When to Consider a Third Party Audit
August 2, 2023
In the same way that some private companies regularly carry out external audits, (audits performed by a third party, not someone affiliated with the company), religious organizations can also carry out external audits. As this post will demonstrate, there are times it may be wise for your organization to do so.
An audit is a report prepared by a certified public accountant (CPA) evaluating the fairness and accuracy of an organization’s financial statements and disclosures.1
Nonprofit organizations carry out external audits for four main reasons: 1) because it is required by law; 2) because it is a good practice to assure donors that resources are being well used; 3) because stakeholders/directors are concerned that there may be some financial anomaly within the organization; 4) because a potential donor is a grant-making foundation that requires an audit as a condition of receiving the grant; or 5) because a regular audit is an established practice in the organization’s bylaws or policies.
State Law Audit Requirements
As noted above, some states across the U.S. have laws that require an audit for certain nonprofit organizations for several reasons:
- There are states that require nonprofits to submit a copy of audited financial statements so they may be able to engage in fundraising activities in that state.
- Additionally, many states require nonprofits that receive government funds to submit independent audits to the state agency providing the funds.
- Likewise, there are some state government contracts that require an audit; and there is a federal requirement to conduct an independent audit if the nonprofit expends $750,000 or more in federal funds in a single year.
Please be aware that each state may have different requirements regarding the type of independent audit that nonprofits must conduct, and there are some states that allow nonprofits to ask for an exemption. For more information on which states require nonprofits to carry out independent audits, consult Napa Legal’s Multi-State Compliance Matrix.
When an Audit is Not Required
If your organization is not required by law to conduct a third party audit, there remains the question of whether it is prudent for your organization to conduct an audit. A major factor in answering that question is the cost. There are several factors that impact this cost, including the size and location of the organization.
The size and complexity of the organization play fundamental roles in determining the cost of the audit, since the larger the organization, the more documentation the CPA will have to review. The location of the organization also has an impact on the cost, as certified public accountants charge different fees depending on where the organization is located.
That being said, sources estimate that the cost of an audit can easily be more than $10,000, even for small to midsize nonprofits.2
Since conducting a third-party audit can be costly, you need to determine whether an audit is worthwhile for your organization. Even if not required by law, an audit may be worthwhile if important stakeholders or directors consider that there may be a major anomaly within the finances of the organization. In such a situation, despite the costs, investing in an audit could be a good use of donor funds to protect the overall financial well-being of the organization. If this does not apply to your organization, it may be advisable for nonprofits to consider a financial review rather than a full audit.
A financial review is less intensive than a third-party audit, mainly because the accountant does not give a formal opinion on the financial status of the organization. In a review, an accountant simply prepares financial statements without expressing an opinion as to whether or not the financial statements are free of material misstatements. The financial review can cost up to one-third of what a third-party audit would normally cost,3 while still giving your organization the benefit of a professionally-prepared financial statement to help determine the financial health of your organization.
If the law does not require you to conduct a third-party audit, you should consider conducting one voluntarily if there are financial concerns from donors, directors, or other important contributors to your organization. If you think your organization could benefit from this process but do not think a full audit would be worth the cost to your organization, consider conducting a financial review instead. If you think your organization’s circumstances warrant an audit or review, consult with the organization’s leadership and consider speaking with an accountant for further information. Also, keep in mind that if your organization does not intend to conduct an audit or financial review, it may be worth evaluating the laws in the states where you solicit or receive funds. In some instances, it may be better not to accept certain donations from a state that may trigger burdensome audit requirements.
To learn more about the financial health of your organization, check out Napa Legal’s “How to Start a Faith-Based Nonprofit” toolkit and consider consulting with an attorney about what is best for your organization.
1See “Charitable Registration Audit Requirements,” Harbor Compliance. https://www.harborcompliance.com/charitable-registration-audit-requirements.
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