Management, donors, lenders and regulators all rely on not-for-profit entities’ financial statements to tell the organizations’ stories. While many individuals come face-to-face with financial information daily, much of it, when presented in financial statement format, is not intuitive or self-explanatory.
This article is the third in a series (read articles one and two) intended to help non-profit stakeholders better understand financial statements in order to make intelligent use of the information. Prior articles examined the three primary financial statements, the relationships between statements, and the process of capturing financial data and producing statements. This final article discusses how audited financial statements differ from internally prepared statements and the role of an organization’s independent auditor.
Why Undertake an Audit?
Not-for-profit organizations may have requirements in their Articles of Incorporation or bylaws that obligate them to have their financial statements audited. Certain grants or state, county or federal regulations may also necessitate the services of an auditor. In other cases, organizational leadership may seek an audit to obtain the comfort provided by outside verification.
Audited Financial Statements
Audited financial statements include the three primary statements (Statement of Financial Position, Statement of Activities and Statement of Cash Flows), plus a full set of required disclosures.
The United States standard for accounting methods and disclosures is known as Generally Accepted Accounting Principles (US GAAP). US GAAP is determined by the Financial Accounting Standards Board (FASB)—and the Securities and Exchange Commission for public companies. If US GAAP is not used, it must be clearly indicated. US GAAP is intended to make financial statements for all organizations consistent; that is, “apples to apples.” In reality, many decisions and estimates must be made, so there is room for manipulation. It is critical to understand these choices to compare organizations.
Not-for-profit organizations have a specialized set of disclosures that must address:
- Contributions / donations / restrictions
- Functional expenses
- Fair value
Disclosures have become very complicated, based on past high-profile fraud cases and the complex nature of the world economy. The rules have now gone international, with the establishment of the International Accounting Standards Board (IASB) in London in 2001. The existence of two different standards-setting boards means many rule changes. Whereas FASB takes a rules-based approach, IASB takes a principles-based approach; these two approaches need to be reconciled. This is an ongoing process that will take several years to complete.
Read the rest of the article, which discusses common audit misconceptions and the role of the independent auditor here.