The annual audit report for nonprofits is set to change in 2020. While these changes will not affect how you do your accounting, they will affect how future audits are conducted.

Let’s take a look at how the main changes will affect you.

What are non-profit audit reports?

Let’s first clarify what is meant by the nonprofit ‘audit report’.

Many people think of the audit report as a document that includes the auditor’s opinion on the financial statements, as well as the financial statements and footnotes.

In reality, the audit report or independent auditor’s report is limited to the signed letter from the audit firm opining on the financial statements.

While the auditor’s report relates to the financial statements, the financial statements are not technically part of the audit report.   

Why the need for change?

Earlier this year, the AICPA approved the Statement on Auditing Standards No.134 (SAS 134).

This will become effective with the calendar year ending December 31, 2020.

Over the past few years, nonprofit organizations have grown accustomed to changes in accounting principles relating to nonprofit financial statements, accounting for contributions, revenue recognition, and leases.

These pronouncements have required nonprofits to reevaluate and/or modify the way they do their accounting.

SAS 134 is different in the sense that it is an auditing standard, rather than an accounting standard.

You may be pleased to hear that the implementation of SAS 134 will require extra work for your audit firm but not your internal accounting department.

The main goal of the changes is to make the auditor’s report more meaningful and transparent to the parties who rely on it, such as your funding sources.

What are the main changes to the report?

The main changes to the non-profit audit report include:

• Position of the opinion paragraph

The opinion paragraph (where the auditor indicates whether or not the financial statements are reliable) will come first.

It is currently presented at the end of the report.

• Additional wording

The report will include additional wording about the auditor’s responsibilities in exercising professional judgment and professional skepticism.

• Inclusion of Key Audit Matters (KAMs)

Perhaps the most significant provision in the new statement deals with the inclusion of Key Audit Matters (KAMs) in the nonprofit audit report.

A major complaint from many about the current version of the auditor’s report is its basic wording, which is largely identical from organization to organization.

KAMs should result in audit reports that are less “boilerplate”, more customized, and more in-depth. The change should also make audit reports more transparent.

In addition to the audit report’s current language that summarizes management’s responsibility for the financial statements, the auditor’s responsibility to audit the financial statements, and the auditor’s opinion, examples of KAMs to be disclosed include:

• Areas of the financial statements that are at risk of material misstatement.
• Amounts or disclosures that are determined based on management estimates.
• The impact of significant events’ and/or transactions on the audit.

The importance of KAMs in audit reports

It’s important to know that SAS 134 will not require KAMs. However, if KAMs are reported, the statement governs how they will be reported.

This means that you and your auditor will need to agree in advance if you are going to undergo a standard audit or an audit with KAMs. Either way, it should be documented in the engagement letter.

It will be interesting to see how users of audit reports respond when two different types of audit reports are in circulation.

With many nonprofits competing for the same foundation grants, for example, those who furnish an audit report enhanced with the transparency of KAMs may be at a competitive advantage

over organizations who provide a report with the old, basic, boilerplate wording.

As KAMs become more prevalent, it will also be interesting to see if funders come to expect their grantees to provide audit reports that include KAMs.

The auditor’s communication with those charged with governance

In addition to changes to the audit report, the auditor’s communication with those charged with governance is being expanded.

This is a restricted-use letter to the board, which is not subject to California’s public disclosure requirements governing audits.

The letter will be enhanced to disclose areas of significant risk in the auditee.

A couple of points are worth mentioning here.

1. The communication of significant risks should not be confused with the significant deficiencies or material weaknesses in internal control that auditors are currently required to communicate. In planning an audit, auditors are required to document in their files the significant risks in the auditee organization that have the potential to hinder the reliable preparation and fair presentation of the organization’s financial statements. This is by no means new.

2. Your auditors may or may not have discussed these significant risks with you in the past. Even if they have, there is a good chance that you have never seen them presented in writing. SAS 134 will change that. In addition to reporting known problems (i.e. significant deficiencies and material weaknesses), the board letter will also report potential problems (i.e. significant risks).

Finally, the significant risks disclosed in the board letter may or may not rise to the level of a key audit matter that needs to be disclosed in the audit report itself.

This all means that, over this next year, it is important to start having conversations with your auditor about the role that KAMs may play in your audit, as well as the other changes that are being introduced.