by Meagan Bulloch
The establishing and maintaining an audit committee is considered a best practice for nonprofit organizations. An audit committee can greatly help the governing board perform their fiduciary and oversight roles over financial reporting, reducing risk and maintaining donor confidence. Some organizations may utilize their finance committee as an audit committee. What is important is not the form of the committee but the substance.
Q: Why should a nonprofit consider forming an audit committee?
A: In addition to Sarbanes Oxley and state requirements imposed for organization’s soliciting funds within certain states, the Form 990 asks if an organization has an audit committee. Although, such a committee is not a requirement, the establishment of one is considered a best practice by the IRS. As the Form 990 is a public document, answering “no” to this question may lead to funders questioning why the organization is not following a suggested best practice. The American Institute of Certified Public Accountants’ (AICPA) Audit Committee Toolkit: Not-for-Profit Organizations, 2nd Edition (available at AICPA Store) lists numerous reasons as to why a nonprofit organization should consider forming an audit committee, including providing better: financial results, decision-making in terms of accuracy and quality of financial reporting; ability to build stronger relationships with stakeholders; as well as facilitating transitions in leadership.
Q: Who makes the best audit committee members?
A: Audit committee’s typically consist of 3-6 members with diverse backgrounds and experience all of which are considered “financially literate.” To be financially literate, members should be able to read and understand fundamental financial statements and recognize when the numbers along with associated disclosures to not make business sense. Additionally, the best audit committee members are fully involved and engaged with the organization and ensure that two-way constructive dialogue occurs at all times between all parties involved. Members should also be independent in both fact and appearance. To be truly effective, the committee must be able to resist any attempt by management to compromise financial reporting. The following relationships are considered to impair independence:
- An audit committee member who is or has been an officer or employee of the organization during the past 3 years
- A member who is an immediate family member of an officer or someone in management
- A member who has a direct business relationship with the organization in the past three years; such as a consultant
Q: Who can serve as a financial expert on the audit committee?
A: The inclusion of at least one financial expert is a highly recommended best practice. The following attributed are deemed essential components of a financial expert:
- An understanding of generally accepted accounting principles (GAAP) and nonprofit financial statements
- The ability to assess the general application of such principles in connection with the accounting for estimates, accruals and reserves
- Experience preparing, auditing, analyzing or evaluating financial statements that are comparable to those of the organization
- An understanding of internal controls and procedures for financial reporting
- An understanding of the audit committee function
- A general understanding of nonprofit financial issues and specific knowledge of the nonprofit industry in which the organization operates
It is worth noting that an audit committee financial expert has no greater obligations or liability than any other members of the audit committee and board of directors who are not designated as financial experts.
Q: What should be the mission of an effective audit committee?
A: Simply put, the mission should be oversight. Specifically, the following areas should be their main focus:
- Financial reporting
- Risk Management
Audit function – oversight of and communication with independent auditors, both internal and external
Langdon & Company LLP will be happy to assist with your audit needs. Please contact our office!