Nonprofit Audit: A Comprehensive Guide and Checklist for Financial Transparency

Latest Facts and News

• As of 2023, nonprofits receiving $750,000 or more in federal funding are required to undergo a single audit.
• The COVID-19 pandemic has increased scrutiny of nonprofit financial management, making audits more critical than ever.
• Recent changes in accounting standards (ASU 2016-14) have impacted how nonprofits report net assets and liquidity.
• The IRS has increased its focus on nonprofit compliance, with a 10% rise in audit rates for tax-exempt organizations in the past year.

You may be required to conduct a nonprofit audit as per the IRS, state government, or certain donor requests. It is important to work on this audit and conduct it as soon as possible and noncompliance may result in donations being cut off, and even the bank account may be frozen. Since most nonprofits operate on good faith, not conducting an audit can erode this trust. Some donors may even cut off their funding.

In this blog, we give you a comprehensive guide on nonprofit audits so that you can prepare for and implement the audit solutions, which will boost your reputation as a transparent charitable organization. Most prestigious charity donors prefer to provide funding to reputable nonprofits, and making these audit reports available publicly will boost your organization’s image for such donors.

Understanding Nonprofit Audits

A nonprofit audit is conducted to review all of a charity’s records, including their reports, policies, procedures, and transactions. Independent auditors who conduct these audits and give you their examination reports of your nonprofit’s overall workings and its compliance with general, financial, federal, and state regulations.

Types of Nonprofit Audits

Conduct a nonprofit audit regularly to ensure compliance with regulations and build trust with donors and stakeholders. Understanding the different types of nonprofit audits can help your organization prepare effectively and maintain transparency.

1. Internal Audit

Purpose: Conducted by the nonprofit’s own team to evaluate internal processes and identify areas for improvement.
Benefits: Helps in the early detection of issues and enhances internal controls.
Consideration: While beneficial, internal audits may lack the objectivity of external reviews.

1. External Audit

Purpose: Performed by an independent third-party auditor to provide an unbiased assessment of the organization’s financial statements and practices.
Benefits: Enhances credibility with donors, grantors, and regulatory bodies.
Consideration: Often required by funders or governing bodies, especially for larger nonprofits.

1. Compliance Audit

Purpose: Assesses adherence to federal, state, and local laws, as well as internal policies and bylaws.
Benefits: Ensures the organization operates within legal frameworks and maintains its tax-exempt status.
Consideration: Regular compliance audits can prevent legal issues and penalties.

1. Financial Audit

Purpose: Focuses on evaluating the accuracy and fairness of the organization’s financial statements.
Benefits: Provides assurance that financial reports are reliable and free from material misstatements.
Consideration: Often a component of external audits and may be mandated by stakeholders.

1. Operational Audit

Purpose: Examines the efficiency and effectiveness of the organization’s operations, including management practices and use of resources.
Benefits: Identifies opportunities to improve productivity and resource utilization.
Consideration: Can lead to strategic changes that enhance overall organizational performance.

By understanding and utilizing these various audit types, your nonprofit can uphold transparency, ensure compliance, and foster trust among stakeholders.

When is a Nonprofit Audit Required?

Nonprofit organizations must navigate various regulations to maintain nonprofit governance and uphold public trust. One critical aspect is understanding when an audit is legally required. Audit requirements can vary based on federal guidelines, state laws, and specific funding stipulations.

• Federal Audit Requirements: At the federal level, any nonprofit organization that expends $750,000 or more in federal funds within a single fiscal year is mandated to undergo a Single Audit (formerly known as an A-133 audit). This comprehensive examination assesses both the financial statements and the organization’s adherence to federal award regulations.
• State-Specific Audit Requirements: Beyond federal mandates, many states impose their own audit requirements for nonprofits, often linked to the organization’s revenue or contributions. These thresholds and stipulations differ significantly across states.

The Nonprofit Audit Process Step-by-Step

Conducting a nonprofit audit is a critical process to ensure financial accountability, compliance, and organizational integrity. Understanding each step can help your organization navigate the audit with confidence. Here are the main steps in conducting a tax-exempt organization audit:

