Auditing Nonprofits: Tips and Traps

Auditing nonprofits is a challenge. Nonprofits and for-profits have inherent differences in structure, operation and reporting. Auditors encounter a variety of clients with limited resources, quirky terminology and unusual reporting. This course will equip you to understand essential aspects of auditing nonprofits and offer practical tips to guide you through possible traps encountered along the way

Objectives:

• Recognize key accounting and reporting issues that make nonprofit clients different from other entities and adjust the audit for them
• Understand the operational differences of the nonprofit industry and effectively adjust the audit to address them
• Plan audits utilizing common techniques and tools used in nonprofit auditing

Value Aid! Not-for-Profit Organizations AICPA Audit and Accounting Guide

Prerequisite: General audit experience and knowledge of nonprofit accounting

"Donors don't give to groups they don't trust."

Dr. Eugene R. Tempel, Executive Director
Indiana University Center on Philanthropy

This course is about auditing. It is predicated upon the following formula:

Trust = Accountability + Assurance

It is also predicated upon the application of this formula to third party attestation of financial reporting by a very special industry - nonprofit organizations.

The course does not presume that auditing nonprofit organizations is more or less difficult than auditing business enterprises. It does recognize that, for entities that comprise this special industry, there are inherent differences in

• Structure.
• Operation.
• Reporting.

These differences may lead an auditor to take a different approach to auditing nonprofits than he/she might take to auditing for-profit business entities.

We will examine the uniqueness of the nonprofit as compared to the for-profit, and to some extent, explore peculiarities of particular types of nonprofits as one type might differ in structure and organizational patterns from another type. There are far too many kinds of nonprofits to attempt to look at every one imaginable. Nonetheless, it is hoped that the auditor's investigative acumen, his/her quickness in dealing with a situation, will be honed as a result of the thought processes suggested by the examples in this course.

If all auditees, and therefore, all audits were generic, the auditor's life would be simple. One approach, one audit program would fit them all. On the other extreme, if no two auditees or their audits were alike in any respect, how would an auditor ever be able to evaluate his/her efficiency? Because all audits are not the same, auditors need to find just the right mix of The course approaches the auditor's need to respond to the uniqueness of nonprofit organizations through the use of traps and tips.

Traps – signified by the familiar shape of the highway danger, or caution sign are those

perceived situations in an audit of a nonprofit where the auditor might, out of predisposition,

choose a less effective or less efficient approach than might be appropriate under the

circumstances.

Tips – signified by this symbol are suggestions of possible alternative approaches.

Chapter 1 is somewhat basic, but is essential to the remainder of the course. It sets the stage for an auditor's approach to accepting an audit engagement of a nonprofit organization. The chapter recognizes the typical auditor's dilemma where the potential audit client is seeking the best possible audit for the least cost. It also points out the auditor's need to understand, at the onset, where customization may be required, and where standardized audit procedures used in the forprofit world may or may not be appropriate.

Accordingly, Chapter 1 is designed to help the auditor decide whether or not to accept the audit engagement by describing unique characteristics of nonprofits. The chapter also reviews briefly the authoritative guidance applicable to all audits and special guidance for audits of nonprofit organizations. Finally, Chapter 1 addresses the issue of independence, an issue much in the forefront.

Chapter 2 assumes the nonprofit audit client has been engaged and directs the auditor's attention to the planning of the audit. Considering the overall importance of planning as a part of every audit, much attention is given to both efficiency and audit effectiveness in this chapter. It is in the planning stage where customization of audit procedures should be anticipated, not down the road after the auditor has tried inappropriate procedures and found them to be ineffective.

Chapter 3 is about the resources, or revenue of a nonprofit organization. These two terms, resources and revenues will be used interchangeably. Revenue is a term more generally applied to business enterprises, but there is no pressure here to be politically correct. The author may even occasionally refer to this element as income, although that term is becoming increasingly out of vogue in the nonprofit community. If a nonprofit organization needs resources, it looks for income, which it may call revenue. Whatever you call it, this class of transactions deserves special consideration by auditors of nonprofit entities.

Chapter 4 addresses the auditing of the reported expenses of a nonprofit organization. The approach taken in this chapter in similar to that introduced in the preceding chapter and reiterated in each succeeding chapter, that of assertion-directed audit procedures. Not only must a nonprofit's expenses be appropriate, but the classification of the expenses is critical to most In Chapter 5, the course is directed to both unusual assets that an auditor might encounter in the audit of a nonprofit organization as well as the issue of ownership. Because a nonprofit organization does not have any equity owners, all assets reflected in the nonprofit's financial statements and notes thereto are really assets over which the organization's responsibility is more of a fiduciary nature.

