A committee that financial professionals are often asked to join is an organization’s audit committee. This is especially true of CPAs. What are the roles of an audit committee? Does every nonprofit need an audit committee? This article will answer those questions and others.
Roles of the Audit Committee
A finance committee provides oversight of the organization’s financial operations. An audit committee maintains independence from that committee to better oversee the audits of those financial operations and other areas of the nonprofit. Below are the common roles of a nonprofit audit committee:
Selection of Auditors
One of the main duties of the audit committee is selecting who will perform the financial statement audit. If the nonprofit receives a large amount of federal grants, that same auditor will perform a single audit. This assesses the organization’s compliance with federal grant guidance. I’ll discuss this more later.
The audit committee of large nonprofits will also provide oversight of the internal audit process. Internal audits address operations and compliance in addition to the financial reporting process. This may be conducted by internal audit staff who are employees of the organization or by hiring an outside company to provide internal control testing.
A process related to the selection of auditors is setting the scope of audits. The committee must assess the following:
- The inherent risks of the organization
- The controls and other mitigations to those risks
- The residual risk of the organization. Higher-risk areas will receive more frequent testing than lower-risk areas.
Another process related to the selection of the auditors is the assessment of the auditor’s work. This will determine if they continue to use the same auditors or select another. Part of the assessment is determining the auditor’s knowledge of nonprofits. Some of the nonprofit auditor requirements and accounting practices are very different than those of for-profits. There are many firms that specialize in nonprofit audits.
Receiving the Audit Reports
Since the audit committee formally contracts with the auditors, they also directly receive the audit report from the auditors. Of course, management will have seen drafts of the audit reports or have been verbally informed of the findings.
Auditors present the report to the audit committee, which may be joined by the finance committee, the full board, and/or management. These groups can ask questions of the auditors. Auditors also often use this time to educate the audit committee or board on new guidance. The board or audit committee may go into executive session to talk with auditors without staff present. This is a good practice.
The report communication process I just described is more common with a financial statement audit and related single audit than with internal audit reports. Those reports may be presented in person or only in written form to the audit committee, which then communicates key items from the reports to the board.
Oversight of Internal Controls
The audit committee provides oversight and assessment of the company’s internal controls throughout the year. One aspect of this is tracking the remediation of any findings in past audits. The committee also must monitor the effectiveness of controls to perform the risk assessment I discussed earlier.
The whistleblower policy I mentioned in an earlier lesson can fall under the area of internal control oversight. A report from a whistleblower or any other report of improper activity should be investigated by the audit committee. They also ensure no retaliation is made against an employee making a report.
A mistake board members can make is thinking that an external financial statement audit is the best way to detect errors and irregularities. Fraud is detected more often through other ways, such as tips, management reviews, and internal audit procedures.
Audit Committee Effectiveness
Finally, the committee must look at itself and its effectiveness.
- Does the committee have the expertise it needs?
- Should the committee look for new members with that experience?
- Does the committee need education?
- Are the committee’s actions effective and leading the company to better compliance and risk management?
The committee should also assess its relationship with the board and management. Being independent doesn’t mean being antagonistic. Auditors who are good at asking tough questions can sometimes come across as adversarial.
Composition of the Audit Committee
The audit committee is usually comprised of a few board members. No employees of the organization are committee members, though staff may attend many committee discussions. A red flag is a board and audit committee that’s dominated by the CEO or Executive Director of the nonprofit. The committee is chaired not by the treasurer but by any other board member.
Committee members should understand financial processes, especially the audit process. This means that larger nonprofit organizations need a few financial professionals on the board. One would lead the finance committee, and the other would lead the audit committee.
Do All Nonprofits Need an Audit Committee?
The short answer is no. In boards of small organizations, the full board or the finance committee conducts the audit committee roles listed above. These organizations often have a small board that performs many management or internal control functions. Classic examples of this are having board members create reports or sign checks. It’s hard for members of these boards to be truly independent of the processes to be audited.
There are a few times when a nonprofit board should strongly consider having an audit committee. In some states, an audit committee may be required by state law once a nonprofit organization achieves a certain size. I was on a nonprofit board that created an audit committee because we would score better in an accreditation process.
An audit committee can be very beneficial for the following nonprofits:
- Large and complex nonprofits
- Nonprofits with large grants, especially federal grants
- Organizations that have had many audit findings or significant findings that could lead to sharp drops in revenue
For more info, check out these topics pages: