A nonprofit audit is an independent examination of a nonprofit organization’s financial statements and records to ensure compliance. An audit can also provide insight into the organization’s financial health and help identify areas of improvement.
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Nonprofit Audit Guide
Preparing an audit for a nonprofit requires careful planning and consideration of best practices. From establishing goals to reporting findings, there is an organized process that should be followed to ensure accuracy and efficiency when conducting the audit. In this blog post we will discuss the best practices for preparing an audit for a nonprofit organization including gathering necessary documentation, determining scope of the audit, assessing risk and developing a plan for addressing it, undertaking steps to complete the process, and reporting findings from the audit.
What is a nonprofit audit?
A nonprofit audit is an independent examination of a nonprofit organization’s financial statements and records in order to determine whether they are free of material misstatement, accurately reflect the transactions that have occurred, and are in compliance with generally accepted accounting principles (GAAP). Nonprofit audits typically include evaluating internal controls, analyzing financial data, and assessing risks.
Nonprofit financial audits are performed by outside public accounting firms to verify that nonprofits comply with federal tax laws and regulations. The IRS and the nonprofit’s board of directors also use financial audits to ensure that nonprofits are in compliance with all laws, regulations and their governing documents.
An accounting professional examines financial statements to determine whether they conform to accounting standards. Independent audits are performed by a public accounting firm or an individual who is a certified public accountant (CPA).
What is the purpose and goals of a nonprofit audit?
The primary goals of a nonprofit audit are to provide transparency into the operations and financial health of the organization. Additionally, this allows organizations to make informed decisions about how they manage their funds, endeavor to be compliant in their operations, and demonstrate good stewardship of donor funds.
Ultimately, an audit allows the nonprofit to provide financial overviews that are clear, concise and meaningful. This process will help strengthen public confidence in the organization’s financial transparency as well as give members an opportunity to share their feedback. By understanding the goals behind an audit, nonprofits can strive for greater accountability and improved long-term success.
A nonprofit audit evaluates internal controls, analyzes financial data, assesses risks, detects any material misstatements or errors in the financial statements, determines whether the organization is following GAAP guidelines properly, and generates accurate reports that reflect the true state of the organization’s finances. An independent auditor should be able to determine if there have been any irregularities or fraudulent transactions made by management as well as uncover potential opportunities for improvement within the organization’s operations.
Gathering Necessary Documentation for the Audit
Gathering the necessary documentation for a nonprofit audit is an essential part of the process that helps to ensure accuracy and compliance with reporting standards. The steps involved in gathering the required paperwork are fairly straightforward, but they must be followed diligently in order to provide sufficient evidence for the auditor.
- Collect any financial statements or reports used by the nonprofit organization such as income statements, balance sheets and other documents related to the operations of the organization. This information is essential for auditors to gain a comprehensive overview of the financial situation of the nonprofit.
- Gather supporting documentation such as bank account statements, check registers and receipts from purchases or donations made during specific periods. These documents should be organized chronologically and clearly labeled so that auditors can quickly reference them when needed. It’s also important to provide financial statements from preceding years in order for auditors to identify any areas of concern or discrepancies between current year performance and previous year performance.
- Compile all relevant contracts, agreements and records pertaining to employee salary and benefits packages along with donor information, if applicable. All this paperwork needs to be organized neatly in preparation prior to handing over everything to the auditor who will review every document carefully before beginning their work.
Determining the Scope of an Audit
Understanding the scope of a nonprofit audit is an important part of the process to ensure accuracy and compliance with reporting standards. The scope refers to the extent and type of review that will be conducted by the auditor. This can vary greatly depending on the size and complexity of the organization, as well as its financial activities and strategy.
When determining the scope of an audit, it’s important to consider any areas where there could be potential discrepancies or weak points in operations or governance. Auditors must have access to all relevant documents and records related to the finances of the organization, including cash management practices, long-term investments, accounting systems and procedures, internal controls, legal contracts, risk assessment policies and processes.
Goal of Audit
The goal is for auditors to gain a comprehensive understanding of how funds are being used and managed across various departments within the nonprofit organization. By understanding any risks or areas for improvement within each department’s operations, auditors are able to provide meaningful feedback that can help nonprofits improve their overall financial planning and performance.
Once a clear understanding has been reached about what needs to be reviewed during an audit process, auditors can develop a timeline for completion along with budgeting requirements necessary to complete an effective review in accordance with reporting standards. Timely completion is essential for ensuring transparency into the finances of a nonprofit organization while also providing assurance that donors’ funds are being used in accordance with their stated goals and objectives.
