Financial Management 3
Financial Management (cont'd)
What is an Audit?
An audit is a process for testing the accuracy and completeness of information presented in an organization's financial statements. This testing process enables an independent certified public accountant (CPA) to issue what is referred to as an opinion on how fairly the agency's financial statements represent its financial position and whether they comply with generally accepted accounting principles (GAAP). GAAP is determined by the American Institute of Certified Public Accountants (AICPA). Board members, staff, and their relatives cannot perform audits because their relationship with the organization compromises their independence.
The audit report is addressed to the board of directors as the trustees of the organization. The report usually includes the following:
A cover letter, signed by the auditor, stating the opinion, as described above.
The financial statements, including the statement of financial position (balance sheet), statement of financial activity (income statement), and statement of cash flows. Health and social service organizations also have a statement of functional expenses. Many audits show comparative information between fiscal years.
Notes to the financial statements, as required by GAAP, which might include information about functional expenses, a depreciation schedule, further information about contributions, volunteer services, and other significant information not obvious in the financial statements.
In addition to the materials included in the audit report, the auditor often prepares what is called a management letter or report to the board of directors. This report cites areas in the organization's internal accounting control system which the auditor evaluates as weak.
What an Auditor Does
The auditor will request information from individuals and institutions to confirm bank balances, contribution amounts, conditions and restrictions, contractual obligations, and monies owed to and by your organization. The auditor will review physical assets, journals and ledgers, and board minutes to ensure that all activity with significant financial implications is adequately disclosed in the financial statements. In addition, the auditor will select a sample of financial transactions to determine whether there is proper documentation and whether the transaction was posted correctly into the books. In addition, the auditor will interview key personnel and read the procedures manual, if one exists, to determine whether the organization's internal accounting control system is adequate. The auditor usually spends several days at the organization s office looking over records and checking for completeness.
Auditors are not expected to guarantee that 100 percent of the transactions are recorded correctly. They are only required to express an opinion as to whether the financial statements, taken as a whole, give a fair representation of the organization's financial picture. In addition, audits are not intended to discover embezzlements or other illegal acts. Therefore, a "clean" or unqualified opinion should not be interpreted as an assurance that such problems do not exist.
An unqualified opinion includes wording such as, "In our opinion, the accompanying financial statements present fairly the financial position of ABC Agency at the fiscal year ending June 30, 19XX, ... in conformity with generally accepted accounting principles."
A qualified opinion is issued when the accountant believes the financial statements are, in a limited way, not in accordance with generally accepted accounting principles. A qualified opinion might include wording such as, "In our opinion, except for the omission of... the accompanying financial statements present fairly..."
Many auditors provide nonprofits with year-end financial management services which are not part of the audit. These include preparing:
year-end financial statements based on client records
notes to the financial statements
depreciation schedules
accrual and other adjustments based on client information
Smaller nonprofits with limited accounting expertise may choose to pay their auditors for these tasks. However, you should know that these services are provided in addition to the audit and can be completed by staff or volunteers to lower the cost of the audit.
Should we get an Audit?
An audit is a process for testing the accuracy and completeness of information presented in an organization's financial statements. This testing process enables an independent certified public accountant (CPA) to issue what is referred to as an opinion on how fairly the agency's financial statements represent its financial position and whether they comply with generally accepted accounting principles (GAAP).
Some nonprofits are legally required to obtain audits. Many states require an audit for nonprofits which receive contributions over a specified amount (the amount varies from state to state) and/or nonprofits who hire a paid fundraiser. You may contact the Secretary of State or Office of the Attorney General for regulations in those states where you raise money. In addition, nonprofits which receive $25,000 or more in direct or pass-through federal funding during a single fiscal year are usually required to have an audit.
You may choose to obtain an audit even if you are not legally required to do so. Many funders commonly request audited financial statements. In some cases, they will accept statements prepared in-house. Alternatively, they may accept a CPA review (see below.)
