A financial audit is a careful evaluation of your organization’s accounting operations, fiscal controls, contract budgets, internal controls, cost, revenue and payroll, to ensure that your financial data is reliable and complete.
FINANCIAL AUDIT – “DOES MY NONPROFIT NEED ONE?”
If your organization’s annual gross income exceeds $500,000, then it is generally recommended that you hire an independent auditor (an external auditor having no personal or professional ties to your nonprofit or its personnel) to audit your agency at least annually. However, if your organization expends more than $500,000 in federal funds annually, then an independent financial audit is required by federal regulations (see OMB A-133). A financial audit will also be required from governmental agencies providing grant funding to your organization (sometimes referred to as a grant audit), regardless of the funding amount.
FINANCIAL AUDIT – “THE AUDITING PROCESS”
Although my 13 years of auditing experience has been conducting grant audits, the auditing process of all financial audits is more or less the same. Below is my step by step process of conducting an audit of some of the vital aspects of an organization’s accounting system. This information will provide you with a birds-eye view of what auditors look for; which in turn will help you to be better prepared for an audit of your organization.
Initial Contact: Once I’ve made contact with the Executive Director of an agency regarding my intent to conduct a financial audit, I send out an engagement letter confirming our agreed upon date and time to begin the audit (usually a two-week notification). The engagement letter requests that the agency have the following records available for review: General Ledger; Payroll Ledger; General Journal; Cash Receipts Journal; Cash Disbursements Journal; Chart(s) of Accounts; Current list of accounts or notes payable; Canceled checks; Bank statements; Invoices and purchase orders; Duplicate bank deposit slips; Employee payroll register; Organizational chart; Current list of Board of Directors; Client/participant files; Lease, rental, or mortgage agreements; Written travel and mileage policies; Written cost allocation plan; List of other funding sources; Supporting documents or financial records used to prepare the previous year’s cost report(s); and any additional supporting documents necessary to complete the financial audit. DO NOT BE ALARMED! Depending on the size, nature, and type of services provided by your organization, some of these documents may/may not be applicable.
Financial Audit: The auditing process begins with an entrance conference, which is a meeting with the organization’s Executive Director, Accountant, Program Managers, and any other designated staff. Here I explain the purpose and scope of the financial audit; and I ask about an hours’ worth of questions to gain an understanding of the agency’s structure, internal controls, management and fiscal policies and procedures. Subsequent to the entrance conference, the financial audit proceeds with a review of the following:
Revenue: A selection of transactions involving client fees, grants, donations, and other revenue collections applicable to the time period under review (typically the prior year of operations), are sampled to determine if they were properly receipted, recorded, and deposited into the agency’s bank account in a timely manner. This portion of the financial audit is accomplished by tracing revenue collections to the agency’s cash receipts journal, general ledger, and bank statement deposits.
Non-Personnel Expenses: Cash disbursements for rents, utilities, program supplies, equipment, and any other program expenditures are sampled to determine whether the expense was reasonable, appropriate, and supported with sufficient documentation. This involves tracing expenditures recorded in the general ledger to invoices, cancelled checks, receipts, and bank statements. In addition, expenditure items are verified against program budgets to ensure that they are allowable under the regulations governing the grant contract; and a determination is made as to whether or not expensed equipment charges are being depreciated (written off over its expected useful life).
Payroll: Payroll expense records are reviewed to determine if salaries charged to each contract are in accordance with the percentage of time spent providing services under the contract. In a perfect situation, the payroll ledger shows salary payments allocated to each program based on the hours worked per program; and employee timecards show the hours worked for each program. My review involves tracing the salary allocations from the payroll ledger, to the hours recorded on the employee’s timecard for the program under review. Additionally, cancelled checks are reviewed for payment verification, and timecards are examined for signatures of the employee and a supervisor.
In summary, your preparation for a financial audit should be an ongoing process. Your organization should be able to support every dollar it receives/spends with sufficient supporting documentation. This practice will ensure a smooth financial audit, and will minimize audit findings and costly monetary disallowances.