Preparing for a Nonprofit Financial Audit: What the Auditor Will Ask For

The funder's agreement says audited financial statements. The state's charitable registration form asks for them above a certain size. The board chair has started using the word. And the last time anyone looked, the bank reconciliations stopped in March.

An audit is not an accusation. It is an independent accountant's opinion that the financial statements fairly present the organization's position, and the work of preparing for one is the same work that makes an organization fundable and governable. Here is when an audit is required, what the auditor will ask for, and how to prepare so the process takes weeks rather than months.

Audit, review, or compilation

Three levels of outside accounting work exist. A compilation assembles statements from your records with no assurance. A review applies limited procedures and gives limited assurance. An audit tests the records, evaluates internal controls, and gives the auditor's opinion, which is the level funders and regulators usually mean. A separate, additional audit, the single audit, applies to organizations that spend one million dollars or more in federal awards in a fiscal year, and it tests compliance with federal grant rules on top of the financial statements. Our article on government grants for small nonprofits covers that threshold.

When an audit is required

• State law. Many states require audited or reviewed statements for charitable registration above revenue thresholds that vary widely by state. Check the rules where you are registered and where you solicit. Our article on the deadlines nonprofits quietly miss covers the registrations themselves.
• Funders. Foundations and government agencies often require an audit above their own grant sizes, or as a condition of any grant.
• Lenders and landlords, for loans and leases.
• Federal spending, at the single audit threshold.
• The board's own judgment, which for many organizations is the reason that matters most: an audit is how a board discharges its duty to know the money is where the statements say it is.

An organization ready for an audit is an organization whose books tell the truth every month, not just in the month the auditor arrives.

What the auditor will ask for

Every audit begins with a list of documents the organization prepares. The list varies, and it nearly always includes:

• The general ledger and trial balance for the year, and the prior year's statements.
• Bank and investment statements with monthly reconciliations, every month, every account.
• Accounts receivable and payable listings, with aging, at year end.
• Grant agreements, award letters, and a schedule of restricted funds showing what was received, released, and still restricted.
• Pledges and their documentation, and in-kind contributions with the basis for their value.
• Payroll records, payroll tax filings, and the employee census.
• The fixed asset register with additions, disposals, and depreciation.
• Leases, loans, and contracts.
• Board minutes for the year, the bylaws, the conflict of interest policy and its annual disclosures, and any policies on reserves, gift acceptance, and investments.
• The prior Form 990, so the auditor can reconcile it to the books. Our article on the Form 990 and who is reading it explains that filing.
• Descriptions of internal controls: who approves, who records, who reconciles, and how they differ.

The preparation that saves weeks

• Close the books monthly, all year. Reconciled bank accounts, restricted funds tracked by grant, and expenses coded by program, management, and fundraising. Our article on nonprofit bookkeeping without a finance department is the routine.
• Track restricted funds separately from day one. The most common audit adjustment in small organizations is restricted money that was not tracked as restricted.
• Keep the policies current. Auditors ask for them; funders read them; boards forget to update them.
• Separate duties where you can. With two or three people, that means the person who writes checks does not reconcile the account, and a board member reviews the bank statements. Where full separation is impossible, document the compensating review.
• Engage the auditor early and agree on the list and the timeline before year end, so the first weeks of the new year are gathering rather than scrambling.
• Answer the same day. Audits stall on unanswered requests. One person owns the list and the responses.

Monthly closes, restricted-fund tracking, the policy calendar, and the audit preparation list are the routine our Ops and Finance department runs for organizations without a finance lead. See how our staff keep the books audit-ready every month.

What comes back

The auditor issues an opinion on the statements, ideally unmodified, and usually a management letter describing weaknesses in controls and recommendations. Read the letter as a to-do list, not a rebuke; funders who see the same letter two years running draw conclusions. The board, or an audit committee, meets the auditor without staff present at least once, accepts the audit, and tracks the recommendations to completion. Then the audit's numbers feed the Form 990, the annual report, and every proposal that asks for audited statements.

Costs and timing

Audit fees scale with the organization's size and the state of its records; clean monthly books are the largest discount available. Timing runs from engagement before year end, through document gathering and fieldwork in the early months of the new year, to a draft and a final report typically within four to six months of year end. Organizations that need the audit for a state filing or a funder deadline should count back from that date when engaging.

Questions nonprofits ask about audits

Our revenue is small. Do we need an audit at all?

Check your state's thresholds and your funders' requirements. Many small organizations need a review rather than an audit, and some need neither until they grow. A clean monthly close is required either way.

What is the most common problem auditors find in small nonprofits?

Restricted funds not tracked as restricted, followed by unreconciled accounts and missing documentation for in-kind gifts.

Can our treasurer or a board member do the audit?

No. An audit must be independent. A board member can review the books and should, but that is oversight, not an audit.

How do we choose an auditor?

One who audits nonprofits regularly, understands restricted funds and the Form 990, and can explain the management letter in plain words. Ask for references from organizations your size.

Your mission is bigger than the audit

The audit is a once-a-year event, and the readiness for it is a twelve-month habit that also happens to be what makes an organization fundable. You do not need to become an accountant on top of everything else. You need a staff that is already closing the books each month, already tracking every restricted dollar, and already assembling the list the auditor will ask for while you lead the mission only you can lead. Find out what our staff can do for you.

Zoya Syal is Content and Production Manager at Nonprofits Engine, where she leads the content and testimonial work for a team that helps small nonprofits get set up and funded.