DATELINE: April 28, 2009, Chicago
We are big fans of the National Council of Nonprofits (NCP). We particularly like their monthly newsletter, but we disagree with their apparent belief that raising the dollar threshold for nonprofit audits required by regulators is a good thing. In its April Newsletter, NCP reports that Maryland Governor Martin O’Malley signed into law legislation...
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raising the audit threshold from $200,000 to $500,000 for charities required to register under Maryland’s charitable solicitation statute. This legislation also increased the threshold for financial reviews from $100,000 to $200,000.
NCP notes that similar legislation is pending in Connecticut and Minnesota. The pending Minnesota legislation would raise the threshold from $350,000 in total revenue to $750,000 in total revenue. The pending Connecticut legislation does not appear to be tied to charitable solicitation registration and reporting requirements. Instead the legislation focuses on Connecticut’s Single Audit Act. The proposal would require nonprofits to obtain audits if they expend more than $300,000 state assistance.
NCP’s position is a sympathetic one. They point out that an organization with revenue under $600,000 could pay anywhere from $12,000 to $20,000 in audit fees. Its anyone’s guess where audit thresholds should be set, but before state legislatures revise the thresholds upward they should consider the benefits that an audit provides.
At the outset, we should acknowledge that audits are not designed to detect fraud. That alone might warrant upping the thresholds, but audits do:
Independent Review of Internal Controls. Involve an independent review of the organization’s internal controls by a knowledgeable professional. Adequate internal controls do detect and detour fraud. Many smaller nonprofits are notorious for woefully inadequate internal controls. An audit requires them to at least consider the inadequacies.
Assess Quality of Interim Financial Statements. Identifies adjustments that must be made to the financial statements before they clearly reflect the nonprofit’s financial position and results of operations. Those adjustments force management and the board to assess the quality of the interim financial statements that the board and management are using throughout the year to make resource allocation and other decisions. If the auditor requires 100 adjustments before the auditor will issue an unqualified opinion, management and the board are most likely relying on incomplete and inadequate interim financial reports.
Insights Through Management Letter. The auditor is now required to send a letter to management and the board communicating material weaknesses and significant deficiencies in internal controls. This letter offers an important checklist of needed improvements to the accounting system.
Imposition of Discipline. The auditor’s presence imposes discipline on the nonprofit’s accounting staff. They need to get ready for the audit, make adjusting and closing entries, and take other actions that may otherwise go unattended to. It is a test and while teachers hope students study throughout the semester, the test sets a deadline and forces students to hit the books.
Increase Funding Sources. Audited financial statements will make nonprofits eligible for funding from foundations and other donors that require an audit. It is not just the state that requires audits.
We are far less sympathetic to the exception for “small” entities than most. There are costs to doing business. If an organization can’t do what is necessary to be a viable and sound entity, it should not exist. Small organizations can do a lot of damage. Bernard Madoff took advantage of an exception that appears to have been aimed at smaller entities. His auditor did not need to be registered with Public Accounting Oversight Board and Madoff took advantage of that fact. His auditor is now subject to criminal prosecution. William K Rashbaum and Diana B. Henriques, Accountant for Madoff is Arrested and Charged with Securities Fraud, N.Y. Times (Mar. 18, 2009). More importantly, a lot of people are out a lot of money.
Too often, small nonprofits argue that controls and process shift money from mission to overhead. Well, so does some portion of employee salaries. Anyone who argues against good controls because they are costly should just put the money out on the nonprofit’s doorstep with a sign that reads “Needy people should help themselves.” Most people find that suggestion laughable, but they don’t see that the argument against audits and controls on cost grounds is the exact same argument.
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