Avoid These 16 Common Nonprofit Audit Mistakes

When you get a clean bill of health from your doctor, you can feel confident as you navigate through life. That goes for financial health at your nonprofit organization, too. Think of the different annual audits you perform as opportunities to receive a clean bill of health, inspiring confidence from funders and leadership alike.

From your annual financial audit to drilling into your internal controls, each type of audit helps you improve your compliance and proactively address issues before they become major problems. But audits can also take a lot of resources, and if not done correctly—or at all—your organization can spend even more time cleaning up the mess.

In this article, you’ll learn about the different types of audits nonprofit finance teams commonly work on and the most common nonprofit audit mistakes for each, giving you a better understanding of how to avoid these mistakes for your next audit.

Key Takeaways

• There are several different types of nonprofit audits the finance team is involved with, including financial audits, internal or operational audits, compliance audits, IRS audits, and internal control audits.
• Conduct an internal control audit quarterly to ensure that your nonprofit is adhering to the policies you’ve set. This will help with your financial audit as well.
• Not completing a monthly close is a top reason for financial nonprofit audit mistakes.
• Implementing fund accounting software with subfund capabilities can help your team avoid common nonprofit audit mistakes by streamlining grants management, documentation management, and other key processes.

Annual Financial Audit and Common Mistakes

Financial audits are the most common and robust type of audit. A third-party auditing firm will conduct your annual nonprofit financial audit and review your organization’s financial records, accounting practices, and internal controls, providing an objective picture of your nonprofit’s financial health and compliance.

Your CFO, executive director, board treasurer, finance staff, and program managers will all play essential roles in working with your auditor to prepare for and review the financial audit.

Some nonprofits are required to conduct this type of audit due to state laws or federal funding requirements, but even if your nonprofit isn’t required, it’s a great way to demonstrate transparency and build credibility with donors. Here are some of the top nonprofit audit mistakes when it comes to financial audits.

1. Insufficient planning

Many nonprofits make the mistake of underpreparing, only to realize too late that they are missing documentation that’s necessary for the audit’s accuracy.

To avoid this common nonprofit audit mistake, your organization should meet with your auditors before the audit begins to set timelines and expectations. You can also run through an audit preparation checklist to ensure you are as prepared as possible.

2. Failing to complete a monthly close

Completing a monthly close in your finance office ensures that your numbers are accurate and up-to-date at the end of each month. It’s difficult to accurately track your numbers if they are constantly changing when someone finds an unpaid invoice or transactions from previous months are charged late.

To avoid these issues, be sure to run through a closing checklist, which often includes:

• Confirming transactions in the month
• Posting closing entries
• Closing subledgers
• Performing reconciliations
• Running review reports

3. Lack of communication with your auditor

Your financial audit can already be a stressful time, gathering paperwork and making sure your reports are accurate. Getting caught off-guard by a new regulation or adding extra time to your onboarding because your auditing firm has new staff can set your processes back weeks.

Stay in regular contact with your auditor and inform them of any changes to your organization or software, like new fund accounting systems. Set up a quarterly check-in to make sure everyone is aware of what is happening.

4. Poor document management

With so many documents required for a financial audit, your nonprofit needs a foolproof document management system in place prior to the audit. The auditor will need recent tax documents, payroll details, annual financial statements, among other documentation.

If your office has to scramble to track down all these documents in the weeks leading up to the audit, you are more likely to grab an outdated file or spend hours you don’t have searching for the missing receipt. Time sheets could be incomplete, or grant expenses might be missing proper authorization.

Maintaining clear and accurate documentation using a connected system, like Blackbaud Raiser’s Edge NXT® and Blackbaud Financial Edge NXT®, can help you seamlessly track donor restrictions in your fund accounting system. Documents like gift agreements and receipts flow automatically between your fundraising CRM and your finance accounting system, lightening the load when it comes to your next audit.

Compliance Audits and Common Mistakes

A nonprofit compliance audit assesses whether your organization is complying with federal, state, and local regulations and with your own policies. While this audit reviews financial management activities, the focus is more on compliance than financial health, and it also involves reviewing data security and other compliance measures.

The main purpose of these audits is to ensure that your organization is using funds from grants, donors, and foundations as intended. These audits can be mandated by federal agencies or private donors who want additional oversight, and they are conducted by a third-party auditor. Here are a few of the most common nonprofit audit mistakes when it comes to a compliance audit.

