Nonprofits are subject to a great deal of accountability. Donors want to make sure their funds are used as intended. Grantors have reporting requirements. Grants can also come with audit requirements. This means that nonprofits may be required to or may choose to have audits.
Financial Statement Audit
A financial statement audit by a CPA provides strong assurance that the financial statements are materially accurate. This is important because donors and grantors often rely on these statements when making funding decisions.
In addition to the financial statements with a full set of disclosures and an opinion on those statements, the auditors provide other very useful information.
It’s important that the full board understands the scope of a financial statement audit. Some believe that it is primarily looking to make sure there is no fraud or that it covers operations. This is not true. The auditors, the audit committee chair, or a similar person can educate the board on the scope and purpose of the audit.
An excellent tool for this education that also contains other valuable information is the governance letter. This letter states:
- The scope of the audit
- Significant risks identified by the auditors
- Significant accounting estimates
- Disagreements with management or difficulties encountered
- Significant unusual transactions
- Adjustments made during the audits
An internal control letter is issued by auditors when they find internal control deficiencies. When It’s never fun to discover you have a material weakness or significant deficiency in your internal controls, but it’s better to find out from your CPA than to have a poor control environment that leads to an incident that causes significant losses or damages your reputation with funders.
A management letter from the auditors has many ideas for ways to improve financial processes at the organization. In addition, the board or audit committee should ask auditors for their ideas and suggestions. CPAs are a wealth of financial and business knowledge.
Is a Financial Statement Audit Required?
A big question for a board is determining whether a financial statement audit is required. An excellent resource to help answer that question is the State Law Nonprofit Audit Requirements page of the National Council of Nonprofits at https://www.councilofnonprofits.org/running-nonprofit/nonprofit-audit-guidec/state-law-nonprofit-audit-requirements. The link to this is also in the resources document provided with this course. The web page outlines the audit requirements of each of the fifty states with links to relevant statutes.
Here are times when an audit is required:
- Some private foundations require audits.
- It’s good to check guidance from all grants.
- Some states require audits when an organization receives grants above a certain threshold.
- Some state contracts require an audit.
- Many states require nonprofits to submit audited financial statements as part of their charitable solicitation registration.
- Organizations that receive more than $1 million in federal funds in a year are required to have an independent audit. This is part of a single audit, which I’ll soon explain.
Why Wouldn’t an Organization Get a Financial Statement Audit?
A full financial statement audit can be expensive for small organizations. It’s also a significant time commitment. This is why some nonprofit boards choose to have a review or agreed-upon procedures performed instead of an audit. I’ll discuss these options later in this lesson.
What are Some Benefits of a Financial Statement Audit?
Some board and staff members may think that a financial statement audit is a massive waste of money, but it can come with many benefits. These include:
- Having an audit allows donors and grantors to better trust your financial statements. This may lead to more funding. As noted earlier, some funding sources may require an audit. Lenders may require an audit or may be more likely to make a loan if the organization has audited financials.
- The report, including the footnotes, is very educational to potential donors and the board of directors. It’s a good tool to help new board members understand the organization.
- Audits aren’t primarily designed to detect fraud, but the testing may uncover fraud or inadvertent errors.
- Having an audit also prevents fraud and errors. Those people who contemplate fraud will be less likely to act on that impulse if they know auditors will be looking through the records. Staff also put more effort into procedures when they know their work will be checked.
- I noted earlier that the governance letter and management letter can both be helpful. The CPA may make suggestions to strengthen the internal controls. Implementing the observations and suggestions helps the nonprofit improve.
- The nonprofit’s staff and board of directors can tap into the expertise of the CPAs. These CPAs often work with other nonprofit clients. They have a vast knowledge of the industry and industry best practices. They can provide their thoughts on software, processes, and management practices.
The Single Audit
Single audits are required by the federal government for nonprofits that receive $1 million or more of federal grants in a fiscal year. It’s called a “single audit” because it rolls multiple compliance audits into one audit. A nonprofit with multiple federal grants will receive one audit and report for all the grants.
The audits report whether:
- The nonprofit’s financial statements are presented fairly and accurately in accordance with federal cost principles.
- The organization has an adequate internal control structure.
- The nonprofit complied with regulations and laws applicable to federal funding.
These audits are also sometimes referred to as “yellow book” audits. The Yellow Book is the name for generally accepted government auditing standards (GAGAS). Fun fact: The Government Accountability Office originally wanted the book of these standards to have a gold cover to match the working title for the standards, which was “The Golden Rule of Accounting.” The Comptroller General thought that was too presumptuous, so it was instead called the Yellow Book with a yellow cover.
Financial Statement Review
Some boards may not be able to justify the commitment of a financial statement audit but still want someone to look at their financial statements. A financial statement review may be an option in this scenario.
A review is less comprehensive than an audit and thus cannot give the same level of assurance that the financial statements are correct. The CPA does not have to understand the internal control system or test transactions. The interaction with the CPAs still provides some of the education benefits I listed for audits. However, the CPA will have much less insight into the company and its processes.
Agreed-Upon Procedures
A board may only want certain processes tested. They don’t want to pay for assurance of the financial statements and testing of all systems. Agreed-upon procedures allow a board to contract a CPA to do this limited testing.
I was the treasurer of a church board. The church didn’t have a review or an audit, but the board was interested in some testing to make sure some processes, like donation handling and expenditure processing, had good controls. Our denomination had an excellent treasurer’s guide with a large set of testing procedures for church boards to consider. We used a CPA to conduct these procedures.
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