Ultimate Guide to Understanding a Non-profit Audit
In many states non-profit organizations are required by law to be audited at various times. Understanding a financial statement audit of a not-for profit is relatively simple when you have the right person guiding you through the process.
This post seeks to provide you with the knowledge you need to survive an audit of your non-profit. Whether you have been with the organization for 10 years or 10 weeks, everything you need to know is here.
Format of this article:
- What is a Non-Profit Audit?
- Why does a Not-for-Profit need a Financial Statement Audit?
- How much does an audit of a non-Profit Cost?
- Who Audits a not-for-Profit Organization?
- What is the Difference Between a Non-profit Audit and a Financial Statement Review?
- What are the stages of a Non-Profit Financial Statement Audit?
- Planning and Risk Assessment
- General Procedures
- The Audit Process
A non-profit financial statement audit is an examination of a Not-for-Profit organization’s financial statements, and related operations, by an independent auditor. The purpose of the audit is to provide assurance to stakeholders, such as donors, grantors, and the public, that the organization’s financial statements are presented fairly and in accordance with applicable accounting standards.
The key elements involved in a non-profit financial statement audit:
The primary focus of the audit is on the organization’s financial statements, which typically include the statement of financial position, statement of activities, statement of cash flows, statement of functional expenses, and notes to the financial statements.
The auditor assesses whether the non-profit organization has complied with relevant accounting principles and financial reporting standards. Compliance may also extend to specific laws and regulations applicable to non-profit entities.
The auditor evaluates the organization’s internal controls over financial reporting. Internal controls are processes and procedures designed to ensure the accuracy and reliability of financial information and safeguard assets.
At the conclusion of the audit, the auditor issues an audit opinion expressing their professional judgment regarding the fairness of the presentation of the financial statements.
The audit findings and the opinion are summarized in the auditor’s report, which is included in the non-profit’s financial statements. This report provides transparency and confidence to stakeholders about the accuracy and reliability of financial information.
Communication with Stakeholders:
The results of the audit are typically communicated to the board of directors, management, and other relevant stakeholders. This communication may include recommendations for improving financial management and internal controls.
A not-for-profit organization may choose to undergo a financial statement audit for several reasons, and these reasons often revolve around accountability, transparency, and the need to demonstrate fiscal responsibility to stakeholders.
Here are some key reasons why a not-for-profit might opt for a financial statement audit:
Credibility and Trust:
An audited financial statement provides an independent and objective assessment of the organization’s financial health. This can enhance credibility and build trust with donors, grantors, volunteers, and the general public.
Many not-for-profits are subject to state specific regulations and accounting standards. An audit ensures that the organization is in compliance with these standards and any legal requirements governing financial reporting for non-profits.
Donors and grantors may feel more confident in supporting an organization that undergoes regular financial audits. Knowing that an independent third party has reviewed the financial statements can reassure stakeholders about the organization’s fiscal responsibility.
Some grants and funding sources require not-for-profits to undergo a financial statement audit as a condition for receiving funds. This is especially common for larger grants or government funding.
The board of directors of a not-for-profit organization has a fiduciary responsibility to oversee the organization’s finances. An audit provides the board with an independent assessment of the financial management practices and internal controls in place.
Transparency and Accountability:
Transparency is a crucial element for not-for-profits. An audited financial statement demonstrates a commitment to openness and accountability, showing that the organization is willing to be held to a high standard in its financial reporting.
The cost of an audit for a non-profit organization can vary widely based on several factors. These factors include the size and complexity of the organization, the scope of the audit, the level of detail required, and the specific requirements of the funding sources or regulatory bodies involved.
Here are some key factors that can influence the cost of a non-profit audit:
Size and Complexity:
Larger and more complex non-profit organizations typically require more extensive audit procedures, which can contribute to higher costs. The number of transactions, the diversity of revenue sources, and the complexity of the financial structure all play a role.
Scope of the Audit:
The scope of the audit refers to the depth and breadth of the examination. A full-scope audit that covers all financial statements and related activities will generally be more expensive than a limited-scope audit focused on specific areas.
Audit Firm and Location:
The choice of audit firm and its location can influence costs. Larger, more established audit firms may charge higher fees, and costs can vary based on geographic location due to differences in labor rates and overhead expenses.
Frequency of Audits:
Some non-profits undergo audits annually, while others may opt for less frequent audits, such as every two or three years. More frequent audits may be associated with lower costs per audit due to increased familiarity with the organization.
