Preparing for a nonprofit audit requires a meticulous, structured approach to ensure transparency, identify gaps, and maintain audit-ready documentation. Using a nonprofit audit checklist helps organize and segment financial documents, simplifying the process.
Whether it’s a state-mandated audit, an independent CPA audit, or a due to meet the federal funding threshold, going through an audit for a nonprofit organization reflects more than just the entity’s financial health.
Going through an audit for a nonprofit is a high-stakes occurrence that reflects more than just an organization’s financial health. A clean audit strengthens donor confidence and demonstrates sound financial stewardship. It also reinforces your credibility and serves as a symbol of strong financial and operational success.
Nonprofits that reap such audit results are those that remain audit-ready throughout the year. Being consistently audit-ready requires entities to maintain clean financial books, reconcile bank accounts regularly, ideally every month, and store all receipts safely. All of these practices fall under audit preparation that all organizations must have to ensure a stress-free audit. One of the most straightforward approaches to audit preparation is to maintain a detailed nonprofit audit checklist. This helps oversee all of the financial and operational aspects of the firm, ensuring a smooth and compliant review.
This blog provides a thorough, step-by-step guide for Nonprofit organizations to help create a template for their own pre-audit preparation systems. It also provides a template of a not for profit audit checklist that organizations can use for their own audit preparation processes.
What is Included in a Nonprofit Audit?
A nonprofit audit typically includes subject matter that often varies from that of a traditional business audit. This is because, in contrast to an ordinary audit, where emphasis lies on profit and value for the shareholders, in a nonprofit organization audit, the emphasis lies on regulatory requirements, fund accounting, donor restrictions, and accountability to the public. Some of the important components of an audit are listed below in the table, while the usual steps involved in an audit process include the following:
| Component | Focus Area | Key Documentation & Testing |
|---|---|---|
| Financial Statements (GAAP) | Accuracy of presentation under Not-for-Profit accounting rules. | • Statement of Financial Position (Balance Sheet) • Statement of Activities (Income Statement) • Statement of Functional Expenses • Statement of Cash Flows |
| Fund accounting and restrictions imposed by donors | Accurate categorization and allocation of funds. | • Net assets without donor restrictions vs. net assets with donor restrictions • Release of restrictions tracking • Grant and pledge agreement compliance |
| Internal Controls | Safeguards against fraud, errors, and mismanagement. | • Segregation of duties • Dual authorization/check-signing protocols • Cybersecurity and access privileges |
| Regulatory and Tax Compliance | Compliance with regulations set by federal, state, and local authorities. | • IRS Form 990 series filings • Unrelated Business Income Tax (UBIT) review • State charitable solicitation registrations |
| Federal Program Compliance (Single Audit) | Special rules for organizations expending significant federal funding. | • Uniform Guidance testing (if spending federal awards above the required threshold) • Schedule of Expenditures of Federal Awards (SEFA) • Allowable cost validation |
| Governance & Policies | Oversight and board operational integrity. | • Board meeting minutes • Conflict of interest disclosures • Executive compensation approvals |
How to Prepare for a Nonprofit Audit?
Preparing for a nonprofit audit requires organizations to carry out a meticulous clean-up within their organization. This clean-up includes executing a strategic, structured approach to ensure full documentation transparency and identify gaps within their financial workflow and fund allocations. The goal is to ensure a smooth, seamless, and stress-free audit. The following section provides a structured approach for the required steps nonprofits need to ensure audit-readiness, broken down in a phase-by-phase approach:
Phase 1: Year-Round Maintenance and Governance
Year-round audit readiness is a continuous process, not a one-and-done task to check off a list. Instead, being audit-ready requires a regular, year-round ongoing process to maintain continuous compliance.
Monthly Account Reconciliation
One of the best practices that any organization requires to be audit-ready is to ensure its balance sheets are regularly reconciled, ideally on a monthly basis. This allows for early detection of any possible discrepancies within the entity’s accounts (bank accounts, credit cards, loans) before they can have any impactful consequences.
Maintaining Fund Accounting Integrity
Nonprofits must maintain their fund allocations with precision and accuracy. This includes accurately tracking and categorizing Net assets with donor restrictions and those within donor-restricted funds to ensure the allocation of funds meets the required donor stipulations. This step is especially crucial in maintaining a consistent level of trust within the existing donors, while keeping a pristine reputation, crucial in attracting additional donors. That level of trust is a crucial asset during an audit.
Maintain Records of Board Governance
It is imperative to maintain signed records of all meetings held by the Board of Directors, disclosure of conflicts of interest, and all approvals regarding executive remuneration and substantial investments. During the auditing process, these signed documents ensure that there are no loopholes or room for ambiguity and provide complete clarity from the point of view of all stakeholders.
