Forewarned Is Forearmed when It Comes to Audits
By John Cohen

John Cohen
John Cohen
Under the best of circumstances a state or federal audit, especially when conducted by the Inspector General’s staff, disrupts your agency’s operations, sometimes for months, and can be a significant cause for concern #147; for you and your board.

Even the most diligent nonprofit managers make innocent mistakes (or incorrect interpretations), and the thought of having costs disallowed after spending government-provided funds with the best of intentions is not pleasant.

To be forewarned is to be forearmed, so here are some tips gleaned from recent audit reports and personal experience.

1. Internal Controls

Audit reports always, always mention the agency’s internal control system. While the auditors aren’t there to assess it step by step, it’s the first thing on their checklist. If you don’t have a procedures manual, or haven’t updated it in years, the auditors can understandably start out with some cynicism. And don’t forget that the auditors are likely to interview employees. At one agency, a veteran administrator said she didn’t even know there was a procedures manual she was supposed to follow.

2. Payroll

Audit reports frequently have a finding relating to payroll distribution, and these can be incredibly costly. If your employees fill out time sheets based on their budgeted percentages of time to each project —rather than actual time—you’re in trouble. And if an interviewee says, “I don’t charge much time to that project because it doesn’t have enough funding,” your problems just multiplied.

3. Occupancy Costs

Occupancy costs are always closely examined and the allocation methodology questioned. It’s important to have a simple, written, well thought-out methodology. The methodology can be general and multiple choice for different situations, but if it appears that you were charging the programs based on the funding availability, the consequences can be severe. It is important to keep in mind that every single project at every single location needs to have an occupancy cost or documentation that shows it is insignificant. Without documentation, the auditors will have no basis to agree with you, and it can become an issue that will cost you money. If you acquire a new program mid-year, be sure to re-do your occupancy allocation to include the new program. Some organizations recalculate monthly.

4. Inventory

Equipment purchases generally require pre-acquisition “special” approval and post-acquisition proof that it is “inventoried.” The wording in the federal Office of Management and Budget circulars can be ambiguous, but why risk it? Strict compliance isn’t that difficult, and paying back thousands of dollars for lack of a few minutes’ extra effort will sting.

5. Attitude

While this term is never used in reports, some reports reek of “bad attitude” by the agency under audit. If you have made a mistake, admit to it and think creatively about how to minimize the impact. If you insist that you’re right in spite of the facts, or if you make up an implausible rationale and repeat it ad nauseam, you will only extend the length of the audit disruption and lose credibility in areas where you could have reached a compromise solution. The auditors are generally just trying to do their jobs objectively, not trying to play “gotcha”, so antagonizing them with an “above the law” attitude is not a wise path.

John Cohen is Managing Director of NPA Consultants, nonprofit process improvement specialists. Contact him at or 617 694 4600.
November 2011