Your nonprofit’s board isn’t required to form an audit committee — even if your organization is required to conduct audits. Some organizations assign oversight of independent audits to their executive or finance committee — or the entire board participates in the audit process. But a dedicated audit committee, whether it’s a temporary task force or a standing committee, can promote better financial reporting, fewer fraud incidents and a smoother audit process.
To work as intended, audit committees need to follow a strict set of rules, particularly when it comes to independence. Good communication — with auditors, fellow board members and the nonprofit’s executives — is also critical.
What exactly does independence mean? Audit committee members can’t be employed by either the nonprofit or the audit firm that’s engaged. Being independent also precludes contracting and fee arrangements, but not compensation that committee members might receive for serving on the organization’s board. Close family members and business partners of committee members shouldn’t be employed by the nonprofit or auditing firm, either.
Ideally, committee members are financially literate — familiar with Generally Accepted Accounting Principles (GAAP) as well as nonprofit financial statements, internal controls, procedures for financial reporting, and financial issues specific to nonprofits. At least one member of your committee should be a financial “expert,” such as a CPA or CFO, who has conducted or supervised audits and analyzed audit and other financial reports.
Although there’s some discretion in how often your audit committee holds meetings, it should meet at least several times a year to ensure it discusses critical issues thoroughly. All members should receive materials (such as audit reports) for discussion before meetings, and meetings should last long enough for everyone to voice their opinion.
Although the audit committee is an independent body, it’s responsible for keeping other parties informed of its activities and decisions. It should meet as needed with your organization’s CFO and other financial staffers to discuss management’s financial decisions and reporting practices.
In some organizations, audit committees act as ombudsmen and handle complaints from staff and others about potential financial mismanagement. And in almost all organizations, the committee plays an active role in preventing fraud. This includes ensuring that:
- Internal controls are robust and adhered to,
- Suspected fraud activity is investigated, and
- Any perpetrators are punished.
But, of course, the most important communications are those between the committee and your nonprofit’s outside auditors. Members should meet with independent auditors before, during and after an audit so audit committee members are able to answer questions and provide feedback throughout the process. When the auditing firm presents its final reports, the committee is responsible for communicating its findings — including accounting or operational weaknesses that should be addressed — to the full board and gaining its formal approval. Depending on the extent of the auditor’s activities, your audit committee may want to update the board more frequently during regular meetings.
Even if your nonprofit and its board are small, you may reap benefits from forming an audit committee. If you’re not sure about adopting what might seem like an additional layer of bureaucracy, talk to your accounting advisor for his or her recommendation.