Facing an Audit? Mind Your Payables and Receivables
By Kay Snowden

Kay Snowden
Kay Snowden
Does the prospect of an audit leave you with a feeling of dread? Many nonprofit accountants and financial staff dread the audit because it can be such an intrusive and time consuming process, and they may worry about having their work subject to intense scrutiny from an outsider.

Try to think of an audit as something other than a necessary evil. Think of yourself as the steward, not the owner, of your organization’s funds. Is it unreasonable for your constituents, governing boards and funders to want some verification that their funds are properly managed? Would you really want no oversight of financial activity in the nonprofit sector?

How can an audit and the audit process help you?

Auditors may be aware of new regulations imposed by the government or by the Financial Accounting Standards Board with which you need to comply.

We all benefit from a little spring cleaning - making sure that schedules of fixed assets, depreciation, and other records are current.

Your board and funders like to know that an auditor has expressed the opinion that your financial statements accurately reflect your organization’s financial activity and state. Executive Directors and other staff also feel more confident when someone else has delved into the details and found them in good order, or indicated what needs to be done to correct any deficiencies.

The auditor’s management letter generally contains a number of suggestions for improvements; think of it like the goals you might set in an annual performance review.

Accounting is not all black and white - there are lots of nuances, and complex situations especially in areas like revenue recognition and in-kind donations. If you haven’t been quite sure how to handle a specific situation, your auditor can provide guidance.

What Kind of Audit Do You Need?

Many nonprofits choose a fiscal year ending June 30. If that’s the case with your nonprofit, you are or will soon be facing your annual audit. Depending on your size (measured by revenue), your IRS tax exempt status and the state in which you operate, you are required to:
  1. File annual reports only;
  2. Have an audit by an independent CPA;
  3. Have a less rigorous audit, called a “management review,” or, if you receive enough federal money;
  4. Have a more rigorous audit called an A-133 audit.
Step one is to determine what state and federal requirements apply to your nonprofit.

The Internal Revenue Service requires that organizations whose gross receipts are normally more than $25,000 to file a form 990 within four and a half months of the end of their fiscal year. The form 990 is like a tax return, even though as a nonprofit you are exempt from income taxes.

Beginning in 2008, small tax-exempt organizations that previously were not required to file returns will be required to file an annual electronic notice, Form 990-N. For more information, click on the “charities & nonprofits” tab on the IRS website.

If you receive federal funding, be sure to determine if an A-133 audit is required. The current threshold is $500,000 in Federal funds, and those with a high tolerance for detail can learn more at the OMB website.

How can you ease the burden of an audit?

  1. Be organized.
  2. Document everything.
  3. Create checks and balances (known to accountants as “internal controls”).
  4. Mind your P's and R's (payables and receivables).

Be organized

  • Have files for expenses by vendor and for revenue by funder or contracting agency, with copies of invoices, checks and correspondence.
  • File all bank and investment account statements, cancelled checks and transaction verifications.
  • Have timesheets for all employees, and employee files with both the documentation they are required to complete and the documents which authorize their pay rates and raises.
  • Identify staff time and other expenses associated with fundraising. You will also need to separate administrative time and expenses from program time and expenses.
  • Have copies of all contracts, leases, loans, policies and other agreements which represent a financial commitment on your part.
  • Know the status of any type of claim - insurance claims or other legal actions - against you.
  • Use the “Prepared by Client” list your auditor provides to organize your work in the coming year.

Document Everything

Even if you (or another staff member) know the details of a transaction—what it was for, when it occurred, etc.—have it written down and filed with the invoice or bill. Include emails and “notes to the file” as well as the standard documents.

When in doubt, file a duplicate copy or cross reference the location of information that pertains to more than one category. (For example, an invoice for a capital purchase could be filed with other fixed assets and with the vendor.)

Be especially vigilant with your temporarily restricted funds—grants or contributions for which the donor stipulates the timing or purpose for which they can be used. If you and the funder agree to modify the use of the funds, be sure you capture that agreement in writing, signed or sent by someone authorized to modify it.

The auditor will want to see minutes of your Board meetings. Be sure the minutes are clear about what actions or decisions the board has made.

Create Checks and Balances

Checks and balances in handling money are not only a way to prevent fraud or unscrupulous use of funds, they are an excellent way to double check transactions and reduce errors.

With few staff members, smaller nonprofits can’t always have the same types of checks and balances which larger organizations implement. Keep in mind that you always want to have someone other than the person who receives the money approve any disbursement. If this is not practical for all outlays, at least implement a system where larger amounts need approval. Use a board member if there is no other staff person.

Someone other than the accountant or bookkeeper should verify the balances of bank accounts against the nonprofit’s financial statements. Likewise, another person should receive and track incoming checks and cash, listing the date received, source or sender, amount and check number.

An annual budget should be approved by the board and used to monitor financial statements on a regular (preferably monthly) basis; unplanned or unexpected spending or lagging revenues should be questioned.

Remember that the Board is responsible for evaluating the Executive Director and setting his or her compensation. This can get forgotten, especially in organizations with a long-term Executive Director, often the founder.

Mind Your Payables and Receivables

You will need to provide details for the balance sheet accounts for any money you owe (payables and accruals), are owed (receivables), or have paid or received in advance (prepaid expenses, deferred revenue). Within reason and within the limits of your cash flow, the fewer items on these lists, the easier for you.

Prompt followup to collect monies owed to you is good for your cash flow. Prompt payment to others is good for your reputation.

The audit will require a little extra stamina on your part; after all, your normal job responsibilities don’t go away while the audit is underway. Just like preparing for the SATs, go to bed early and eat a good breakfast. Finally, don’t forget to plan a good celebration for the conclusion of the audit!

Kay Snowden is senior organizational development specialist in the Fiscal Sponsorship Program at Third Sector New England, a nonprofit providing management support to build the capacity of individual nonprofits and the sector. Reprinted with permission.