Assessing Risk and Developing a Plan
Once all documents and records have been gathered, auditors will conduct an examination to identify any risks posed either internally or externally to the nonprofit organization. These risks could be associated with financial reporting processes, cash management practices or internal control systems. Auditors will then evaluate the potential effects that these risks could have on the accuracy of the financial statements or on compliance with applicable laws and regulations.
Based on their evaluation of these risks, auditors should be able to develop a plan for addressing them in order to minimize any potential impact on the operations of the nonprofit organization. This will involve creating controls or procedures to ensure that corrective action is taken should any issues arise during future audits. In addition, proper documentation should be maintained in case further evidence is needed by auditors at a later date.
By assessing risk carefully and developing a plan for addressing it, nonprofits can help protect against errors or misstatements while also maintaining their reputation with donors who trust them with their donations. Through careful planning and effective risk assessment strategies, organizations are better equipped to deliver accurate financial reports while remaining compliant with all reporting standards.
Do all nonprofits need to have an audit?
An audit is not required for small nonprofits but it is highly recommended because it provides a third-party assessment of the organization’s financial records and practices.
Nonprofit organizations are audited for a number of reasons:
- To ensure that the organization is operating in a legal and ethical manner
- To verify the financial statements are accurate
- To determine if the organization has complied with laws, regulations or its governing
Criteria for nonprofits, public charities, private foundations required to conduct an independent audit:
- Annual gross receipts of more than $500,000 or total assets (net worth) of more than $250,000 at the end of a fiscal year.
- Federal, state and local governments may request a copy of the nonprofit’s audited financial statements.
- Charitable nonprofits who spend $750,000 or more in federal and state funds per year.
- Some contracts with state and local governments to provide community services.
- State requirements may request charitable nonprofits to submit a copy of their audited financial statements when they register with the state for fundraising purposes.
- Private foundations may request a nonprofit to submit a copy of recent audited financial statement(s) when applying for a grant.
Alternatives to Audits
If a nonprofit is exempt from preparing an independent audit, they can opt for less expensive alternatives: such as a review or a compilation. This is much more cost-effective for smaller organizations.
- Review: Certified Public Accountant examines specific financial statements. This is less thorough than a full audit. It does not include a formal written opinion about whether the financials are in accordance with Generally Accepted Accounting Principles (GAAP).
- Compilation: Least expensive alternative. This involves an accountant to assemble financial statements from the information provided by the nonprofit. Financials are not subject to an audit or review. Transactions are not tested or analyzed. No opinion is provided regarding compliance with GAAP.
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When does my charitable organization need an audit?
An audit is not always necessary, but it may be required by law or contract. The Board of Directors should determine which type and frequency of audits to conduct based on the organization’s circumstances.
Audits are not always necessary, but they may be required by law or contract. Nonprofit Organizations may need an audit to fulfill a legal requirement or as part of a contractual agreement. In these cases, the Board should determine which type and frequency of audits to conduct based on the organization’s circumstances.
How long do they anticipate the audit will take?
Nonprofit Audits are often used by donors, grantors and other stakeholders in an organization’s financial health. Nonprofits must provide a minimum of five years’ worth of documentation for the auditor to review. The audit will examine the organization’s financial statements, including income and expenses (including salaries), as well as any other relevant information that may be requested by the auditor.
The length of the audit will depend on the size and complexity of the nonprofit. The average length is three to four weeks, but if a nonprofit has not been audited in several years, it may take longer.
Auditors will also review the organization’s policies and procedures, including its operations and management. They will look at any documentation provided by the nonprofit to ensure that it is accurate and complete.
The auditor will also look at the nonprofit’s financial statements from previous years, if they are available.
The length of time required for an audit will depend on a number of factors including:
- The size and complexity of the nonprofit organization
- The effectiveness of internal control and management systems
- The number and type of transactions being audited
Federal Government Requirements for Nonprofit Audits
Audits are not always required by law, but they are required by the IRS and other governmental agencies. Audits are also required by some donors to make sure their money is being used properly, and they may require a financial audit before any federal funds can be disbursed.
What variables determine length of audit?
- What is your annual budget? What is the total value of your annual budget? (ie. $1,000,000). How much of your total budget was spent on administrative costs and how much was spent on program services? (ie. Program A- $10,000; Program B-$5,000; Program C-$8,000).
