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AUDIT COMMITTEES May 2003In an age where a new corporate scandal is being exposed on a regular basis, there has been an increased emphasis on the role of the Board of Directors and the audit committee. New laws are being passed, and the Security and Exchange Committee has issued regulations that require the CEO of an organization to take more responsibility for the financial results published throughout the year. While these rules do not specifically apply to not-for-profit organizations, they are also being subjected to increased scrutiny. The recent problems, and the related publicity, of the United Way of the National Capitol Area and the American Red Cross made it clear that not-for-profit organizations are not exempt from public attention. The results can be devastating in terms of decreased levels of funding. As a result, many NFPO's are now investigating ways to increase the oversight role of the Board of Directors in financial matters. Many are starting audit committees, while others are increasing the role of their existing committees. There are many ways to increase the effectiveness of an audit committee. To begin, it is often important to create a written charter that outlines the structure and responsibilities of the audit committee. Having a written charter in place will give more authority to the audit committee as it carries out its responsibilities during the year. These guidelines can cover the following: Membership The number of members of an audit committee can vary depending upon the needs of the NFPO. Generally a minimum of 3 to 4 members should be considered. When selecting members for the committee it is important that each have a good knowledge of the organization and its financial operations. Further, at least one member of the committee should have an accounting or strong financial background. This is especially important in the case of associations where essentially all of the members of the Board of Directors specialize in an area other than accounting. For example, an association of doctors may find it difficult to fill this need. In this case it may be helpful to appoint an individual who does have this expertise to the Board, regardless of that individual's ability to be a member based upon occupation, certification or other parameters. In addition, the members of the committee should be independent of management to allow for objective communications and results. Responsibilities Oversight of the Audit The audit committee provides oversight of the audit. Currently this generally means meeting once a year with the external auditors after the audit has been finalized. A more proactive stance would be to hold a meeting prior to the audit to discuss the anticipated scope of the audit, the general extent of the audit planned and the major risks to be addressed during testing. This establishes a dialogue with the auditors and allows for open communication with the committee if problems arise during testing. It is also appropriate to ensure the independence of the external auditors at this time. This can be accomplished by verifying that the auditors do not have personal or business relationships with members of the organization. Further, the committee should be aware of all the work performed by the external auditors for the organization during the year. This includes consulting, IT installation or maintenance and budget assistance. It is important for the auditing firm to be, and remain, independent of the organization to ensure that there are no conflicts of interest that would affect the audit results. After the audit, the external auditors should meet with the committee to present the audited financial statements, discuss any limitations placed on the scope or nature of the testing performed, outline deficiencies in internal control and relate recommendations for addressing the deficiencies. At this time the severity of any findings can be discussed. Review of Staff Performance It is also during this meeting that the committee holds an executive session with the external auditors. Questions relating to the performance of the accounting department personnel can be addressed. The auditors should be forthcoming when addressing any issues the committee presents. Further, the performance of the executive director as it relates to the financial management of the organization can be reviewed. If the audit committee rather than management, as discussed below, is responsible for the selection of the auditors, these discussions and assessments may prove more objective. Selection of the Auditor Each year the audit committee should also review the performance of the external auditors. Was the audit performed in a timely fashion? If not, what are the reasons for the delay in completion of the work? Were the accounting staff and the executive director satisfied with the work performed and their interaction with the accounting firm's personnel? Are the fees reasonable? At the end of this process, the committee is responsible for determining whether the contract with the current auditing firm should be renewed or if bids should be taken to find a new auditor. In either event, once the committee has made a selection, it will need to make a recommendation to the full Board of Directors. The decision of the Board should be documented in the minutes of the meeting. It should be noted that "rotating" audit firms (i.e. periodically changing firms) does not enhance audit quality and auditor independence. On the contrary, evidence points to the fact that many audit failures occur shortly after new audit firms are engaged. An alternative is to "rotate" the audit partners and/or managers assigned to the engagement. Monitoring of Internal Controls The audit committee is also responsible for understanding and monitoring the internal controls in place within the organization. The size of the organization will often have an impact on how involved this process will be. In smaller organizations, the audit committee may also need to test transactions to ensure that procedures are being followed. This is especially true if an audit conducted by an outside auditor is not an option due to price considerations. In any event, internal control procedures should be documented in a policy manual and enforcement of the procedures should be a priority. The committee will investigate any financial or control matters that arise during the year. The committee should also work with the executive director to determine that he/she is aware of the internal controls in place and understands the importance of each. Policies should be reviewed and an understanding of how risk is assessed should be developed. Reporting Finally, the committee should report directly to the full Board of Directors at least once a year. The Board should then review and approve the committee's charter for the coming year. Meetings Currently many audit committees meet once a year to discuss the results of the audit process with the external auditors. More frequent, perhaps quarterly, meetings should be considered. In this manner, the committee will be aware of any changes to accounting policies or to internal control procedures made during the year. The committee will then be able to advise the Board of their recommendations and concerns relating to the changes. There are no guarantees that your organization will not experience lapses in controls, financial management or reporting at some point. However, having effective oversight over the process can lessen the likelihood of experiencing poor results in this area. CONFLICT OF INTEREST POLICIES It is also a good idea for organizations to establish and enforce conflict of interest statements for the board of directors, committee members and employees. A conflict of interest arises if an individual has competing interests when making decisions affecting the not-for-profit organization. For example, a board member may own an office building that could potentially lease space to the not-for-profit organization. A conflict arises between the fiduciary duty to put the interests of the not-for-profit first and the desire to lease the unfilled space and potentially benefit the director. The organization should consider both real and perceived conflicts when developing a policy to address these types of issues. The board of directors should always be aware of potential conflicts. This can be accomplished through several provisions:
The conflict of interest policy should be read by all board and committee members and employees when service to the organization starts and then annually thereafter. A statement should then be signed by each person noting that they have done so. The policy itself should also be reviewed and updated each year.
Please contact Patricia A. O'Malley, Senior Manager, at pomalley@rubino.com for information on the articles in this newsletter. Please contact A. Michael Gellman, Director, at mgellman@rubino.com Nonprofit Specialty Group, for any additional information. Rubino & McGeehin 6903 Rockledge Drive Suite 1200 Bethesda, MD 20817
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