Building an Effective Audit Committee

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If your nonprofit has an external audit, a dedicated audit committee can promote better financial reporting, lead to fewer fraud incidents, and help create a smoother audit process. For example, take the recent headlines regarding the Key Worldwide Foundation. It served as a front for the bribery scandal admitting children of wealthy parents into elite universities. Appropriate oversight might have identified the fraudulent activity early on, rather than from a tipster six years later.

To work as intended, audit committees need to follow a strict set of rules, particularly when it comes to independence.  Good communication — with auditors, fellow board members and the nonprofit’s executives — is also critical.

Understand the mission

An audit committee should operate as a task force or standing committee of the Board of Directors that has been given the authority to provide accountability for the nonprofit’s independent audit.  A well-thought-out charter is an integral part of good governance and should define the committee’s authority, functions, and mission. Ultimately, the committee’s job comes down to:

  • Overseeing financial reporting, including reviewing audited financial statements;
  • Overseeing external and internal audit functions, including the staff;
  • Complying with legal and regulatory requirements;
  • Establishing procedures for receipt of complaints including anonymous submissions from employees.

An effective audit committee can lead to improved financial practices and reporting, reduced fraud, and enhanced internal and external audits. The goal is to protect the nonprofit’s assets, strengthen the reliability and accuracy of financial reporting and reduce the risk of fraud.

Independence first

What exactly does independence mean? Audit committee members can’t be employed by either the nonprofit or the audit firm that’s engaged.  It’s possible for members to still receive compensation for serving on the board of directors; however, such transactions should be closely scrutinized and clearly defined.  Further, close family members and business partners of audit committee members shouldn’t be employed by the nonprofit or auditing firm.  They must also remember they are nonexecutives and have a responsibility to remain objective.

Committee members should have the following skill sets:

  • Financial literacy: Members should be familiar with accounting principles generally accepted in the United States of America (U.S. GAAP), as well as nonprofit accounting;
  • Familiarity with the organization’s internal controls, procedures for financial reporting, and financial issues specific to nonprofits;
  • Personal expertise: At least one member should be a financial “expert,” such as a CPA or CFO, who has conducted or supervised audits and analyzed audited financial statements and other financial reports.

The ideal committee size is three to five members, which is small enough to streamline the decision-making process, while having an odd number allows to reach a quorum.

Although there is some discretion as to how often your audit committee holds meetings, it should meet at least two to three times a year to ensure critical issues are discussed thoroughly. And the committee should meet one month before the audit to review all materials. Members should receive all materials (such as audited financial statements) prior to the meeting, and meetings should last long enough for everyone to voice his/her opinion.

Critical communications

Although the audit committee is an independent body, it is responsible for keeping other board members informed of its activities and decisions.  It should meet as needed with your organization’s CFO and other financial staffers to discuss management’s financial decisions and reporting practices.

In some organizations, audit committees act as ombudsmen and handle complaints from staff and others about potential financial mismanagement.  And in almost all organizations, the committee plays an active role in preventing fraud.  This includes ensuring that:

  • Internal controls are robust and adhered to;
  • Suspected fraud activity is investigated; and
  • Any perpetrators are punished.

The most important communications are those between the committee and your nonprofit’s outside auditors.  Members should meet with the independent auditors before, during and after an audit so audit committee members are able to answer questions and provide feedback throughout the process. 

When the auditing firm presents its final reports, the committee is responsible for communicating its findings — including accounting or operational weaknesses that should be addressed — to the full board and gaining its formal approval. 

Depending on the extent of the auditor’s activities, your audit committee may want to update the board more frequently during regular meetings.

Reaping benefits

Even if your nonprofit and its board are small, you may reap benefits from forming an audit committee.  If you’re not sure about adopting what might seem like an additional layer of bureaucracy, talk to your accounting advisor for his or her recommendation.

As a Senior Audit Manager and Certified Fraud Examiner, Sarah is responsible for client management regarding annual financial reporting and general consulting services. Additionally, she specializes in employee plan benefits, litigation support services and works with nonprofits located throughout Central and Southern Indiana.

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