Preparation by the Non-Profit:
The extent to which the non-profit is prepared for the audit can affect costs. Well-organized financial records and documentation can streamline the audit process and potentially reduce fees.
It’s important for non-profit organizations to obtain quotes from several audit firms, considering their specific circumstances and needs. The cost of an audit is an investment in the organization’s credibility, transparency, and financial integrity. Small, localized organizations are generally between $5,000 and $10,000.
Not-for-profit organizations typically engage independent certified public accountants (CPAs) or auditing firms to conduct audits. Here are the key entities or individuals involved in the audit process for a not-for-profit organization:
External Audit Firms:
Many not-for-profits hire external audit firms to conduct their financial statement audits. These firms employ certified public accountants (CPAs) who are trained and qualified to perform audits.
Certified Public Accountants (CPAs):
CPAs are accounting professionals who have met specific education and experience requirements and have passed the Uniform CPA Exam. CPAs can work for audit firms or as independent practitioners, and they play a crucial role in conducting financial audits for not-for-profit organizations.
Many not-for-profits have audit committees, which are subcommittees of their boards of directors. The audit committee oversees the organization’s financial reporting process, internal controls, and interactions with the external auditors.
Some larger not-for-profit organizations may have internal audit functions. Internal auditors are employed by the organization and focus on assessing and improving internal controls, risk management, and operational efficiency.
Board of Directors:
The board of directors is ultimately responsible for overseeing the financial management of the not-for-profit organization. The board may be involved in the selection of the external audit firm, and the audit findings are usually presented to the board for review and approval.
Regulatory Bodies and Funding Sources:
Some not-for-profits may be subject to specific regulatory requirements or receive funding from sources that mandate financial audits as a condition for funding. In such cases, the regulatory bodies or funding sources may specify the qualifications and independence requirements for the auditors.
Both non-profit audits and financial statement reviews are types of engagements conducted by independent accounting professionals, but they differ in terms of scope, level of assurance provided, and the procedures involved. Here are the key differences between a non-profit audit and a financial statement review:
Level of Assurance:
An audit provides the highest level of assurance. The auditor expresses an opinion on whether the financial statements are presented fairly in all material respects, in accordance with the applicable financial reporting framework. The audit involves a comprehensive examination of financial statements and supporting documentation.
A financial statement review provides a moderate level of assurance. The reviewer performs analytical procedures and inquiries to obtain limited assurance that there are no material modifications needed for the financial statements to be in accordance with the applicable financial reporting framework.
In an audit, the auditor conducts a thorough examination of financial statements, including testing of transactions, verification of account balances, assessment of internal controls, and other procedures as necessary. The auditor also considers the risk of material misstatement due to fraud or error.
In a review, the accountant performs analytical procedures and inquiries. However, the procedures are generally not as extensive as in an audit. The reviewer focuses on identifying any unusual trends or significant fluctuations that may indicate the need for further investigation.
The scope of an audit is broader, covering a wide range of financial statement elements and often extending to the assessment of internal controls. The auditor provides an opinion on the fair presentation of the financial statements as a whole.
The scope of a review is narrower compared to an audit. The accountant provides limited assurance on specific aspects of the financial statements, but the level of detail and testing is not as comprehensive.
Documentation and Reporting:
Auditors are required to provide a detailed report that includes the scope of the audit, the procedures performed, and the results of those procedures. The report also includes the auditor’s opinion on the financial statements.
The reviewer issues a report expressing limited assurance on whether the financial statements are free from material misstatements. However, the report is less detailed than an audit report.
Engagement Letter and Retainer
The financial statement review engagement letter is designed to spell out the who, what and how of the review. It generally contains five parts: the introduction, the CPA responsibilities, the company responsibilities, the report, and other matters. Like any contract it is a binding legal agreement if properly prepared.
The introduction sets out what will be done. It’s where the CPA explains that a financial statement review will be performed. It also provides the time frame that is being reviewed.
“Our Responsibilities” sets out the CPAs responsibilities during the audit. This is where the auditor spells out that financial statements will be prepared and audited following specific guidelines.
The nest section is titled, Your Responsibilities. The company has to state they will comply with suitor requests and provide the necessary information to perform the audit.
The next section discusses the report that will be issued with the financial statements. It also explains that the CPA does not assure that a clean (unmodified) report will be issued. It also provides an out if the CPA feels they need to withdraw from the engagement. Last it specifies what the company can and can’t do with the financials.
