Nonprofit auditing and compliance are essential to check and ensure that the organization meets the requirements to be tax-exempt.
The US federal and state governments exempt charitable organizations from annual taxes; however, their guidelines might differ. This allows the non-profit organization to spend that amount on the public welfare.
Although your non-profit organization might not be required to pay taxes, and thus the IRS might have no interest in conducting an audit.
However, other organizations and entities might want an audit, making your organization prone to external audits.
This can be done to check whether your organization is actually following the tax-exempt regulations. Therefore, such organizations should always keep nonprofit auditing and compliance in mind.
Purpose of a Non-Profit Audit
The main goal of a nonprofit audit is to provide a transparent insight into the financial operations of the company. The audit aims to evaluate the correctness of the financial records and form an opinion on the finances of the company.
Moreover, an audit helps the organization make informed business decisions to manage funds and utilize resources to serve its mission better.
With the help of an audit, the NPO can present a transparent and credible view of its finances and help build public confidence in the organization.
A nonprofit requires an internal audit to work with greater accountability and also be ready for an external audit.
Benefits of Nonprofit Audits
Here are the salient ways a nonprofit audit helps the organization.
The nonprofit audit –
- Confirms the accuracy and correctness of the financial statement and financial health
- Assures whether the organization complies with legal guidelines and regulations
- Identifies the errors and irregularities in the financial record and accounting practices.
- Builds the confidence of the investors, donors, and authorities in the organization.
- Spot the risks and allow the organization to manage them before they become a big problem.
- Inspires the staff and employees to work ethically and expect regular audits.
Therefore, we have put together a nonprofit auditing and compliance guide to help you make informed decisions and prepare for external audits.
Before we begin with nonprofit auditing and compliance, let us see different types of audits.
Different Types of Nonprofit Audit
To get started, there are two critical things one should have a sound understanding of in this context – audit and the types of audits.
Audit means the examination of financial operations, records, and statements by an authority, certified firms, or certified accountants.
A nonprofit audit can be of different types, such as:
- External Audit
- Financial Audit
- Compliance Audit
- Operational Audit
- Internal Audit
- Independent Audit
What is an Independent Audit?
An independent audit is an examination by an external body of the accounts, financial records, accounting practices, internal controls, and transactions of the nonprofit organization.
It is conducted by a licensed, certified firm or a certified public accountant not employed by the nonprofit organization in question. Instead, the auditor is hired for the service and is an external body independent of the nonprofit organization.
Although these regulations are not laws but guidance, they are essential. Therefore, if the accounting and financial practices of the nonprofit organization deviate from GAAP, the auditor must mention that in the report.
Understanding the Audit Report
This section of the nonprofit auditing and compliance guide explores the different types of reports.
There are four types of reports an auditor may issue: unqualified opinion, qualified opinion, adverse opinion, and disclaimer of opinion.
The unqualified opinion independent auditor issues state that the financial statements of the organization are fairly presented. An unqualified opinion is what a business or nonprofit organization hopes to receive.
The auditor issues a qualified opinion when the organization follows generally accepted accounting principles in most cases, but not entirely. A qualified opinion means that there are no material misstatements of financial positions.
However, adverse opinion means there are material misstatements of financial positions, or the organization is not following GAAP.
Disclaimer of Opinion
The last kind of report is a disclaimer of opinion, which means something prevented the auditor from forming an opinion; therefore, they refuse to do so.
It is not suitable for the financial health or reputation of a company to receive an adverse opinion or a disclaimer of opinion.
Core Elements of a Nonprofit Audit
There are two reasons why a business owner, accountant, or management should be aware of the core elements of nonprofit auditing and compliance.
One, knowing what constitutes an audit will help you to design, carry out, and supervise the audit. Secondly, having proficiency in audits will help you support and prepare your organization during an external audit.
Let us look at the critical elements involved in nonprofit audits.
1. Financial Statements
The core purpose of the audit is the evaluation and assessment of the financial statements.
