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By Guest Blogger Charlie Blanton, CPA | Surgent McCoy CPE LLC

1. Not all not-for-profits are the same

The not-for-profit sector of the economy is diverse. For example, not-for-profit entities have diverse missions. Part of the National Wild Turkey Federation’s mission includes the “preservation of the hunting tradition,”while part of the People for the Ethical Treatment of Animals’ mission is “establishing and defending the rights of all animals.” Even where entities within the not-for-profit sector have similar missions, there is diversity in size. For example, the University of Notre Dame in recent years has had an enrollment of about 12,000 students and net assets in excess of $8 billion, while Texas Wesleyan University in recent years has had about 3,000 students and net assets closer to $60 million. The diversities between not-for-profits affects the audit process. For example:

In the area of materiality, auditors attempt to use the benchmarks that makes the most sense for the particular not-for-profit being audited. In an audit of a charitable foundation, total net assets (i.e., a number from the statement of financial position) might make sense. However, for a social services organization, total revenues (i.e., a number from the statement of activities) might make more sense.

2. Key differences between not-for-profits and business entities

FASB Accounting Standards Codification 958 tells us that not-for-profits possess the following characteristics, in varying degrees, that distinguish them from business entities:

• Contributions of significant amounts of resources from resource providers who do not expect commensurate or proportionate pecuniary return
• Operating purposes other than to provide goods or services at a profit
• Absence of ownership interests like those of business entities

Because of these characteristics, the FASB has developed unique accounting and reporting requirements for not-for-profits. The unique accounting and reporting for items such as contributions, pledges, restrictions, net assets, fundraising expenses, split-interest agreements, functional expenses, and membership dues can pose challenges and risks to auditors. Since donors generally view program service expenses more favorably than supporting activity expenses, some not-for-profits have an incentive to report expenses as program services instead of fundraising or management and general expenses. This incentive to improperly categorize expenses may increase the risk of material misstatement in a not-for-profit audit in contrast to a business entity where the bottom-line is the focus of financial statement users.

The nature of what is being measured in a not-for-profit’s financial statements also creates inherent challenges for auditors. Not-for-profits often receive contribution revenues with little or no supporting documentation. Examples include an offering plate cash contribution at a church or a donor mailing in a check at the end of the year where the not-for-profit has no notice that the donor is sending a donation until it arrives. Poor internal controls, errors, and fraud can prevent contribution revenues from being reported completely in a not-for-profit’s financial statements. Thus, auditing the completeness assertion for a not-for-profit’s revenues may be more problematic than auditing a business entity’s revenues that are often generated from sales transactions involving processes and documentation such as invoices, inventory records, and shipping documents.

3. Auditing in a compliance environment

For many not-for-profits, grants are a significant source of funding. Grants often come with varying levels of compliance requirements. In many not-for-profits, it is not unusual for an individual or a limited number of individuals, to have substantive control over how a particular grant is expended. For example, in a university setting, a professor may obtain a grant for research and then be responsible for spending the grant funds. It may be difficult for others within the university to know if the grant funds are being used appropriately or inappropriately. When you combine weak controls and weak oversight with compliance requirements, there is a heightened potential for noncompliance. Sometimes the problem is intensified by highly mission-minded individuals being more concerned about achieving the mission than following the precise compliance requirements. For example, compliance requirements may seem strange to a fine arts professor who is likely more concerned about when the costumes for the school’s next stage production are going to arrive. For auditors, the presence of compliance requirements typically imposes additional audit requirements under AU-C Section 250 and the Yellow Book at the financial statement level. If the not-for-profit expends $500,000+ per year in federal awards it will also have a compliance audit performed in accordance with OMB Circular A-133, where an auditor will provide an opinion on compliance at the major program level, which is much different than a financial statement audit.