What Funders Need to Know Part 3: Audits and Reviews

By Abby Rolland and Jill Greenfield Feldman

In the simplest yet incomplete of descriptions, institutional philanthropy, such as giving through foundations or donor-advised funds, is about channeling resources to support organizations that are making positive change.

There’s an entire field dedicated to expanding on that very basic definition, layers of complexity of how and in what ways organizations can give money away, and questions about effectiveness, strategy, community, and best practices that permeate conversations and actions on philanthropy. However, what can be missing are discussions about the more technical aspects of establishing and maintaining entities such as private foundations. Through this blog post series, we at harp-weaver compile resources from organizations like Exponent Philanthropy, the National Center for Family Philanthropy, and more while also sharing our own experiences and thoughts about topics like insurance, investing, cyber-attacks, audits and reviews, and memberships at various philanthropy-serving organizations.

These topics may be viewed as the less interesting aspects of establishing and maintaining a charitable giving institution in good standing, but we think that understanding them is vital to ensuring a healthy, well-functioning foundation that fully optimizes its giving.

The third post in the series on “what you need to know” focuses on audits and reviews for private foundations.

Audit and review definitions

Audits and reviews are tools used to assess whether a foundation is in legal and financial compliance. 

The Council of Nonprofits shares that an independent audit is an examination of the financial records, accounts, business transactions, accounting practices, and internal controls of a charitable nonprofit by an "independent" auditor. "Independent" refers to the fact that the auditor/CPA is not an employee of the nonprofit but is retained through a contract for services. Accounting firms often offer both audit and review services. The goal of the auditor is to be able to form an opinion about the organization’s financials practices and whether the financial statements accurately present the position of the organization.

The objective of a financial "review," also conducted by an independent accountant, is to examine the nonprofit's financial statements and determine whether the financial statements are consistent with generally accepted accounting principles. A review shares the goals of an audit; however, a review is not conducted with the same level of investigation or analysis as an independent audit and it does not provide an opinion about the nonprofit’s financial statement.

What happens during an audit and review

During an audit, the auditor will review the organization’s financial statements to determine whether they adhere to “generally accepted accounting principles” (commonly referred to as “GAAP”). These accounting principles are created by the "Financial Accounting Standards Board," known as "FASB."

While not law, the standards carry weight - when they are not followed, the auditors are required to note that in their report. The auditors will spend significantly more time and request more documentation from the organization than on a review, thus charging more, as well. They will want to meet with employees and board members to understand the way everything works- from who collects and opens the mail to who writes the checks and where the bills are saved.

During a review, the auditor examines the financial statements but does not conduct an examination of the nonprofit’s internal controls. The review provides a limited level of assurance that the financial statements are free of misrepresentations. The auditor’s report after a review will note whether the auditor is aware of any “material modifications” that should be made to the financial statements. The report after a review is not considered to provide a professional opinion about the nonprofit’s financial statements as a whole. 

Is an audit or review required?

Generally speaking, the IRS does not mandate that private foundations have an audit, regardless of their size or other criteria. Instead, the IRS seeks to promote voluntary compliance by analyzing operational and financial activities of exempt organizations.

How much does an audit or review cost?

There are a variety of factors that contribute to the cost of an audit or review, including but not limited to the size of the funder, the complexity of their investments and operations, and the number and size of grants made. Speak with an accounting firm about your organization if you are interested in receiving an estimate.

Language for an audit

While audits are private documents intended for internal foundation stakeholders, understanding the language in them is helpful to better understanding private foundations as a whole. In that vein, we have included the beginning statements to an independent audit recently conducted for one of harp-weaver’s clients.

Report on the Audit of the Financial Statements

Opinion: We have audited the accompanying financial statements of “Foundation” (a nonprofit organization), which comprise the statement of financial position as of June 30, 2022, and the related statement of activities and changes in net assets, functional expenses, and cash flows for the year then ended, and the related notes to the financial statements. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of “Foundation” as of June 30, 2022, and the results of its changes in its net assets and its cash flows for the year then ended in accordance with accounting principles generally accepted in the United States of America.

Basis for Opinion: We conducted our audit in accordance with auditing standards generally accepted in the United States of America (GAAS). Our responsibilities under those standards are further described in the Auditors’ Responsibilities for the Audit of the Financial Statements section of our report. We are required to be independent of “Foundation” Foundation and to meet our other ethical responsibilities in accordance with the relevant ethical requirements relating to our audit. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.

Why conduct an audit or review

Questions may arise during an audit which may include a foundation's tax-exempt status, whether it incurred private foundation excise taxes, whether it paid employment taxes and tax on unrelated business income when required, and whether it filed required returns and reports. Any issues of concern will come to the attention of the Foundation’s Board and staff, if applicable, and can be resolved once they are determined.

Audits and reviews can also reveal potential fraud and mismanagement, ensure regulatory compliance, identify areas for improving internal controls and financial processes, demonstrate a commitment to transparency and accountability, and help identify potential financial and operational risks.

Advice

As mentioned above, audits and reviews may not required by law for private foundations, varying on their size and state, but they can be helpful in ensuring legal and financial compliance.

harp-weaver advises each funder to assess their stakeholder expectations, risks, and budget to determine whether or not an audit or review is necessary in order to operate the foundation in good standing.

Thanks to the Council of Nonprofits for their resources about audits and reviews.