5 Common Misconceptions (& Realities) About Nonprofit Audits

It’s no secret that effective financial management is critical for nonprofits to thrive. However, many aspects of nonprofit finance can be confusing or difficult to navigate, from deciding how much of your budget to spend on overhead to choosing an accounting platform to organize your records.

One of the most misunderstood elements of financial management is the nonprofit audit. While the idea of a financial audit strikes fear into many people’s hearts, there is no need for your nonprofit to worry. In fact, audits can be an effective tool for understanding your organization’s financial situation more deeply and improving your procedures. 

In this article, we’ll debunk five common misconceptions about nonprofit audits to help you see the value of these processes. Let’s dive in!

Misconception #1: Most nonprofit audits are conducted by the IRS.

This widespread myth has two sides to it. On the one hand, the first thing many people think of when they hear the word “audit” is the image of an IRS agent going through an individual’s or organization’s financial information with a fine-tooth comb. On the other hand, some nonprofit professionals may believe that because their organization is exempt from federal taxes, it’s also exempt from federal audits.

Neither of these ideas reflects the reality of nonprofit audits, which is that there are many different types, including:

• Independent financial audits, in which a third-party auditor examines your nonprofit’s accounting documents and practices to provide an objective perspective on its financial health.

• IRS financial audits, which happen occasionally and are usually triggered by reporting discrepancies or failure to file your nonprofit’s annual Form 990.

• Internal financial audits, which give your management team a chance to consider opportunities for large-scale (but not objective) improvements to your strategy.

• Compliance audits, which focus specifically on your organization’s adherence to government regulations and its own policies.
• Operational audits, which assess certain areas of your internal systems, such as human resources or technology implementation, to determine strengths and potential improvements in productivity.

For the purposes of this post, we’ll focus on independent financial audits—the most common and beneficial to your nonprofit’s financial management practices.

Misconception #2: All nonprofits are required to conduct annual financial audits.

Independent financial audits are only mandatory for some nonprofits, specifically those that meet one or more of the following criteria:

1. Audits are written into the organization’s bylaws.
2. The nonprofit receives more than $750,000 in federal funding per year.
3. The organization’s total annual funding exceeds the audit threshold in the state where it’s registered (typically $500,000).
4. The nonprofit is pursuing a grant opportunity that requires an audit report to be submitted along with the proposal to demonstrate financial accountability.

Even if your nonprofit falls into one of these categories, it might not have to undergo an audit every year. For example, some organizational bylaws specify that audits should be conducted at least once every two, three, or five years. Or, if you aren’t applying for any grants that require audit reports this year, even though you have in the past, you may not need to undergo another audit just yet.

Misconception #3: Compliance is the only benefit of conducting a financial audit.

While improved compliance is naturally a key benefit for nonprofits that have to undergo financial audits, Jitasa’s nonprofit audit guide explains that there are many other advantages to conducting one, including:

• Regular internal accountability to the same high standards for financial recordkeeping and reporting.

• Clear opportunities for improvement as your nonprofit grows and becomes more financially complex.

• Increased transparency if you let supporters know that you’ve conducted audits and changed your processes accordingly.
• A potential reputation boost since nonprofit watchdogs like GuideStar and Charity Navigator sometimes rank organizations higher if they’ve recently undergone audits.

These benefits are why your nonprofit should consider conducting occasional financial audits even if you aren’t required to do so. While the process may seem daunting at first, careful attention to it can pay off massively!

Misconception #4: The auditor does all of the work in an independent financial audit.

Once your nonprofit has chosen an independent financial auditor, it isn’t time to sit back and relax. Instead, plan to spend two to four weeks preparing for your audit by:

• Gathering the financial documents on the auditor’s Provided by Client (PBC) list. This might include everything from bank and investment statements to your fiscal policy handbook or board meeting minutes—generally, any reports or records that will help the auditor understand your nonprofit’s financial situation.

• Bring your transaction records up to date. If your nonprofit has undeposited funds, unpaid membership dues, or other uncleared transactions, try to pinpoint why these discrepancies occurred and resolve them before your audit.
• Clean up your accounting data. NPOInfo’s guide to nonprofit data hygiene recommends removing ambiguous, duplicate, and inconsistent information from your nonprofit’s databases—including your accounting platform—to ensure your data is clear and understandable for your team and your auditor.

Working with a nonprofit accountant can help your audit prep go more smoothly and ensure you complete these tasks correctly. While your accountant likely won’t conduct your audits themselves to avoid a conflict of interest, they’re usually happy to assist your organization with various responsibilities before and after.

Misconception #5: If your audit report isn’t clean, it’s a major problem for your nonprofit.

It’s completely normal to have some flagged issues in an independent financial audit report! Especially if it’s your nonprofit’s first time undergoing this process, don’t be surprised—or worried—if the auditor thinks you need to make some improvements to your financial management practices.

When you get your audit report back, what really matters isn’t how many recommendations the auditor made—it’s how promptly and thoroughly you act on them. Shortly after receiving the report, sit down with your leadership team and financial professionals to review it in detail and create an action plan to address everything the auditor identified across all relevant areas of your organization.

Although independent financial audits aren’t actually as scary as they may sound, it’s essential to approach them carefully and seriously to maximize their benefits. Use your accurate understanding of the process to get started, and don’t hesitate to contact a nonprofit accountant for help or to address questions you may still have to make your audit go smoothly from start to finish.

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