Most nonprofit finance directors and executive directors know an audit is coming long before one arrives. A funder requires it. A grant agreement stipulates it. The board requests independently reviewed financial statements. And yet, when a nonprofit auditor walks through the door and fieldwork begins, many organisations find themselves scrambling to locate documents they assumed were in order, explain classifications that made sense internally but do not hold up to independent scrutiny, and answer questions about internal controls that nobody has formally documented.
That gap between assuming you are ready and actually being ready is where most audit findings originate. This post breaks down what a nonprofit auditor examines during an engagement, where organisations consistently fall short, and what you can do before fieldwork begins to close those gaps.
What You’ll Learn
• What a nonprofit auditor actually examines beyond your financial statements, including internal controls, grant compliance, and governance records
• The most common areas where nonprofits receive audit findings or management letter comments, and why they keep coming up
• What triggers a single audit under Uniform Guidance and what federal grant auditors look for specifically
• How to assess whether your organisation is audit-ready before fieldwork begins
• The difference between a clean audit opinion, a qualified opinion, and a management letter, and what each means for your funder relationships
What Does a Nonprofit Auditor Actually Do?
An independent nonprofit auditor provides external, objective verification of your organisation’s financial statements, internal controls, and compliance with applicable requirements. This is not the same as having your bookkeeper review the accounts or your fractional finance support prepare the year-end reports. Independence is the operative word. The auditor has no stake in how the numbers look. Their job is to determine whether what your financial statements say is actually supported by your records, your processes, and your compliance documentation.
The scope of that engagement depends on what type of engagement has been agreed upon. The four most common for nonprofit organisations are:
• Financial statement audit: The highest level of independent assurance. The auditor tests accounts, assesses internal controls, and issues an opinion on whether the financial statements are presented fairly and in accordance with generally accepted accounting principles (GAAP). This is what most funders and grant administrators mean when they require an “audit.”
• Financial review: Provides limited assurance rather than full audit-level assurance. The auditor performs analytical procedures but does not conduct the same depth of testing as an audit. Appropriate for organisations with less formal reporting requirements.
• Agreed-upon procedures (AUP): The auditor performs specific procedures defined by the client and reports on findings without providing an overall opinion. Often used for grant-specific compliance checks or targeted financial reviews.
• Single audit: A federally mandated audit for organisations that expend $750,000 or more in federal funds in a single fiscal year. This goes substantially further than a standard financial statement audit and is governed by Uniform Guidance.
Understanding which engagement type applies to your organisation is the starting point. If you have confirmed that an independent audit is required, and your nonprofit audit and assurance services provider has not yet clarified the engagement type, that conversation needs to happen before any preparation work begins.
The Six Areas a Nonprofit Auditor Will Examine
A nonprofit audit is not a single review of a single document. It covers multiple interconnected areas of the organisation’s financial and operational life. Here is what the auditor is looking at in each.
1. Financial Statements and Disclosures
The auditor reviews the statement of financial position, statement of activities, statement of functional expenses, and statement of cash flows. They are assessing whether these documents are complete, accurate, and presented in accordance with GAAP for nonprofit entities. Disclosures, the notes that accompany the statements, are also reviewed in full. Missing or incomplete disclosures are a common source of findings.
2. Internal Controls
Internal controls are the policies and procedures your organisation has in place to prevent errors, misappropriation of funds, and compliance failures. The auditor assesses whether those controls exist, whether they are documented, and whether the evidence suggests they are actually being followed. Weak or undocumented controls are flagged in the management letter, even when no material errors are found in the financials themselves.
3. Revenue Recognition and Grant Accounting
A nonprofit auditor does not only review your financial statements. They assess whether your internal controls, grant accounting practices, and compliance documentation would hold up to independent scrutiny.
Revenue recognition is one of the most complex areas of nonprofit accounting and one of the most frequently flagged. The core question the auditor is asking is whether revenue has been recognised in the correct period and in the correct category. Multi-year grants, conditional grants, and grants with performance obligations all have specific recognition requirements that differ from straightforward contribution accounting. If your organisation has been recognising revenue on a cash basis or applying blanket recognition policies across different grant types, this is where it surfaces.
4. Expense Classification
Auditors examine whether expenses are classified correctly across program services, management and general, and fundraising. Misallocation of expenses, particularly when grant funds are involved, creates compliance risk. If a salary is partially charged to a federal grant but the time allocation documentation does not support that split, that is a finding.
5. Compliance with Grant Restrictions
For organisations with restricted funding, the auditor will test whether restricted funds were used for the purposes specified in the grant agreement. This includes reviewing grant agreements, tracking expenditures against budgets, and assessing whether compliance reporting was completed accurately and on time. Unspent restricted funds that were not properly returned or carried forward are also reviewed.
