The Internal Revenue Service (IRS) doesn’t require nonprofits to have independent audits, but that doesn’t mean your nonprofit never needs an audit. Some federal, state, and local government agencies require audits, as do some banks and foundations. Generally, the requirements relate to the nonprofit’s size or spending.
When an Audit Is Required
An independent audit might be required in the following circumstance:
- To respond to a request. A federal, state, or local government requests a copy of your nonprofit’s audited financial statements.
- To verify assistance. A nonprofit spends more than a certain amount in federal or state financial assistance. Keep in mind that this amount includes funds received directly from the agency as well as funds that come through another entity (e.g., a donor-advised fund).
- To solicit funds. A nonprofit is in a state that requires audits if you solicit funds by mail, phone, or other means in their states, even if the organization isn’t located there. In states that require it, the audit must be submitted as part of the registration process.
- To contract services. A nonprofit has a contract for services with federal, state, or local government that requires an annual financial statement audit.
- To apply for funds. A nonprofit receives or wants to apply for funding from a foundation or other entity that requires audited financial statements.
These requirements are straightforward. If your nonprofit falls into any of those categories, an independent audit is required.
When an Audit Is Beneficial
Sometimes, however, it is a good idea to have an audit even if one is not required. Better community relations and greater transparency can be compelling reasons to have an audit. Here are three ways an audit can be beneficial:
- Demonstrates transparency. By eliminating the deduction for charitable deductions for taxpayers who don’t itemize their deductions, the Tax Cut and Jobs Act of 2017 (TCJA) has made obtaining funding more competitive. It has been estimated that nonprofit contributions may drop by $20 billion per year. This makes it even more important for your nonprofit to convince donors that their donations will be used to further the organization’s mission. Having an independent audit supports this argument by demonstrating your organization’s commitment to financial transparency to the public, the media, and watchdog groups.
- Enhances internal controls. An independent audit can monitor your nonprofit’s internal controls and help prevent theft and embezzlement. Although these audits aren’t foolproof, they can spot vulnerabilities and risks that aren’t apparent on a day-to-day basis.
- Increases accountability. As part of its fiduciary responsibilities, your nonprofit’s board of directors is responsible for overseeing its financials. Having an independent audit helps the board and the nonprofit’s executives be more accountable.
For some nonprofits considering an independent audit that is not required, the cost of an audit may outweigh its benefits, however. These organizations should consider more cost-effective alternatives, such as a review, compilation or agreed-upon procedures.
A review, in contrast, is a lower level of assurance on the reliability of the financial statements. It may be appropriate for smaller nonprofits. Another service is a compilation, where a certified public accountant takes information supplied by management and prepares financial statements, without offering any assurance. The differences between an audit, review, and compilation are subtle but significant.
If you’re still unsure what’s best for your nonprofit, give us a call so we can help.