In addition to these external requirements, the board may seek reassurance that the financial information they are considering as part of their oversight function is accurate and complete. In cases where financial problems or irregularities in the financial system have occurred, the board and the general public may look to an audit to provide assurance that these problems have been resolved. Also, the audit process can be valuable to your executive director and finance staff since it confirms the financial picture and helps you strengthen internal control procedures.
Finally, an audit signals a new phase in the organization's maturity. As your organization's financial transactions become more complex, undergoing the rigors of an audit will help your staff understand and develop the financial systems required to track and manage finances responsibility. In addition, as others become attracted to your organization's work, many will expect you to be able to provide them with audited financial statements as they are considering making a contribution as a donor and/or a volunteer.
Alternatives to an Audit
A review is a more limited examination of the financial statements by a CPA. During a review, the CPA asks questions of management and conducts some analysis, but does not undertake the extensive testing required for an audit. As a result, the review provides only limited assurance that the financial picture is fairly presented. A review may cost less than half of an audit and may satisfy state requirements for smaller nonprofits.
A compilation is a report prepared by an accountant using financial data supplied by the organization. The accountant organizes this financial information into standard financial reporting formats, but does not review the numbers for accuracy or provide assurance regarding the information that is included.
What is an A-133 Audit?
In 1990, the Office of Management and Budget (OMB) issued Circular A133, Audits of Institutions of Higher Education and Other Nonprofit Institutions, which defines audit requirements for nonprofits receiving more than $25,000 in federal funding. Your organization is subject to these audit requirements even if the federal money you receive is passed through another agency. For example, a city housing authority may make a grant to a local nonprofit housing developer which contains H.U.D. funding. The local housing developer is subject to A-133 audit requirements even though the grant was not directly from H.U.D.
When is an A-133 Audit required?
Fortunately for smaller nonprofits, the federal guidelines may permit you to combine a regular audit of your whole agency with a program- specific-133 audit of the program receiving federal funding. The amount of your total combined federal funding will determine the type of audit you are required to have under A-133. The following table shows when an A-133 audit is not required, when a program-specific A -133 audit may be elected, and when you must have an agency-wide angle federal audit:
Total Amount of One Program More Than One Program
Federal Awards
$0 -- $24,999 No Audit No Audit
$25,000 -- $99,999 Program Specific or Program Specific of
A-133 Single Audit A-133 Single Audit
$100,000 or More Program Specific or A-133 Single Audit
A-133 Single Audit
A-133 audits, like non-federal audits, test financial statement information. However, the A-133 audit looks more closely at tracking and classifying revenue from federal sources. In addition, the auditor looks for compliance with general and specific government audit requirements, which cover both financial and non-financial factors such as program effectiveness, client eligibility, efficiency with which resources are used, etc. The auditor must also test internal control procedures more rigorously than in a standard audit, making sure that adequate systems are in place for complying with the requirements noted above. Because of the expanded procedure involved and increased reporting requirements for the auditor, the audit may cost substantially more than a traditional audit and involve more time from your staff. You should be allowed to build these additional audit costs into your grant. In practice, however, many nonprofits receiving pass-through federal funding have had difficulty convincing their government funders to include audit money in their grant.
In summary, if your organization receives over $100,000 in federal funding, whether directly or indirectly, and that funding is for more than one program, you are required to have an agency-wide A-133 audit. In addition, a program which receives more than $100,000 in combined federal awards is likely to be classified as a major program, and, therefore, subject to significantly more testing by the auditor. Whether a program is major or non-major is based on the dollar value of expenditures during the audit period. A program is a major program when total expenditures equal or exceed three percent of total federal funds expended or $100,000, whichever is greater. A program is non-major when expenditures are below this threshold. On other words, if one program spends $100,000 or more in total federal funds it is a major program, unless you have received more than $3,333,333 in total federal funding for all programs.
How often will you be Audited?
