The Audit Committee Commission

Corporate reforms in the for-profit sector have prompted nonprofits to also re-evaluate their governance practices to enhance accountability. One way many organizations have responded is by establishing an audit committee or improving how theirs operates. Whether you need to create an audit committee depends on your organization and board.

Smaller nonprofits that don’t conduct outside audits probably don’t need an audit committee. They may have a finance committee instead, which oversees financial matters relating to the organization. Nonprofits that do have an audit committee should separate it from the finance or investment committee to achieve greater independence.

The purpose of the Audit Committee is to assist the Board of Directors in fulfilling its legal and fiduciary obligations and responsibilities with respect to matters involving the accounting, auditing, financial reporting, and internal control functions of the Organization.

Responsibilities and duties

In carrying out its duties and responsibilities, the following should be considered within the authority of the Audit Committee:

Financial Matters

The committee oversees accounting and financial reporting policies and practices, including the resolution of any disagreement between management and the independent auditors regarding financial reporting, to prepare or issue an audit report or related work.

The committee reviews the financial statements of the Organization and the results of the independent audit, including the audit of government grants and awards if any, underlying accounting judgments and estimates and the auditor’s internal control recommendations to management and management’s response.

Some audit committees will also assume responsibility for reviewing the annual Form 990 and Form 990T and any other related federal, state, or local tax returns/filings.

The duties of the committee include a review with management, internal auditors and independent auditors:

• the communications required by professional standards;
• acceptability, appropriateness, and consistency of application of accounting methods;
• unrecorded adjustments and omitted disclosures;
• reasonableness of judgments;
• degree of aggressiveness or conservatism in applying accounting policies;
• completeness and clarity of financial statements and related disclosures;
• review the conformity of the financial statements and generally accepted accounting principles.

Oversight of Internal Control Matters and Functions

The Audit Committee typically reviews and approves the internal audit function, including: (a) purpose, authority, and organizational reporting lines; (b) annual audit plan, budget, and staffing, and any changes thereto; (c) the charter for the internal audit function; and (d) the effectiveness of the internal audit function, including compliance by the internal audit staff with the Institute of Internal Auditors’ Standards for the Professional Practice of Internal Auditing.

Committee members must understand the scope of the review of the Organization’s internal controls and financial reporting by the independent auditors and Director of Internal Audit, and obtain reports on significant findings and recommendations, together with management’s responses.

Communicate with and review the activities and effectiveness of the internal auditors, including the review of internal controls relating to information technology security and controls. The Committee will review the results of internal audits and any significant findings and any difficulties encountered in the course of the internal audits, including any restrictions on the scope of the internal audit function’s work or access to required information.

Oversight of the Relationship with the Independent Auditors

Audit Committee members

• Have the sole authority and responsibility to select, evaluate, compensate, and oversee the work of any accounting firm engaged for preparing or issuing an audit report or performing other audits, review, or attest services for the organization. The independent auditor reports and is accountable directly to the Committee. The Committee has sole authority in its discretion to approve all audit engagement fees and terms and to terminate the independent auditor. The appointment of the independent audit firm and lead audit partner will be considered annually by the Audit Committee. The Audit Committee then advises the Board of Directors of its decision to continue with or terminate the engagement of the independent audit firm. The Audit Committee’s decisions regarding the use of the existing audit firm and lead audit partner versus the selection of a new firm and partner should be summarized in the Audit Committee’s meeting minutes.
• Confirm the independence of the external auditors in compliance with the independence rules of the American Institute of Certified Public Accountants (AICPA) and the U.S. General Accountability Office (GAO) standards via inquiries as to whether any additional relationships with or services provided to the organization, beyond the annual audit engagement, could have an impact on the auditor’s objectivity and independence. The Audit Committee should pre-approve all audit and non-audit services performed by the independent auditor. The Audit Committee may designate its Chair to represent the entire Committee for purposes of approval of non-audit services, subject to review by the full Audit Committee at the next regularly scheduled meeting.
• Obtain and review at least annually a formal written report from the independent auditors delineating the auditing firm’s internal quality-control procedures and any material issues raised within the preceding five years by the auditing firm’s internal quality-control reviews, by peer reviews of the firm, or by any governmental or other inquiry or investigation relating to any audit conducted by the firm. The Committee shall review steps taken by the auditing firm to address any findings in any of the foregoing reviews.
• On a regular basis, meet separately with the independent auditors to discuss any matters that the Committee or the independent auditors believe should be discussed in executive session.

Depending on the composition and size of the Board and organization, the Audit Committee may also provide oversight of corporate risk management and regulatory compliance.

Who should sit on the Committee?

Each member of the Audit Committee must be financially independent of the organization. Our experience has been that nonprofit audit committee members are not paid for their services. Each of the Audit Committee members shall be “financially literate,” which shall include the ability to read and understand fundamental financial statements. In addition, at least one member of the Audit Committee shall qualify as a Financial Expert and be appointed to such designation by the Board of Directors An Audit Committee Financial Expert shall be selected considering the following attributes:

• an understanding of generally accepted accounting principles and 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 present a breadth and level of complexity of accounting issues that are generally comparable to the breadth and complexity of issues that can reasonably be expected to be raised by the organization’s financial statements, or experience actively supervising one or more persons engaged in such activities;
• an understanding of internal controls and procedures for financial reporting;
• an understanding of audit committee functions.

The Annual Process

The Committee usually meets with representatives of the independent auditor at least annually, maybe more often to review and discuss appropriate matters within the scope of the committee’s responsibilities and duties. including, but not limited to:

• the planning, scope, approach, staffing, and identified objectives of the independent audit for the current fiscal year;
• the results of the independent audit and underlying accounting judgments and estimates;
• the auditor’s comments regarding the adequacy of organizations internal accounting controls;
• external auditor’s relationships with the Organization that may impact objectivity and independence;
• management’s representations regarding the integrity of internal controls and financial reporting systems and conformity of financial statements with generally accepted accounting principles;
• other relevant matters noted during the auditor’s examination, along with management’s response regarding such comments;
• assurance that auditors were not subject to undue influence by management during the course of the audit.

Annually, the Committee should meet with the internal auditors to discuss and determine the scope of the internal audit and to review the results of the internal auditor’s examination and management’s response regarding the auditors’ findings and recommendations.

As necessary or desirable, the Audit Committee is empowered to investigate any matter brought to its attention with full access to books, records, facilities, and personnel of the Organization and may request that representatives of the independent auditors, the internal auditors, or legal counsel be present at meetings of the Committee related to such investigation. In addition, the Committee should have the authority to retain, at the Organization’s expense, special legal, accounting, or other consultants or experts it deems necessary or appropriate to carry out its duties and to assist in the fulfillment of its obligations, including the provision of training to the Audit Committee members in order to meet the financial literacy requirements.

Please reach out to the Nonprofit Solutions Group for additional information on Audit Committees or if you would like more information on how HBK can help.