Last, the CPA inserts the cost for services as well as charges for ancillary services like photocopying and other side items. They can also add legal things like how disputes are handled. Pretty much anything not covered above can be inserted here. A retainer is often required before work begins. Generally, retainers are in the range of 25% of the total.
Planning and risk assessment are critical phases in the audit process. They lay the foundation for the entire audit engagement, guiding auditors in understanding the client’s business environment, identifying potential risks, and developing an effective audit strategy. Here’s an overview of planning and risk assessment in an audit:
Understanding the Client’s Business and Environment:
Auditors begin by gaining a thorough understanding of the client’s business operations, industry, and regulatory environment. This includes understanding the organization’s mission, objectives, internal controls, and the external factors that may affect its financial statements.
Client Acceptance and Continuance:
Before accepting or continuing an audit engagement, auditors assess the client’s integrity, independence, and the risks associated with the engagement. They may consider factors such as management’s competence, the integrity of financial reporting, and any potential conflicts of interest.
Engagement Team Selection:
The audit team is assembled based on the complexity of the engagement, the required expertise, and the specific risks associated with the client. This includes assigning roles and responsibilities to team members.
Preliminary Risk Assessment:
Auditors perform an initial assessment of the risk of material misstatement in the financial statements. This involves considering inherent risks (risks related to the nature of the client’s business and industry), control risks (risks related to the effectiveness of internal controls), and detection risks (risks related to the auditor’s ability to detect errors or fraud).
Auditors identify and assess risks that may result in material misstatements in the financial statements. These risks can include fraud, errors, technological changes, changes in regulations, and economic conditions.
Auditors establish materiality thresholds, which are the levels at which misstatements in the financial statements would be considered significant. Materiality is a key factor in determining the extent of audit procedures.
Understanding Internal Controls:
Auditors evaluate the design and implementation of the client’s internal controls relevant to financial reporting. This understanding helps in assessing control risk and determining the nature, timing, and extent of substantive procedures.
Assessment of Fraud Risk:
Auditors assess the risk of fraud, including the risk of management override of controls. This involves considering factors such as the integrity of management, the presence of opportunities for fraud, and any incentives or pressures that may exist.
Documentation of Planning and Risk Assessment:
Auditors document their understanding of the client’s business, the preliminary risk assessment, and the planned audit approach. This documentation serves as a reference point throughout the audit and provides transparency for future reviews.
Audit procedures are specific tasks and activities that auditors perform during the course of an audit to gather evidence and evaluate the reliability of financial information. The specific procedures can vary based on the nature of the audit, the characteristics of the audited entity, and the risks identified during the planning and risk assessment phases. However, here are some general audit procedures commonly performed in financial statement audits:
What Does the Auditor Need from You?
Generally, for audits, I provide the client with a list of documents and access I will need to begin. This is a sample of what is requested to start the process:
Minutes of meetings
Copy of prior audit or review
Founding documents, i.e., incorporation documents
Brief 2-4 paragraph description of the company, its operations, its founding, etc.
Brief 2-4 paragraph description of the company’s revenue sources.
List of board of directors
A copy of QuickBooks backup or online accountant’s access.
Copies of contracts, notes, agreements, and any other covenants that affect the company legally as an asset or liability.
Copies of leases
Complete the attached audit questionnaire for both companies. Some may not pertain to you; you may skip those sections.
Copies of employee manuals and company guidelines, IT and risk policies.
941’s and W3
1099s and 1096
I also provide a user login to my website in order for them to complete a four-part audit questionnaire. The questionnaire covers all aspects of the organization from how they handle cash to fraud risk controls. I suggest it be completed in multiple sessions as it is quite extensive. However, it generally much easier for them to do this than to have a 3-4 hour session where I just keep firing questions at the principle members of the group.
Confirmation and Verification
Audit confirmation involves obtaining and evaluating evidence directly from a third party in response to a request for information. This third party is often external to the audited entity and may include customers, vendors, financial institutions, or legal representatives.
The objective of audit confirmation is to verify the accuracy and completeness of information included in the financial statements. By directly confirming certain information with external parties, auditors can obtain independent and reliable evidence to support their conclusions.
Audit verification refers to the process of gathering and evaluating evidence to support the assertions made by an entity in its financial statements. Verification is a crucial step in the audit process, as it helps auditors ensure the accuracy, completeness, and reliability of the financial information presented by the audited entity.
