Though many not-for-profit organizations aren’t required to obtain a financial statement audit, there are various benefits that come with going through the process, such as providing financial transparency to stakeholders and internal members.
Why Should a Not-for-Profit Consider a Financial Statement Audit?
Not-for-profit organizations may be audited for several reasons, including the following:
- Financial transparency
- Applying for or receiving grant funding
- Contract or agreements that requires an audit
- Federal, state, and local government audit requirements
Not-for-profit entities may have many users—external and internal—of the financial statements. It’s important to understand who those users are and the information they may rely on to make decisions about the organization.
Regular audits can help the organization be accountable to themselves and stakeholders as well as help management and the board evaluate performance. In many cases, even when a financial statement audit isn’t required, it’s still a way to provide financial transparency and trust within the organization.
To express an opinion on the financial statements, the auditors are required to follow professional standards in performing audits, giving management and users confidence that the audit can be relied on.
A common reason not-for-profits conduct an audit is when the organization applies for or receives grant funding. Many grantors seek audited financial statements to support that the awarded grant funds are spent in accordance with the grant.
Many grant givers also have a responsibility to their donors or boards when they have policies to only do business with transparent organizations or organizations that have proper controls and policies in place. An audit helps grant givers in these decisions.
Contracts or Agreements
Contracts or agreements, such as bank or loan agreements, may have requirements for not-for-profits. Debt holders or banks may request audited financial statements as a condition for receiving loans to ensure that the internal information provided is accurate and to support continued compliance with various loan agreements or lines of credit.
What’s the Threshold for When an Audit Is Required?
Federal, state, and local governments may have thresholds that require not-for-profits to conduct a review or audit. These requirements include an independent audit, review, or compilation of generally accepted accounting principles (GAAP) financial statements.
As many as 26 US states require charitable not-for-profits to submit a copy of their audited financial statements when submitting their registration.
For example, California requires an audit when gross annual revenue exceeds $2 million. Washington State requires an audit when gross revenue exceeds $3 million over three preceding years. Other states, such as Oregon and Texas, have no state law requirement.
Audit Versus Review or Compilation
Completing an audit can be costly for smaller organizations, but they can still show financial transparency with a review or a compilation.
The differences between an audit, review, and compilation are outlined below.
What Is a Financial Statement Audit?
An audit consists of an examination of financial records, internal controls, accounting policies, and operations.
The audit is performed through walk-throughs, analytical procedures, testing, and the understanding of transactions by an independent auditor. An audit provides reasonable assurance that the financial statements are materially correct.
What Is a Financial Statement Review?
A review consists principally of inquiries of organization personnel and analytical procedures applied to financial data. The scope of a review is significantly less than that of an audit, and it doesn’t provide a basis for the expression of an opinion on an organization’s financial statement.
Rather, a review provides limited assurance that no material modifications should be made to the financial statements to bring them into conformity with the applicable financial reporting framework, such as GAAP.
A review may be a viable option to provide a limited level of assurance when a not-for-profit is small and unable to incur the cost of an audit.
What Is a Financial Statement Compilation?
A compilation differs significantly from, and is substantially less in scope than, a review or audit of an organization’s financial statements. A compilation is one of the lowest level financial statement services an accountant can provide.
The objective of a compilation is to present information, in the form of financial statements, that’s the representation of management. A compilation requires significantly fewer procedures than either an audit or a review.
A compilation doesn’t include the expression of an opinion or any assurance on the financial statements, and an accountant need not be independent to perform a compilation engagement.
What Are the Benefits of a Financial Statement Audit?
The beneficial byproducts of a financial statement audit include:
- Training and assistance for the accounting staff
- Recommendations from a best practice perspective related to internal control and documentation
- Assurance that significant transactions are supported with appropriate documentation
What Can You Expect from a Financial Statement Audit?
The audit process involves significant communication from the beginning to the end of the process as well as throughout the year.
A prepared-by-client (PBC) request listing with timelines should be provided to management early in the process to help make the audit as smooth as possible. During the audit process, auditors dedicate time to perform extensive procedures.
The procedures are performed to accomplish the following:
- Examine records supporting transactions and balances
- Understand and test estimates
- Check calculations
- Understand controls
- Confirm or verify assets and liabilities
Expectations for Your Accounting Team
Your accounting department may need to devote time prior to the scheduled audit to prepare items on the PBC request listing. Most auditors will require these items prior to starting the audit.
The expectation is that the accounting team has performed proper reconciliation of account balances and closeout of the year prior to the audit starting. There’s a good chance that you’re already preparing many of these requested items during your closing process.
During the audit, your accounting department and others in management may need to devote time for internal control walkthroughs, answer questions regarding certain transactions, or provide explanations regarding documentation being provided.
We’re Here to Help
For guidance on whether having an audit, review, or compilation is right for your organization, please contact your Moss Adams professional.
You can also visit our Not-for-Profit Practice page for additional resources.