A Comprehensive Guide to Annual Independent Audits for Nonprofits

What is an Annual Audit?

An annual independent audit is a thorough review of a nonprofit's financial statements conducted at the end of its fiscal year. This examination ensures the accuracy, reliability, and compliance of the statements with relevant laws and regulations. In the US, nonprofit audits typically focus on adherence to Generally Accepted Accounting Principles (GAAP), the established standards for financial reporting. The audit process involves a meticulous examination of financial records and statements to identify errors, inconsistencies, or potential fraud. Additionally, auditors may assess internal controls and evaluate the organization's financial reporting processes.

The Consonance Group: Your guide through the nonprofit independent audit process

This guide covers all the details of the annual independent audit process, informed by over 20 years of TCG staff experience in the nonprofit finance sector. The Consonance Group is a financial, HR, and operations services firm specializing in nonprofits and small businesses. We have helped dozens of organizations navigate the intimidating independent audit process, acting as their expert liaison and internal agent to ensure a smooth audit. This guide covers all our clients’ frequently asked questions, best practices we recommend, and outlines expectations for the audit process–before, during, and after. Learn more about our services and experience.

Do All Nonprofits Need an Annual Audit?

For nonprofit organizations, annual independent audits are considered standard practice. In some cases, they may even be mandatory. Not all nonprofits are legally required to have annual audits. However, most should strongly consider them. In fact, audits can serve as a valuable protective measure for the organization.

Benefits of Annual Independent Audits for Nonprofits

• Enhanced Donor Trust: Independent audits inspire and maintain trust among donors, grantors, and the public by demonstrating a commitment to financial transparency and accountability.
• Boosted Board Confidence: Audited financial statements provide the board of directors with greater confidence in the organization's financial health due to the objective analysis conducted by a third-party auditor,. helping guide strategic decision-making
• Funding Eligibility: Certain private foundations might require grant applicants and recipients to submit audited financial statements (or similar certified documents) as a funding eligibility criterion.
• Broader Trust Building: An audit showcases an organization's dedication to financial transparency, which fosters trust with the public, lenders, donors, grantors, and board members alike.
• Risk Management: The audit process identifies weaknesses in internal controls, allowing nonprofits to address them and prevent potential financial problems.

Is an Audit Required for My Nonprofit?

Not all nonprofits are mandated to have annual audits. Here's a breakdown of factors that might influence the requirement:

• State Regulations: Each state has its own audit requirements for nonprofits. The National Council of Nonprofits offers a helpful resource with state-by-state guidelines.
• Revenue Threshold: Many states require audits for organizations exceeding a specific annual revenue threshold.
• Donor Requirements: Some grant makers might stipulate an audit as a condition for funding

Who Performs the an Annual Audit?

Independent audits are conducted by a licensed Certified Public Accountant (CPA) acting as an independent agent. This ensures an objective and unbiased examination of the nonprofit's financial records. While the organization hires and engages the auditor, the audit itself must be independent. 

The best practice is to select a new auditor every 5 to 7 years, or at a minimum, a new lead auditor within the selected firm. Using the same auditor for several years allows them to gain valuable institutional knowledge that makes the audit process more efficient. It is important not to change auditors too frequently, as the first year onboarding process can be cumbersome. However, over time, they may become too close to the organization’s audit process, unintentionally glossing over details or making assumptions. Changing auditors ensures fresh eyes and new reviewers periodically, strengthening the transparency and accuracy of the audit overall. 

The Annual Audit Process

The annual audit process for nonprofits typically follows a well-defined sequence:

1. Planning and Selection
   

   Ideally, the board of directors initiates the process by establishing an audit committee and selecting a qualified, experienced CPA firm specializing in nonprofit audits. In some organizations, this process may be initiated by management or the finance team.

2. Engagement Letter
   

   A formal agreement outlining the scope of the audit, associated fees, and timelines is established between the nonprofit and the chosen CPA firm.

3. Information Gathering
   

   The CPA firm gathers and reviews financial records, accounting policies, and other relevant documents provided by the nonprofit.

4. Internal Controls Assessment
   

   The auditors evaluate the effectiveness of the organization's internal controls in safeguarding assets and ensuring the accuracy of financial reporting.

5. Testing Procedures
   

   The CPA firm performs various tests on financial transactions and account balances to verify their accuracy and completeness.

6. Management Discussions and Analysis
   

   Open communication is maintained between the auditors and the nonprofit's management team to address any questions or concerns that may arise during the process.

7. Audit Report Issuance
   

   Upon completion of the audit, the CPA firm issues a formal report expressing their opinion on the fairness of the financial statements and highlighting any areas requiring improvement in internal controls or financial reporting practices.

8. Management Response
   

   The nonprofit's management prepares a written response to the audit report, outlining corrective actions planned to address any identified weaknesses. In some cases, this may be handled by the board’s audit committee in conjunction with the executive team.

