By Janet Toll Davidson
Nonprofits should protect themselves by forming audit committees because, while the Sarbanes-Oxley Act of 2002 does not govern nonprofits, its requirements likely will influence the evaluation of their financial operations.
In this litigious world, nonprofits are not immune to legal action that may involve governance and financial matters.
Therefore, if for no other reason than defensive purposes, the establishment of an audit committee is a prudent step.
There are many compelling reasons to form an audit committee for your organization beyond defensive purposes.
The audit responsibilities often fall to the finance committee, but these responsibilities get short shrift as the day-to-day financial matters of the organization are considered more important.
An audit committee helps assure that these responsibilities are being addressed. Nonprofits are not immune to fraud.
The audit committee can provide effective oversight by reviewing the appropriateness of the ethical standards maintained in the organization and determining whether there are adequate controls in place to prevent fraud.
The audit committee should be comprised of at least three independent, non-employee members of the board of directors with financial expertise. The committee should engage and evaluate the services of the external auditors, who must be accountable to the audit committee and the board of directors, not management.
The committee should meet regularly, at least three times a year and, ideally, should have the external auditors at each meeting for input, questions and executive session.
The audit committee should present to the board of directors for adoption a charter that establishes reasonable, defined responsibilities of the committee, including hiring outside auditors, approving the scope of the audit, overseeing the financial reporting process and evaluating the external and, if applicable, the internal audit process.
External auditors should be able to help a nonprofit develop an appropriate charter.
An effective audit committee must understand and stay focused on the its role by assessing and evaluating critical risks, understanding and evaluating internal controls and, most importantly, assuring that the organization is operating in accordance with its basic principles.
Therefore, though not mandated under the current law, an effective audit committee helps reassure nonprofit board members and management that the organization is operating in a financially responsible manner.
Janet Toll Davidson, a retired partner in the international law firm of Paul, Hastings, Janofsky and Walker, is chair of the board of directors of Orange County’s United Way in Irvine, Calif., and vice-chair of the board of directors of Children’s Hospital of Orange County in Orange, Calif.