Selecting an Auditor

• The audit committee responsibilities include evaluating the records of your nonprofit organization and suggesting the recommendations you will follow on the basis of it. Hence, the right auditor needs to be chosen for the task. Here are some factors you should take care of:
• Experience with Nonprofits: Ensure the auditor has a track record of working with nonprofit organizations.
• Understanding of Compliance Requirements: The auditor should be well-versed in federal and state regulations affecting nonprofits.
• Reputation and References: Seek recommendations and check references to assess the auditor’s reliability and professionalism.
• Preparing for Your Nonprofit Audit
• When preparing for an audit, there are too many things for you to keep track of. The nonprofit audit checklist given below ensures a smooth and efficient audit so that your organization maintains transparency, compliance, and donor confidence.
• Before the Audit
• Review Financial Records: Ensure all financial statements, ledgers, and records are up-to-date and accurate.
• Reconcile Accounts: Verify that bank accounts, donations, grants, and expenses are properly reconciled.
• Organize Supporting Documents: Gather receipts, invoices, payroll records, and grant agreements.
• Update Internal Policies: Ensure financial management, expense tracking, and conflict of interest policies are current.
• Compile Board Meeting Minutes: Maintain a record of financial discussions and decisions made by the board.
• Review Previous Audit Reports: Address past recommendations to show compliance improvements.
• Confirm Compliance Requirements: Check federal and state audit regulations specific to your nonprofit.
• Assign Internal Roles: Designate a team responsible for audit coordination and communication with auditors.
• Prepare a Nonprofit Audit Checklist: Create an internal checklist to ensure all required documents are ready.
• During the Audit
• Facilitate Auditor Access: Provide a dedicated space for auditors to review documents and conduct interviews.
• Be Ready for Questions: Ensure key staff members are available to clarify financial transactions and policies.
• Provide Quick Document Access: Have all requested files organized and readily available.
• Demonstrate Internal Controls: Explain how financial processes are managed and monitored within the organization.
• Encourage Transparency: Maintain open communication and cooperation with the auditors.
• After the Audit
• Review the Draft Audit Report: Go through findings with the finance team and board.
• Clarify Any Issues: Address discrepancies or auditor concerns before the final report is issued.
• Develop an Action Plan: Create a strategy to resolve identified weaknesses and improve financial management.
• Update Policies & Procedures: Implement necessary changes based on audit recommendations.
• Monitor Implementation: Set deadlines and assign responsibilities for policy updates and procedural changes.
• Schedule the Next Audit: Plan ahead to ensure continuous compliance and financial accountability.
• If this list makes you feel overwhelmed, reputed tax relief services firms like Hall’s IRS offer IRS audit representation services to help your nonprofit prepare for and pass the nonprofit audit conducted by the IRS.
• During the Audit: What to Expect
• While you have already prepared for the charitable organization financial review, knowing what to expect during the actual examination will make it easier to cooperate with auditors and ensure a successful review. Here are the key steps that take place during the audit:

• On-Site Visits by Auditors: Auditors may visit your organization to observe operations and internal controls in action. They will assess whether financial practices align with documented policies and industry standards.

• Review of Financial Documents: Auditors will examine financial statements, tax filings, and accounting records for accuracy. Supporting documents such as receipts, invoices, and grant agreements will be cross-checked.

• Internal Control Evaluation: The audit will assess how well your organization prevents financial mismanagement or fraud. Auditors will analyze whether proper oversight is in place for financial transactions.

• Interviews with Key Staff and Board Members: Financial officers, executive leadership, and board members may be interviewed. Auditors will ask about financial procedures, compliance measures, and governance structures.

• Clarification Requests and Follow-ups: If discrepancies are found, auditors may request additional documents or explanations. Clear and timely responses can help avoid prolonged review times.

• Being cooperative and transparent during the process ensures a smoother experience and demonstrates your nonprofit’s commitment to financial accountability.
• Understanding and Acting on Results
• After completing a nonprofit audit, the next crucial step is reviewing the findings and making necessary improvements. Here are some steps you can take to follow the suggested improvements systematically:

• Interpreting the Audit Report: The final report will cover financial statements, internal controls, and any compliance issues found. Evaluate the reports and identify and improve on the suggested grounds.

• Addressing Identified Issues: Develop a corrective action plan with clear steps and strict timelines to carry out the changes. Assign specific duties to each team member so that they remain accountable.

• Implementing Improvements: Strictly regulate internal controls and the approval processes. If needed, also look into training your staff on financial policies, accounting standards, and fraud prevention.

