Keeping Your Books Audit Ready

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For arts managers outside the finance team, the idea of an audit may seem either terrifying or mundane. Even some inside the finance teams, of organizations of all sizes, the annual external audit process can consume a significant portion of staff time and mental energy for several months of the year.

The external audit process results in a document known as the audited financial statements, which provides a professional opinion that the organization’s accounting records are clear of misstatement. Institutional funders, charity watchdog agencies, and other entities look to this document for a reliable summary of the organization’s financial management.

The external audit in and of itself remains an important element of nonprofit management, so there is one key practice finance managers can follow to make it more palatable for all involved: keep the books audit-ready throughout the year. We do this by reconciling each balance sheet account every month.

Your organization very likely already has monthly financial reports of some kind that are reviewed by senior staff members and possibly a finance committee or even the full board of directors. These reports generally comprise summaries of ticket sales and donations, as well as expenses across both operations and administration. This collection of revenues and expenses is your Statement of Activities, which is different, though connected to, the balance sheet.

A robust accounting function will make no distinction between the data underlying monthly financial reports and the data underlying annual financial statements, because there shouldn’t be. If the books are kept audit-ready as part of the monthly close process, finance teams will get to the end of the fiscal year and have only to complete a final review of relatively clean data before locking the file and sending to the audit firm.

Disclaimer: What is a blog post about a legal topic without a disclaimer? This is not legal advice. You should not be getting your legal advice from a blog post. The purpose of this post is to give you things to think about before taking action. Speak to an accountant and/or a lawyer about specifics.

Going Through the Balance Sheet

For the most part, finance teams can reconcile each balance sheet account against the organization’s other internal records. Here is how to think about each type of balance sheet account:

Assets

Your accounts receivable may be a single line or disaggregated to distinguish contracts receivable, grants receivable, and pledges receivable. Either way, reconciling accounts receivable requires a monthly review with the department head or team lead with the best current knowledge of the component items. It might also be a nudge to the grants manager or gifts officers to follow up with the grantors and donors about the status of their awarded or pledged payments, respectively. You might also find that some receivables did arrive in the past month but weren’t applied to open balances.

Your prepaid expenses at the end of each month should consist only of items for future months. On the programming side, this could include airfare for future guest artists and venue deposits and music materials purchases for future productions. Finance should cross-reference this schedule with the artistic, production, and/or operations teams. On the administrative side, your group health insurance premiums and office rent are often paid in the month prior to the month they apply to. Except for the month in which annual rate increases take effect, this will very likely be an identical journal entry each month.

And finally, your undeposited funds or deposits in transit at the end of each month should consist only of income in the final few days of the month that haven’t cleared to the bank as of the last day of the month. This would be physical checks dated in the previous month that didn’t arrive in the mail, and weren’t deposited, until early in the new month, as well as donations and ticket sales via your website on the last business day of the month, as your payment processor likely batch deposits on the first business day of the new month. This schedule should be checked with your gift processing and box office teams.

Liabilities

Your accounts payable is most likely split into bill payments made check and credit card expenditures that accrue during the statement period. For bills, the end of the month should only have invoices that were logged but not paid until early in the new month (perhaps because an invoice was sent the last day of the month). For credit cards, the end of the month should be the difference between the last posted statement from the bank and any expenditures made through the last day of the month.

Your deferred revenue at the end of the month should be whatever ticket sales or advance contract payments you have for future month productions. Cross-reference ticket sales with your box office team and contract payments most likely with operations.

Your accrued liabilities are something of the opposite of deferred revenue, in that you have an obligation to pay for something in the future, rather than with deferred revenue, an obligation to provide something in the future that you’ve been paid for. Accrued liabilities most often consists primarily of payroll related items such as accrued vacation, retirement matching, and similar, so this is an area to cross-reference with the HR team or simply the payroll journals.

Net Assets

One of the distinguishing features of nonprofits is seen in the last section of the balance sheet, as prominently as the name of the section: net assets rather than equity.

To reconcile net assets at the end of each month, review the schedule of assets with restrictions and determine if any are able to be released from restrictions due to satisfying those restrictions. This often happens if you have sponsorships or grants for particular productions and those productions occurred in the previous month.

Sidebar: This section of your balance sheet is also what ties to the proverbial bottom line on your Statement of Activities. There are two other elements of the balance sheet that tie to other elements of the Statement of Activities: the release of deferred revenue will post to your various earned revenue lines (ticket sales, contract fees, and so forth), and the release of prepaid expenses will post to various expense lines.

You Probably Already Do Some of This

It’s quite likely that your organization already keeps some aspects of the books audit-ready on a monthly basis. Since we are defining this as reconciling each balance sheet account every month, then the reconciliation of bank and credit card accounts each month absolutely qualifies as part of this work.

Any account on your balance sheet that represents a real-world account with a financial institution that sends you a monthly statement is going to be the most straightforward part of this work. The accounting software has the built-in functionality to guide the finance managers through reconciling what’s in the books against the statement.

Cross-Team Collaboration

It was noted in the section-by-section discussion of the balance sheet above above, but bears highlighting: the process of keeping the books audit-ready throughout the year is best accomplished through regular cross-referencing datasets between the finance team and every other team that either generates or spends money for your organization. There are myriad benefits here beyond keeping the books audit ready: breaks down the walls of mystery that often surround the finance function from the perspective of other teams, and just generally provides forums for strengthening the relationship between teams, as an antidote to the siloing that so often exists in the workplace.

About Eric Joseph Rubio

Eric Joseph Rubio is a nonprofit and arts management professional originally from Chicago, and now based in Washington, DC. He has served in staff and leadership roles with churches, schools, and arts organizations in the Chicago, South Florida, and Washington, DC areas. Eric is a proud alumnus of the Wheaton College (IL) Conservatory of Music, and is an occasional freelance writer across a variety of platforms. Follow Eric on Twitter and Instagram at @TheRubioRoom.

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