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Nonprofit organization leaders and boards know they need independently prepared financial statements, but they may not always know whether an audit, review, or compilation is the right fit.
To help clarify the differences, we spoke with Kirsten Houghton, CPA, MBA, a Principal at SVA Certified Public Accountants who focuses her expertise on nonprofit organizations. Kirsten provides audit, accounting, tax, review, compilation, and management advisory services, and she has deep experience with nonprofit financial statements.
In this Q&A, Kirsten explains how the three services differ, when each may be required, what value they provide, and why it is important for nonprofits to understand what an audit does and does not cover.
The biggest difference between the various engagements is the level of assurance provided.
| Audit | An audit is the most comprehensive service and provides the highest level of assurance that the financial statements are materially correct. |
| Review | A review is narrower in scope and generally focuses on inquiry and analytical procedures, such as looking at relationships between numbers and changes from year to year. A compilation is the lowest level of assurance. |
| Compilation | In a compilation, the CPA firm takes the information provided by the organization and presents it in financial statement format, at times with footnotes, but does not provide assurance that the numbers are correct. |
During an audit, the auditor looks at source documentation, asks questions of management and others within the organization, documents internal controls, and performs walkthroughs of key controls. For example, auditors may review bank statements, loan statements, or other original documents to support balances in the financial statements.
The goal is to determine whether the financial statements are free from material misstatement. If no issues are identified, the auditor issues an unmodified opinion, what an organization wants to receive.
A review is less comprehensive than an audit. The CPA firm still prepares or reviews financial statements and related footnotes, but the engagement does not include any internal control documentation, walkthroughs, or testing.
A review often focuses on whether financial statement relationships make sense. For example, if revenue is decreasing while expenses are increasing, the CPA firm will ask why. There may be a logical explanation, such as staffing changes or a new revenue initiative, but the process can also highlight trends management may not notice during day-to-day operations.
A compilation can be useful when a smaller organization needs a formal, professional set of financial statements for a bank, lender, tax preparer, or other outside party, but doesn’t need the level of assurance provided by a review or audit.
For nonprofit organizations, compilations are less common than audits or reviews, but they can still provide value by organizing financial information into a clear statement format.
Start with the drivers. A nonprofit organization may need an audit or review because of state requirements, bylaws, grant agreements, funder requirements, lender expectations, or board preference.
In Wisconsin, charitable organizations that meet certain contribution thresholds may be required to submit reviewed or audited financial statements. The requirement is based on contribution revenue, not total revenue. For example, an organization could have significant total revenue but a smaller amount of contribution revenue, which may affect whether a review or audit is required.
Because requirements can change and vary by situation, nonprofit organizations should talk with their CPA firm before deciding which service is appropriate.
It can, if there is no outside requirement for an audit. However, cost shouldn’t be the only consideration. Organizations should first ask what they are trying to accomplish.
If a board member wants an audit because they are concerned about fraud or internal controls, an audit may not directly answer that concern. In some cases, a different service, such as agreed-upon procedures focused on specific controls, may be a better fit.
It’s not recommended to switch back and forth between reviews and audits from year to year. If a CPA firm has not audited the beginning balances from the prior year, it may need to perform additional procedures when the organization returns to an audit. As a result, alternating between services may not create the savings an organization expects.
Growth, complexity, and outside requirements are common reasons to move to a higher level of service. As nonprofit organizations grow, add entities, accept larger contributions, or develop more complex operations, an audit may make more sense.
The board and management team should periodically evaluate whether the organization has reached a point where a higher level of assurance, transparency, or oversight is needed.
One of the biggest misconceptions is that an audit looks at every transaction, tests every internal control, and is designed to find fraud. That isn’t the case. Auditors use sampling and focus on areas of risk. They document and test key controls, but they don't test every control.
Auditors also ask questions about fraud and may uncover fraud, but a financial statement audit isn't the same as a forensic audit specifically designed to detect fraud.
Audits and reviews can bring issues to the surface. If auditors identify internal control deficiencies or unusual trends, they can make recommendations and have deeper conversations with management and the board. Sometimes it also helps for recommendations to come from an outside advisor.
Be responsive and provide the requested documentation as completely and timely as possible. When information is delayed or requests have to be repeated, the engagement can take longer and become more costly. A smooth process depends on both the audit team and the client staying organized and engaged.