Audit Guide For Audit Committees of Small Nonprofit Organizations
There is almost no literature to guide the audit committee of the small nonprofit organization (NPO) in the performance of its function. Articles and other publications on the audit of NPOs are written for the practicing accountant in terms the lay person would have difficulty understanding.
This guide is intended to assist the audit committees of small NPOs to perform limited review of their organizations' financial statements. The audit committee cannot replace the CPA in the audit of an NPO, and perhaps the material in this guide will convey the importance of securing professional assistance.
Nevertheless, for every museum, symphony foundation or family service organization that has adequate funds to retain the services of a CPA, there are scores of small churches, service clubs, literary groups and similar organizations that lack the funds for an outside audit.
This guide should help an NPO board of directors control financial activities until they reach the stage when a professional audit is possible. It will also emphasize the importance of internal controls in safeguarding the assets of the NPO.
The audit committee can play a critical role in maintaining the integrity of the NPO's financial reporting. Volunteers should be selected from the board or general membership with the following qualities needed for serving on this committee:
Consideration should be given to individuals with experience in business such as bankers, internal auditors, retired CPAs, corporate officers, etc.
You have been appointed to the audit committee of Goodworks, Inc. You accept the assignment with some trepidation, as your experience with business matters has been limited to balancing your own checkbook.
Goodworks receives contributions of approximately $50,000 per year, and it uses these funds to assist runaway teenagers. It employs one part-time social worker. The board of directors considered engaging a CPA to audit its records but decided that the cost of an audit would not be justified.
The above scenario is probably replicated hundreds of times each year by literary groups, churches, historical societies and other NPOs. The following material won't tell you how to eliminate the need for an audit by a CPA, and it may even make the need for such an audit more obvious.
The audit committee should be concerned with the following things, at a minimum:
In developing the audit program, the adequacy of the internal accounting controls is an influencing factor. For example, if all disbursements in a small NPO are authorized separately by the board, recorded in the minutes by the secretary, supported with invoices approved by the president, and paid by checks signed by the treasurer and one other officer, the number of these transactions to be reviewed can be minimized.
However, the committee would be required to satisfy itself that the internal control procedures outlined above actually were being followed.
When an NPO does not have a good system of internal control, it is extremely difficult to determine that all transactions have been properly recorded. Under these circumstances, substantive tests should be performed. Executives of NPOs have been known to inflate their income by failing to record all liabilities. Checking cash disbursements in the months following the end of the period might uncover this manipulation.
Confirmation of balances with creditors also would identify unrecorded liabilities. Tests of bank reconciliations, reviews of minutes, comparisons of current and previous financial reports and of the period's transactions with the budget are examples of substantive procedures that can prove evidence of the completeness of financial statement account balances.
The procedure followed by the audit committee (the audit program) will vary with the type of NPO, its volume of income and the complexity of its operations.
The committee should develop a written plan for each account balance or class of transaction selected for examination.The plan should indicate the relationship to the financial statement assertions and audit objectives. An example of this would be the examination by a committee of a museum store that maintains an inventory of merchandise. The committee desires to gather evidence as to the existence of the inventory listed as an asset on the balance sheet.
The following is an example of how audit objectives would be developed.
Account: Museum Shop Inventory
The adequacy of internal controls should be of primary concern to the audit committee. Lack or inadequacy of internal controls can make the task of even the CPA auditor extremely difficult and, in some cases, almost impossible. Volunteers often are so dedicated to the mission of the NPO that they feel that running the organization in a businesslike fashion may not be compatible with this mission.
Regarding the hypothetical Goodworks, Inc., we were told that the organization employed one part-time social worker. Imagine this individual collecting the funds, disbursing the funds, recording the financial transactions, signing the checks, recording the minutes of the board meetings and preparing financial reports.
This would be an example of a complete lack of internal control. To correct this, each one of these functions really should be performed by a different volunteer.
Common sense must be applied in considering internal controls as well as the other areas being reviewed by the audit committee.
If Goodworks, Inc., received all of its funds from one source, internal control of receipts would be a simple matter. A review of receipts would involve verification with the sole source of these funds. If the only expenses were rent and the social worker's salary, internal control and a review of these items would not present any difficulty. But if funds were received from hundreds of donors, then internal control of receipts becomes critical. Whatever the situation, internal control must be examined and improved if found lacking.
The budget and the board of directors' minutes are the usual source of verification of NPOs' activities in a broad sense. Additionally, the corporate charter and bylaws should be reviewed to determine that all activities comply and that the designated individuals are performing their proper functions. A review or test of specific transactions should be included in the audit program.
Verification of bank balances, an actual count of securities owned and a count of merchandise are some of these procedures. An examination of deeds and tax assessments is another procedure applicable when real property is owned by an NPO. Securing appraisals of art owned might be appropriate in the case of a museum or art organization.
An NPO has the same obligation to file tax returns and corporate reports as a for-profit organization. Failure to comply with these requirements will expose the NPO to possible fines or penalties. At its planning meeting, the audit committee should prepare a list of these taxes and reports. This might include the following:
The preceding material is only a limited discussion of the complex requirements to perform an audit of an NPO. For example, insurance and bonding should be reviewed by a professional in the field.
But it is hoped that this guide will aid the audit committee to perform its review of the organization's financial statements and operations in a relevant manner. The committee should satisfy itself that income and expenditures are being classified in a consistent manner; otherwise comparisons of financial reports over the years will have limited significance.
Some suggested controls for cash disbursements:
Some suggested controls for cash receipts:
This guide was last updated in September 2007. Permission to duplicate this guide may be obtained from the Virginia Society of CPAs, P.O. Box 4620, Glen Allen, VA 23058-4620, (804) 270-5344 or email@example.com.