Why Good Governance Depends on an Effective Audit Committee
Unlike public companies, nonprofit boards aren't required to have audit committees. So it's not surprising that 42% of nonprofits don't, according to Stanford Graduate School of Business's 2015 Survey on Board of Directors of Nonprofit Organizations.
If your nonprofit belongs to that 42% — or you have an audit committee, but it's generally ineffective — consider taking action. Good audit committees help ensure financial integrity, limit risk and protect your reputation with regulators and the public.
Relevant to all Nonprofits
An audit committee is an integral part of good governance, making it relevant for nonprofits of all sizes. You may be tempted to assign audit committee functions to your finance committee, but finance committees are mainly responsible for monitoring their nonprofit's budget and approving the distribution of its financial resources.
In contrast, an audit committee oversees:
- Financial reporting,
- External and internal audit,
- Compliance with legal and regulatory requirements, and
- Internal controls over these areas.
The audit committee's duties include such tasks as reviewing Form 990 filings and other reporting to regulatory agencies, studying audit results (and actions taken in response to such results) and deciding whether a second opinion is required to resolve auditing issues.
Ultimately, your audit committee is responsible for ensuring that all financial reports are accurate and that they portray your organization's condition and performance transparently. This means that, among other things, the committee should look for signs of fraud — such as unreported revenue — in your organization's financial statements.
Internal and External Auditors
Audit committees regularly interact with both internal and external auditors, which includes approving the annual internal audit plan and reviewing internal auditors' reports. Your committee also may be responsible for approving the appointment of the head of internal audit.
Because audit committees are responsible for hiring, compensating and overseeing external auditors, they're considered both the auditors' client and point of contact with the organization. Your audit committee should regularly communicate with its auditors. For example, hold preaudit meetings to discuss your work plan, request regular updates during the audit and conduct postaudit discussions to review findings before you present them to your board.
Risk management is central to all audit committee responsibilities. But your committee should also take specific measures to reduce your nonprofit's risk profile by conducting a comprehensive risk assessment.
This assessment needs to identify financial vulnerabilities such as those related to investment practices, antifraud policies, insurance coverage, and compliance with laws, regulations and donor and grantor requirements. Your audit committee should take the lead in ensuring that internal controls are effective in minimizing those risks it identifies as your nonprofit's greatest threats.
Ideal Committee Members
The composition of audit committees might vary, but one thing is certain — at least one member should have strong financial expertise. This expert will bring to your committee a working knowledge of financial reporting (including Generally Accepted Accounting Principles) and internal controls. Although for-profit experience doesn't hurt, the expert should have specific knowledge of nonprofit-sector accounting and financial reporting issues.
In addition, the American Institute of Certified Public Accountants recommends that at least a few audit committee members also be members of the board of directors. However, some states limit the number of audit committee members who also are finance committee members. And don't make the mistake of turning to your organization's treasurer. Because the audit committee is charged with independently monitoring financial results, appointing your treasurer to the committee could create a conflict of interest.
Above all, committee members must maintain their independence. They can't accept any consulting, advisory or other compensatory fee from your organization. And they shouldn't have been an officer or employee of your nonprofit (or the immediate family member of one) in the prior three years.
Improved Practices and Reporting
An effective audit committee can lead to improved financial practices and reporting, reduced fraud risk and enhanced internal and external audits. If you want to establish an audit committee, or are concerned that your nonprofit's current committee isn't making the grade, talk to your financial advisor.
For more information, contact one of our nonprofit experts at (973) 328-1825.