Existence and Occurrence
The existence assertion is a management assertion related to financial statement items. It states that all assets, liabilities, and equity interests that are included in the financial statements actually exist at a given date.
Auditors are concerned with verifying that the assets, liabilities, and equity balances reported in the financial statements are real and tangible. This includes physical existence (e.g., inventory, property) and legal existence (e.g., rights to certain assets).
Occurrence is one of the management assertions related to financial statement items. Specifically, it refers to the assertion that all recorded transactions and events have actually occurred and pertain to the entity.
During an audit, auditors assess the occurrence assertion to ensure that the transactions and events recorded in the financial statements are valid and represent real economic events.
Auditors verify that all transactions during the reporting period have been recorded and are reflected in the financial statements. This includes examining supporting documents, such as invoices, receipts, and bank statements, to ensure that no material transactions have been omitted.
In addition to numerical completeness, auditors assess whether the financial statements include all necessary disclosures. This involves ensuring that the footnotes and other supplementary information provide a comprehensive and accurate picture of the entity’s financial position and performance.
The valuation assertion asserts that assets, liabilities, and equity interests are included in the financial statements at their appropriate amounts. This involves ensuring that the amounts recorded reflect the fair value, market value, or other appropriate valuation methods in accordance with the relevant accounting standards.
Auditors need to verify that the values assigned to various items in the financial statements are reasonable and in accordance with the applicable accounting principles. This assertion is particularly relevant for items like inventory, property, plant and equipment, investments, and financial instruments.
Accuracy and Classification
In the context of auditing, audit accuracy means that there have been no errors while preparing documents or in posting transactions to ledgers. The reference to disclosures being appropriately measured and described means that the figures and explanations are not misstated. This involves verifying the accuracy of financial information, calculations, and other data used in the audit process.
Classification refers to ensuring that all items are classified into the correct accounts. This requires the auditor to review transactions to be assured that expenses are correctly identified or that assets and liabilities are in the proper accounts.
Cut-off and Timing
Cut-off refers to the point in time at which transactions are recognized or recorded in an entity’s financial statements. It’s crucial that transactions are recorded in the correct accounting period to ensure the accuracy of financial reporting.
The cut-off period is important because financial statements are prepared for a specific period, typically a month, quarter, or year. Transactions occurring near the end of the reporting period should be recorded in that period, and those occurring after should be recorded in the subsequent period.
Timing in an audit refers to the scheduling and coordination of audit procedures throughout the audit engagement. It involves determining when audit work is performed, including when substantive testing and analytical procedures are conducted.
Proper timing is essential for an efficient and effective audit. Auditors need to schedule their work to coincide with the client’s accounting cycle and to obtain the necessary evidence to support their conclusions on the financial statements.
In the context of an audit, “understandability” typically refers to the clarity and comprehensibility of financial statements. It’s one of the qualitative characteristics of financial reporting that auditors consider during the course of their work. While understandability is more closely associated with financial reporting standards and the preparation of financial statements, auditors play a role in assessing whether the financial statements are presented in a way that is clear and understandable to users.
Analysis refers to the process of reviewing and assessing financial information, transactions, and other data to gain insights, identify trends, anomalies, or areas of potential risk, and to form conclusions about the financial statements. Analysis is a fundamental part of the audit process and is performed at various stages to obtain a deeper understanding of the entity’s financial position and performance.
Management Representation Letter
The financial statement management representation letter is designed to complete managements responsibilities in the review. The letter is signed at the end of the engagement and is dated at the time of the review report. The management representation letter has three basic parts, the introduction, statements about the financials and declarations on the information management has provided.
An auditor provides deliverables to a client in the form of various reports and documents that communicate the results of the audit.
It’s important to note that the delivery of audit reports represents the conclusion of the audit engagement. The client can use these reports for various purposes, including meeting regulatory requirements, providing assurance to stakeholders, and making informed business decisions. Throughout the process, communication between the auditor and the client is crucial to address any questions or concerns and to ensure a clear understanding of the audit findings.
As you can see, an audit is a very detailed process which is much more involved than a financial statement review. Audits take from 4-8 weeks for the typical small entity. It can be a stressful time for the organization, and its staff, if not handled properly. At ELTCPA we strive to make the process quick and pain-free for you and your people. Contact us today.