Phase 2: Compile the Required Documents and Account Cleanup
A smooth audit depends on the organization and the accuracy of its documentation. Before an audit, it’s best practice to conduct a thorough account clean-up to prevent potential mismanagement of information during the audit. Additionally, maintaining a centralized digital database of all of your required documentation allows for easy and secure access to the nonprofit’s financial information. The following table illustrates the list of all of the necessary document copies that a nonprofit might require during an audit, as a baseline:
| Category | Required Documentation |
|---|---|
| Financial Statements & Ledgers | General ledger for the full fiscal year, adjusted trial balance, chart of accounts, and journal entries. |
| Cash & Equivalents | Year-end bank reconciliations and statements covering one to two months after the fiscal year-end are performed to identify liabilities that have not yet been recorded. |
| Revenue & Grants | Grant agreements, award letters, receipts for donations, pledge schedules, and records of restrictions that have been lifted. |
| Payroll & Personnel | W-2 forms, 1099s, quarterly filings of Form 941, payroll records, and allocation schedules distinguishing program expenses from administrative staff costs. |
| Fixed Assets & Liabilities | Depreciation plans, records of fixed asset acquisitions and disposals, aging reports for accounts payable and receivable, and loan repayment schedules. |
| Legal & Operational | Active leases, vendor contracts, tax-exempt determination letters (IRS 501(c)(3)), and insurance policies. |
Phase 3: Have a Pre-Audit Checklist
Having a nonprofit audit checklist is the most straightforward and simple approach to prepare for an audit. Typically used for a final overview, a checklist can be used to have oversight of multiple aspects of the organization’s financial and operational practices, ensuring all necessary components are in place and thoroughly reviewed before the audit process begins. The following checklist can be used as a template for nonprofits to help navigate what should be included in an audit support services not for profit audit checklist:
- Have we kept signed minutes for all board meetings this year?
- Do we have signed conflict-of-interest disclosure forms for all board members and key staff?
- Have we reconciled all bank accounts and credit card statements through the end of the fiscal year?
- Do we have valid receipts, invoices, and approvals for all recorded expenses?
- Have we matched all restricted grant funds to their specific project expenses?
- Have we prepared an accurate balance sheet, income statement, and cash flow statement?
- Do we limit accounting software access only to authorized staff?
- Do we require dual authorization for large checks or electronic fund transfers?
- Have we filed our annual IRS Form 990 or 990-EZ on time?
- Is our state charitable solicitation registration active and up to date?
- Have we paid all local, state, and federal taxes if we have taxable unrelated business income?
- Do we keep copies of our 501(c)(3) determination letter and state tax-exemption certificates handy?
- Do we have a signed Form W-4 and Form I-9 for every current employee?
- Have we filed all quarterly federal and state payroll tax returns?
- Have we issued Form 1099 to all independent contractors who earned over the reporting threshold?
- Are all employee benefit plans, like health insurance or retirement, properly documented and funded?
Key Takeaways
As mentioned in the above blog, being year-round prepared for an audit is of crucial significance to a nonprofit organization. Being prepared entails extensive, continuous implementation of best practices, revisions, and analysis of the accuracy of an organization’s financial reconciliations, along with formalized account clean-ups. Additionally, all necessary stakeholders must be transparently informed, along with extensive paper trails. These paper trails play a crucial role in ensuring a seamless audit as much as possible.
Having a step-by-step approach to pre-audit preparation and reviewing the preparation with a thorough nonprofit audit checklist helps organizations maintain a holistic view of their financial documents. It also ensures that the documentation is segmented in a formalized and audit-ready way.
Frequently Asked Questions
Holding 501(c)(3) tax-exempt status does not automatically require a federal financial audit, as the IRS does not impose such a mandate. However, federal guidelines on Uniform Guidance require any organization that spends a minimum of $1,000,000 in federal funding within a year to carry out an independent audit, otherwise known as Single Audit. In addition, various state regulatory bodies, for instance, those in charge of charity registration and fund-raising activities, can require financial audits or reviews of organizations based on certain revenue/contribution criteria.
Generally, a nonprofit is required to be audited on a yearly basis when mandated by state or federal laws. An audit can also be required annually by a specific donor grant. Nonetheless, as a form of general best practice, nonprofits must maintain themselves to be audit-ready throughout the year.
There are specific triggers for different types of audits. The trigger for an independent audit differs from that of a federal- or state-mandated audit. A federal Single Audit is triggered when your nonprofit expends $1,000,000 or more in federal awards during the fiscal year. Additionally, an internal audit can also be triggered by the various stakeholders/donors as a requirement.
No, not all not-for-profit organizations need to be audited, as it is not an IRS-mandated law. The audit requirements depend heavily upon the specific circumstances and triggers that call for an audit. Also, depending upon the type of audit, they carry varying levels of weight to each of them. If a non-profit organization is in need of a financial audit, it will be determined by its funding sources, income, and state requirements. Despite the fact that the IRS does not require annual audits for tax-exempt organizations, an audit is required if the organization has a high amount of federal funding, certain revenue requirements set by states, or certain contracts.
