Audit Prep & Risk Based Audits
“Audit fees are going to be increasing,” was some of her first words that grabbed our attention. “But, there are things you can do to lessen the sting,” CPA Karen Kowgios told a group of NPCC members.
Last year, the American Institute of Certified Public Accountants released a set of standards that will change the way independent auditors conduct audits. These Risk Assessment Standards (SAS 104-111) essentially mean that an auditor will focus on areas in the financial statements where there is a higher risk of material misstatement and will require increased scrutiny into records and documentation.
Nonprofits are going to have to put more time and effort into developing and implementing adequate internal control systems and producing accurate financial reports.
One of the objectives of the new standards is that the auditor has a better understanding of the organization and its environment, including internal controls, in order to identify the risks of material misstatement in the financial statements, as well as the organization’s actions to mitigate those risks.
An audit is not supposed to be about cleaning up your balance sheet or your books. In fact, an independent auditor is not allowed to fix your books, period. Doing so potentially jeopardizes their independence: how can an “independent” auditor audit your finances if they were the ones who reconciled your bank statements or gave you 72 adjusting journal entries? In the past, many auditors helped their clients if they were struggling to prepare a schedule or bank reconciliation, and may have assisted them. With SAS 104-111, the line is clearly marked in that they can’t function both as a bookkeeper and an auditor. In some cases, the auditor will say they “technically” can prepare certain items. Even if that is true, most board members and funders do not believe that is the spirit of an audit, and, are you sure they have not crossed that line of independence? In essence, a nonprofit is now expected to have total command of its financial house.
Auditors are now supposed to inquire of management and others in the organization about risks of fraud and how they are addressed. If, in the past, your auditor had not been talking to senior staff — including development and program staff — about these issues, you should definitely see them doing so in the future. A good auditor will even talk to junior staff about whether they are aware or suspect that fraud, illegal or unethical activities may have occurred.
More audit evidence is now required so that the risk is limited to a lower level. Your auditor will now be examining more transactions in depth. Finance should anticipate spending more time gathering the requested documentation, and need to be certain of its accuracy.
Auditors should not be preparing the financial statements. The organization should be providing the financial statements—including footnotes—to the auditor so the auditor can audit the statements for no material misstatements. Kowgios said, “We all know this sounds crazy but read your independent auditor’s report — the auditor’s opinion is on management’s representations to management’s financial statements. While you are reviewing documents, read the representation letter you signed for last year’s audit. The new standards emphasize the auditor’s role as independent outsider and not preparer.”
Development and finance staff have to begin talking to each other. Most finance people don’t read grant letters to see how items should be recorded within the books and records; instead they just rely on what the development staff tells them on how they interpret any restrictions. Finance people need to see the grant letters or contracts to make sure everything is kosher, because an award application document from a funder is part of an auditor’s evidence. If the purpose of an award changes, get the input or okay from the grantor, and get it in writing.
If you don’t want to pay twice as much as you did last year, you’ll need to start doing more preparation. Prior to the auditor’s site visit, they should tell you what confirmations, supporting schedules, and supporting documents they will require. Don’t assume that what you sent them last year will suffice. Find out what they will need to conduct the audit, and get it to them prior to their first day in your office.
Double-check that the schedules you are going to provide agree with the books and records. It sounds fundamental but many times the finance office is dealing with so much during the audit process that they rush the schedules and documents to the auditor and the schedules and documents might not be final or agree.
Review all documentation before giving it to the auditor (including the trial balance, general ledger account printouts, vendor invoices, grant letters, contracts, etc.). Be sure that supporting schedules tie into the trial balance you provided. Kowgios notes, “The audit time is your dime, so make sure the auditors are not wasting it by figuring out how your schedule or supporting documents relate to the books and records.”
The auditors will ask for copies of your board minutes. Review the board minutes and make sure you can answer any questions about them.
Probably most crucial is that of a financial policies and procedures manual, especially given that many organizations don’t yet have one. Finance must design, implement, document and maintain internal controls to manage risk and prevent and detect fraud. According to another new auditing standard, (SAS 112), not having a fiscal policies and procedures manual or having an out-of-date manual is likely to result in a significant or material deficiency. Your auditor is now required to communicate such a deficiency to management and the board in writing.
Kowgios urges finance staff to try to get their organization’s financial affairs in order today to help make tomorrow’s audit process proceed more smoothly.
Karen Kowgios is partner at Fried and Kowgios CPAs. She can be reached at 212-490-2200 or email email@example.com.
Many auditors will provide a generic template of fiscal policies and procedures manual for their clients. Ask your auditor if they can provide one for you, and use this as a starting point in creating your policies and procedures manual.
Public Health Solutions (formerly MHRA) offers FITA’s Common Sense Training on fiscal policies, procedures, and other financial matters, and assistance in preparing a policies and procedures manual and implementation plan. More information is at www.healthsolutions.org/fita/commoncents.cfm.
Fiscal Management Associates offers services in preparing policies and procedures manual, as well as other fiscal and accounting training services, including training and coaching for staff and boards. Visit www.fmaonline.net for information.
This article originally appeared in the July 2008 issue of New York Nonprofits, the monthly pubication of the Nonprofit Coordinating Committee of New York, Inc. www.npccny.org