If your nonprofit organization operates in California, one important question to ask is: Are you required to conduct an audit?
Under California law, charitable organizations with annual gross revenues of $2 million or more must obtain an independent financial audit.
However, even if your organization falls below that threshold, an audit, or a less extensive financial review, can provide valuable benefits. Strong financial oversight reassures donors, board members, grant-makers and the public that your organization is managing its resources responsibly.
Friendship Center to Have First Audit in 50 Years
“Our first audit marks an exciting milestone for Friendship Center,” Executive Director Kathryn Westland said. “While no nonprofit gets excited about adding another line item to the budget, reaching the point where an audit is required means we’ve grown our impact and the community has entrusted us with more resources.
“With that growth comes a responsibility to strengthen our governance. I’m looking forward to working with our audit committee and our experienced nonprofit accountant Lisa Macker to ensure we continue the strong financial stewardship that has defined Friendship Center for the past 50 years.”
Understanding Different Types of Audits
Not all audits are the same. Nonprofit organizations typically choose from three levels of financial review, each offering a different degree of assurance and cost.
Full Audit
A full audit provides the highest level of assurance. An independent CPA examines financial records, tests transactions, and evaluates internal controls to determine whether the organization’s financial statements are fairly presented according to Generally Accepted Accounting Principles (GAAP).
Review — A review provides limited assurance. The CPA performs analytical procedures and makes inquiries about the organization’s finances but does not conduct extensive testing. A review offers greater confidence than a compilation but less scrutiny than a full audit.
Compilation — A compilation provides no assurance. The CPA simply organizes financial information provided by the nonprofit into GAAP-compliant financial statements without verifying the accuracy of the data.
Single audit — Organizations that expend $750,000 or more in federal funds during a fiscal year are generally required to undergo a Single Audit. This comprehensive examination evaluates both financial reporting and compliance with federal grant requirements.
Why Audits Matter
California’s audit requirements stem from the Nonprofit Integrity Act of 2004, legislation designed to strengthen accountability and governance in the nonprofit sector. Passed in the aftermath of major corporate scandals such as Enron and WorldCom, the law sought to increase transparency and public trust.
An audit does not guarantee fraud or errors will never occur. However, it can identify weaknesses in financial controls, improve reporting practices and provide confidence that the organization is managing funds appropriately.
Should You Have an Audit Committee?
While California law does not require every nonprofit to maintain an audit committee, it is widely considered a best practice, particularly for organizations undergoing annual audits.
The board of directors appoints the audit committee, which may include non-board members and can consist of a single individual. However, several safeguards apply:
• No staff members, including the executive director, may serve on the committee.
• Individuals with a material financial interest in businesses that work with the nonprofit may not serve.
• Members of the finance committee may participate, but they must make up less than half of the audit committee.
• The audit committee chair may not also chair the finance committee.
These requirements help preserve the committee’s independence.
Audit Committee Responsibilities
The audit committee serves as the board’s primary liaison with the independent auditor. Its responsibilities include:
• Recommending the selection or termination of the auditor.
• Reviewing and accepting the completed audit.
• Meeting with auditors to discuss findings and recommendations.
• Approving any non-audit services performed by the auditing firm.
• Reporting audit results and recommendations to the full board.
The committee should also ensure audited financial statements remain available to the public for at least three years.
Beyond these formal duties, effective audit committees evaluate the auditor’s qualifications, monitor implementation of audit recommendations, and help strengthen the organization’s financial practices.
Strengthening Internal Controls
Good governance extends beyond the annual audit. Nonprofits should establish strong internal controls that reduce the risk of fraud, waste and financial mismanagement.
Important practices include:
• Written financial policies and procedures.
• Clear segregation of financial duties.
• Regular review of financial reports by the board.
• Consistent oversight of cash handling and expenditures.
Organizations should also maintain a strong whistleblower policy that allows employees to confidentially report suspected financial misconduct without fear of retaliation. Employees who raise concerns in good faith should be protected from disciplinary action, even if an investigation ultimately finds no wrongdoing.
Special attention should be given to situations involving concerns about the executive director. Policies should clearly identify an alternative reporting path, such as the board chair or executive committee.
Ongoing Oversight
An audit should not be viewed as a once-a-year event. Effective oversight requires ongoing attention from the board and audit committee.
Committee members should understand prior audit findings, monitor corrective actions throughout the year and meet periodically with management and auditors to assess financial reporting and internal controls. This proactive approach helps organizations address issues before they become significant problems.
Financial literacy is also critical. As nonprofit boards strive to recruit members with diverse backgrounds and perspectives, organizations must still ensure that audit committee members possess sufficient financial knowledge to understand financial statements, evaluate audit proposals, and fulfill their fiduciary responsibilities.
The Bottom Line
Whether required by law or pursued voluntarily, audits are an important tool for building transparency, accountability and trust.
Combined with a knowledgeable audit committee, strong internal controls and ongoing board oversight, a sound audit process helps nonprofits protect their resources and demonstrate responsible stewardship of the funds entrusted to them.