Insights into independent financial audits for nonprofit organizations
In the United States, few words instill as much anxiety as "audit." But rest assured that an independent audit isn't the same as an IRS audit. Instead, it's an examination of accounting records and financial statements by an independent auditor, such as a public accounting firm or a certified public accountant who isn't a board member or employee of the organization being audited.
The goal is to discover if financial statements and records are correct and comply with what's known as GAAP — generally accepted accounting principles. A clean bill of health from an auditor indicates that books are being kept in a responsible manner.
Why do an independent audit?
Your nonprofit may be required to complete an independent financial audit at the request of federal funding agencies, state regulatory agencies, grant-making foundations or banks. For example:
- Independent audits are often required for nonprofits that receive more than $500,000 a year in federal funds or those that exceed an annual revenue threshold
- One-third of all states require nonprofits at a certain revenue level to be audited if they solicit funds from state residents (although revenue thresholds vary by state)
- Some foundations and other funders require audited financial statements before issuing funding
- Banks may require an independent audit as a condition for offering a loan
To learn how laws regulating independent audits vary from state to state, check out this interactive map from the National Council of Nonprofits.
Some nonprofits choose to do a voluntary independent audit to assure stakeholders of transparency and a sound financial management system. That said, audits aren't typically pursued by small nonprofits with limited financial transactions.
How much does an audit cost?
Independent audits are time-intensive and usually require staff and board member involvement. The price for an independent audit varies by region and nonprofit size. For large nonprofits in major urban areas, fees can exceed $20,000. Fees in the ballpark of $10,000 are common for small nonprofits.
What's the role of the board in an audit?
If your nonprofit pursues an audit, you'll likely want to establish an audit committee within your board of directors or trustees. The committee will:
- Select or approve the auditor
- Review the auditor's results
- Address any concerns from the auditor before, during or after the audit
In addition, audit committees often have ongoing responsibility for the organization's overall financial oversight and internal financial controls.
What are the alternatives to audits?
There are two less expensive alternatives to a full independent audit: a review and a compilation. Although neither alternative is a substitute for an audit if an audit is strictly required, smaller nonprofits seeking to manage costs may ask if a review or compilation is adequate.
In a review, a certified public accountant examines select financial records — but much less thoroughly than in a full audit, and without a formal written opinion about whether financial records are in accordance with generally accepted accounting principles. Instead, the accountant indicates whether any modifications should be made to the financial statements to ensure conformity with generally accepted accounting principles. A review costs about half as much as an audit.
A compilation, the cheapest alternative, involves an accountant assembling financial statements from information provided by your nonprofit. Financial records aren't subjected to audit or review, transactions aren't tested or analyzed, and no indication is given regarding compliance with generally accepted accounting principles.
For additional information about independent audits and your nonprofit, consult your tax adviser.
National Council of Nonprofits: What is an independent audit?
National Council of Nonprofits: State law nonprofit audit requirements
National Council of Nonprofits: Does your nonprofit need to have an independent audit?
BerganKDV: Types of independent audits for nonprofits (2013)
GrantSpace: Where can I learn more about nonprofit audits?