Audits and Management Letters

Each month, Nonprofits Assistance Fund hosts the Financial Management Network.  These free, informal gatherings are opportunities for members of the nonprofit community to get together to discuss different financial topics and network with peers. Key takeaways from these discussions will be posted and form an archive to help promote healthy financial practices.

Notes from Audits and Management Letters (4/22/09)

"Audits are easy. If you reconcile every line on the balance sheet, you're ready for the audit."

Unfortunately, audits are not that easy in practice. 

What is an Audit?

A financial report that has been tested and verified for accuracy and prepared in accordance with Generally Accepted Accounting Principles (GAAP). An essential component of the audit is the Opinion Letter.

An audit includes

  • Financial Statements
    • Statement of Financial Position (balance sheet) from the last day of your organization's fiscal year
    • Statement of Activities (income statement)
  • Opinion or Management Letter which letter expresses a professional opinion on the accuracy of the financial information
  • Supplemental Footnotes

The audit is the highest level evaluation of the accuracy of an organization's financial reports.  CPA's can also conduct less expensive assessment by performing a Review or a Compilation.

Useful Definitions

Internal Control: The process of internal control is designed to provide reasonable assurance that an organization's assets are safeguarded, that operations are managed effectively and efficiently, and that financial reports are reliable. They vary according to organizational size, complexity, and management structure.

Material Weakness: When one or more an organization's internal controls are considered to be inadequate.  Such a deficiency could lead to a material misstatement in the financial statements.

Significant Deficiency: When one or more an organization's internal controls are considered to be inadequate.  Although this finding is less severe than a Material Weakness, the deficiency is significant enough to merit attention.

When is an Audit Required?

Minnesota just passed a law raising the audit threshold to total revenues of $750,000 (up from $350,000).  Read MCN's testimony in favor of the proposal.

Even if you are not required to be audited, it is always useful to have a professional assess your books.  To increase transparency, double check your bookkeeping, or establish benchmarks for future audits, an organization could undergo a Review or Compilation.

Single Audit

A single audit is required for any nonprofit organization that expends $500,000 or more of Federal awards in a year.

Other Requirements

Some funders will require an audit as part of grant reporting, even if your organization's annual revenue is below the audit threshold.

The Board's Role

It is the board's responsibility to hire the auditor and approve the audit.  Each board should have an audit committee (which may or may not be the finance committee) to ensure oversight of the audit process and board approval of the final product. We strongly recommend you get copies of the audit to the entire board at least one week before the meeting to approve the audit. 

Changes in Audit Standards

  • Changes dictated by AICPA affect how the auditor approaches the management letter.  Learn more about AICPA's Auditing Standards.
  • UPMIFA (Uniform Prudent Management of Institutional Funds Act): Requires that endowment funds are prudently managed so that the purchasing power of the corpus is maintained.
    • This change increases the flexibility of your endowment, allowing organziations to spend "below water," so long as the corpus' purchasing power is intact
    • Although a spending policy is not required in addition to an endowment policy, it is helpful
    • Read notes from Investment and Endowment Policies for more information.
  • FASB 157 on Fair Value Measurements will affect audits in the next fiscal year. For some assets it is more challenging to determine what is "fair value."
    • Use the footnotes to paint a bigger picture
    • Ensure you receive quarterly statements for your investments

Making the Most of Your Audit

An audit is more than a legal requirement, it is a tool for your organization. An audit is a document that you use to better understand your organiztion and financial position.

  • The management letter is an action plan to help your organization be more compliant.  The comments spell out what steps you can take.
    • Some organizations use it as a tool to communicate with the board
  • For small organizations, it is can be challenging to have internal control mechanisms that meet audit standards.  Auditors understand the reality of your situation, but they are required to mention it.
    • Do your best to make improvements.  Common sense goes a long way.
    • There may be instances where 
      • Do a cost benefit analysis - is it more costly to fix the problem or have a recurring material weakness?
        • For example, how would this impact your administrative cost ratio?
      • You can use the footnotes to explain to funders that you are doing everything you can to improve this deficiency.
  • Management can respond to the auditor's narrative and explain and additional information or circumstances that may inform the audit.  If there is something worth responding to, you should do so.  An audit is an internal document - you can create another supplement internal document to accompany it.
  • Use the footnotes to tell your story
    • If you want to take space for narrative footnote, it's your document and you can.
    • You cannot recognize all volunteers hours on your audit, but you can ask your auditor to add a note with the total hours donated.
    • Be transparent

Finding and Hiring an Auditor

  • Local vs Regional vs National audit firms
    • Larger firms have more resources, but they may cost more
    • Working with a national firm can feel impersonal, one participant described never seeing the same person during field work
    • With a local firm, you may have the same people each year
      • Makes the audit process faster (they "know where the bodies are buried")
      • However, that is a double-edged sword. Having a fresh set of eyes every few years is valuable.
    • Some organizations split the difference, staying with one firm but having a different partner take the lead every 3-4 years.
      • They have access to the previous auditors, they can ask their colleagues if any questions arise during field work.
  • Do a peer view - look at others of your size and area of service to see what they are doing
    • Contact current clients of any potential audit firms
  • Resources to help you find an auditor: 
  • Sample RFPs:
  • Fees
    • Generally audits cost approximately $5,000-6,000, although this varies based on different factors:
      • Funding sources (number/type of grants, government contracts)
      • Quality of your books - how you track pledges or other restricted dollars etc
      • The first year with an audit firm is always more expensive
    • You get what you pay for.  If you also need a 990, you should include that in the RFP

Working with Auditors

  • Have a face-to-face meeting with your auditor(s) on site to set expectations.
    • Make sure you are on the same page
    • Receive the schedule
  • Prep for field work
    • Review your books
    • Look over the comments in your last management letter
  • Maintain communication between the RFP and the audit - you don't want to have any surprises during field work
    • Some organizations maintain communication throughout the year - usually about every quarter
    • For example, if they receive a unique gift or anything out of the ordinary, they email their auditor to inquire about best practices.
      • This keeps the auditor in the loop about anything out of the ordinary and ensures the organization and auditor are on the same page (easier to make adjustments on the front end than have something flagged in the audit)
        • Easier for your auditor - no adjusted entries
    • Some audit firms charge for every communication, if your organization would like ongoing communications with your auditor, it's worth including that in an RFP
      • You can contact MAP, Nonprofits Assistance Fund, or other resources; however, they cannot replace an auditor.  If you want to be positive you are in compliance, you should contact your auditor.
  • Worth asking the auditor if there is anything you should be aware of that was not included in the management letter

Resources

Nonprofits Assistance Fund

Other Resources


Interested in Learning More?

View our Resource Collection or check out the Discussion Archive for notes from other Financial Management Networks.

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