- How many employees does the nonprofit have? What are their roles in the organization? (ie. President/CEO, Vice President, Secretary, Program Director, Program A- 1; Program B- 2). Do they receive any compensation for their service to the organization?
- Are you a member of any other organizations that might require an audit? (ie. United Way, etc.)
- How many volunteers do you have? Do they get paid or is it strictly a volunteer position? What are their roles in the organization? (ie. Board- 3; Program A- 2; Program B- 1; Program C- 4).
Additional factors
- What kind of fundraising activities does your nonprofit participate in on an annual basis? These can include:
- How many board members do you have? Do they receive any compensation for their service on the board?
- How many programs do you offer, and what are the costs associated with each program? (ie. Program A- $10,000; Program B-$5,000; Program C-$8,000)
- What is your total revenue for the last fiscal year?
- What is the total value of your assets? (ie. building- $200,000; equipment- $100,000; cash- $50,000)
- What is the total value of your liabilities? (ie. building- $200,000; equipment-$100,000; cash- $50,000)
- What is the total value of your net assets? (ie. building-$200,000; equipment-$100,000; cash-$50,000)
- What is the total value of your endowment?
How much does an audit cost?
Onsite audit fees can cost $20,000 or more for large nonprofits. There is a growing trend for smaller nonprofits to have “remote audits” where the auditors conduct the audit without a site visit. This can reduce fees.
How to reduce audit costs?
Using a fund accounting software system like FastFund Accounting can help your organization improve tracking and compliance with reporting standards requirements. It can also help your organization prepare for your audit, eliminating preparation expenses with an auditor.
Key benefits of using a fund accounting system for nonprofit audit preparation:
- Access to an auditable general ledger system.
- Complete audit trail of transaction changes.
- Generate Audit-ready financials for compliance.
Nonprofit Audit Report
The Financial Accounting Standards Board (FASB) principles require auditors to issue a report to the board of directors, presenting a professional opinion about the nonprofit’s financial practices. It will determine whether the financial statements represent the financial position of the organization without inaccuracies or material misrepresentations.
There are four types of reports:
- Unqualified Opinion – Shows no red flags or misstatements of any financial position.
- Qualified Opinion – Shows the auditors found one or two situations where the organization is not following GAAP. Overall, there are no misstatements of any financial positions.
- Adverse Opinion – Shows auditors found a material misstatement. Overall, the organization is not conforming to GAAP.
- Disclaimer of Opinion – Shows auditors found material misstatements. This can have a serious negative impact on obtaining funding.
What are Nonprofit Audit SAS Standards?
SAS 112 and nonprofit audit standards is an audit that redefines the types of internal control issues that will be reportable.
Nonprofit Audit Standards Pinpoint Internal Control Deficiencies
When the American Institute of Certified Public Accountants released its nonprofit audit standards (Statements of Audit Standards – SAS) in 2006, it has had a profound affect on nonprofit organizations and the software they use for their financial management. In the past, you may have seen the terms “reportable condition” and “material weakness” in your audit reports. The term “reportable condition” will no longer be used. Instead, the term “significant deficiency” will be used. The term “material weakness” will still be used, but its definition has changed.
According to the SAS, a control deficiency exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent or detect misstatements on a timely basis. Control deficiencies are further categorized as deficiencies in design or deficiencies in operation.
What are control deficiencies?
In simple terms, according to the SAS, a control deficiency exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent or detect misstatements on a timely basis. Control deficiencies are further categorized as deficiencies in design or deficiencies in operation.
For example, a deficiency in design exists when a control necessary to meet the control objectives is missing, or an existing control is not properly designed so that even if it operates as designed, the control objective is not always met. Off-the-shelf accounting software does not have the proper internal controls to meet this SAS requirement. For example, in QuickBooks, you can easily change a transaction even if it clears the bank, or is in closed accounting period. This would be classified in your audit report as a significant deficiency.
Deficiency in operations
A deficiency in operation exists when a properly designed control does not operate as designed or when the person performing the control does not possess the necessary authority or qualifications to perform the control effectively. This is a perfect example of the deficiency inherent in off-the-shelf accounting software in their inability to generate financial statements for your audit. Under these new audit guidelines, if your auditor has to create the financial statements for your audit, then it will be reported as a deficiency in operation on your audit report.
What is a material weakness?
