5 Simple Ways to Prepare for the Year-End Audit on Your Nonprofit

There are over 1.5 million charitable organizations in the United States. These nonprofits range from private foundations to public charities. Despite their differences, most have one thing in common -- they're tax-exempt.

For nonprofits, this is an ideal situation. It means they can provide help to individuals without the burden of taxes. Being tax-exempt has many advantages but it comes at a cost -- yearly nonprofit audits.

Now no one wants to go through an audit. But for nonprofits, the process can be especially tricky because it requires a lot of paperwork and a review by an independent certified public accountant (CPA). All of which can take time, money, and resources from other areas of the company.

Its a hassle going through an audit. But it can help you maintain your nonprofit's legitimacy and financial reputation. And with a little planning, it can be much less challenging.

If you want to know the simplest way to prepare for your year-end nonprofit audit, we've created a list to make the process as painless as possible.

What is a Nonprofit Audit?

Before we provide tips on how to prepare for a nonprofit audit let's answer some basic questions like "what is an audit?" and "why does my nonprofit need one?"

An audit is an independent review of your organization's financial statements. A Certified public accountant (CPA) called an auditor will perform this. In the case of a nonprofit, the process must be performed by an independent CPA meaning they can't work for the organization.

This is based on section 501c3 of the tax code. This section describes which organizations are exempt from taxation and thus might need an audit.

The rules governing nonprofit audits cames from the Single Audit Act of 1984. This act, amended in 1996, was created to verify organizations receiving government money were using the funds the way they were intended.

The act made the auditing much simpler by consolidating several audits into one. Before, the government would require many smaller audits before it would award money to organizations. Now, nonprofits only need one.

The Single Audit Act also outlined the 501c3 audit requirements. These say any nonprofit organization who makes over a certain amount must provide audited financial statements.

Now that you know what an audit is, let's take a look at some ways to prepare for your end-of-year audit.

1. Read up on Federal and State Audit Requirements

In anticipation of your audit, be aware there are different requirements for federal and state nonprofit audits.

Federal nonprofit requirements are relatively straightforward. Every nonprofit must submit a nonprofit audit if they spend over $750,000 in federal funds in a single fiscal year. Failing to do so can have disastrous consequences like losing your tax-exempt status, government funding, and having to pay heavy fines.

The audit required by the federal government is a single audit which is more thorough than a regular independent audit. It ensures your nonprofit has a good internal control structure.

In layman's terms, a good internal control structure means the company has an effective organizational structure and an effective process to protect itself against waste and theft. It also means there is an accurate way of recording and reporting financial data. The single audit also ensures the financial statements are accurately presented in line with federal cost principles, and the statements are done correctly under GAAP or generally accepted accounting principles.

Since auditioning can be a frustrating process, its best to know whether or not your state actually requires an audit. Several states only require an independent audit if you receive a certain level of state funding.

In fact, 26 states insist you provide several copies of the audited financial statements before your nonprofit to engage in fundraising activities. This is referred to as charitable registration.

Almost every state demands an annual audit if your nonprofit makes over a specific amount of money. This amount is either measured by total revenue generated or by total contributions. How high or low the threshold depends on the state.

These rules can vary heavily from state to state and the easiest way to be sure you're in compliance with state law is by checking the laws in each area.

2. Collect and Organize All Necessary Files

One of the easiest ways to do this is to make a nonprofit organization audit checklist.

This list should include anything an auditor will usually go over including:

  • Forms like 1099s, W2s, and other payroll documents and information

  • A list of plant assets (like buildings and equipment owned by the company) and the depreciation schedule

  • A list of inventory you're going to put up for sale

  • Organizational information like charts and HR information

  • Bank reconciliations and statements

  • Information about grants you're going to receive and those you've already received

  • Documents about the internal controls used by your company

  • Receipts from credit card transactions

You should also have a pre-audit meeting to speak with your CPA to talk about any other files you need to collect for your audit.

To cut down on the auditor's time, be sure to ask the auditor about the way they want to receive the documents. Whether as a printed copy, an electronic file, or both.

3. Inform Employees About the Process

Communication is key to a successful audit. The first step in the communication process is holding a pre-audit meeting to educate your team to know what to expect before, during, and after the audit.

During the meeting, you should talk about the timeline for the audit. This'll help your team know the deadline for turning in specific documents.

The meeting will also require you to know which files the auditor will need to look over. The meeting should contain the audit committee and the crew who will help the auditor on their fieldwork. It's also helpful if the chair of the board attends as well.

During the pre-audit meeting, the audit firm may also choose to give you a prep packet. Use this to your advantage to make the audit go more smoothly.

This also requires you to inform your employees about the cost of the audit and to plan for it accordingly. Unfortunately, independent nonprofit audits are not cheap. Auditing a small nonprofit company can cost up to $10,000 per year while auditing larger firms can cost $20,000.

4. Finish Financial Statements for the Year

To give your auditor an accurate picture of your financial position you need to close the books for the year. This requires you to complete all the final adjustments to each account as well as any reconciliations so your financial statements all follow GAAP.

To record any account activity you should use a roll forward schedule. In accounting, this means beginning a new accounting period by using any applicable data from prior periods.

Basically, if an account has a balance from a previous year it should be the beginning balance of the current year unless the account is temporary. You should also provide the auditor with a trial balance about a week in advance.

5. Get Ready for the Auditor's Report

Before the audit, it's important to know what to do once it is completed. The first thing which will happen is you'll receive a draft of the audit report. Later, the staff will review the report, ask questions, and write a management letter.

In this letter, the auditor will offer an honest assessment of the organization procedures and recommendations on how to change it. They will provide information about the material, internal control issues, and operating inefficiencies.

Material internal control issues are basically issues with the recording and protection of assets that are severe enough to be a threat to the company. Prepare to make changes to your nonprofit based on these suggestions and to present the findings to your Board of Directors.

You should also prepare to ask the auditor questions after the audit is done. Some good ideas for questions are:

  • How do you think we should improve our practices for operating activities, financial reporting, and accounting?

  • Where do we stand compared to other similar nonprofits?

  • Is there an area that might alert the IRS? How can we address it if there is?

  • How has the management team addressed concerns from prior audits?

The final thing to do is to present the findings to the board of directors.

Looking for an Accountant for Your Nonprofit?

As we've just shown, a nonprofit audit doesn't have to be painful.

If you want more financial tips for nonprofits like how to pick the right accountant or how to improve your cashflows, check out our blog!

And if you're looking for an experienced CPA to help your nonprofit, sign up for a free consultation today.