Audit Preparation Series: Audit Basics
An annual financial statement audit can be time consuming no matter the size and type of your organization. There are steps you can take to ready your organization for an audit. This is the first in a series of articles addressing preparation for an audit.
What is an audit?
A financial statement audit is an examination of the financial records, accounts, business transactions, accounting practices, and internal controls of an organization by an independent auditor. The examination of the financial statements leads to the expression of an opinion. You will find this opinion within the independent auditor’s report letter at the front of your audited financial statements.
There are four types of opinions that can be issued by an auditor: unmodified, modified, adverse, and disclaimer of opinion. An unmodified opinion is a clean opinion, in which there are no situations that need to be reported as a departure of generally accepted accounting principles (GAAP). Even with an unmodified opinion there may be proposed audit adjustments or immaterial departures from GAAP; these situations will be disclosed in a management letter (more on this in a subsequent article). This is the type of audit that is the best case scenario of all audits. A modified opinion is best described as an unmodified opinion except for certain situations that are departures of GAAP. These situations do not cause an overall material misstatement in the financials, but still should be brought to the attention of governance. An adverse opinion means the organization’s departure from GAAP is material to the financial statements. A disclaimer of opinion is not actually an opinion at all, but rather a statement from the auditors that they were not able to form an opinion. Receiving an adverse opinion or disclaimer of opinion could have an effect on funding for your organization.
When is an audit required?
An audit is not required for every nonprofit organization. Usually certain circumstances will trigger the audit requirement. These circumstances include: 1) receiving state and/or federal funding (all organizations that expend more than $750,000 in total federal funding must have an audit done under Uniform Grant Guidance), 2) contractual and/or debt agreements requiring an audit to be performed, and 3) an audit is part of a required submission for grants.
Would a nonprofit organization want to conduct an audit if there is no requirement to do so?
A nonprofit organization may opt to conduct an audit even if there is no an outside party requirement to demonstrate a commitment to financial transparency. An audit gives donors and potential donors the assurance that the nonprofit meets applicable accounting standards and has implemented appropriate policies. Many granting agencies also require an audit to be submitted with grant applications; having an audit done annually helps organizations meet this requirement easily. An audit could also be part of governance’s due diligence, offering reasonable assurance the financial statements are free of material misstatements.
Are there other options beyond conducting an audit?
Auditors can provide an organization with a review or a compilation as well. These engagement types are not a substitute for an audit and each provides a different level of service.
A review is an examination of the organization’s financial statements to determine whether the financial statements are consistent with GAAP, much like the basis of an audit. The difference is the level of assurance that is given between the two. A review does not include an examination of the organization’s internal controls and only provides limited assurance that the financial statements are free of misrepresentations. A review also does not include the requirement to independently confirm financial information and does not test samples of transactions to determine if the sample has been properly recorded.
A compilation is simply compiling the organization’s accounting records into financial statements that meet the requirements of GAAP. The auditor is required to assess whether the records are free from obvious errors, but there is no assurance provided in relation to the financials. No collaborating documentation is collected to determine if the financial statements are properly stated.
Will an audit assure management that no fraud has occurred?
The underlying goal of an audit is to obtain reasonable assurance the financial statements are free from material misstatement. An audit does not give you 100 percent assurance that the financials are free of fraud or other errors as an audit does not examine every transaction of an organization. Audits rarely detect fraud, but are an important part of preventing potential fraud. We will discuss this topic more in our next newsletter, so stay tuned!
For additional information, please contact the Ketel Thorstenson Nonprofit Team of experts.