This includes analysis of financial statements such as cash flow statements, balance sheets, income statements, and statements of changes in net assets.
The analysis produces an in-depth report on the financial health of the company and elaborates its current position.
Moreover, the auditor checks whether the financial operations and statements abide by generally accepted accounting principles.
2. Internal Controls
An organization utilizes internal controls to ensure accurate financial reporting, prevent fraud, and safeguard assets. In most of the instances, the controller or chief financial officer is in charge of establishing and monitoring the internal controls.
The processes that come in internal controls include financial reporting protocols and cash handling procedures.
The auditor evaluates the strength of these internal controls and identifies any scope for improvement.
The audit report highlights the weaknesses and significant deficiencies in the internal controls if it finds any. This allows the organization to strengthen its internal control by taking corrective measures.
Nonprofit organizations must abide by several laws and regulations, such as reporting regulations, donor restrictions, and tax laws.
The goal of the audit is to ensure that the organization follows these regulations and reduces legal risks.
4. Scope of the Audit
Before the audit is conducted, the auditor must establish a clear purpose of the scope of the audit. The scope of the audit must clearly outline the aim of the objective and the areas to examine.
5. Fund Management
Many nonprofit organizations operate on donor funds that come with guidelines on how to use these funds.
The donor often elaborates on their intentions for the fund’s use and restrictions, if any. The audit studies the allocation and management of the fund and checks if there’s a violation of the donor’s restrictions.
6. Programmatic Evaluation
Nonprofit organizations exist to serve a purpose – which is to bring positive changes to the society. Therefore, their operations and programs should be efficient and effective.
The programmatic evaluation reviews the goals, performance metrics, and effectiveness of the programs.
This helps the organization, investors, authorities, and the public know how effectively the organization uses its resources.
How to Conduct an Independent Nonprofit Audit
Although every nonprofit organization needs audits, most of them rarely conduct them. This is because of the higher cost and difficulties associated with the audit.
Finding the right auditor is not easy, especially for smaller nonprofit organizations operating with low budgets.
The steps below will help you take a professional approach to conducting nonprofit auditing and compliance checks.
1. Selecting the Right Auditor
The cost of the independent audit might vary on various factors, such as the business industry and region and the business size of the organization.
Therefore, you should start by selecting an auditor whose audit fees fit your budget. The auditor should provide rich quality auditing and a good value for money.
2. Signing the Engagement Letter
The engagement letter elaborates on the cost and terms of the nonprofit audit and timeline. The auditor is generally the one providing the engagement letter.
3. Preparing for the Audit
Once the audit is scheduled, the NPO should begin the preparation work. The independent auditor would send a list of documents and information they require for the audit.
The organization needs to get this information ready, which might include payroll documents, financial statements, bank reconciliations, and investments or grants.
An organization should ensure that prior to the audit, they carry out all the bank reconciliations, review uncleared transactions, ensure non-negative or zero balances of vendors, deposit large funds, and double-check statements.
Moreover, it should also check for outstanding payments from the patrons or members and review accounts receivable and payable, and capitalization.
4. Conducting the Audit
The auditor will conduct the audit as per the scheduled timeline and review all the financial documents and information.
The auditor will assess the financial records, internal controls, compliance, and risks and interview the staff members and stakeholders.
Once done, the auditor will provide the organization with the report of the audit highlighting the issues or discrepancies they find.
5. Implement the Suggestions
The organization should review the report and identify the areas where it can improve. It should implement any suggestions offered by the auditor to improve and grow.
The above guide on nonprofit auditing and compliance will help you prepare for conducting an audit. The guide shall also help your organization during the external audit.
An organization needs to ensure that its everyday bookkeeping and financial operations are accurate and efficient. This is important for the sound financial health of the organization. If you are not confident about the effectiveness of your accounting and financial operations, consider delegating to professionals like us.
Dial +1(800) 580-5375 and contact our certified accountant to take a free consultation and explore our services at no cost.