You are subject to A-133 guidelines for each year in which you receive federal monies of $25,000 or more. However, the guidelines are somewhat unclear as to how often these audits must be conducted. According to Position Statement No. 6 issued by the President Council on Integrity and Efficiency Standards Subcommittee, the A-133 single audit must be annual when the not-for-profit has annual financial audits. On other words, if you are usually audited annually, you must also have an A-133 audit annually. If, however, you are usually audited every other year, you may also undergo an A-133 audit every other year, but the report must cover both years under consideration.
As you can see, receiving federal money can require a lot of extra work. This work begins as soon as you receive a grant award. If your organization receives funds from a non-federal agency or grantor, you are expected to ask whether your grant includes federal monies. In some cases your funder will not know the answer, even though they are required to inform you whenever federal funding is included in your award. You are required to make a good faith effort to determine whether federal money is included, and if so how much. Each federal award is identified with a number from the Catalogue of Federal Domestic Assistance (CFDA). Your granting agency should tell you the CFDA number(s) for any federal funds included in your award since you are required to report this information as part of your audit. When you do receive federal funding, alert your auditor right away so you can get help setting up the proper systems for complying with government regulations. You may also want to get a copy of the OMB Compliance Supplement, which describes the A-133 requirements. Alternatively, your auditor may have prepared guidelines for you to follow. Then identify the person on your staff who will monitor compliance with the federal guidelines. The sooner you learn of the extensive requirements which go along with federal funding, the better able you will be to incorporate them into your accounting system.
How do we Prepare for an Audit?
Choosing an Auditor
A nonprofit's audit is addressed to its board of directors, who have ultimate financial accountability for the organization. The board's finance or audit committee should recommend an auditor for approval by the full board. If you do not have an appropriate board committee, the director or an individual board member can bring a recommendation to the board.
While there are many criteria you may consider when selecting an auditor, the following are usually important considerations:
Experience in the nonprofit sector
Since there are some differences between for-profit and nonprofit accounting and in how financial statements are interpreted, an auditor who has other clients in the nonprofit sector is likely to be more helpful and efficient.
Experience with other nonprofits in your area of work
You may want to consider an auditor experienced with similar agencies who knows the specific reporting requirements of your primary funding sources.
Training in General Accounting Office (GAO) Standards
If you are required to have an audit which meets government standards, your auditors must fulfill GAO s continuing education requirements.
References for the audit firm and the auditor
In addition to experience, you are looking for indications that the auditor has the technical expertise, communication skills, and flexibility to conduct your audit in an efficient and effective manner. A good working relationship with your auditor will help ensure that the audit goes smoothly.
Fee
In those states where it is permitted, you will want to compare bids from auditors regarding the fees they charge to do the work you require. Pro-bono (free) audits are rare and nonprofits are cost sensitive. However, fees can be a tricky measuring stick for choosing an auditor. There are some outstanding auditors who work with nonprofits for a reduced fee. A firm may produce a lower bid the first year to get your business and then significantly raise the fee in subsequent years. Auditors who do not have the necessary experience with nonprofits may take longer to produce the audit, causing them to raise the audit fee in later years. They may also prepare a less complete report which has less value to the board and the public. Also, they may require nonprofit staffs, who are typically overburdened, to do even more work in preparing for the audit. Finally, some auditors who charge a lower fee do not provide the organization with a management letter detailing areas of weakness in the accounting system. This letter is an important management tool, of benefit to both the board and staff.
On the other hand, an expensive audit does not guarantee an excellent product. Your goal will be to get the reports and advice that you need and can understand for a reasonable fee.
There are differing recommendations regarding changing auditors after you have established a relationship with one individual or firm. Auditors argue that, if you are getting the information you need from your audit and are satisfied that the reports are complete and usable, it is unwise to start over with a new auditor. Management consultants reply that, after a period of a few years, auditors may be unable to provide the organization with fresh insights. In addition, bidding out the audit may provide an incentive to your current auditor to maintain reasonable fees. It may be useful to talk to one or two other qualified auditors every few years to determine whether the upheaval of working with a new auditor will be offset by better quality, lower fees, and/or new perspectives.
What Information is Needed for an Audit?
