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Do Nonprofits Really Need an Audit Committee?

November 7, 2004

By: Colette Kamps, CPA, Henry & Horne, PLC

(Nov. 8, 2004) The effect of the Sarbanes-Oxley Act is starting to 'trickle down' to nonprofits, and forming a separate audit committee is one of the items on the agenda for discussion.

Trickle down was evident in the June 2004 hearing of the Senate Finance Committee entitled 'Keeping Bad Things from Happening to Good Charities' where the need for increased regulations over nonprofits was discussed. One of several recommendations was an audit committee requirement.

As of September 2004, California now requires tax-exempt organizations with revenues of at least $2 million to have an audit committee. Massachusetts has proposed requiring audit committees for large public charities. A bill recently proposed (and defeated) in New York would have required audit committees for organizations with $3 million in assets or $1 million in revenues.

These recently proposed and pending laws have the effect of raising public awareness and increasing skepticism toward nonprofit organizations.

What Does an Audit Committee Do?

Essentially, an audit committee communicates with the auditors. Much too often, auditors only have access to management during the audit process. Since management is not considered independent from the organization, it is important to improve independence by providing the audit committee opportunities to communicate directly with the auditors.

In short, the audit committee should:

  1. Approve the selection of the auditor.
  2. Review the audited financial statements and the management comment letter from the independent auditor.
  3. Provide audit oversight by meeting with the auditor before the audit fieldwork begins, after fieldwork concludes and after the audited financial statements are issued so that any issues and/or concerns can be discussed openly with someone other than management.
  4. Periodically review and assess internal controls.

Why Have an Audit Committee?

But why form a separate audit committee? Many finance committees perform most of the duties of an audit committee. They approve the selection of the auditor, receive the auditor's presentation, and the audited financial statements. Why have a separate committee just to provide these same functions?

Forming an audit committee now, before it is mandated, demonstrates the independence of the audit function, and sets a higher standard of board governance. It can also influence an increasingly skeptical public and donor pool as they decide where to send their discretionary dollars.

Who Should Serve?

In order to enhance the level of independence of the audit function, an organization should consider including one or several non-board members on the audit committee. Members of the committee should have knowledge of financial reports and a basic familiarity with generally accepted accounting principles and auditing standards.

Nonprofit organizations may have different needs depending on their size and complexity, so the board of directors must determine what the responsibilities of their audit committee should be in order to operate most effectively for their particular organization.

Staying a Step Ahead

The formation of an audit committee, separate from an organization's finance committee, demonstrates that the organization is making an effort to increase and improve board governance best practices.

In light of recent discussions of increased regulations over nonprofit organizations at both the federal and state levels, nonprofit boards would be wise to stay ahead of the game by showing their commitment to and understanding of these best practices.

 

Colette Kamps, CPA, an Audit Manager for Henry & Horne, specializes in not-for-profit and OMB Circular A-133 audits. She can be contacted at 480-483-1170 or colettek@hhcpa.com.

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