A material weakness is a significant deficiency, or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the financial statements will not be prevented or detected.
- A deficiency in design exists when a control necessary to meet the control objectives is missing, or an existing control is not properly designed so that even if it operates as designed, the control objective is not always met. Off-the-shelf accounting software does not have the proper internal controls to meet this SAS requirement. For example, in QuickBooks, you can easily change a transaction even if it clears the bank, or is in closed accounting period. This would be classified in your audit report as a significant deficiency.
- A deficiency in operation exists when a properly designed control does not operate as designed or when the person performing the control does not possess the necessary authority or qualifications to perform the control effectively. This is a perfect example of the deficiency inherent in off-the-shelf accounting software in their inability to generate financial statements for your audit. Under these new audit guidelines, if your auditor has to create the financial statements for your audit, then it will be reported as a deficiency in operation on your audit report.
- A significant deficiency is a control deficiency, or combination of control deficiencies, that adversely affects the entity’s ability to initiate, authorize, record, process, or report financial data reliably in accordance with GAAP such that there is more than a remote likelihood that a misstatement of the entity’s financial statements that is more than inconsequential will not be prevented or detected. Since most reports need to be created outside of the accounting software used by nonprofits, in programs like Excel, there is more of a risk that the audit will report a significant deficiency in their audit report.
Examples of Control Deficiencies
A poorly prepared financial report can lead to incorrect financial information being shared with management or board members and inaccurate reporting to the IRS. This can result in penalties, worse yet material fraud, including misappropriation of funds.
- Financial Risk Management involves implementing procedures to prevent or detect misstatements of the nonprofit’s finances. Here are some examples of control deficiencies and consequences:
- If there aren’t adequate systems in place that can help employees or management prevent or detect misstatements of the nonprofit’s financial position.
- If the same employee opened the mail and logged-in checks received, processed deposits, approved expenses and reconciled bank statements.
- If a nonprofit doesn’t not have staff members capable of preparing financial statements that conform with Generally Accepted Accounting Principles.
Reporting Findings and Recommendations from the Audit
Once these discrepancies or risks have been identified, auditors will then provide their recommendations for addressing them in order to ensure that future operations are compliant with reporting standards. These could include changes to financial reporting procedures, internal control systems, cash management practices or any other areas deemed necessary based on the data that has been reviewed.
Auditors must also provide a detailed report outlining all findings and recommendations so that nonprofits can take appropriate action to address any issues uncovered during the audit process. This allows organizations to remain compliant while also giving donors greater assurance that their funds are being used properly and in accordance with stated goals and objectives.
By clearly articulating the findings of an audit along with recommended corrective action, nonprofits can help ensure transparency into their financials while maintaining their reputation with those who trust them with their donations.
How to prevent audit misstatements by using fund accounting software.
If an organization is using off the shelf accounting software, such as QuickBooks for Nonprofits, it is likely more audit findings will be reportable. The SAS clarifies that the significance of a control deficiency is dependent on the potential for a misstatement, not whether a misstatement actually occurred. Also, the potential misstatement does not have to be a material misstatement; it just has to be “more than inconsequential.” If more findings are reported, you will spend more time correcting and tracking the status of these findings. All of this translates into increased audit fees, the potential for negative reports in your audit and the risk of losing funding from your funding sources.
Using true fund accounting software, like FastFund Online will help to eliminate the potential internal control deficiencies inherent in off-the-shelf accounting software.
FastFund Nonprofit Accounting software includes the following features that are not available in off-the-shelf applications:
- The ability to generate FASB compliant financial statements will benefit your organization by having more real time data available and eliminate the need to report a significant deficiency weakness.
- Internal controls will help eliminate the potential for a significant or material weakness.
- Security functions can create proper segregation of duties.
Schedule a FastFund Online Demo: Learn more about our unique software approach to nonprofit accounting, payroll and fundraising.
Bottom Line
An independent audit reviews financial statements, including your nonprofit’s statement of financial position, related statement of activities, cash flows and notes to the financial statements. With FastFund Accounting, you can generate all the required financial statements. An auditor can examine profit/loss segments so they can easily track expenses back to each donation or grant.
It also gives you the ability to classify net assets (with restrictions or without restrictions) and provide this information to the auditor to determine if restrictions were satisfied. This saves the auditor time reconciling activity.
Another benefit involves grant tracking by funding source, grouping them by state or federal grantors. This is helpful when an auditor requests grant-specific details for generating this information into a report.
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