Nonprofit Organization Fraud: Financial Audit vs. Forensic Investigation
Accountants perform a variety of services for non-profit organizations. Sometimes the services will go outside the standard audit service and entail the investigative accounting realm.
Colorado nonprofits, from trade associations and professional organizations to charitable foundations and community groups, are not immune to fraud. In fact, the same internal control weaknesses that make nonprofits vulnerable nationwide are often more pronounced in smaller Colorado organizations where a single staff member manages multiple financial functions.
Many professionals whether they are engineers, accountants, or writers, belong to their related trade organizations.
Trade organizations are designed to help promote a respective profession’s trade. As a member of the organization, you will usually pay yearly dues and conference fees, if you attend their annual trade conference. You personally get the benefit of belonging to the organization and the ability to network with others in the same industry. As the organization reflects upon the membership, you want to belong to one with a solid reputation.
How the money is managed and what your funds go toward is generally handled by the executive director of the organization.
The executive director will take the direction of the board of directors and, with the assistance of staff, map out where to spend the funds to best benefit the members. I often hear from trade organization members that their organization is reputable, from a financial standpoint, because they “get an audit” ever year. They think that because they “get an audit,” there couldn’t possibly be any theft of funds.
This is a common misconception.
What is the goal of a financial statement audit?
Under the rules and regulations the auditor must follow, the three most common goals of a financial statement audit are to:
- Issue an opinion that the issued financial statements are materially correct.
What does “materially correct” mean?
Well, assume you have $1,000 in $1 bills on your desk. Now let’s say you lose one of those dollars and you know have $999. Would losing the $1 make you upset? Probably not, because in the scheme of things it is immaterial to the overall amount.
This is how auditor approaches financial statements. They only look at the items that are determined to be material. If they did evaluate the entirety of the financials, the cost of the audit would be astronomical.
- Document any internal control weaknesses.
The auditor is required to document and communicate internal control weaknesses. They are only required to make sure the weakness didn’t cause the financial statement balance to be ‘materially’ misstated. In other words, the difference of what is report and what the balance should be is so large it would change the mind of the end user.
- Review management’s assertions.
This is a fancy way of saying that the auditors will ensure that if management is recording something in the books based on an estimate, then the estimate is reasonable.
As you can see, at no time does the auditor develop their audits to test for any fraud or theft. While they may occasionally stumble upon fraud or theft, many times fraud isn’t caught. Especially, in this type of a financial audit. Rarely will a non profit organization fraud be caught.
How often have you heard the saying ‘where were the auditors’ when a fraud happens?
It isn’t that the auditors don’t know how to find fraud. It is simply that their tests are not designed to detect fraud. Their tests are only designed to make sure the balance reported is within a material tolerance of what the balance should be.
Enter the role of a forensic accountant.
In the forensic accounting world, we are hired to perform forensic investigations that specifically hone in on theft and fraud.
We don’t issue financial statements (e.g. balance sheet, income statement, cash flow) but rather a report on the testing of specific transactions.
What is the goal of a forensic investigation?
The three main goals of a forensic investigation are:
- Determine all the parties involved with a possible fraud or theft.
We develop what is called a genogram. Think of it as a flow chart that maps out all of the people in and out of an organization. We do this because if we just focus on the primary people involved, we may miss the larger picture of fraud outside of the immediate area.
- Test all transactions related to the area of suspicion, regardless of dollar value.
Even if an invoice is $1, if it falls in the area we have concerns about then we will test that area. There have been famous cases that unraveled because of the examination of a small amount.
- Report the findings.
The report will be detailed enough that it will break out everything examined and any fraud that has taken place. Additionally, the report can be used in litigation proceedings and, in some cases, criminal proceedings.
So to recap, an audit is more concerned about the material presentation of the financial statements. The forensic investigation is concerned about reviewing every transaction that is specifically related to the area of concern.
Indicating you have no concern about theft from an organization when they ‘get an audit’ is misguided.
What are red flags you should be concerned about?
Most trade organizations are set up a non profit organization. Non profit organization fraud red flags you should be aware of are:
- Expense reports submitted without receipts or reviewed only by the person submitting them
- Executive director or treasurer resistant to financial questions or overly defensive about specific accounts
- Significant or unexpected change in leadership, particularly in financial roles
- Unexplained decreases in cash reserves or donation totals
- Vendors that board members don’t recognize or that lack a verifiable business presence
- Restricted fund balances that don’t match grant agreements or donor designations
- Financial reports that are consistently late, incomplete, or presented without supporting detail
- A single employee controlling both the receipt of funds and the recording of transactions
Many times non profit organizations will bury a fraud and not prosecute. This is done to avoid negative publicity. It is important, regardless of whether an individual will be prosecuted, to report nonprofit fraud.
