The nonprofit sector is extremely diverse. Some organizations deal with hundreds of millions of dollars each year, whereas others' budgets are only in the thousands. But regardless of size and scope, one of the many commonalities that all nonprofits should be concerned with is corporate governance. In fact, many organizations still need to be convinced that they need audit committees. For organizations that are exploring the implementation of audit committees—or for those with active ones—it is extremely important to understand their roles and responsibilities.
Greater focus has been placed on corporate governance of nonprofits ever since the Sarbanes-Oxley Act was passed in 2002. Specific requirements were laid out for public companies and their auditors regarding assurances that must be provided on internal controls. Many members of the accounting community are now saying that these same rules should apply to nonprofits, citing as reasons an ever-smaller pot of charitable funds since the current economic downturn and greater focus on stronger fiscal accountability.
These factors, along with frequent criticism of nonprofits for having weak internal controls due to understaffing, poor training, and lack of segregation of duties, have now moved nonprofits to attempt to compensate by establishing audit committees. This development has thrust philanthropic individuals who typically may not be financial watchdogs into a realm in which they may not be familiar or comfortable.
Today, audit committees have become key aspects of many nonprofits' systems of governance and internal controls. A critical function of the audit committee is to oversee an organization's internal controls and risk-management procedures. To carry out that function, the audit committee will meet with both management and the nonprofit's auditors to gain an understanding of the significant risks and exposures facing the organization. It is also important to understand how the organization is reducing its exposure through adequate internal controls.
Board and audit committee members also need to understand the differences between nonprofits and for-profits to serve effectively. These differences include:
- a nonprofit's focus is to achieve a philosophical mission or a vision rather than to gain profit;
- a nonprofit's funding and support comes from the public, foundations, and government rather than customers and clients;
- a nonprofit operates under a tax-exempt status versus paying taxes up to 35 percent; and
- a nonprofit has an obligation to the public and donors rather than stockholders to acquire, manage, and allocate financial resources to accomplish its mission.
The audit committee becomes an extension of the board to assure that proper financial management is in place. Committee members mentor senior staff as well as hire, evaluate, and interact with the independent auditors and counsel. Both the audit committee members and board members have the same "duty of care" (or fiduciary duty) benchmark to meet, which is to exercise the level of care "an ordinary prudent person would exercise in a like position under similar circumstances."
At least one member of the audit committee should be considered "financially literate." The criteria to consider regarding that member is that he or she must:
- understand financial statements,
- understand financial risks,
- understand the impact of business decisions on the financial statements,
- be able to identify balance sheet risks, and
- understand revenue recognition issues on the financial statements.
If that type of person is not part of the committee, then an outside consultant should be retained to fill the void. Many of these topics should be described in the formation document for the committee, which is called the audit committee charter. A good charter will describe how many members will serve and what is considered a quorum for conducting business. It will also provide guidance on how often the group should meet. A critical issue is that the members must be independent to ensure an objective and impartial committee and to ensure that there are no conflicts of interest.
Audit standards even dictate "The Auditor's Communication with Those Charged with Governance, the matters which must be discussed and during what phase of the audit those discussions must occur" (Statement on Auditing Standards No. 114 (AU 380). Those matters include an overview of the planned scope and timing of the audit and what representations the auditor is requesting from management.
The creation of an effective audit committee can help nonprofits meet their accountability goal; this committee's focus is only in this area. The benefits to the organization also include:
- improved financial practices and reporting,
- better deterrents to fraud, and
- enhanced external and internal audit functions.
Even in such a diverse world as the nonprofit sector, there remain common issues of fiscal responsibility. Corporate governance is one way to enable nonprofits to meet their objectives better and improve their financials through the use of well-managed, well-informed, and well-equipped audit committees.
Jeffrey S. Gittler, CPA, and Kevin Ryan, CPA
© 2011, Citrin Cooperman
Jeffrey S. Gittler, CPA, is a quality control partner in the Philadelphia office of Citrin Cooperman. Prior to joining Citrin Cooperman, Jeff served as a technical manager in the peer review department at the American Institute of Certified Public Accountants (AICPA). He has extensive experience in the nonprofit area, having previously served as chair of the audit committee of Durham County, N.C. He can be reached at firstname.lastname@example.org or (215) 545-4800.
Kevin Ryan, CPA, is an audit partner in the Philadelphia office of Citrin Cooperman. He has extensive experience in the nonprofit area, providing consulting and auditing services to a variety of nonprofit organizations in the Philadelphia, Pennsylvania, area. He can be reached at email@example.com or (215) 545-4800.