Do I Need an Audit and Why? and What is a Certified Audit?

by Verne Hargrave
NACBA Ledger, Fall 2003

As a CPA in the practice of providing services to churches I am frequently asked this question. Unfortunately, my initial response is not very satisfying, because I usually respond; “It depends.” The reason for my response is that there are many misconceptions about audits.

Because so many audits are taking place today, these misconceptions are understandable. In addition to CPAs, there are also audits conducted by IRS agents and other government agencies. There are workers’ comp audits, energy usage audits, environmental audits, and in our profession peer reviews, which are CPA firms auditing other CPAs. Sometimes it seems like no work is getting done because we are spending all of our time checking each other!

This atmosphere has contributed to the confusion about what a certified audit (an audit of financial statement prepared by a Certified Public Accountant) is all about. The reasons potential clients often give for requesting an audit illustrates this point:

“I’m new to the job, and I want to make sure everything is OK.”
“We just had an employee leave, and we want to be sure everything is OK.”
“We had an embezzlement and want to know how much we lost.”
“We think our bookkeeper is embezzling, and we want you to find out for sure”
Or most frequently, “things just don’t seem right.”

All of these are good reasons for needing professional accounting help of some kind, but not necessarily an audit. As we attempt to determine if a potential client needs an audit, we usually follow a three-step approach. First, we must explain what a certified audit by a CPA firm is. Second, we compare that with the needs of the church to determine if an audit meets these needs. Third, we recommend the appropriate services for the church that may or may not include a certified audit.

What is a certified audit?

The primary goal of an audit is to express an opinion on two aspects of the financial statements of the church or organization: the financial statements are fairly presented, and they are in accordance with generally accepted accounting principles (GAAP). Generally accepted accounting principles are the accepted body of accounting rules and policies established by the accounting profession. The purpose of these rules is to promote consistency and fairness in financial reporting throughout the business community. These principles provide comparability of financial information.

So, by this definition, the primary purpose of a set of audited financial statements is for the benefit of outside users of the organization’s financial statements such as banks, government agencies, and membership organizations such as the ECFA. As a part of our audit, we are required to make an assessment of the risk of fraud and perform steps to detect the presence of fraud. However, the audit is not designed to find out how much has been taken. Also a part of our audit includes evaluating the accounting control system as a basis on which to plan and perform our audit, but the audit is not a consulting engagement.

How do you know if you need an audit?

When a client asks us about the need for an audit, we go through a series of questions with them to help them make the proper decision.

Do your church by-laws, or does your denomination require an audit. If so, you need to get an audit performed. It is surprising how many churches come to us requesting audit services only after someone took a few minutes to read the by-laws!

Do you have a bank loan that has a covenant requiring an audit? If you do, then you have no choice. In order to comply with the loan covenant, an audit must be performed. The majority of our church audit clients fall into this category.

Are you anticipating a new building/fund-raising campaign in the near future? If so, and part of the project will be financed, you need to anticipate that the bankers are going to ask to see your audited financial statements. It is much more impressive to reach into a drawer and pull a set out rather than answering their request with a blank stare!

Do you receive government or private grants? Are you anticipating applying for some? This generally does not apply to churches, (especially in regard to federal dollars) but some auxiliary agencies of churches may qualify. Very few granting agencies or foundations will release funds without a certified audit.

Finally, what size is your church? Once a church reaches a certain size (rule of thumb, $1,000,000) it should begin to have some type of procedures performed by outside professionals. Churches of this size, whether they realize it or not, become significant participants in the business community and accordingly are expected to exercise good business practices. That usually includes audited financial statements.

But, is there anything in this for me?

To this point, it sounds like having an audit benefits everyone but the church. The benefits seem to be going to the bankers, the public, government agencies and the business community. (And, oh yes, the auditors who get the fees!) You may be asking, “But, is there anything in this for me?” And, of course there is. Otherwise audits would not be the most popular service we provide to our church clients, even after their loans are paid off and the covenants expire. (Yes, Alice there are debt free churches in this world!)

These are some of the benefits of an audit that we point out to our potential clients.

First, an audit gives a measure of comfort to the congregation when they realize that the staff, finance committee, elders, etc. are willing to let outsiders come in and inspect the books and records. In other words, an audit adds another layer of accountability to the church’s system of controls.

An audit requires an annual clean up of the books and records. In spite of all of our New Year’s resolutions, and in spite of our best efforts, we all get behind in our work. Often, some things get put on the back burner and unfortunately never get done. For example, few churches have the time to keep up with all of the fixed assets purchased throughout the year. Having auditors in once a year provides the opportunity to bring the fixed assets schedule up to date.

An audit performed by a firm that is familiar with churches will help the church stay up-to-date on tax, accounting and legal issues. We live in a fast paced environment where change is the only constant! It is important to surround yourself with professionals who stay current on the issues that affect your situation. The Warren housing allowance tax case is a recent example.

If fraud is detected the appropriate personnel are notified. As mentioned earlier, the primary goal of an audit is related to financial statement presentation, not fraud detection. But, in response to recent events, CPAs perform extensive tests to determine the potential for, or the actual occurrence of fraud. Any occurrences will be reported to the responsible church officials.

An annual audit will also produce a management letter. Earlier I mentioned that part of an audit includes a study and evaluation of the accounting system. This study is conducted by interviews, questionnaires and testing of transactions. The findings are compiled in a letter in which the weaknesses and suggestions for improvements are detailed. Most of our clients find the management letter as beneficial as the audited financial statements themselves.

Usually, after going through this process a church can easily determine if they need to go on with an audit. However, in some cases questions persist.

The most common obstacle is money. Audits can be expensive and difficult to squeeze into a budget in mid-year. If that is the case ask your CPA about the possibility of performing a review, which is smaller in scope than an audit, but does provide the benefit of outside eyes looking at the books and are less expensive.

Many times there are no overriding audit concerns but a few isolated issues, such as concern over misuse of funds or questions over the accounting control system. In that case ask your CPA about the possibility of an agreed upon procedures engagement or a consulting engagement. This allows the church to save money and time and quickly and directly address the problem.

What can we conclude from all of this? That deciding on an audit is like purchasing a car. A lot of different factors go into our selection of an automobile: the miles we have to drive, the amount of money we have for gas, etc. As a result, most of us spend a good amount of time and effort making our choice. The same approach should be followed by a church considering an audit. Take your time, assess your needs and requirements. Then make a good choice.

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