Effective Audit Committee Guide
Nonprofit organizations face an increasingly challenging economic and regulatory environment. As giving practices continue to evolve, nonprofits often find themselves doing more with less. Adjusting to these new realities means that proper financial management is more important than ever. If mismanaged, the various tax and accounting considerations that are part of the annual nonprofit life cycle can become obstacles to an organization’s mission and goals. Audit committees are vital to the health of any nonprofit, be it large or small. Audit committee and its individual members are crucial partners in the safeguarding of integrity, purpose, and ultimately, success.
BDO’s Nonprofit & Education Practice and the BDO Institute for Nonprofit Excellence℠ have long been dedicated to client service, and to furthering the resources and discourse surrounding nonprofit financial management. With this guide, Effective Audit Committees for Nonprofit Organizations, BDO’s nonprofit professionals offer a comprehensive overview of the responsibilities of an audit committee, along with advice and tools to help organizations build or improve their own audit committees. We encourage you to refer to this guide frequently as you consider your organization’s financial needs and progress.
“The independent audit committee fulfills a vital role in … governance. The audit committee can be a critical component ensuring quality reporting and controls, as well as the proper identification and management of risk… Its critical role as guardian of … integrity puts the audit committee at the core of the challenge of governance.”
- Report of the National Association of Corporate Directors Blue Ribbon Commission on Audit Committees
While the preceding quotation was written in a business context, a well-functioning audit committee is important to every nonprofit organization as well – for the very same reasons noted. Adopting and maintaining an audit committee is a best practice for nonprofit organizations and is actually required by some states.
The current economic environment has heightened the need for effective audit committees.
Why Should a Nonprofit Organization Consider Forming An Audit Committee?
Many nonprofit organizations have formed audit committees in response to the Sarbanes-Oxley Act the Act , and certain states require an audit committee if the organization solicits charitable donations.
Before we get into the “WHOs” of the Audit Committee in particular, it is important to ensure that your organization recognizes the key participants within the marketplace, as they all bring unique experiences and perspectives to the governance of financial reporting.
Who Make the Best Audit Committee Members?
The best audit committees are those that set the appropriate tone at the top where the focus is on ensuring the organization acts in accordance with the best interests of its stakeholders.
Who Can Serve as a Financial Expert on the Committee?
The inclusion of at least one audit committee member with financial expertise is a highly recommended best practice. This guidance was mandated for public companies by the Sarbanes-Oxley Act and should be a consideration for all organizations to adopt.
Audit Committee Candidate Decision Tree
The AICPA's Audit Committee toolkit contains the following decision tree that may assist Audit Committees in evaluating a candidate for consideration as their financial expert.
Why Do Audit Committees Need to Include a Financial Expert?
The audit committee should be responsible for making a formal recommendation to the board that the audited financial statements be approved.
Who Should Fill the Role of the Audit Committee Chair?
The role of the audit committee chair is without question a demanding one. This role requires a strong, independent and competent communicator who is willing to ask tough questions of management and others in order to truly understand and ensure that the audit committee is focused on risk management and financial oversight of the organization and that the organization’s strategic direction is in line with reality.
Who Else Is Needed to Serve on the Audit Committee?
To obtain a balanced perspective, in addition to the financial expert, we recommend two to five additional members with diverse backgrounds and experience.
Quite simply, the audit committee’s mission is oversight. More specifically, this oversight should be focused on the following areas: financial reporting, risk management, audit function.
What are the Basic Responsibilities of an Audit Committee?
The audit committee should be directly responsible for the appointment, compensation, retention and oversight of the work of auditors who provide audit services to the organization whether the services are provided by the principal auditor or another firm.
What Suggested Specific Activities or Duties Should an Audit Committee Undertake to Maximize its Effectiveness and Contribution to the Organization in Light of its Responsibilities?
An awareness of the independence rules is essential to maintaining audit committee independence.
What Services are Auditors Not Allowed to Provide to Nonprofit Organizations?
