Is It Time for an Audit?

Blue Avocado reader Bill Mitchell writes: "As a board member of both a small ($400k/year) and a much larger ($1.8m/year) nonprofit, what are the criteria to determine whether or not to conduct a formal outside audit? I have worked on staffs, sat on boards and have been a foundation program officer and I have never had a clear set of guidelines. Thanks!"

Blue Avocado columnist Jeanne Bell [4]replies:

Dear Bill: In these tough economic times it makes perfect sense that a board of directors would weigh the costs and benefits of spending $10,000 or more on this administrative expense. The short answer to your question is: "As soon as you have to."

The longer answer: A first tier for nonprofit audit requirements may be set by whether or not you receive federal funding. The federal government has not yet issued an across-the-board audit standard for nonprofits, although it could very well happen, given ongoing federal attention to charity regulation. Currently, nonprofits that expend $500,000 or more in federal contract dollars in a fiscal year must obtain what's called a ‘single audit' to test for compliance with federal grants management standards.

(See http://www.whitehouse.gov/omb/circulars/a133/a133.html [5] for more information on these requirements.)

Things get a lot more complicated at the state level.  State attorneys general, who regulate nonprofits at the state level, have wildly varying standards for nonprofits, ranging from $100,000 thresholds to no requirement at all. You can contact your state attorney general or any auditor for your state's requirements.

And, in 25 states, audited statements must be submitted if you solicit funds in their states, whether or not you are located there. For instance, if you are based in Seattle but raise funds from donors in all 50 states by mail, phone, or other means, you must not only register annually with the 25 states that require it, you must provide an audit with  your registration.

However, the 25 states vary in the amount of annual revenue at which they require an audit. If you have donors residing in multiple states, check out the Multi-state Filer Project [6]to research and potentially simplify this cumbersome annual registration process. (There are another 13 states that require fundraising registration but do not require audited statements to be attached.)

What else triggers an audit?

If you're not spending more than $500,000 in federal funds, nor raising money in states that require annual audits as part of state registration, what other factors should you consider? In many cases, foundation funders ask for an annual audit as part of their grant application process. If you are otherwise eligible for the grant,  consider contacting a Program Officer or Grants Manager at the foundation and asking if submission of your IRS Form 990 [7] in lieu of an audit will suffice.

The Form 990 actually provides more information about an organization than an audit does, although it lacks a CPA's sign-off attesting to the accuracy of account balances. Many foundations, sensitive to the fact that smaller organizations may not yet be auditing, will accept Form 990 during the application process, but may require a yearly audit  after they have funded you.

You should also be aware that there are many groups that are establishing their own standards for when nonprofits should obtain audits. The Wise Giving Alliance [8] has a $250,000 annual revenue threshold for audits, while the Standards of Excellence Institute [9]'s threshold is $300,000. The Independent Sector [10]recommends a threshold of $1 million dollars. Remember, these are not regulating authorities but rather independent organizations attempting to influence nonprofit practice and how the general public evaluates potential donation recipients.

Benefits of audits

Aside from these specific funder and donor-related factors, it's helpful to recognize three inherent benefits that an audit provides to a nonprofit :

1. Donor and Community Confidence: An unqualified audit opinion is a universally accepted indicator that an organization is investing in its financial management and that its financial statements are likely to be accurate. Beyond donors, the audit is a symbol to an organization's broad constituency, including the media and watchdog groups, that the organization is committed to fiscal accountability.

2. Achieving Financial Best Practices: Board and staff leadership benefit from an audit performed by a CPA who's knowledgeable about current nonprofit accounting standards -- such CPAs can help move an organization towards best financial management practices. And even amongst experienced nonprofit finance staff, knowing that they will have to defend accounting judgments to an auditor at year-end encourages accounting discipline throughout the year.

3. Some Protection Against Fraud: An annual audit can bolster the soundness of internal controls. But caution: although the prospect of an audit may play a role in deterring  malfeasance,  a determined staff person or volunteer can find ways to steal  that an auditor testing on-site for just two days each year may not detect.

Alternatives to audits

If your organization's leadership decides that it wants some of these benefits but cannot afford the $10,000+ price tag, it may elect to engage an outside CPA in a financial statement review rather than a full-blown audit. A review does not include on-site testing and therefore does not conclude with an auditor's "opinion" -- a technical term for the CPA's expert judgment -- as to whether the financial statements prepared by the organization were prepared in accordance with accepted accounting principles.

This report is based on limited document review and communications with staff and/or board, and gives limited assurance that the financial statements reflect an accurate picture. For roughly half the price of an audit, you could share a CPA-prepared document with constituents, albeit one with less "bite."

Another recent wrinkle to factor into your deliberation of when to begin auditing is something called, SAS-112 [11]: an accounting standard with the full name of "Communicating Internal Control Related Matters Identified in an Audit." As Kate Barr of the Nonprofits Assistance Fund [12]recently wrote in The Nonprofit Quarterly [13], "At root, the new standards increase the likelihood that control deficiencies will be identified and reported."

In other words, if you are just beginning to professionalize your accounting and have yet to produce audit-like financial statements each month on your own, you will get very little slack from your auditor come audit time. As Barr concludes, "The new standards make clear that an auditor's role is to test and verify the information provided by an organization and issue an opinion?not to calculate and produce financial statements." (Read her full piece on SAS [14] 112 online.)

Bottom line on audits

So what's the bottom line? In most cases, it makes sense for community nonprofit boards with operating budgets in excess of $250,000 to begin considering whether it's time to audit by evaluating their readiness in the context of SAS 112. And recognizing the potential benefits of an audit to build donor confidence and increase protection against fraud will also influence your decision.   By the time you reach $500,000, the world at large will expect you to be making this annual investment and your accounting systems should be ready for the scrutiny.

Look for a future column taking up the question of screening, selecting and changing auditors.

Jeanne Bell [4] is CEO of CompassPoint Nonprofit Services [15], and a frequent writer on nonprofit finance and strategy matters.