1. Not closely reviewing the notice of award

Winning a grant is an exciting moment, but while you’re celebrating, take a close look at the Notice of Award. It’s common for nonprofits to accidentally miss a requirement that then comes up in the compliance audit, simply because they didn’t know about it or hadn’t informed all departments.

To avoid this, you and all involved departments should carefully review the Notice of Award to ensure that you’re able to uphold all outlined requirements and deadlines. Upload this document to the grant record in your fund accounting system to make sure anyone on your finance team can easily access this information as needed.

2. Using spreadsheets to manage your grant funding

Spreadsheets are incredibly useful tools, but relying on them to track your grants often adds more problems than they solve. More manual data entry means more room for error in your accounting processes.

Because grant restrictions are determined by the funder, you must accurately track these restrictions to show that the money was spent as stipulated, both to pass the audit and to get future grants from the funder.

Using fund accounting software specifically designed for nonprofits like Financial Edge NXT helps you can track your individual grants and any restrictions all in one place.

3. Tracking grant-related payroll incorrectly

Accurate time allocation helps ensure compliance with grant requirements, but it can be a time-consuming and tedious process. Many nonprofits rely on multiple data sources and spreadsheets to track it all, leading to confusion and errors.

You can improve this process by clearly defining which costs need to be allocated, understanding the percentage allowed for each grant, training your staff, using automation, and establishing procedures. Tools like NXT Time from Capital Business Solutions can dramatically simplify the grant payroll tracking process and ensure accuracy for your compliance audits.

Operational or Internal Audits and Common Mistakes

In this type of audit, your own internal teams review your documentation and procedures to evaluate internal systems, productivity, and staffing. Your operational audit might focus on one specific area, like data management or technology. This audit is an opportunity for your organization to identify areas for improvement as well as strengths, giving you a holistic picture of how your organization is operating. Here are a few pitfalls you should look out for.

1. Not dedicating enough resources

Just because this audit is conducted internally doesn’t mean you shouldn’t dedicate proper resources to ensure it’s done accurately and efficiently. Asking your Controller who also doubles as your IT Director to single-handedly run an internal audit on top of their other duties is asking for it to be put on the back-burner behind board reports, financial audits, and monthly close—or a very burned-out Controller.

2. Poor process documentation

If your internal processes aren’t clearly documented, then it will be much more time-consuming to evaluate how well your organization is performing. Instead of referring to your standard process documentation, you’ll need to spend time interviewing your staff, and you may get different answers from different people because there is no standard documented process.

Be sure to carefully document, evaluate, and update your internal procedures, so you have a baseline to compare the results of your audit with. Financial software can help you with automations, audit trails, document management, and more to streamline this process.

3. No leadership buy-in for addressing issues

Your internal audit turns up a few areas that need to be fixed, but then you learn that leadership doesn’t consider them a priority.

To avoid this common nonprofit audit mistake, get leadership together to discuss the areas you’ll be evaluating with this internal audit and understand their willingness to dedicate resources to fixing these issues if a problem is uncovered. Getting buy-in before you conduct the audit can save everyone time and headaches.

IRS Financial Audits and Common Mistakes

Although your organization operates as a not-for-profit organization, you can still be subject to an IRS audit. In fact, the IRS can conduct a federal audit or compliance check, usually if your nonprofit fails to file required forms, or they discover a discrepancy in your reporting. Check out these common IRS nonprofit audit mistakes.

1. Submitting form 990 incorrectly

The purpose of the form 990 series is to provide the IRS and the public with up-to-date information about your nonprofit’s programs, activities, revenue, expenses, and assets.

There are numerous mistakes that can be made when filing this form, such as missing the deadline, filing the wrong form, or losing track of important documentation. You can learn more about the nine most common mistakes made when filing a form 990 in this article.

2. Tracking payroll incorrectly

To stay compliant with the IRS, your nonprofit must accurately report employee wages, handle payroll taxes, and submit the correct tax forms in a timely manner. Nonprofits are typically responsible for payroll taxes that include Social Security, Medicare, and federal unemployment taxes. 501(c)(3) organizations might qualify for exemptions from federal unemployment taxes, but they’ll still be on the hook for the other tax contributions on behalf of their employees.

Additionally, payroll taxes differ between employees, volunteers, and contractors, and must be treated accordingly. Employees are subject to payroll taxes and will receive W-2s, while volunteers are not subject to these taxes, and contractors are responsible for their own taxes and will receive a 1099-NEC instead.

An organized payroll system can help your nonprofit avoid IRS audits in the first place and any potential penalties. Your system should accurately track hours and wages to maintain compliance.

