Section 10: Compliance and Independent Financial Statement Audits

The type of audit your CIL needs depends on the amount of federal funds the Center spends.

Compliance Audit

CILs that spend at least $750,000 in federal funds in a year are required to have a single audit of all federal funds, or compliance audit. These include:

  • Regular financial statement audits
  • Governmental Auditing Standards (the Yellow Book)
  • Additional requirements and controls for the preparation of financial statements
  • Compliance with laws, regulations, contracts, and grants

Auditors must test whether the organization complied with the terms of federal awards, and whether they have proper controls over that compliance, such as training of staff and internal verification. Compliance includes whether individuals being served are eligible for that service, whether services are performed during the time frame required by the grant, and whether cash management requirements are in place and followed. Single audits must be submitted to the Federal Audit Clearinghouse along with a data collection form, Form SF-SAC. (See 45 CFR 74.512.)

Financial Statement Audit

CILs that spend less than $750,000 in federal funds in a year can secure a less expensive financial statement audit, which assures your funders that your financial statements are an accurate portrayal of your finances. This includes an auditor’s report called an Opinion Letter. The Opinion Letter issued by the CPA to the board states an “opinion” as to whether the financial statements fairly report the organization’s activities (income and expenses) and cash flows for the year, and assets, liabilities, and net assets at year-end based on generally accepted accounting principles (GAAP). A letter that positively states this is referred to as an unmodified or a “clean opinion.” If there are “material issues” that indicate compliance issues or GAAP standards that are not followed, then a “qualified” report or disclaimer of opinion stating the issues found is reported. This is a serious matter that will require board and management attention to the points identified in the audit. These may be resolved in a relatively short time or may require a more “systemic” approach to rectifying the cited concerns.

If a CIL does not spend $750,000 in federal funds, a compliance audit cannot be paid for with federal funds. However, a financial statement audit can be paid for with such funds if the CIL secures prior approval and if the expense is properly allocated across cost objectives or funding sources.

Management Letter

Most audits will also include a management letter (auditors call it a “required communications letter”) that offers suggestions by the auditor, which are intended to strengthen the fiscal practices of the organization.

Timing and Process

By law, an independent audit can only be conducted by an outside CPA or CPA firm. The audit should occur as soon as possible after the close of your fiscal year. The auditor will also typically file your IRS Form 990 on your behalf. You should have it done annually, and it is required in order to keep your 501(c)3 status with the IRS. If you lose that status, you lose eligibility to receive Title VII funds.

It is important to recognize that an audit committee or the board selects and contracts with the CPA for the audit, not the executive director. You can collect bids and provide them to the board for their decision, but it should be explicit and clear that the board retains the auditor. The auditor should report any findings directly to the board when the audit is complete. Once the auditor is selected, it is a good practice to receive a written proposal from the CPA in an engagement letter, which is accepted and signed by the president and/or treasurer of the board.

Understanding Your CIL’s Audited Financial Statements[1]

You will want to review past audits as you get a handle on financial matters. Here is a quick overview of audited financial statements and what to look for when reading them.

Auditor’s Cover Letter/Opinion

This is addressed to the board and is dated when the audit was completed and accepted by management. This report has headings, and one of the headings is “opinion.” If what follows is anything other than the standard language “in our opinion the financial statements described above present fairly ....,” you have cause for concern, and you should investigate what led to that modified opinion.

Income Statement or Statement of Activities

  • Includes all income earned by the CIL and all contributions that are not subject to uncertainties (conditions).
  • Income earned isn’t the same as income collected. Some amounts get paid in advance, sometimes amounts are earned but not yet paid.
  • There may be contributions of in-kind items that don’t include any cash. The financial statement should include a Statement of Cash Flows that attempts to explain the differences between what was earned and what was collected, but it is a difficult, often confusing statement to read. Ask your auditor to go over it with you and answer any questions you have.
  • The income statement or statement of activities often includes the prior year as well as the current year, or at least totals for the prior year, so you can tell whether revenue went up or down.
  • The different categories of income tell you how diverse the funding is and whether funding from specific sources is up or down. Diverse funding is considered a sign of financial stability.
  • The board may request five or even 10 years of income by source and expense by type in order to see longer-term trends. This is also helpful for budgeting.
  • When you look at expenses consider where the CIL is spending its money. Is the great majority of it spent directly on program services? How do salaries compare to similar organizations in your area?

Balance Sheet or Statement of Financial Position

  • This statement lists assets (what the organization owns) and liabilities (what the organization owes) on a specific date, most commonly your fiscal year-end. The difference between assets and liabilities is your equity or net assets. Net assets are generally broken down into unrestricted net assets, temporarily restricted net assets, and permanently restricted net assets. Nonprofit financial statements are all being changed in the near future to have just two categories of net assets, which are “net assets without donor restrictions” and “net assets with donor restrictions,” although organizations will be able to include subcategories within each of those categories.
  • CILs don’t typically have a lot of assets, so this statement may be more meaningful for those with property and equipment.
  • This statement will also show debt such as lines of credit, installment loans, building loans, accounts payable, and payroll and payroll taxes that have not been paid yet. Be alert if accounts payable, unpaid payroll or taxes get larger from year to year. That might signal a cash flow problem.
  • The balance sheet or statement of financial position is a good statement for the board to review but, it should not be the only report they review. The income statement or statement of activities is also very important.

Resources for a Deeper Dive

Understanding Financial Responsibilities of Nonprofit Boards, 3rd Edition(https://boardsource.org/product/financial-responsibilities-nonprofit-boards-third-edition/). BoardSource is one of the most highly regarded sources of support for nonprofit boards. Available for purchase for $29.00.

[1] John F Heveron, Jr., Principal, Heveron and Company CPAs, Rochester NY.