Generally audit services provided must be performed by CPAs who are deemed independent. Generally, CPAs are not independent if they are in a position to influence, make management decisions, provide accounting services or have financial interests in a nonprofit organization.
What are the Required and Other Desirable Communications That Audit Committees Should Have with the Auditors?
Accounting rules are not always precise. Quite often there is great latitude in the judgments that produce financial statements. We believe in open, regular discussions with the audit committee, presenting opportunities for direct questions about how different issues are handled by the organization.
What Should Audit Committees Be Focused on in Consideration of Reliable and Transparent Financial Reporting?
The audit committee must have an unwavering mandate for financial statements that transparently and meaningfully portray the organization’s circumstances.
What Specific Steps Might the Audit Committee Undertake in Assessing the Tone at the Top and Ensuring Ethical Behavior within an Organization?
We will continue to stress the importance of understanding an organization’s tone at the top because it provides the basis for ethical behavior within an organization.
What Can Audit Committees do to Better Understand the Organization’s Risks, Including Fraud Risks, and the Adequacy of Controls in Place to Mitigate those Risks?
The global financial crisis and economic turbulence continues to expose organizations that have poor risk assessment and management practices and should serve as a warning to all organizations.
What is the Expected Responsibility of the Audit Committee as Compared to the Board with Respect to Risk Oversight?
Currently, there is debate over the division of responsibilities between the board of directors and other committees of the board e.g., audit, compensation, finance and nominating committees , specifically with respect to risk oversight.
What is the Audit Committee’s Role in Prevention, Deterrence and Detection of Fraud?
No discussion of risk would be complete without a direct consideration of the risk of fraud and the responsibilities for dealing with fraud.
Focus on Fraud: COSO Fraudulent Financial Reporting Study
In February 2010, COSO issued em Fraudulent Financial Reporting: 1998-2007, a report which provided a comprehensive analysis of fraudulent financial reporting investigated by the SEC between January 1998 and December 2007.
What Can the Audit Committee do to Strengthen the Audit Function?
As indicated previously, the audit committee’s oversight responsibility for the audit function covers work performed by both external and internal auditors.
What Role Does the Audit Committee Play in the Organization’s Internal Control Environment?
Internal control over financial reporting is crucial to the governance of an organization. The audit committee’s primary responsibility with respect to internal control is the internal control over financial reporting.
What is the Audit Committee then expected to do with Such Information on Reported SDs and MWs?
If SDs or MWs are identified, the audit committee should ask these questions.
What is the Audit Committee’s Role with Respect to Implementation of IFRS?
The International Accounting Standards Board IASB has developed International Financial Reporting Standards IFRS to address the variability in reporting standards between countries.
What is the Audit Committee’s Role with Respect to Consideration of Income Tax?
The Internal Revenue Service IRS Federal Form 990 Form 990 asks in Part VI, Section B whether the organization provided a complete copy of the Form 990 to all members of its governing board before filing the form.
What are the Best Practices for Establishing Procedures for Handling Complaints?
The audit committee must establish procedures for the receipt, retention and treatment of complaints regarding accounting, internal accounting controls or auditing matters, including procedures for the confidential anonymous submission by employees of concerns regarding questionable accounting or auditing matters.
Under What Circumstances is it Advisable for the Audit Committee to Engage Independent Counsel and Consultants?
Audit committees should have the authority to engage independent counsel and other consultants as they deem necessary to carry out their duties.
We recommend that audit committees establish a timeline for essential meetings, yet be flexible and willing to meet more frequently as circumstances warrant or as issues arise.
An audit committee should adopt a formal written charter that is focused on the mission of the audit committee.
How Much Time Should an Audit Committee Member Spend on Committee Work?
The complexity of the organization’s activities, its stage of development and magnitude of its issues will determine the audit committee’s agenda.
How Does One Maximize the Benefits in Conducting Audit Committee Meetings?
The audit committee needs to participate in the agenda-setting process up front along with other appropriate individuals e.g., external and internal auditors and management , and the audit committee chair needs to preside over these meetings to ensure adherence to this agenda.
