The first quarter of the year is over. Most nonprofits have gotten all the details for last year buttoned up and are working towards this year’s goals. What is next? The audit! There are a number of elements that an independent auditor will scrutinize in a financial audit; preparing a checklist of these items can help your organization effectively manage the needs of the auditors.
Nonprofit audits pay special attention to an organization’s accounting practices. An independent auditor carefully analyzes the accounting system of nonprofit organizations; as tax-exempt entities, nonprofits must be extra careful to avoid unethical accounting practices or costly mistakes. An auditor will analyze an organization’s system of internal controls. Internal controls are policies and procedures designed to protect an organization from mismanagement and/or fraud. An auditor will also review the results of internal controls by comparing relevant metrics, such as the number of identified accounting errors, against previous periods. Make sure your accounts are in order before an audit begins to avoid raising concerns about your accounting practices.
Nonprofit organizations have a fiduciary duty to use income from contributions in responsible ways, so managers must pay careful attention to the ways in which they distribute their contributed income. A comprehensive nonprofit audit will analyze the way contributions are put to use by computing the relative percentages of each type of income distribution and comparing the results with other organizations serving a similar area of need. An auditor will look into the salary levels of top managers, as well as expenses for bonus pay, vacations and other incentives to ensure that money is being spent wisely. If the organization holds any investments, an auditor may analyze their historical and expected future returns to ensure that money is being invested wisely.
Effective nonprofit organizations regularly generate internal financial statements to keep managers up to date on the organization’s financial position. A nonprofit audit will analyze an organization’s management information system and review internal reports for the period beginning after the previous audit. A thorough audit will review an organization’s reporting procedures to ensure that reports are accurate and submitted in a timely manner.
There is a lot your nonprofit can do to prepare for the audit that will result in a smooth audit for your staff, and for the auditors. Having documentation ready for the auditors will save time (and money) and will result in less distraction for your staff during the audit process. The engagement letter can be considered a roadmap of what to expect during the audit, however, you may still have questions about exactly what the audit will entail. The engagement letter will usually include the following basic terms:
- A description of services to be performed
- What the organization’s staff will be responsible for
- The fees charged for the audit and related work
- Start date and completion date for the audit
Is your documentation ready?
Once your audit is completed, Form 990 will be the next project. Completing this form doesn’t have to be awful! Here are some helpful facts.
Every organization that has 501(c)(3) status is required to file a Form 990, regardless of income, with a few exceptions, such as faith-based organizations. If you are unsure if you should file a Form 990, the Internal Service Revenue (IRS) offers a list of qualifications to see if you should file.
The form names seem confusing, but it’s actually simple to figure out which form you need to file. Find which requirements you meet to see which version of Form 990 you should fill out.
- Form 990 EZ – If your gross receipts for the fiscal year were less than $200,000, and your total assets were less than $500,000, then this is the form for you.
- Form 990 – If your gross receipts were greater than or equal to $200,000, and your total assets were greater than or equal to $500,000, then choose this form.
- Form 990-N – If your gross receipts were less than or equal to $50,000 then this form is yours. Different from most forms, this one is filed as an e-postcard.
Before you get to the form, make sure you have important information readily available, such as your Employer Identification Number (EIN), your tax period and your Group Exemption Number (GEN). You’ll also need to fill out any required schedules of your organization. Two of the major schedules are:
Schedule A– Every 501(c)(3) organization needs to file this schedule. It tells more about what type of organization you are, such as a government, education or community safety organization. You’ll also list your public support on this form such as where your grants and gifts come from.
Schedule B – This schedule is based off of your contributors. The general rule is that if your nonprofit received more than $5,000 from any one contributor, you’re required to fill out this schedule.
These schedules are the most popular, but there are other schedules that might fit your nonprofit’s niche. The IRS defines all the schedules on their website.
When it comes time to actually fill out the form, have your audited financial statements close at hand. You will be asked to list your income and where you received that income. You will break down your expenses between program, management and fundraising expenses. All this detail will be in your audited financial statements.
Remember that Form 990 is more detailed than a regular tax form, because the purpose is different. Potential donors can look at this form and make decisions on whether to donate or not. That means when the form asks you for a list of programs and descriptions of how much money you spend on them, you should be thorough and honest. The form will ask you to identify yourself as a public or private organization. And finally, you will need to list all of your board members and how much the top staff member gets paid.