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What you should know about independent audits
Financial health is crucial to a nonprofit’s success. And making a nonprofit's financial results public is a key to the transparency required of many nonprofits today. Although preparing financial statements is the organization’s responsibility, an independent audit of those statements can give granting agencies, donors and others confidence that the financial statements are presented fairly in all material respects.
Types of independent audits
There are many kinds of audits, including those conducted by state agencies, the Internal Revenue Service and lenders. Here we will focus on audits of financial statements performed by independent CPA firms.
There are two types of independent audits. The most common is performed under Generally Accepted Auditing Standards (GAAS). The rules for GAAS audits not only include the testing of account balances such as cash, payables, revenues and expenses, but also require a consideration of fraud risk and an understanding of internal controls.
Organizations that receive a significant amount of government funding also might be required to have a compliance audit performed under Generally Accepted Government Auditing Standards and OMB Circular A-133. Currently, this is required when the organization expends more than $500,000 in federal awards.
Reasons for an independent audit
Many states require Section 501(c)(3) organizations to have independent audits if they exceed legally defined amounts of revenue or specified levels of contributions. Depending on the state, these thresholds can range from $100,000 to $2 million. Organizations not exceeding state limits may still be required to undergo an audit for a specific grant or funder or at the request of the board of directors.
When an organization has its financial statements audited, it receives an opinion on the statements and, if significant internal control deficiencies are found during the audit, a letter explaining those deficiencies. Your auditors are required to understand how your internal controls were designed and whether they’re being used appropriately. Additionally, they can suggest ways to improve existing controls and specific measures to implement. It’s then your responsibility to act on their recommendations.
Alternatives to the GAAS audit
An organization that isn’t required to be audited may nonetheless seek assurance about its financial statements and accounting controls. But if cost is an issue, there are alternatives to an independent GAAS audit. A nonprofit may, for example, decide at the request of its finance committee or the board of directors to conduct some testing internally to review the support for financial transactions performed by management.
The nonprofit might also decide to engage an independent CPA firm to perform an Agreed-Upon Procedures engagement (AUP). In an AUP engagement, the not-for-profit and the CPA firm agree in advance on specific procedures, such as a review of all checks written over a specified dollar amount or a test of the controls surrounding transactions during a two-month period. The CPA firm reports the findings in a formal letter.
Reviews and compilations are other alternatives to an audit of the financial statements under GAAS. See the sidebar "If you can’t afford an audit . . . ."
Your first step
For help in determining what type of audit you’ll need, ask your accounting professional. Also consult with granting agencies to determine which level of service they will require.
If you can’t afford an audit . . .
For organizations that can’t afford a Generally Accepted Auditing Standards (GAAS) audit of their financial statements but still want the input of an independent accounting firm, there are two other levels of service to consider:
Reviews - In a review, an independent CPA firm obtains the not-for-profit’s financial statements, performs inquiries of management and certain analyses, including (but not limited to) tests of revenue and expense change, functional expense percentages and liquidity, to determine whether the financial statements reflect expected results. The financial statements are provided along with the independent accountant’s review report.
Compilations - In a compilation, the CPA provides no tests or analysis but assists management in presenting financial information in a format consistent with Generally Accepted Accounting Principles. A report attached to the financial statements explains that they were compiled from client records but not audited or reviewed.
Both reviews and compilations allow for input from an outside CPA firm at a lower cost. While evaluation of internal controls is a required audit procedure, you may not receive any suggestions for improvement in controls with these levels of service.