EFFECTIVE AUDIT COMMITTEES HELP NOT-FOR-PROFITS AVOID FINANCIAL MISSTEPS

In an age where new corporate scandals are being exposed on a regular basis, there is an increased emphasis on the roles 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, not-for-profits are also being subjected to increased scrutiny.  The well-documented problems 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 examination.  And, negative attention can be devastating for not-for-profits in terms of decreased levels of funding.

The end result is that many not-for-profits are now investigating ways to increase the oversight role of the Board of Directors in financial matters.  Many organizations are also establishing audit committees, while others are increasing the roles of their existing committee structure.

There are many ways to increase the effectiveness of an audit committee.

To begin, it is often important to develop 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 might cover the following issues.

Membership

The number of members of an audit committee can vary depending upon the needs of the not-for-profit.  Generally, an audit committee should include a minimum of three to four members.

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 organization’s 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 important to ensure the independence of the external auditors.  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, maintenance, and budget assistance.  It is critical 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

External auditors can also be helpful to the organization in assessing the performance of accounting department personnel.  Working together, the external auditors and the organization’s audit committee can meet in executive sessions to discuss the performance of the accounting department personnel.  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 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 what is involved in this process.  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 ensure that he/she is aware of the internal controls in place and understands the importance of each control.  Policies should be reviewed and an understanding of how risk is assessed should also 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

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.  More frequent meetings enable the audit committee to 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.

Even with these measures in place, there are no guarantees that organizations will not experience lapses in controls, financial management, or reporting at some point.  Effective oversight over the process, however, can lessen the likelihood of problems and poor results.