How to Audit a Not-for-Profit Organization

Unlike publicly traded companies, nonprofit organizations are not required by the Securities and Exchange Commission to undergo annual audits. Many not-for-profit organizations, however, are required to receive an audit if they accept certain types of funding or earn a large amount of revenue. A positive audit opinion can increase donor and board member confidence in the nonprofit's operations.

Auditors usually kick off an audit by evaluating a nonprofit's inherent risk -- the risk that employees are misstating financial information. Such risk may arise when management has strong incentives to misstate financial information or when an accountant makes an honest mistake in reporting. Inherent risk can be high in not-for-profit organizations that must report certain results to continue receiving grants. Nonprofits that pay low wages may have trouble attracting qualified accountants. If the auditor deems inherent risk to be high, he should increase testing to compensate for the potential mistakes.

Auditors also base the amount of testing procedures on the quality of internal controls. Nonprofits with small staffs often don't have enough employees to properly segregate duties. Auditors should evaluate not only the number of people involved in the accounting process but the level of supervision. If no one is approving junior-level accounting staff entries, mistakes are less likely to be caught. As with inherent risk, auditors should increase the amount of testing if they find that internal controls are weak.

Auditors typically test a variety of accounts and transactions. They should pay special attention to revenue accounts when auditing a nonprofit. Nonprofit entities have different sources of revenue than their for-profit counterparts, and all employees may not be familiar with the revenue recognition rules for donations and grants. Auditors should check to see if the nonprofit has adequate supporting documentation and determine the correct timing of revenue recognition for grants that have strings attached.

After testing an adequate number of transactions and accounts, auditors compile their findings into an audit report. They must identify the accounting framework and auditing framework used during the process. In the United States, most nonprofits are set up as corporations and use generally accepted accounting principles. Because nonprofits are corporations but not publicly traded, auditors should use the U.S. generally accepted auditing standards as the auditing framework.