NACD’s “Ten Principles of Effective Audit Committee Oversight”
The NACD Blue Ribbon Commission on the Audit Committee recommends the following principles that it believes provide “a foundation for engaged, effective audit committee oversight.”
How Should an Audit Committee Evaluate its Own Effectiveness?
We believe that an audit committee should conduct an annual assessment of its own effectiveness. There are a number of ways to conduct this self-assessment.
How Should an Audit Committee Remain Current with Regard to Technical Guidance?
We believe that an audit committee should conduct an annual assessment of its own effectiveness. There are a number of ways to conduct this self-assessment.
The following is intended as an example to assist the audit committee in constructing its own organization-specific charter that will be used as a working document or practical roadmap to outline its responsibilities and required duties.
Model Audit Committee Meeting Agendas
The following Model Audit Committee Meeting Agendas suggest the timing, objectives, specific actions to be performed, and communications to be made to the board for certain audit committee meetings.
Sample Audit Committee Questions to Ask of Auditors and Management
To assist the audit committee in performing its duties, this is a list of questions it may ask the auditors and management in the context of periodic discussions.
Other Questions an Audit Committee Should Ask
Examples of questions which may be asked by an audit committee of management, other board members, or the external or internal auditors. Specific questions to be asked will depend on the organization’s circumstances.
Signs Which May Indicate Financial Trouble For Nonprofit Organizations
Signs that indicate financial trouble include community support, financial independence, productivity, deferred current costs, and management practices.
Audit Committee Self-Assessment
This Audit Committee Self-Assessment document may be used by those charged with governance in particular, audit committees in performing an annual self-assessment.
Auditor Required Communications with Audit Committees
The guidance covering these requirements is located in the following four sections of the revised AICPA Auditing Standards SAS Codification – Post Clarity subsequent to the Clarity Project.
Strengthening Governance: Effective Mechanisms for Reporting, Investigating and Remediating Fraud
There are numerous resources available that guide those charged with governance toward building programs to include anti-fraud controls and cultivation of anti-fraud environments.
Foreign Corrupt Practices Act
The FCPA of 1977, as amended, has been the recent focus of U.S. DOJ and SEC Enforcement and has resulted in significant risk and penalty/violation costs to companies, not to mention the exposure of directors to personal liability.
Effective audit committees are not merely formalities to receive lip service. They can be of significant help to governing boards in effectively performing their fiduciary and oversight roles in ensuring reliable financial reporting, reducing risk, and maintaining donor and public confidence (e.g., avoiding legal problems and preventing the negative consequences that inevitably result from financial fraud or irregularities).
This guide, Effective Audit Committees for Nonprofit Organizations, incorporates many specific recommendations, guidelines and rules of governmental and private sector bodies concerned with such matters. Its purpose is to provide you with an overview of the common functions and responsibilities of an audit committee to help you and your nonprofit organization: (1) form and maintain an effective audit committee and (2) set an appropriate agenda for its ongoing activities. However, your organization’s specific circumstances, as well as the distinctive nature of the relationships among the audit committee, organization management, leadership volunteers, internal auditors (if you have them) and outside professionals, should dictate the role of your audit committee.
This booklet is intended for use by all types and sizes of nonprofit organizations. However, it recognizes that smaller organizations may not need as extensive a set of procedures as a larger or more complex organization. For example, some organizations may find that their finance committee can also function effectively as an audit committee, or you may conclude that less extensive responsibilities or fewer meetings per year are adequate for your needs. What is important is not the form, but the substance. On the other hand, large or complex nonprofit organizations are every bit as challenging to manage and govern effectively as are large businesses, and these organizations need the full range of audit committee functions described herein.
In several places reference is made to internal auditors, which, it is recognized are probably found only in larger organizations; smaller organizations may want to have some internal auditor functions performed by the audit committee, the finance committee, members of management or the governing board, members or other volunteers. Each organization should decide what method will best serve its needs.
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