The dreaded scarlet letter for many nonprofits is A, for audit. We dread it because we’ve been told an audit is expensive, time-consuming for staff, and invasive.
So, when does a nonprofit really need an audit? My best recommendation is to plan for an audit when your organization has an annual operating budget of $1,000,000 or more. I also suggest that you shop around. Accounting firms are not all alike. You may also consider a bi-annually audit.
Foundation funding is why most of us go through the audit experience, but it’s always a good idea to ask if they will accept a review or compilation.
Here are two examples of when you must have an audit:
Federal funds
If your organization expends $750,000 or more in federal funds in a single year, then you need an audit.
State funds
26 states require audited financial statements from nonprofits that want to raise funds in those states. Texas has no requirement for an independent audit.
Just to be absolutely clear, here are some simple definitions:
Audit - the auditor must corroborate the ending balances in the client's accounts and disclosures. This calls for the examination of source documents, third party confirmations, physical inspections, tests of internal controls, and other procedures as needed.
Review - the auditor conducts analytical procedures and makes inquiries to ascertain whether the information contained within the financial statements is correct. The result is a limited level of assurance that the financial statements being presented do not require any material modifications.
Compilation - requires the auditor to simply present financial statements based on the representations made by management, with no effort to verify this information.
Other considerations
Level of assurance - The level of assurance that the financial statements of a client are fairly presented is at its highest for an audit and at its lowest (none at all) for a compilation, with a review somewhere in between.
Reliance on management - In all three cases, the auditor begins with the account balances provided by management, but an audit requires a significant amount of corroboration of this information. A review requires some testing of the information, while a compilation almost entirely relies on the presented information.
Understanding of internal control - The auditor only tests the internal controls of the client in an audit; no testing is conducted for a review or a compilation.
Work performed - An audit requires a significant number of hours to complete, since there are many audit procedures to be performed. A review requires substantially fewer hours, while the effort associated with a compilation is relatively minor.
- An audit requires vastly more effort for an auditor to complete so audits are much more expensive than a review, which in turn is more expensive than a compilation.
An audit or other financial review is a best practice for your nonprofit organization to follow. Keep in mind that an outside evaluation demonstrates fiscal transparency for your organization and protects your reputation.
Cheers,
Michelle Crim, CFRE
Dynamic Development Strategies can help. We offer coaching and fundraising services for our nonprofit clients. We specialize in startup and smaller nonprofits because we understand your challenges. Please contact us for more information.