6. Governance and Board Oversight
The auditor reviews board meeting minutes, conflict of interest policies, and governance documentation. If your board minutes are incomplete, out of date, or missing key approvals, that creates a compliance gap. Governance documentation is not a formality. It is evidence that the organisation’s leadership is exercising appropriate oversight of financial decisions.
Where Do Nonprofits Fall Short Most Often?
This is the question most finance directors actually want answered before an audit begins. Not the procedural overview, but the specific areas where organisations consistently receive findings and management letter comments.
The most common nonprofit audit findings are not caused by fraud or mismanagement. They result from classification errors, documentation gaps, and internal control weaknesses that were never designed for the level of scrutiny an audit applies.
The pattern that appears most consistently across nonprofit audit engagements includes these areas:
• Restricted fund misclassification: Net assets are classified as unrestricted when the underlying grant or donation imposed specific restrictions on use. This happens most often when the organisation has grown its grant portfolio without updating its accounting practices to match the complexity of the restrictions involved.
• Insufficient separation of duties: One person handles both the authorisation and the recording of financial transactions with no independent check. In small and mid-sized nonprofits with lean finance teams, this is nearly universal and nearly always appears in the management letter.
• Revenue recognition timing errors: Grants with conditions attached are recognised as revenue before the conditions are met. Multi-year grants are recognised in full upon receipt rather than over the grant period. These are not minor technical points. They affect whether your statement of activities accurately reflects the organisation’s financial position.
• Grant compliance documentation gaps: The grant agreement required specific reporting, a matching schedule, or a cost allocation methodology that was not maintained in a way the auditor can verify. The work may have been done correctly, but without documentation, the auditor cannot confirm it.
• Incomplete board minutes: Key financial decisions, conflict of interest disclosures, or executive compensation approvals are missing from the board record. Auditors review minutes as evidence of governance oversight. Gaps create questions that documentation could have answered.
• Functional expense allocation: Expenses shared across program and administrative functions were allocated without a documented methodology. The auditor needs to see the basis for the allocation, not just the allocation itself.
A concrete example of how this plays out: a nonprofit with two active federal grants and one foundation grant discovers during audit fieldwork that program staff salaries charged to the federal grants were allocated based on a flat percentage rather than actual time records. The time allocation had never been formally documented. The result is a finding related to cost documentation under federal grant requirements, and the organisation must implement a time-tracking system before the next audit cycle. This is not an unusual situation. It is the kind of gap that exists in organisations that have been managing grants informally and scaling the practice without scaling the documentation.
What Triggers a Single Audit and What It Covers
Nonprofits that receive federal funding exceeding $750,000 in a fiscal year are required to undergo a single audit under Uniform Guidance, which goes significantly further than a standard financial statement audit in its review of grant compliance and federal program requirements.
A single audit is a federally required independent audit governed by the Office of Management and Budget’s Uniform Administrative Requirements, Cost Principles, and Audit Requirements for Federal Awards, commonly referred to as Uniform Guidance. The $750,000 threshold applies to the total amount of federal funds expended during the fiscal year, not the total amount received or the size of any individual grant.
The single audit covers two components that a standard financial statement audit does not:
1. Schedule of Expenditures of Federal Awards (SEFA): A supplementary schedule that lists every federal award expended during the year, including pass-through awards from state agencies or other intermediaries. The auditor tests whether the SEFA is accurate and complete.
2. Compliance with federal program requirements: For major programs (determined by a risk-based approach under Uniform Guidance), the auditor tests compliance with the specific requirements that apply to each federal award. This includes allowable costs, cash management, eligibility, matching, period of performance, procurement, and reporting requirements.
Federal grant audit standards under Uniform Guidance are significantly more detailed and demanding than the standards that apply to a standard financial statement audit. Organisations that cross the threshold for the first time are frequently surprised by the scope of what fieldwork involves. If your organisation is approaching or has crossed the $750,000 threshold in federal expenditures, the preparation timeline and documentation requirements are substantially different from a standard audit engagement.
For organisations navigating both audit requirements and broader financial transactions, LNB’s financial due diligence review services can provide additional financial clarity during high-stakes periods.
How to Assess Your Own Audit Readiness Before the Auditor Arrives
Audit readiness is not a state you arrive at the week before fieldwork begins. It is built over the months leading up to the engagement through consistent financial management, documentation practices, and internal review. The organisations that move through audits cleanly are the ones that maintain their records as though an auditor could arrive at any time, because effectively, one can.
