"Nonprofit Financial Management - Managing the Audit":
Study Notes: Nonprofit Audit Management
I. Types of Audits
Internal Audits: Evaluate internal controls and program efficacy.
Conducted by in-house auditors in larger nonprofits.
Performance (Operational) Audits: Assess the effectiveness of specific
programs.
Financial Audits: CPA provides an opinion on whether financial
statements adhere to GAAP. Most common type.
II. When is a Financial Audit Required?
Required by a funding agency.
When a nonprofit receives over $500,000 in federal/state funds
(triggers A-133 audit).
Required by bank loan covenants.
III. Benefits of a Financial Audit (Even if Not Required)
Increases donor confidence.
Ensures compliance with accounting standards.
Strengthens internal controls; auditor reports significant deficiencies.
IV. Audit Alternatives (Less Expensive)
Member Review: Board member with financial expertise reviews
records.
Compilation: CPA compiles financial statements but doesn't verify or
review controls. Cost: ~1/2 of an audit.
Independent Review: CPA issues a letter on GAAP compliance, but no
opinion. Cost: ~2/3 of an audit.
Agreed-Upon Procedures: CPA evaluates specific accounting
procedures.
V. The Audit Process
1. Designate an Audit Coordinator: Usually the CFO.
2. Select the Auditor: Use an RFP.
3. Conduct the Audit.
VI. Audit Committee
Subset of the board or includes external financial experts.
Reduces financial reporting problems.
Should not include management.
Members must be able to read/interpret financial statements.
Reviews financial statements with auditor, reports to the board.
Drafts a response to the management letter.
VII. SOX Provisions (Useful Guidelines for Audit Committees)
At least one financial expert (e.g., CPA) on the committee.
Restrictions on the audit firm providing non-audit services
(bookkeeping, IT system design, HR, investment advising, legal
services).
Restrictions on hiring the nonprofit's CEO/CFO if they were previously
employed by the audit firm.
The audit committee selects and oversees the audit firm.
The audit firm reports directly to the committee, not the CEO.
The audit committee cannot accept compensation from the audit firm.
A process for employees to report unethical accounting practices.
VIII. Selecting the Auditor (RFP Process)
Cast a wide net.
Use a ranking system for technical qualifications.
Do not select solely based on price.
Nonprofit audit experience is crucial.
IX. Why Nonprofit Auditing Differs
Different accounting standards.
Indirect cost allocation.
IRS Form 990.
Unique government reporting requirements.
X. RFP Provisions
Audit Firm's Qualifications: Identify the team, require partner
supervision, references.
Scope of Work: Financial statements audited per GAAS, tax filings (IRS
Form 990), an opinion on the financial statements.
Work Schedule: Timely completion, exit interview with CEO/CFO.
Services the Nonprofit Will Provide: Timely closing of books,
reconciliations, schedules, insurance information, budget copies,
minutes, confirmation forms, access to prior auditors.
XI. IRS Form 990
CPA typically prepares it.
Price depends on the number of schedules and time required to clarify
data.
XII. Sample Audit RFP (Key elements - Exhibit 4.3)
Multi-year contract period (e.g., three years).
Requests the firm's most recent peer review letter.
Details audit requirements: GAAP, Government Auditing Standards,
Single Audit Act, OMB Circular A-133, etc.
Specifies the timeline, information requested, and assistance available
to the auditor.
XIII. Non-Audit Services
Auditors may perform non-audit services, but independence must be
maintained. Distinguish between allowable and unallowable services
(see Exhibit 4.5 - not provided).
Study Notes: Elements of Basic Audited Financial Statements
This document outlines the essential components of audited financial
statements for nonprofit organizations, as required by FAS 117.
I. Required Financial Statements (FAS 117):
Statement of Financial Position (Balance Sheet): A snapshot of assets,
liabilities, and net assets at a specific point in time.
Statement of Activities (Income Statement): Reports revenues,
expenses, gains, and losses, leading to changes in net assets over a
period of time.
Statement of Cash Flows: Tracks the movement of cash both into and
out of the organization during a period.
Statement of Functional Expenses (Required for Voluntary Health and
Welfare Organizations; Useful for All): Details expenses by function
(program services, management and general, fundraising).
Notes (Footnotes): Provide additional information and explanations
about the financial statements.
II. General Principles
Responsibility: Management is responsible for preparing the financial
statements monthly, presented for the month and year-to-date. At
year-end, they are the accumulation of the previous 12 months.
Entity-Wide Focus: FAS 117 requires reporting on the entity as a whole,
not on separate fund groups.
Net Realizable Value: All lines in the financial statements should be
reported at net realizable value (the amount the organization expects
to receive or pay out in cash). This often involves estimates developed
using GAAP methodologies.
III. Auditor's Opinion Letter
A complete audited financial statement includes the auditor's opinion
letter.
