valuation procedures used by management and the auditor's evaluation of their reasonableness.

If the appraised values for the collection were determined solely by museum curators and other museum employees, this would be equivalent to the collection items being valued at fair value as determined by the board of trustees. The auditor should review the procedures applied to determine whether they are reasonable and inspect the underlying documentation to determine whether it is appropriate. Even if those conditions are present, an inherent uncertainty is likely to exist because the board's estimate of fair value may differ significantly from the value that would have been used had a ready market existed for the collection items or had the appraisal been made by specialists (i.e., appraisers) unrelated to the museum. This situation is analogous, in the authors' opinion, to investment companies and securities broker dealers that hold investments that are not marketable and are therefore valued a fair value as determined by the board of directors. Editors' Note: The editors believe that it would be desirable for the auditing standards division of the AICPA to take a position on the circumstances in which this analogy is appropriate. For example, is the analogy appropriate only when there is no qualified third-party appraiser? In that event, in a manner similar to reports on investment companies and broker dealers as set forth in SOPs 89-1 and 89-2, the auditor should add an explanatory paragraph to the report (which would be unqualified) because of the inherent uncertainty. An example of such paragraph follows.

Example: "As discussed in Note 1 to the financial statements, collection items not readily marketable amounting to $10,730,685 (27% of net assets) as of December 31, 19X1, have been valued at fair value as determined by the Board of Trustees. We have reviewed the procedures applied by the trustees in valuing those items and have inspected underlying documentation, and in the circumstances, we believe the procedures are reasonable and the documentation appropriate. However, because of the inherent uncertainty of valuation, the Board of Trustees' estimate of fair values may differ significantly from the values that would have been used had a ready market existed for the collection items or had their value been determined by appraisers not employed by and otherwise independent of the museum, and the differences could be material."

If the auditor concluded that the procedures used were not adequate or reasonable or the documentation did not support the valuation, he or she might need to qualify the audit report because of a departure from GAAP.

Only if outside specialists provided the basis for the appraised values (with or without consultation with the museum's curatorial and other staff0 and the auditor is satisfied concerning the professional qualifications and repulation of the specialists and had determined that the specialists' findings are sufficiently reliable to support the representations in the financial statements, will the auditor not be precluded from expressing a standard, unqualified from expressing a standard, unqualified opinion without any explanatory language. An inability to obtain the necessary satisfaction would lead the auditor to conclude that he or she should qualify the opinion or disclaim an opinion because of a scope limitation.

Scope Limitations and

Uncertainty Modifications May Be

Quite Common

In summary, a museum that retroactively recognized its collection as an asset could receive a standard, unqualified audit report without any explanatory paragraph only if: 1) adequate accession and inventory records existed; 2) purchased items were valued at cost (or at current fair value if cost was not available); 3) contributed items (and purchased items for which records of cost did not exist) were valued based on reliable, externally generated data, such as appraisals by qualified appraisers not on the museum's staff; and 4) the auditor could obtain the necessary assurance that those values were reasonable. This may be the likely outcome for some museums, particularly newer ones with well-designed and effectively operating information systems.

Our review, however, of the information systems of older museums, of the costs associated with retaining independent appraisers to estimate collection values, and of the reliability of the values assigned by those appraisers suggests that in many cases the auditor may be faced with a scope limitation (as a result of a museum's inadequate records of values of purchased or contributed items or because the auditor cannot establish the reasonableness of the appraiser's estimates of fair value) or may have to acknowledge in an explanatory paragraph the uncertainty of the value assigned to the collection (as a result of a museum's failure to include outside appraisers in the valuation process for contributed items).

By Henry R. Jaenicke, PhD, CPA, Drexel University, Philadelphia, and Alan S. Glazer, PhD, CPA, Franklin and Marshall College, Lancaster, Pennsylvania

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