To prepare for your audit ask your auditor what information you will be required to provide. Many auditors prepare a list of those records which they will need to examine, forms which you will need to complete, and questions you will need to answer. Complete, accurate, and accessible records and other information prepared well in advance of the audit will help ensure that the process goes smoothly and more quickly, reducing the financial and emotional cost of an audit.
While the following is not a complete list, it is representative of the information an auditor is likely to require:
Confirmations
A confirmation is an independent statement which supports the financial information in your records. Auditors will ask you to prepare confirmation letters on your letterhead (they will provide the format) to your bank(s), funders, attorney, people, and organizations you owe money to and who owe you money to confirm the amounts reflected in your books. Confirmations are mailed by and returned directly to your auditor to ensure their credibility.
Evidence of Internal Controls
The auditor will either meet with staff members or request that they complete a questionnaire documenting the procedures related to spending and receiving money and other resources, complying with laws, donor restrictions and regulations, maintaining property and equipment, and recording financial information in the books.
Documentation
The auditor will request a number of schedules (lists) of information related to the following:
Assets
Accounts Receivable -- Who owes you money, how much, when it was due?
Property and Equipment (Fixed Assets) -- When acquired, how much you paid, how long they are expected to last, how much they are depreciated each year, and how much has been depreciated to date?
Note: Many nonprofits ask their auditors to maintain this schedule for them and to prepare the annual calculation of depreciation.
Liabilities
Payables -- Who you owe money to, how much you owe each individual/organization? Copies of invoices or loan agreements.
Deferred Revenue -- If you have deferred any contributions due to donor conditions or restrictions, provide the information noted under Grants and Contributions, in the Revenue section below.
Revenue
Grants and Contributions--Funder/donor names and addresses, grant period, grant amount, when received, restrictions, and copies of the grant letters and grant applications. In the case of individual contributions, your auditor will specify which donors to include on this list based on a minimum level of contributions they will establish for you based on your overall budget and total contributions.
Donated services and materials--You may be required to place a dollar value on contributions of certain services and materials. Prepare a list of these donations to discuss with your auditor.
Special events and benefits--Show income and expenses, and documentation for the value of goods or services which donors received (and, therefore, are not included in the tax-deductible portion of their payment.)
Documentation--such as contracts and invoices, names and addresses, registrations, etc. for fees from memberships, tuition, performances, and other services.
Inventory--If you sell tee-shirts, books, or other products, keep a record of sales throughout the year so that beginning inventory can be reconciled with inventory at the end of the year.
Expenses
Payroll records, including federal and state tax returns related to payroll, vacation records.
Smaller nonprofits rely on their auditors to prepare many of these schedules based on information they give to the accountant. You can save on the cost of your audit by preparing the majority of these schedules internally, using staff or board volunteers, rather than asking the auditor to prepare them.
ADDITIONAL INFORMATION
In addition to the schedules noted above, be prepared for the auditor to review the following items:
Board minutes
Leases and other contracts
Bank statements, bank reconciliations, checkbooks, and canceled checks
Financial files for paid bills and deposits
Components of the accounting system -- chart of accounts, journals and ledgers, printouts if the system is computerized, trial balance, etc.
Budget for the fiscal year being examined
Finally, you will want to consider the non-financial aspects of the audit. The staff should understand what is involved in an audit, that it is a routine examination of financial and other information, and that they may be asked a few questions in relationship to that examination. You should assign one person to be the audit coordinator. In a small nonprofit, that may be the bookkeeper or executive director. In a larger organization, it may be the finance director. The audit coordinator should have access to all in formation the auditors may need, and should plan to be available to the auditors while they are on-site. In addition, some thought should be given to setting aside a physical location for the auditors so they can work efficiently.
When Does an Audit Begin?
Most organizations select an auditor prior to the end of their fiscal year. About the time your fiscal year ends, you will want to meet with your auditor to determine what information will be required for the audit. If your financial management system is reasonably well organized, the audit can usually begin within two months of the end of your fiscal year. However, new government funding and other complicating factors may extend the amount of time needed to prepare for the audit.
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