• Nonprofit Audit Checklist: Essential Items to Prepare
• Before the nonprofit audit takes place, there are a number of documents you need to collect together and organize, as these documents will help prepare a comprehensive report. The list of such official paperwork required has been categorized into financial and organizational records for this blog and is given below:
• Financial Documents
• Gather and organize the following key financial documents before the process starts:
• Nonprofit Financial Statements: Financial position balance sheet, income statement, cash flow statements, and the statement of functional expenses.
• Internal Financial Reports: General ledger, budget-to-actual comparisons, and bank reconciliations.
• Tax Filings: Recent IRS Form 990 preparation reports and state tax returns.
• Grant and Donation Records: Grant agreements and related correspondence, donor contribution records, and documentation of donor restrictions.
• Expense Documentation: Invoices and receipts, payroll records, contracts, and lease agreements.
• Schedule of Expenditures of Federal Awards (SEFA): If expending $750,000 or more in federal funds annually, prepare a SEFA for a single audit.
• Organizational Records
• Here are some other records needed relating to the working of your organization:
• Compliance and Regulatory Documents: State charitable solicitation registrations, licenses and permits, and correspondence with regulatory agencies.
• Board and Governance Materials: Board meeting minutes, approved budgets and organizational policies (e.g., conflict of interest, whistleblower).
• Internal Controls Documentation: Policies and procedures manuals and flowcharts of financial processes.
• Prior Audit Reports: Previous audit findings and management letters.
• Contact Hall’s IRS audit lawyers for help in organizing the nonprofit audit successfully.
• Common Nonprofit Audit Findings and How to Address Them
• Ensuring accurate financial practices is crucial for nonprofits to maintain trust and compliance. Below are common nonprofit audit findings and strategies to address them:
• Missing or Inaccurate Financial Records
• Auditors often encounter missing receipts, invoices, or donation records, which hinder the verification of financial transactions.
• Solution: Implement a robust record-keeping system, utilizing software tools tailored for nonprofits. Regularly cross-check records to ensure accuracy before audits.
• Lack of Internal Controls
• The absence of internal controls can lead to errors and potential financial mismanagement.
• Solution: Establish strong accounting processes with clear policies, assign specific responsibilities, and conduct internal audits to detect and correct issues promptly.
• Misclassification of Revenues and Expenses
• Incorrectly categorizing funds, such as donations or grants, can complicate financial reporting.
• Solution: Collaborate with an experienced nonprofit accountant to ensure proper classification of all financial transactions, adhering to current accounting standards.
• Mishandling Funding Restrictions
• Failing to adhere to donor-imposed restrictions can lead to compliance issues.
• Solution: Develop clear guidelines for fund usage, detailing the source, intended purpose, and conditions of each fund. Utilize accounting software to monitor and enforce these restrictions.
• Misclassification of Workers
• Incorrectly classifying workers as volunteers, independent contractors, or employees can result in tax complications.
• Solution: Educate organizational leaders on proper worker classification, referring to IRS guidelines, and consult with HR specialists or employment law attorneys as needed.
• By proactively addressing these areas, nonprofits can enhance their financial integrity and ensure smoother audit processes.
• Post-Audit Actions: Implementing Recommendations
• After completing the nonprofit audit, it’s essential for nonprofits to act on the findings to enhance financial management and uphold stakeholder trust. Here’s how to effectively implement audit recommendations:
• Review the Audit Report Thoroughly: Begin by carefully examining the auditor’s findings and recommendations. Engage with your board and finance committee to prioritize actions based on urgency and impact.
• Develop an Action Plan: Create a detailed plan outlining steps to address each recommendation. Assign responsibilities, set timelines, and establish measurable outcomes to track progress.
• Strengthen Internal Controls: Enhance policies and procedures to mitigate identified risks. This may involve segregating duties, implementing approval processes, or adopting new financial software for better oversight.
• Train Staff and Volunteers: Ensure that all team members understand updated protocols. Regular training sessions can reinforce the importance of compliance and accurate financial practices.
• Monitor and Evaluate Progress: Regularly assess the effectiveness of implemented changes. Use internal audits or periodic reviews to ensure sustained compliance and identify areas for further improvement.

• The Role of Technology in Nonprofit Audits
• In today’s digital age, technology plays a pivotal role in streamlining the audit process for nonprofits. By leveraging advanced software and digital tools, organizations can enhance efficiency, accuracy, and compliance in their financial reporting.
• AI-Powered Financial Reporting: AI-driven platforms can swiftly generate comprehensive financial reports and establish robust audit trails, significantly reducing the time and effort traditionally required. This automation minimizes the risk of human error, ensuring that financial data is both accurate and readily accessible. 

• Ensuring Compliance with Regulatory Standards: AI tools assist organizations in continuously monitoring financial records. By automating compliance checks, nonprofits can proactively identify and address potential issues, thereby reducing the likelihood of non-compliance findings during audits. 

• Enhancing Grant Management: AI and automation technologies can streamline the monitoring process, providing real-time insights into grant utilization and reporting. This ensures that funds are managed appropriately and reporting requirements are met, facilitating a smoother audit experience.
• By embracing these technologies, nonprofits can not only streamline their audit processes but also enhance overall financial management, allowing them to focus more effectively on their core mission.

• Make Your Audit Preparation Easier and Contact Hall’s IRS Today!
• Conducting a nonprofit audit is an important part of maintaining an efficiently working charitable organization. Getting audits done from time to time helps you identify room for improvements in your nonprofit while ensuring that you stick to the main mission and are guided by your vision, with the audit reports as your guiding post.
• Professional firms like Hall’s IRS offer IRS audit representation services, especially when a nonprofit audit is conducted by the IRS federal service. If you have any doubts about conducting an audit, preparing for it, or the documents that need to be prepared in advance for the audit, contact Hall’s IRS today.