Here is a practical pre-audit checklist organised by the six examination areas covered earlier:
Financial statements and disclosures
• Confirm that all account balances have been reconciled to source documents
• Review prior year financial statements and ensure any adjustments have been reflected
• Confirm that disclosures are complete and up to date, including grant commitments, related party transactions, and subsequent events
Internal controls
• Document the key controls in your financial processes: who authorises, who records, who reconciles
• Identify any areas where one person performs two steps that should be separated and document the compensating controls in place
• Confirm that your policies and procedures manual reflects how the organisation actually operates
Revenue recognition and grant accounting
• Review each active grant agreement and confirm the revenue recognition policy applied is consistent with the grant’s conditions
• Identify any multi-year grants and confirm revenue has been recognised in the correct periods
• Confirm that conditional grants have not been recognised before the conditions were met
Expense classification
• Review the functional expense allocation methodology and confirm it is documented
• Verify that staff salary allocations are supported by time records or another defensible methodology
• Confirm that direct program expenses are correctly distinguished from management and general expenses
Grant compliance documentation
• Locate and organise all active grant agreements, including amendments and extensions
• Confirm that compliance reports submitted to funders align with the financial records
• Gather matching documentation if any grants require a match contribution
Governance records
• Review board minutes for the period under audit and confirm that key financial decisions are documented
• Confirm that conflict of interest disclosures have been completed and filed for the relevant period
• Verify that executive compensation approvals are on record
For organisations managing a formal review process alongside other compliance obligations, LNB’s resource track and manage your due diligence process provides a structured framework that can help assign owners and monitor completion across multiple workstreams.
For organisations in the San Francisco Bay Area and across California, nonprofit audit requirements intersect with California-specific reporting obligations including the Attorney General’s Registry of Charitable Trusts. Bay Area nonprofits managing federal grants alongside state-funded programs often face layered compliance timelines, and audit preparation should account for both sets of requirements. Starting that preparation early, before the fiscal year ends, is not overcaution. It is how organisations avoid the scramble.
Key Takeaways
• A nonprofit auditor examines far more than your financial statements. Internal controls, revenue recognition, expense classification, grant compliance, and governance records are all in scope.
• The most common audit findings come from documentation gaps and classification errors, not financial misconduct. Most of them are preventable.
• The $750,000 federal expenditure threshold triggers a single audit under Uniform Guidance, which has a significantly broader scope than a standard financial statement audit.
• A management letter does not mean your audit failed. It identifies internal control weaknesses that should be addressed before the next cycle.
• Audit readiness is built through consistent financial management over time, not assembled in the weeks before fieldwork.
Ready to Assess Your Audit Position?
If an audit has been required by a funder or is approaching on your compliance calendar, the right time to assess where your organisation stands is now, before fieldwork begins. LNB Accounting CPAs provides audit and assurance services for nonprofits, with specific experience in financial statement audits, single audits under Uniform Guidance, and audit readiness preparation for organisations managing complex grant portfolios.
Schedule an audit readiness call to talk through where your organisation is and what needs attention before your auditor arrives.
Questions Nonprofit Finance Directors Ask About Audits
What does a nonprofit auditor actually look at?
A nonprofit auditor examines your financial statements, internal controls, revenue recognition practices, expense classifications, grant compliance documentation, and governance records. The scope goes well beyond reviewing the numbers and includes assessing whether your financial management processes meet the standards required by funders, regulators, and your board.
What is a single audit and when does a nonprofit need one?
A single audit is a federally required independent audit for organisations that expend $750,000 or more in federal funds in a single fiscal year, governed by the Uniform Guidance standards. It covers both your financial statements and your compliance with specific federal program requirements, and it goes further than a standard nonprofit audit in its scope and documentation demands.
What are the most common findings in a nonprofit audit?
The most common findings include misclassification of restricted and unrestricted net assets, weaknesses in internal controls such as insufficient separation of duties, revenue recognition errors on multi-year or conditional grants, incomplete grant compliance documentation, and inadequate or missing board meeting minutes.
What is a management letter from an auditor?
A management letter is a separate communication from your auditor that identifies internal control weaknesses or operational issues noted during the audit but not significant enough to affect the audit opinion itself. Receiving a management letter does not mean your audit failed, but the findings it contains should be addressed before your next audit cycle.
How do I prepare my nonprofit for an audit?
Start by reconciling all accounts and confirming that restricted fund balances are correctly classified and documented. Gather all grant agreements, compliance reports, and board minutes for the period under review. Review your internal control documentation and confirm that expense allocations are consistent with your grant budgets. The earlier you begin this process, the fewer surprises the auditor will surface.
What is the difference between a nonprofit audit and a financial review?
A financial audit provides the highest level of independent assurance and includes in-depth testing of your accounts, controls, and compliance. A financial review provides limited assurance and involves analytical procedures rather than detailed testing. Audits are typically required by funders, grant administrators, or by law, while reviews may satisfy less formal reporting requirements.
Talk to an Auditor
An audit requirement does not have to be a source of anxiety if you know where your organisation stands before fieldwork begins. LNB Accounting CPAs works with nonprofits at every stage of audit readiness, from initial gap assessment through to final report. Schedule an audit readiness call to get a clear picture of what your organisation should address before the auditor arrives.
