Audits, Reviews, and Compilations, Oh My!

All 501(c)3 nonprofits must publicly present their financial information in the form of a 990 tax filing. But at some point, newer or smaller nonprofits also need to address the question of whether to get an audit.  

Audits are an independent evaluation and presentation of a nonprofit’s financial information prepared by a Certified Public Accountant (CPA). They are a better representation of your organization’s financial situation than the 990, but they take time and money to conduct. While some nonprofits choose to or are required to get an audit, not all nonprofits need to. CPAs also offer other options for financial services that nonprofits can and often should consider before jumping straight into an audit.  

This blog post outlines three options – including audits – for nonprofits that wish to verify their financials through a CPA. We cover the steps required to complete each option and how to decide which financial service is best for your organization. 

• Audits, reviews, and compilations: which financial statement service is best for my nonprofit?
• Summary of options for independent financial evaluations
  • Audit
  • Review
  • Compilation

The first step in making this decision is to figure out when and whether your organization is required to get an audit. 

• Check your state’s requirements; many states do not require that nonprofits obtain an independent audit. 
• If a nonprofit spends $750,000 or more in federal funds in one year, then the federal government requires an audit. Be careful here: some funding that comes from state and local governments is actually considered federal funding! 
• Foundations, banks, and local governments may require audits as a condition for funding.  

While not all nonprofits need an audit, many stand to benefit from some form of independent review by a CPA...and that doesn’t have to be an audit! Here are a few questions you can consider when you assess which service (if any!) is best for your nonprofit. Please note that NFF services in no way replace those of a CPA. 

• Who (internal or external stakeholder) is asking for an audit? Why are they asking? Would they be okay with a review instead? Would they be okay with the 990? 
• Has the organization missed funding opportunities due to not having an audit? 
• Who on the staff would lead the process? What experience do they have?  
• Where does the Board stand on this question? What experience do they have in leading audits, and who on the Board would be involved? 
• Any level of independent financial evaluation requires time, input, and energy from staff. So who on the Board would support staff and management in this process? 

An audit is the most thorough evaluation available. It is an in-depth examination of an organization’s financial statements, records, accounts, business transactions, accounting practices, and internal financial controls, conducted by an independent licensed CPA. It provides the most assurance on the accuracy and presentation of the financial data and systems, based on the application of generally accepted accounting principles (GAAP).  

An audit includes:  

• Testing for accuracy by checking supporting documentation for randomly selected individual transactions.
• Physically or virtually inspecting and observing a nonprofit’s financial practices.
• Reviewing and evaluating a nonprofit’s internal financial controls.

The audit also includes a report to the Board, issued by the auditor, that explains the auditor’s opinion of a nonprofit’s financials. There are only four opinions an auditor issues:  

1. Unqualified – everything is in accordance with GAAP and there are no flaws. This is the goal! 
2. Qualified – there are some instances where the organization is not following GAAP, but there is no significant misstatement of the organization’s financials.
3. Adverse – the auditor found significant misstatements, or overall the organization isn’t following GAAP. The auditor is likely to mention whether they think the organization is a going concern, which means whether they think it will be able to remain in existence.  
4. Disclaimer of Opinion – means that for some reason the auditor is unwilling to express an opinion.  

While an unqualified opinion is the goal, qualified opinions can sometimes be helpful, as they uncover areas where a nonprofit’s leaders should focus their attention. If a nonprofit receives a qualified opinion, it should understand the issues uncovered by the initial audit, address them, and then seek a second audit that demonstrates that the issues were fixed.  

If a nonprofit thinks it might get an adverse or disclaimer opinion, management should resolve any potential financial issues before seeking an audit. In other words, it is best to get an audit only when you can be reasonably certain of an unqualified opinion. 

Considerations 

• Auditors require organizations they audit to have bookkeeping and accounting systems in place, which isn’t always realistic for newer and/or smaller-budget organizations.  
• Funders that require that their grantees undergo an audit should consider: 1) whether a review might give them what they are looking for; 2) whether an audit is a realistic ask for their grantees; and 3) paying for the service they require – ideally up front — and covering both the audit cost itself and the opportunity cost of staff who take time away from their other jobs to help with the audit. 
• The auditor’s fee is based on the amount of time they spend conducting the audit. If your financials are organized by the time the audit begins, the auditors will spend less time going through them, and your costs will be reduced.  
• The cost charged by your auditor will not account for the opportunity cost of staff diverting time from their normal duties to work with the auditor. This cost is an important consideration, and is another reason why funders should carefully consider whether they really need to make their funding conditional on a nonprofit having audited financials!
• If you aren't required to conduct an audit by the federal government, the state your organization is based in, or your funders, then great, you can save that expense! If you want one anyway, either because you want that assurance about your financials or because it's been strongly recommended by funders, then you have the time and space to get a review this year and an audit the next.  
• You can also save costs by alternating between audits and reviews. If the first audit comes back with an unqualified opinion, you could wait two or three years before conducting your next one. 

Potential benefits of an audit

• A nonprofit would have expert assurance on the accuracy of financial statements as well as the financial systems and processes in place.  
• An audit would help uncover any lingering issues and assure management that the practices and processes in place are the correct ones. 
• An audit can help provide a nonprofit an additional level of legitimacy, particularly in the foundation world. Some foundations and many lenders require an audit in order to consider a nonprofit for a grant or loan. 

A review is also done by a CPA, but only examines an organization’s financial statements, accounting practices, and accounts. It does not cover records, individual transactions, or internal financial controls, and therefore provides less assurance on the accuracy and presentation of the financials than an audit does.  

A review includes:  

• Analytical procedures that are less rigorous than the testing done in an audit but still give the CPA a reasonable insight into the accuracy of the financial statements. 
• A report stating whether the CPA is aware of any material issues and deviations from GAAP. Unlike the auditor’s report, the review does not give an opinion about the financials as a whole.  

Potential benefits and considerations of a review 

A review points out issues with an organization’s finances and management’s response to those issues, without offering additional opinions, solutions, or comments. A review might therefore be helpful in pointing out issues before heading into an audit, if a nonprofit hasn’t previously had an audit. A nonprofit might also consider getting a review one year and an audit the next if an audit is too expensive to maintain on a yearly basis. This article explains more potential benefits of a review.  

A compilation is the least in-depth examination of financial statements and provides no assurance as to the accuracy of those statements. In a compilation, the CPA simply collects the financial data provided and puts it into a format that complies with GAAP, without conducting any of the testing done in an audit or the analysis done during an audit or review. 

Potential benefits and considerations of a compilation 

A compilation is the cheapest option and can help highlight issues with how financial data is currently organized. However, a competent bookkeeper can do the same. A compilation provides no assurance or analysis of the numbers themselves beyond whether they all add up correctly. NFF does not generally recommend that organizations invest in compilations.  

NFF regularly produces tools and resources like this to help nonprofits navigate big questions, challenges, and opportunities. Find guides to budgeting, cash flow, financial storytelling, and much more on our Fundamentals for Nonprofits page.