Auditing a nonprofit's liabilities and net assets is the subject of Chapter 6. A nonprofit's liabilities are claims against assets that the entity manages, in a stewardship role, for all of the stakeholders of the organization. As with any audit, the auditor needs to be particularly concerned with the completeness assertion. This may be especially true in nonprofits, however, because of the typical nonprofit's propensity to operate with minimum working capital. Special attention is also directed to the compliance assertion due to the array of external restrictions often encountered in a nonprofit entity. Chapter 6 also discusses issues related to contingent liabilities, subsequent events, and going concern.

Chapter 7 takes a look at a variety of issues, including auditing for fraud, compliance auditing, independence, related parties, and special reporting issues. An auditor may not encounter some of these issues in every audit but should at least consider the possibility they could be present in any audit.

"Them which is of other naturs [sic] thinks different. [Mrs. Gamp]"

Charles Dickens-Martin Chuzzlewit

Upon completion of this chapter, an auditor should be able to

• Recognize special qualities and characteristics of nonprofit entities.
• Understand how these unique attributes affect audits of nonprofits.

In a way, audits are audits and auditing is auditing. Yet, certain entities possess qualities or characteristics that set them apart from other entities. Understanding the uniqueness of the nonprofit organization might help an auditor achieve a greater degree of proficiency in auditing the nonprofit organization. Proficiency is defined here in terms of effectiveness and efficiency.

In this chapter we will explore the ways in which the nonprofit entity differs from the for-profit entity and how those differences might alter an auditor's perspective in planning or performing an audit. We will take a close look at the definition of nonprofit organizations as offered by accounting standards and search that definition for potential audit ramifications.

Our task may be made somewhat more difficult to understand because, not only do nonprofit entities differ from for-profit entities, but also a particular nonprofit may differ in many respects from another nonprofit. Part of the problem is that nonprofit is, itself, a very broad term. Just as an auditor would not approach an audit of a for-profit construction company in the same way he/she would approach the audit of a for-profit restaurant chain, an auditor would address different types of nonprofit audits differently.

Yet there are generic differences between for-profits and nonprofits and we will attempt to identify them and their potential audit implications. We will also take a look at some of the typical sub-types of nonprofit entities and attempt to compare them with one another as to possible audit peculiarities.

What is to be gained, you might wonder, from all this proposed dissection of terms? So, nonprofits differ from for-profits and some nonprofits differ from other nonprofits. What might this mean to an auditor? This course and this chapter are predicated upon the belief that auditing should be

• Thorough.
- Auditing standards prescribe minimum requirements for planning with an emphasis on understanding the entity, its environment and its internal control, and procedures generally based upon existence, completion, valuation, rights or obligations, and the classification/understandability of certain assets, liabilities, and transactions. These minimum requirements must not be ignored or compromised.
• Standard-based.
- Statements on Auditing Standards (SASs) comprise generally accepted auditing standards (GAAS). These are promulgated by the American Institute of Certified Public Accountants and have been established as the basis of comparison in measuring content, extent, quality, and value of audit planning and performance. At a minimum, these standards must be adhered to in any audit.
• Flexible.
- In applying GAAS, professional judgment is necessary. Some regulatory agencies, governments, and other third-party users of audits, establish minimum audit requirements that are in addition to or are stricter than GAAS. Furthermore, the auditor often is obligated to exceed the minimum established standards as a result of judgment decisions based upon particular characteristics of an asset, a liability, a transaction or upon a specific or general risk assessment.
• Effective.
- The audit must get the job done. An audit report conveys a level of reasonable assurance as defined by SAS No. 104, Amendment to Statement on Auditing Standards No. 1, Codification of Auditing Standards and Procedures (Due Professional Care in the Performance of Work). That assurance must be there and it must be supported by sufficient, appropriate audit evidence as defined in SAS No. 106, Audit Evidence. Anything else is, at a minimum, wasted effort.
• Efficient.
- Auditing is a professional business. Businesses must survive economically. Auditors who are not rewarded with fair compensation for their efforts will not be around long. Survival is a result of effectiveness and efficiency. The perfect audit might be described as one where the auditor does everything that is necessary to be effective but wastes no time in doing what is not necessary.
• Enjoyable.
- John Ruskin once said, "I believe the right question to ask, respecting all ornament, is simply this: Was it done with enjoyment? – Was the carver happy while he was about it?" Auditing, as with any pursuit, is more enjoyable when it is done well and that usually means effectively and efficiently. A thorough understanding of the entity and its environment, including its internal control, and an audit plan based on adapting the audit to the unique characteristics of the auditee should provide for a more enjoyable task.

Chapter 1 examines the unique characteristics referred to above.

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