Concerned about fraud in your Colorado nonprofit? Hovland Forensic & Financial provides confidential forensic investigations for nonprofit boards, executive directors, and attorneys throughout Colorado and nationwide. Schedule a free confidential consultation →
Grant Misuse and Restricted Fund Fraud in Nonprofits
For nonprofits receiving government grants, foundation funding, or donor-restricted contributions, grant misuse is one of the most serious and legally consequential forms of fraud an organization can face. Unlike general embezzlement, grant misuse carries additional exposure including repayment demands from grantors, loss of future funding eligibility, and potential federal liability for organizations receiving government grants.
Grant misuse occurs when funds designated for a specific purpose are used for something other than what the grant agreement requires. This can be intentional fraud or the result of inadequate financial controls, but either way the consequences for the organization are severe. Common forms include:
| Type of Grant Misuse | What It Looks Like |
|---|---|
| Commingling of Funds | Restricted grant funds deposited into the general operating account and used interchangeably with unrestricted funds |
| Unallowable Expenses | Salaries, overhead, or personal expenses charged to grant budget line items that do not qualify under the grant agreement |
| Falsified Time Reporting | Employees whose salaries are grant-funded falsify time and effort records to justify salary charges |
| Duplicate Billing | The same expense is charged to two or more grant budgets simultaneously |
| Diversion to Personal Use | A staff member or executive with grant account access diverts funds directly for personal benefit |
| Unreported Program Income | Income generated by grant-funded activities is not reported or returned as required by the grant agreement |
Suspect grant misuse at your Colorado nonprofit? Hovland Forensic provides same-day intake and confidential investigations for nonprofit boards and their attorneys throughout Colorado and nationwide. Schedule a free consultation →
The Difference Between Noncompliance and Fraud
Not all grant misuse is intentional fraud. Some organizations, particularly smaller nonprofits with limited financial staff, make genuine accounting errors that result in noncompliance. A forensic accountant can help distinguish between intentional misappropriation and unintentional error, a distinction that matters significantly for how the organization responds and what remedies are available. When grant misuse appears intentional, a forensic investigation produces the documentation needed to support criminal referral, civil recovery, or a defense against grantor claims. When it appears unintentional, a forensic review can quantify the exposure and provide the factual foundation for a voluntary disclosure or corrective action plan.
Who Investigates Nonprofit Grant Misuse?
Grant misuse investigations are typically initiated by one of the following parties:
| Board of Directors | When board members suspect staff have misused grant funds, commissioning an independent forensic investigation protects the board from personal liability and demonstrates accountability to grantors and the public |
| Legal Counsel | Attorneys advising nonprofits on grant compliance, grantor disputes, or government investigations routinely retain forensic accountants to quantify exposure and document the facts before the organization responds |
| Federal and State Grantors | Organizations receiving federal funding under HHS, HUD, or Department of Education programs may be required to commission an independent forensic review as a condition of continued funding |
| Insurance Carriers | Nonprofits carrying fidelity bonds or crime insurance policies may be required to commission a forensic investigation as part of the claims process following a discovered fraud |
What a Forensic Investigation of Grant Misuse Covers
A forensic investigation of nonprofit grant misuse typically involves reconciliation of grant expenditures to allowable budget line items as defined in the grant agreement, review of time and effort documentation for grant-funded staff, tracing of restricted fund deposits and disbursements to confirm funds were used as designated, analysis of any commingled accounts to separate restricted and unrestricted activity, documentation of any duplicate billings across multiple grant budgets, and preparation of a court-ready report quantifying misused funds and identifying responsible parties.
The resulting report can be used to support a grantor response, legal proceedings, an insurance claim, or a voluntary corrective action disclosure.
Concerned about grant misuse or restricted fund fraud at your Colorado nonprofit? Hovland Forensic & Financial provides confidential forensic investigations for nonprofit boards, executive directors, and attorneys throughout Colorado and nationwide. Schedule a free confidential consultation →
Who Should Commission a Nonprofit Forensic Investigation?
Unlike an angry HOA homeowner who suspects fraud but has no authority to act, the following parties do have the authority to commission a forensic investigation of a nonprofit:
Board of Directors: The board has fiduciary responsibility for the organization’s finances. If the board suspects the executive director or treasurer of misappropriation, commissioning an independent forensic investigation is both appropriate and legally defensible.
Legal Counsel: Attorneys representing nonprofits in civil or criminal proceedings frequently engage forensic accountants to quantify losses, document the fraud methodology, and provide expert witness testimony.
Insurance Carriers: Organizations carrying fidelity bonds or crime insurance policies may require a forensic investigation as part of the claims process.
Government Agencies: Nonprofits receiving grant funding may face required forensic investigations if a grantor suspects misuse of restricted funds.
Hovland Forensic & Financial investigates nonprofit fraud for boards, executive directors, and attorneys throughout Colorado, including Denver, Colorado Springs, Fort Collins, Boulder, Pueblo, and Grand Junction, as well as clients nationwide.
Learn More About Our Forensic Accounting Services
Ready to discuss a potential nonprofit fraud situation? Hovland Forensic provides confidential consultations with no obligation. We work directly with nonprofit boards and their legal counsel. Schedule your free consultation →