Building an effective audit committee Featured

11:19am EDT February 24, 2005
An abundance of accounting scandals suggests that audit committees are not always effective at doing their jobs.

What exactly is an audit committee, and what exactly are its functions? Which nonprofit organizations should have one?

The Sarbanes-Oxley Act was passed into law as a response to the corporate and accounting scandals of Enron, WorldCom, Arthur Andersen and others. While nearly all of the provisions of the bill apply only to publicly traded corporations, the bill should be a wake-up call to the entire nonprofit community.

One of the best practices for nonprofits taken from the Sarbanes-Oxley Act is the establishment of an audit committee whose members are independent and competent to perform a function that is increasingly important to good governance -- effective financial reporting and internal control oversight. If nonprofit leaders do not ensure effective governance of their organizations, the government may begin regulation instead of voluntary compliance.

What is an audit committee?

An audit committee is made up of a selected number of members of a company's board of directors whose responsibilities include oversight of financial reporting and internal controls, and the duty to ensure that both internal and external auditors remain independent of management and the organization as a whole.

Most audit committees are made up of three to five directors who are not part of management. A typical audit committee decides such things as which audit firm to retain and the scope of services the CPA firm is to perform. It maintains ongoing communication with both external and internal auditors and meets periodically with the auditors and management to discuss audit progress and findings, and helps resolve any conflict between them.

What should audit committees do?

In the public company environment, investor activists have attacked audit committees for lacking independence or the financial expertise to uncover most financial reporting failures. They note that audit committees sometimes fall short because a chief executive picks members who are willing to go with the flow.

In response to these concerns, the Securities and Exchange Commission issued a report in 1999 titled "Report and Recommendation of the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees." Some of the recommendations to improve audit committees contained in the report were for each committee to:

* Write and publish a charter

* Identify clear lines of communication and reporting responsibility between the outside auditor and the board

* Hold discussions with the outside auditor about the quality, not just the acceptability, of the company's accounting principles

* Hold discussions regarding sensitive accounting estimates

* Ensure independence of committee members with no conflicts of interest with the organization

Specifically for nonprofits

Best practices for nonprofit organizations follow the same general guidelines, with a few additions that originated with the Sarbanes- Oxley Act. The audit committee should include a financial expert who understands Generally Accepted Accounting Principles in the not-for-profit environment and has enough experience with the organization's internal financial reporting and controls to help the rest of the committee make informed decisions.

The audit committee should also monitor compliance with laws and regulations, as well as the organization's code of ethics policy.

Finally, if the board decides to establish a formal whistleblower policy, the audit committee should be sure that employees have the option of bringing up issues of concern in the accounting, auditing or internal control areas through a protected process.

As with public companies, nonprofit organizations should build effective audit committees to strengthen the financial oversight process and improve the public confidence in the industry as a whole.

Pamela J. Plott, CPA, is a director of Accounting and Auditing at Saltz, Shamis & Goldfarb Inc., the tax and accounting division of SS&G Financial Services Inc. (www.SSandG.com). Reach her at PPlott@SSandG.com or at (614) 488-3126.