Forming audit committees is becoming a more common practice in the nonprofit sector, offering an unbiased outlet to monitor the financial health of an organization. Appointed by the board of directors as part of its fiduciary duty to the nonprofit, audit committees ensure that the leadership team is effectively following internal and external auditing protocols, and that the organization's financial reporting practices are objectively reviewed on a regular basis.

Recently, increased pressures from regulatory bodies and increased public scrutiny have created an even greater need for such oversight, safeguarding the nonprofit from fraudulent or reputation-damaging activity. With so much at stake, it's important for organizations to remember that simply creating an audit committee is not enough. Proper measures must be taken to make sure the committee is maintaining its effectiveness, and more importantly, its core responsibilities to the organization. The following article will explore how to appoint, integrate and monitor a well-rounded nonprofit audit committee.

Understanding the Responsibilities of an Audit Committee

In its simplest form, an audit committee is either a temporary or standing committee that's convened by the board to oversee a nonprofit's accounting procedures. Based on the needs of the board and the organization, it may be prudent to draft a committee mission statement, outlining the exact functions of the audit committee. According to the National Council of Nonprofits, duties may include liaising with the organization's internal financial teams or monitoring the hiring and evaluation of an independent auditor. While they are not involved in the day-to-day accounting activity of the organization, the committee is often charged with making sure that recommendations made by an auditor are fulfilled by the board or internal team members.

Audit committees are typically organized to offer financial expertise the board cannot provide on its own, and therefore may be tasked with reviewing complaints of financial mismanagement, protecting the organization's assets and limiting exposure to financial risk. Members of such committees must also be well-versed in the nonprofit's overall financial history, insurance coverage and any regulatory standards that may impact the organization.

As an extension of the board, audit committee members should meet regularly with internal and independent audit teams. Such meetings should include a thorough review of the organization's financial and accounting practices, such as compliance reporting, audit results, spending behavior and trends in financial statements.

All findings should be presented to the board during regular board meetings, though potential red flags should be reported immediately.

Selecting Audit Committee Members

Audit committees typically consist of three to six members depending on the needs of the organization they serve. The goal is to keep the committee as independent as possible. Depending on the size and capabilities of the board of directors, an audit committee may be formed as a subcommittee of the board. Executives of the organization should not be part of this committee. It's important to remember that the core function of the audit committee is to establish the appropriate checks and balances for the nonprofit, so creating a subcommittee from the board may not always be the best course of action. Ideally, serving on the audit committee should also be completely voluntary—no financial or other coercive incentive should be offered in exchange for membership to the committee.

The majority of committee members should have a strong background in business or finance, with a specific focus on accounting. Some nonprofits may also have a need for specialized members, such as experts in regulatory compliance or risk management techniques. The key is to source the right mix of professionals that share in the organization's values and have the capability to carry out the mission of the audit committee.

Monitoring Independent Auditors

Chief among the committee's responsibilities is to evaluate the performance of independent auditors. Public companies are required to rotate audit partners every five years. The American Institute of Certified Public Accountants believes this provides a “fresh look” to ensure objectivity, yet nonprofits are not held to the same standard. Oftentimes, nonprofits are so consumed with day-to-day challenges that they retain the same firm or individual for several years, which can be extremely risky. The longer an independent auditor is in place, any irregularities within the organization's finances will be more difficult to detect. Accountants assigned to the project could be covering something up for personal gain or critical mistakes could have been made over the years that can be harder to correct down the line.

Take for instance the case of Loeb & Troper, a now infamous accounting firm that previously represented several prominent nonprofit organizations in New York City. In 2015, one of the firm's clients, FEGS (a nonprofit health and human services organization), announced it had uncovered a $19 million deficit, forcing its eventual closure. The deficit was only $1 million the year before yet no warning flags were raised by FEGS' long-time partner—an effective audit committee may have prevented this situation.

To combat such issues, audit committees should perform annual assessments of outside auditors, measuring the effectiveness of their role and the competency of their team and should consider a regular rotation of the independent auditor.

Evaluating the Audit Committee

According to the National Council of Nonprofits, audit committees should perform regular self-evaluations to make sure all duties outlined in its mission are upheld. Some questions may include: How efficient was the audit process? How well did the audit committee move the process along? Was the nonprofit disrupted by the audit process or the auditors' fieldwork? If so, what could be changed next time to limit the disruption? Does the audit committee's charter adequately describe its role and the scope of its authority? Are the right board members serving on the audit committee? Who will be the chair of the committee in the future? Did the audit committee provide a thorough report to the full board? Does the committee or full board need more preparation or financial literacy education in order to really understand the audit function and the auditors' report?

Board members who do not sit on the committee should also be tasked with evaluating the audit committee's effectiveness. This might include reviewing the self-evaluations or interviewing the committee members individually.

Maintaining the Committee's Effectiveness

Though many nonprofit organizations may never experience a serious case of financial mismanagement, it is impossible to avoid all potential issues. Whether it's illegal activity or simply human error, having a dedicated audit committee in place is the best way to ward against improper financial reporting.

Patricia E. Farrell is an attorney at Pittsburgh-based law firm Meyer, Unkovic & Scott. She focuses her practice on corporate and business law services. She can be reached at [email protected].