Preparing for a Smooth Audit

• Organized Records: Maintaining a well-organized accounting system with readily accessible documentation can significantly streamline the audit process for both the auditor and the nonprofit.
• Internal Controls Assessment: Regularly review your organization's internal controls to ensure their effectiveness in safeguarding assets and preventing errors.
• Open Communication: Maintain clear and open communication channels with the chosen CPA firm to facilitate a smooth and efficient audit experience.

By understanding the annual independent audit process and taking steps to prepare effectively, nonprofit organizations can leverage audits to their advantage. This fosters a culture of accountability, sound financial management, and ultimately, increased public trust. 

The Price Tag and Timeline of Nonprofit Audits

Annual independent audits can be a significant investment for nonprofits, but the cost and duration can vary depending on several factors. Here's a breakdown of what to expect:

Cost:

• Range: Costs typically fall within the range of $5,000 to $20,000 for US nonprofits.
• Factors Affecting Cost: Several factors influence the final cost, including:
  • Organization Size: Larger and more complex organizations with a higher budget tend to have higher audit fees.
  • Financial Complexity: Nonprofits with diverse revenue streams, complex grant funding, or significant investments may incur higher audit costs due to the increased time needed for review.
  • Auditor Selection: The experience and reputation of the chosen CPA firm can influence their fees.
  • Geographic Location: Audit rates can vary depending on the region where the nonprofit is located.
  • Scope of Work: The extent of procedures performed by the auditor will impact the cost. For instance, additional testing or specialized expertise might necessitate higher fees.

In addition to the fees paid to the external CPA firm, a nonprofit organization can expect to dedicate some internal resources to supporting the annual audit process. Here's a breakdown of the Human Resources (HR) and internal staff support typically involved:

Human Resources

• Staff Time: HR personnel might be involved in tasks such as:
  • Payroll Data Gathering: Preparing and providing payroll data to the auditors for verification.
  • Benefits Administration: Assisting the auditors with reviewing employee benefit plans and related documentation.
  • Personnel Files: Ensuring relevant personnel files, such as timekeeping records and leave policies, are accessible to the auditors if needed.
• Communication: HR might be responsible for communicating with staff regarding the audit and potential requests for information or documentation.

Internal Staff Support

• Finance Department: The finance department bears the brunt of internal support for the audit.
  • Record Gathering: Gathering and organizing financial records, including invoices, bank statements,receipts, and general ledger entries, for the auditor's review.
  • Reconciliations: Performing account reconciliations, such as bank reconciliations, to ensure accuracy.
  • Schedule Preparation: Preparing various financial schedules requested by the auditors to support specific areas of the financial statements.
  • Communication: Providing clear and timely responses to the auditors' questions throughout the process.
• Program and Development Staff: Depending on the nature of the nonprofit's programs, program staff might be involved in:
  • Grant Documentation: Providing grant agreements, budgets, and expenditure reports related to specific grants for audit review.
  • Inventory Management: Assisting with the verification of physical inventory if applicable.
• Management: Senior leadership, including the Executive Director and relevant department heads, might be involved in:
  • Opening Meeting: Participating in the initial meeting with the auditors to discuss the scope of the audit and any specific areas of focus.
  • Organizational and Governance Documents: Management will need to provide information related to the board, which may include a list of members, minutes, bylaws, articles of incorporation or charter, and other governance documents.
  • Closing Meeting: Attending the closing meeting to review the audit findings and discuss next steps.

Minimizing Internal Resource Strain

Here are some tips to minimize the strain on internal resources during the audit:

• Planning and Communication: Early planning by the finance department and clear communication with other departments about the audit process can help staff prepare and manage their workload.
• Organized Records: Maintaining a well-organized accounting system with readily accessible documentation streamlines the process for both internal staff and the auditors.
• Dedicated Staff: If feasible, designating a point person within the organization to coordinate with the auditors can enhance efficiency.
• Leveraging Technology: Utilizing accounting software with online document storage capabilities can simplify record retrieval for auditors.

Alternatives to Full Audits:

• Reviews: For smaller nonprofits, a review might be a more cost-effective option. A review involves a limited examination of financial statements and provides less assurance compared to a full audit.
• Compilations: Compilations are the least expensive option. However, they involve compiling financial statements based on information provided by the nonprofit itself without any assurance by the CPA.

Duration:

• Timeline: The audit process usually takes several weeks to a couple of months to complete.
• Factors Affecting Duration: The complexity of the organization's finances, the scope of the audit, and the efficiency of the internal controls all play a role in how long the audit takes. Good organization of financial records and open communication with the auditors can significantly expedite the process.