3. Not gathering contractor W-9s at the onset of the relationship

This common audit mistake is an easy one to avoid. Businesses are required by law to track and record all payments to independent contractors, so that the IRS can confirm both parties pay the appropriate taxes. If your nonprofit pays a contractor $600 or more in a calendar year, then you will need to issue them a form 1099-NEC at the end of the year. The W-9 gives you the necessary details like name, address, and TIN to complete the form.

Don’t get caught unprepared at the end of the year. Make it a policy at your organization to always get a W-9 from all contractors at the start of the relationship, before any money is paid out. Keep track of all W-9s in your fund accounting system as part of the vendor record so you never lose them.

Internal Control Audits and Common Mistakes

Nonprofit internal controls are a set of rules and processes designed to protect your organization’s resources, promote operational efficiency, and avoid waste or fraud. They are also a key part of your annual financial audit and compliance audits for your grant funders.

The goal of your nonprofit internal control audit is to uncover any areas of weakness that could be putting your organization at risk of financial mismanagement or non-compliance. However, there are a few key places where this type of audit can go awry.

1. Not conducting regular internal control audits

If your organization decides to forgo regular internal control audits, you could be putting the nonprofit at risk of losing trust with donors, mismanaging funds, getting deficiencies in your financial audit, or veering off track from your mission and objectives.

Set a timeline to audit your internal control policies and identify who will conduct the audit. Aim for quarterly to make sure everything is up to date, and you can address any issues before your financial audit.

2. Not documenting your internal controls

Your internal controls are only as strong as your documentation. Say a key finance employee leaves, taking years of unwritten knowledge with them. How can their replacement learn the ropes and ensure compliance when they don’t have the proper policies and procedures to refer to?

Create and carefully document your internal control policy, including financial controls, separation of duties, documentation controls, personnel controls, physical controls, and IT controls. Whether contained in a single document or broken out by category, writing these policies down will be essential to completing your future internal control audits.

3. Not having a clear plan for updating or fixing issues

Many nonprofits make the mistake of just going through the motions when it comes to an internal control audit, expecting to pass with flying colors. But if something is flagged, like you discover your pre-approval policy for expenses is being skirted, you need a plan for how you’ll address it immediately.

Get buy-in from leadership up front, before you conduct the internal control audit. That way, the key players know that they may soon need to authorize a new policy or reevaluate an existing one, and you’re met with less resistance after the audit is conducted. Also make sure that human resources and department managers are on the same page and ready to enforce new internal controls when necessary.

At a Glance: Nonprofit Audit Mistakes

Audit Mistake Category	Common Mistakes	How to Avoid This Mistake
Financial audit	Insufficient planningFailing to complete monthly closeLack of communication with auditorPoor document management	Meet with your auditors beforehand to set expectations, stay in contact with your auditors through the process, always complete a monthly close, and maintain good document management with a connected CRM and fund accounting system.
Compliance audit	Not closely reviewing the Notice of AwardUsing spreadsheets to track grant fundingIncorrectly Tracking grant-related payroll	Review the Notice of Award for grants up front to identify all restrictions and requirements, use a fund accounting software to track grant funding, and track payroll correctly by training staff and implementing a tool like NXT Time from Capital Business Solutions.
Operational/internal audit	Not dedicating enough resourcesPoor process documentationNo leadership buy-in to address issues	Make sure you have the staff and resources available and budgeted for operational audits, maintain clear and accurate documentation of all processes, and get buy-in from leadership beforehand so you have leverage to fix key issues that may come up.
IRS audit	Mistakes with form 990Tracking payroll incorrectlyNot gathering contractor W-9s at onset of relationship	Know your 990 form and deadlines, keep an organized payroll system so you don’t become non-compliant, and always collect W-9s from contractors at the start of the relationship.
Internal control audit	Not conducting an audit of internal controlsNot documenting internal controlsNo clear plan for fixing any issues found	Conduct an internal control audit on a quarterly basis, be sure to document all internal controls clearly and update regularly, and make sure leadership is on board to fix any internal control issues that need attention.

Make Audit Readiness a Year-Round Habit

It pays to be proactive when it comes to audits. Conducting regular financial audits is the best way to demonstrate transparency and build trust with your team, your stakeholders, and your donors.

Save time, ensure accuracy, eliminate manual tracking, and get a virtual audit trail with robust fund accounting software like Financial Edge NXT. You get the functionality you need to simplify your annual financial audit and avoid nonprofit audit mistakes—for good. Check out how to get prepared for and manage your next financial audit with Financial Edge NXT today!