Instances When Audits are Required
Before we discuss why an organization would want to conduct an audit when one is not required, let’s first talk about some of the instances where an audit may be required for a nonprofit organization:
- Federal, state, and local governments may request a copy of the organization’s audited financial statements.
- Charitable nonprofits that expend $750,000 or more in federal funds in a year are subject to an independent audit. A few states have laws that require nonprofits that receive a certain level of state funding submit an audit to the state agency.
- Some contracts with state and local governments to provide services in the community may require that the nonprofit conduct an independent audit.
- Many state laws require that charitable nonprofits submit a copy of their audited financial statements when they register with the state for solicitation or fundraising.
- Private foundations may request audited financial statements when submitting a grant proposal.
- Some banks may require a nonprofit to have an audit as a condition of receiving a loan.
Currently, 26 states require an audit when registering the charitable nonprofit to engage in fundraising activities. This is usually required due to the total revenue earned or contributions received during the year. In New Jersey, a nonprofit organization with over $500,000 in revenue must submit an audit and when revenue is between $25,000 and $500,000 the financial statements must be certified by an authorized officer of the organization.
Find out the requirements for your state at: State Audit Requirements.
Reasons to Conduct an Independent Audit
Even if the above requirements do not apply to an organization, there are several reasons why an organization might still want to conduct an independent audit annually. An audit by an independent third party shows an organization’s commitment to financial transparency. Before a potential donor gives to a nonprofit organization, he or she first wants to see where their donation will go. Annual audited financial statements will have a statement of functional expenses so a donor can get an idea of how much is spent on programs compared to management and staff salaries. When an audit is conducted that is not required, it tells donors and the public that the organization has nothing to hide and wants everything available for potential donors to see.
When sites such as CharityWatch and Charities Review Council rate nonprofit organizations for potential donors, they take into consideration whether an organization has had an independent audit. They have a section within each organization’s evaluation for transparency, which consists of:
|Meets Transparency Benchmarks|
|Provides Financial Information||X|
By providing audited financial statements on the organization’s website or by request, the Organization meets the transparency benchmarks set in place by these charity analysis websites. The nonprofit organizations on the website can even be filtered so that only top rated organizations (those that meet the transparency benchmark) are displayed.
Another reason why an audit might be conducted is for the assurance of the board of directors. An independent audit provides assurance that the financial statements are free from material misstatements due to fraud or error.
Reasons Not to Conduct an Independent Audit
A nonprofit can build a reputation for integrity, transparency and professionalism from an independent audit. However, sometimes an organization simply cannot afford the fees of conducting an independent audit. An audit can easily cost over $5,000 for a small organization and well over $10,000 for an organization with revenue exceeding $1 million. While an audit from an independent third party is ideal, there are other ways for an organization to be transparent with potential donors. The organization can conduct a review or compilation rather than an audit as these engagements are usually not as costly. A review has the same goals as an audit but at a smaller level of investigation and analysis, and the CPA does not give the same level of assurance on these statements. A compilation is simply the preparation of the financial statements based on client work papers. No test work is performed and no assurance of the information reported is made. All organizations should conduct a cost-benefit analysis before deciding whether to conduct an audit, review or compilation.
Some organizations that don’t want to have an independent engagement may just want to prepare their own financial statements internally for the public. This is probably the most cost-effective option but it does not provide the level of assurance that an independent accountant would provide.
Whether it be an audit, review, compilation, or internally prepared financial statements, it is important for an organization to provide the public with a financial picture so that donors, current and future, can see that the organization is really trying to achieve the goals set out in its mission.