Nonprofit audits: Intro guide, checklist, and tools to plan ahead

As a nonprofit, your relationship with donors and government entities is vital, and has to be built on trust. That is best achieved with accurate and transparent documentation.

While audits can be onerous, the process presents the ideal opportunity for verifying that everything is in order with your nonprofit’s finances. Not only does a well-organized audit process add weight to your standing with supporters, it’s also excellent practice for good financial management and ensuring regulatory compliance.

This guide will help you understand the nonprofit audit process and prepare for it.

Here’s what we’ll cover:

What is a nonprofit audit?

A nonprofit audit is a review of your nonprofit’s financial records to verify their accuracy, compliance with laws, and adherence to accounting standards.

If you have qualified staff, an internal audit can be a cost-effective way to ensure your organizational controls are working.  

External auditors, in contrast, give your organization credibility and are often required for compliance with funders and regulators. For example, some US jurisdictions demand an external audit from nonprofits whose annual revenue exceeds a certain threshold—a threshold that varies between the different jurisdictions. 

Unlike standard audits, nonprofit audits must check for compliance with specific regulations and requirements, including restrictions imposed by donors.  

The concept of restricted and unrestricted funds is unique to charitable organizations, with restricted funds allocated for specific purposes, while unrestricted funds can be used for general operations. 

6 types of nonprofit audit

1. Financial audit 

One of the most common types of nonprofit audit.

This focuses on the accuracy of financial statements and providing stakeholders with an objective overview of your organization’s financial health and practices.  

2. Compliance audit

This examines whether your operation adheres to applicable laws, regulations, and funding requirements.

It is especially relevant for if your nonprofit receives government grants or public funding as the audit will check if you’re following the specific spending guidelines set by the grant providers.

These guidelines might include restrictions on how funds can be used, such as prohibiting the use of grant money for lobbying activities, requiring detailed financial reporting, and ensuring that funds are spent within the grant period.

Additionally, the audit might verify that your administrative costs do not exceed a certain percentage of the total grant amount and that all expenditures are directly related to the grant’s objectives 

3. Operational audit 

This reviews your internal processes and efficiency.

It evaluates how effectively you use the available resources to achieve your mission, identifying areas where internal practices could be optimized.

Although internal, it shouldn’t be confused with an “internal audit”, which includes financial aspects.

For instance, an operational audit might assess the efficiency of your volunteer management system, ensuring resources are used effectively. 

4. Internal audit  

This is your proactive check-up, often done by in-house staff or independent auditors.

It looks at your control procedures, risk management, and adherence to policies. Imagine reviewing how you handle cash donations to ensure everything is secure and properly documented, catching any issues before they become big problems. 

5. Program-specific audits  

Some grants or funding sources require audits focused solely on a specific program.

Your funders would want to know exactly how their money is being used. If you received a health grant, a program-specific audit would ensure those funds are used exclusively for health-related activities and outcomes.

These audits verify that your donors’ stipulations have been followed and that program outcomes align with the funders’ expectations. 

6. The IRS audit 

Although rare, this can happen if there are discrepancies in your tax filings or if the IRS randomly selects your nonprofit for review.

It assesses your tax-exempt status, unrelated business income, and proper handling of donations and expenses.  

Picture the IRS checking if you correctly report income from a major fundraising event, like an annual gala or charity auction.

These events often involve significant donations, ticket sales, and auction proceeds, which need to be accurately reported to ensure compliance with tax regulations. 

When does your nonprofit need an audit?

Not all nonprofits are required to undergo an audit, but there are specific circumstances when it may be necessary.

These include legal and regulatory requirements, donor or grantor stipulations, and operational needs for transparency and accountability.  

Here are some common situations in which your nonprofit may be required to perform an audit: 

Legal or state requirements

Some states mandate annual audits for nonprofits, especially those that meet a certain revenue threshold, or solicit donations from the public.

Check your state’s nonprofit audit requirements to determine if you fall into this category. 

Grant or funding requirements

Certain grants, particularly those from government agencies or large foundations, require audited financial statements as part of their awarding criteria.