Tips for Managing Audit Costs:

• Shop Around: Obtain quotes from several qualified CPA firms specializing in nonprofit audits to compare fees and find the best fit for your organization's needs.
• Be Prepared: Having well-organized financial records readily available minimizes the time required by the auditors, potentially reducing costs.
• Open Communication: Maintaining clear communication with the auditors throughout the process can help avoid misunderstandings and ensure the audit stays on track.

Understanding Audit Reports and Taking Action

Following an annual independent audit, the process concludes with the issuance of a formal report by the CPA firm. This report conveys the auditor's opinion on the fairness and accuracy of the nonprofit's financial statements. Let's delve into the different types of audit reports and the corresponding next steps for a nonprofit:

Types of Audit Reports

The auditor's report will fall under one of four categories:

1. Unqualified Opinion (Clean Opinion): This is the most desirable outcome, indicating the auditor found the financial statements to be presented fairly in accordance with GAAP, with no material misstatements.
2. Qualified Opinion: This report signifies that the auditor encountered one or two instances where the nonprofit deviated from GAAP, potentially causing a material misstatement. A material misstatement refers to an error or omission that could significantly influence the interpretation of the financial statements by users. The report will detail the specific deviations and their potential impact.
3. Adverse Opinion: This report is issued when the auditor identifies significant and widespread deviations from GAAP, resulting in material misstatements that fundamentally compromise the reliability of the financial statements.
4. Disclaimer of Opinion: In rare cases, the auditor may be unable to gather sufficient information or encounter limitations that prevent them from forming an  opinion on the financial statements. This situation would be reflected in a Disclaimer of Opinion report.

Responding to the Audit Report

Following receipt of the audit report, the nonprofit's management is responsible for:

• Reviewing the Report: Meticulously examine the report, paying close attention to the auditor's  opinion and any identified areas of concern.
• Developing a Response: Prepare a written response that acknowledges the auditor's findings and outlines a plan for addressing any weaknesses or noncompliance issues identified in the report. For a clean opinion, this might involve a brief confirmation of receipt and appreciation for the audit process.
• Taking Corrective Action: Implement the corrective actions outlined in the response plan. This might involve revising accounting policies, strengthening internal controls, or addressing any errors or inconsistencies in financial reporting.

Utilizing the Audit for Improvement

Beyond ensuring compliance, the audit report serves as a valuable tool for identifying areas where the nonprofit's financial processes or internal controls can be strengthened. By taking the following steps, a nonprofit can leverage the audit for continuous improvement:

• Board Discussion: Present the audit report and management's response to the board of directors for their review and discussion.
• Process Improvement: Integrate the auditor's recommendations into the organization's financial management practices to enhance efficiency and accuracy.
• Future Audits: Utilize the learnings from the current audit to streamline preparations for future audits.

Remember, a successful audit outcome builds trust with stakeholders and strengthens the nonprofit's financial health. By understanding the post-audit process and taking proactive steps in response to the auditor's report, a nonprofit can leverage the audit experience for continuous improvement and long-term success.

Taking the Mystery Out of Non-Profit Audits: How The Consonance Group Can Streamline Your Process

At The Consonance Group, we understand that navigating the intricacies of annual independent audits can be daunting for non-profit organizations. That's why we're here to act as your trusted partner throughout the entire process. As a leading financial services firm specializing in the non-profit sector, we go beyond simply offering accounting services. We act as your primary point of contact for the auditors, smoothing the path to a successful and stress-free audit experience.

The Consonance Group Advantage

Our team of experienced professionals possesses a deep understanding of non-profit accounting standards and the unique challenges faced by non-profit organizations during audits. We take the burden off your internal staff by:

• Facilitating the Audit Process: We serve as the primary point of contact for the auditors, managing communication and ensuring a seamless flow of information.
• Preparation is Key: We meticulously compile all the necessary financial documents and schedules the auditors require at the outset of the audit fieldwork. This saves your valuable time and resources.
• Expert Inquiry Resolution: Our team handles all audit inquiries that don't necessitate direct staff input. This frees up your internal staff to focus on their core responsibilities while ensuring timely and accurate responses to the auditors.

Why Choose The Consonance Group?

By partnering with The Consonance Group, you gain more than just an audit facilitator; you gain a dedicated team passionate about non-profit success. We offer:

• Peace of Mind: Our expertise ensures a smooth and efficient audit experience, allowing you to focus on your mission-critical work.
• Enhanced Efficiency: We streamline the audit process, minimizing disruptions to your daily operations and internal staff workload.
• Reduced Costs: By expediting the audit process and minimizing the need for internal staff involvement, we can potentially help you reduce overall audit costs.
• Confidence in Results: Our comprehensive approach fosters a collaborative environment that promotes accurate and transparent financial reporting.

Let The Consonance Group be your partner in ensuring a successful and stress-free annual audit. Contact us today to discuss how we can empower your non-profit organization to thrive.