Does My Nonprofit Need an Audit?

Whereas, a financial statement audit is an independent examination performed by a certified public accountant (CPA), to ascertain whether in the auditor’s professional opinion, the organization’s financial statements fairly represent its financial position, activities, functional expenses and cash flows in accordance with generally accepted accounting principles (GAAP).

One common misconception is that the purpose of an audit is to detect fraud. While an auditor is required to assess those financial areas where the risk of material misstatements and fraud might occur in planning and performing the audit, the objective of an audit is not to provide a guarantee that fraud has not occurred within the organization. Rather, the outcome of an audit is to provide, in the auditor’s judgement, whether or not the organization’s financial statements are fairly presented in all material aspects in accordance with GAAP. Receipt of an unmodified audit opinion, or a “clean bill of health from an auditor,” lets the financial statement user know the organization is keeping its books in a responsible manner and reporting appropriately.

Are all nonprofits required to conduct an audit?

Not all nonprofit organizations are required to conduct an audit. However, certain circumstances may trigger a requirement for the independent audit of an organization. These include the following:

• Federal, state, and local governments may require the organization to submit copies of its audited financial statements for regulatory reporting purposes.
• Nonprofits that expend more than $750,000 in federal funds in a year are required to conduct a financial statement audit and subject to the additional audit requirements of the Uniform Guidance promulgated by the Office of Management and Budget (OMB).
• Some service contracts with state and local governments may require a nonprofit to conduct an independent audit.
• State law may require a charitable organization to submit a copy of its audited financial statements when they register for charitable solicitation and fundraising purposes.
• Private foundations may request that a nonprofit submit a copy of its most recent audited financial statements in conjunction with submitting a grant proposal.
• Banks may require a nonprofit to have an audit as a condition of receiving a loan.

Why would a nonprofit consider conducting an audit if an audit is not required?

• To provide transparency and assurance to donors and other stakeholders that the nonprofit’s financial practices are sound and its adherence to acceptable financial practices.
• For use in applying for grants and funding from nongovernmental sources like public and private foundations.
• To respond to nonprofit “watch dogs” like GuideStar and Charity Navigator.
• The organization’s Board requires an audit as a component of its due diligence and governance practices.

Why would a nonprofit choose not to have an audit?

Nonprofits often have limited resources and audits can be a significant expense for an organization. For small organizations (under $1 million in annual revenue) the audit may cost thousands of dollars in professional fees (excluding the internal cost of staff time preparing for and working with the auditors).

If audit costs are prohibitive, there are other ways an organization can provide some limited assurance to stakeholders about its financial sustainability and commitment to transparency in financial matters. One alternative would be to conduct a financial statement review or compilation rather than an audit.

What’s the difference?

There are several differences between an audit, a review, and compilation. A compilation requires the accountant to present financial statements, with or without disclosures, based on the representations made by management, with no effort to verify this information. While the accountant is not providing assurance on the financial statements to stakeholders, if the organization shares this information publicly it may demonstrate the organization’s desire to be transparent.

In a review engagement, the accountant performs analytical procedures and inquires of organization management personnel to determine whether the information contained within the financial statements is reasonable. The accountant will analyze financial trends and past results to those of the current year, the reasonableness of management’s responses to inquiries, financial ratios and other support to provide limited assurance the financial statements do not require material modifications.

Comparatively, in performing an audit, the auditor must corroborate the ending balances in the client’s accounts and disclosures. This requires an examination of source documents to support transactions, confirmations with third parties, physical inspections of capital and other tangible assets, certain procedures on internal financial controls, and other procedures as deem necessary by the auditor.

I strongly recommend an organization seek assistance from its accounting firm when evaluating your organization’s need for an audit.

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