The auditor reviews year-end figures and provides an opinion on
whether the financial statements are fairly presented in accordance
with GAAP.
A "clean" or "unqualified" opinion letter typically has three main
paragraphs.
A fourth paragraph usually indicates the statements are not in
compliance with GAAP (qualified or adverse opinion) or the auditor
can't form an opinion (disclaimer).
Qualified, disclaimed, or adverse opinions require immediate attention
from the board's audit and finance committee.
IV. Statement of Financial Position (Balance Sheet)
Basic Equation: Assets = Liabilities + Net Assets
Assets: What the organization owns.
Liabilities: What the organization owes.
Net Assets: The difference between assets and liabilities (similar to
retained earnings in for-profit entities).
Key Difference from For-Profit: The Net Assets section replaces
"Shareholder Equity." There is no "Paid-In Capital" in a nonprofit
balance sheet because nonprofits do not have equity owners.
V. Key Balance Sheet Items
Assets:
o Cash: "Grease" that allows the organization to operate. Classified
as current (checkbook, money market accounts, CDs < 365
days) or noncurrent (designated for capital replacement, trustee
investments). Tracked monthly.
o Accounts Receivable: Money owed for services rendered (e.g.,
tuition, hospital bills). Arises when services are provided before
payment.
Debit: Accounts Receivable (Balance Sheet)
Credit: Service Revenue (Income Statement)
Liabilities
*Accounts Payable
o Accrued Liabilities
o Current Portion of Long-Term Liabilities
o Long-Term Debt
Net Assets:
o Unrestricted
o Temporarily Restricted
o Permanently Restricted
VI. Importance of Cash
Cash is the most important financial statement element because it
allows the organization to meet its current liabilities.
Tracked on a monthly basis in a trended format to understand cash
flow.
VII. Accounts Receivable
Organizations that charge for their services are likely to provide those
services before payments are made.
In some nonprofits, the accounts receivable may be the largest current
asset.
Study Notes: Understanding Nonprofit Financial Statements
This document provides a basic understanding of nonprofit financial
statements for board members.
I. Board Member's Responsibility:
Understand the organization's financial statements.
Ask questions about anything unclear.
Financial comprehension helps the organization achieve its mission.
Ignoring financial responsibility can lead to personal liability for poorly
governed funds.
II. Treasurer's Role:
Ensure financial records are maintained.
Compare actual income/expenses with the budget and take corrective
action.
Report on finances to the board and general membership.
File required financial reporting forms.
The treasurer is the link between the board and financial records.
III. Finance Committee (Larger Organizations):
Review financial statements.
Make investment decisions.
Consider real estate transactions.
Meet with the auditor.
Work with staff to prepare the budget.
Review accounting procedures.
Treasurer is often an ex-officio member or chair.
IV. Financial Reports:
The board should receive timely and accurate financial statements.
Frequency determined by the board chair, treasurer, and chief
executive.
The purpose is to base decisions on accurate financial data.
Establishes and reviews financial objectives.
V. Users of Financial Statements:
Board of Directors
Contributors (individuals, foundations, businesses)
Government grantors
Government regulators (federal and state)
Creditors and potential creditors
Beneficiaries of the organization's services
Employees
VI. Three Accounting Concepts:
1. Cash vs. Accrual Basis:
a. Cash Basis: Records transactions only when cash changes hands.
b. Accrual Basis: Records transactions when they happen,
regardless of cash flow. Matches income and expenses in the
same period. Provides a more accurate financial position.
c. GAAP requires the accrual basis.
2. Fund Balance (or Net Assets):
a. Net resources available to carry out the organization's objectives.
b. Calculation: Total Assets - Total Liabilities = Fund Balance (Net
Assets)
c. For-profit equivalent: Net worth or stockholders' equity
d. FASB standards now emphasize using "net assets" instead of
"fund balance."
3. Fund Accounting:
a. Used mainly by nonprofits and government entities.
b. Maintains separate financial records for each program with
designated contributions. Each set of records = "fund".
c. Funds are separate accounting entities.
d. Organizations need not have separate bank accounts for each
fund but must track transactions.
e. Too many funds can obscure the overall financial picture.
f. SFAS 117 requires nonprofits to report total assets and liabilities.
g. Typical funds: Current unrestricted, current restricted,
land/building/equipment, endowment.
VII. Financial Statements:
Statement of Financial Position (Balance Sheet): Summarizes assets,
liabilities, and net assets at a specific point in time.
Statement of Activity: Summarizes revenue and expenses within each
fund for a period of time. Reconciles net assets at the beginning and
end of the period. (Business equivalent: Income statement/Profit &
Loss statement.)
Compares actual results with the budget.
VIII. Key Takeaways:
Board members need to understand financial statements to fulfill their
oversight responsibilities.
Accrual accounting and understanding fund accounting are essential.
The Statement of Financial Position (Balance Sheet) and the Statement
of Activity are the two key reports.