This assures them that your nonprofit has what it takes to manage funds responsibly and can be trusted to respect their guidelines.

Those guidelines could include reporting requirements, performance metrics, or legal observations.  

Internal policies and best practices

Many nonprofits choose to conduct regular audits as best practices, even if it’s not legally required.

Regular audits reinforce your nonprofit’s transparency, strengthen donor trust, and help you stay on a good footing financially. 

Significant growth or operational changes

Rapid growth, major changes in campaign programming, or the arrival of a new leadership team may warrant a fresh audit.

This helps ensure that your organization’s financial framework can support new demands or changes in strategy. 

Benefits of a nonprofit audit

Nonprofit audited financial statements offer much more than financial validation; they help you detect internal inefficiencies, which means your financial affairs stay on track, enhancing overall accountability.  

By showing your commitment to fiscal and legal responsibility, an audit strengthens donor confidence, helping you retain contributors and therefore increasing the chance that they will step up donations.  

A financial audit may also be an official prerequisite as part of the application process when you seek a grant, particularly when the funders are government agencies or corporations.  

Finally, solid financial information is essential for long-term planning and the ongoing development of your organization and its mission.

A clear game plan is another factor that works in your favor when pitching to potential supporters, especially if you have a trustworthy reputation supported by verified information. 

Advice for choosing an auditor

There are individual auditors or entire audit firms that specialize in the nonprofit sector.

They will have the appropriate qualifications, such as the Certified Nonprofit Accounting Professional (CNAP) or Certified Public Accountant (CPA) with nonprofit specialization. 

Many such professionals will be listed in directories maintained by entities like the American Institute of Certified Public Accountants (AICPA) or the National Council of Nonprofits.  

References from other organizations in your field will help you identify firms with experience in the different types of audits for nonprofits.  

Ideally you will find an auditor who has a greater emphasis on mission alignment and sector-specific challenges compared to those working purely in the business or financial sectors.

That kind of vision generally goes hand in hand with a more collaborative approach, addressing the organization’s operational needs rather than simply crunching the numbers. 

However, this does not mean that nonprofit auditors are any less business-like than commercially oriented auditors, and you can be sure their experience brings a good understanding of the regulations surrounding nonprofit operations. 

Auditing features to look for in a nonprofit accounting software

Specialist nonprofit accounting software with audit automation capabilities can make sense of this entire operation by organizing documents, ensuring secure access, and tracking internal review processes.

Here are the minimum set of features your automation system will need to perform these functions: 

Document management

The software must manage a centralized system to store, organize, and retrieve documents, often including tasks like tagging, searching, and version control.  

Audit trail

Your system must feature a robust audit trail to track all changes and activities, ensuring transparency and accountability throughout the many tasks, documents, and workflows in the system.

This should include the history of actions by time, date, user, ledger, and change detail–all of which can be queried and reporting on. 

User controls

Such as approval rules and user access rights, are essential to maintain security and proper workflow.

This means you can set who can view, edit, or approve documents, reducing the risk of unauthorized access.

Although centralized, the system can be configured to facilitate access to external auditors so they can run the nonprofit audit remotely. 

Compliance tracking

A good system matches your account entries to nonprofit-specific regulatory requirements, such as IRS, GAAP and state reporting standards.

It generates alerts for upcoming deadlines and monitors adherence to donor restrictions. 

Data encryption

Security features like data encryption protect sensitive donor, financial, and organizational information, restricting access only to people you have authorized.

This is particularly important if your organization has the technological means to run paperless nonprofit audits. 

Compiling reports

Reports can be generated based on financial statements, donor reports and compliance summaries, often in real-time and allowing customization.

This lets you rearrange the data depending on the audience. 

Tracking grants and donations

One of the most helpful features is the ability to track the receipt and allocation of grants and donations, recording details such as restrictions, spending deadlines, and reporting requirements. 

Final thoughts

Picking the right audit partner and specialist financial software can help make sure you are prepared to pass the audit process with positive outcomes.  

Leveraging AI tools and a partner you can trust, not only benefits your organizational efficiency but helps grow your mission.