Contents

• Audit Committee — Fiduciary Recommendations for Meetings with External Auditors
• Contact SC&H Tax & Advisory Services

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Audit Committee — Fiduciary Recommendations for Meetings with External Auditors

The economic crisis in 2008 - 2009 caused the public and other stakeholders in not-for-profit organizations to lose confidence in the quality of the capital markets and to question corporate governance practices. Issues such as the separation of the roles of the Executive Director and the Board of Directors, say on pay, and effective risk management continue to be discussed and debated. New legislation continues to be proposed, and new laws and regulations that will impact NFP corporate governance guidelines are anticipated.

One of the primary results of the emphasis on corporate accountability has been the increased attention on the audit committees as guardians of financial integrity. Initially, audit committees were formed by a board of directors to fulfill part of the board's responsibilities for oversight in the area of financial reporting and other related areas. Over the past 20 years, audit committees have become more involved in the review of corporate accountability and governance, particularly as the focus on risks and controls expands to include not only financial integrity, but also compliance systems and processes needed for an organization to meet legal and ethical standards. Hence, the audit committee has had a broadening agenda in recent years.

First, let's look at a textbook definition of an audit committee. An audit committee is a standing committee of the board of directors that is charged, at a minimum, with overseeing the integrity of the organization's financial reporting processes. The audit committee oversight responsibility typically includes internal and external financial reporting, risks and controls related to financial reporting, and the internal and external audit processes.

The importance of the audit committee in overseeing financial integrity will continue to be significant. Financial information is the most widely accepted measure of accountability and is used to evaluate the effectiveness of a board of directors, management and the organization. In some cases, financial executives are pressured to manipulate or manage earnings to provide more favorable results or results more in line with budgets, forecasts and other expectations.

An active and informed audit committee should be the vehicle used by a board of directors to assure that financial reporting is understandable, accurate, and conveys the proper message to financial markets, shareholders, and other stakeholders, including the general public. One of the ways in which the audit committee discharges this responsibility is through the selection and oversight of the external auditor.

Guidelines for Selection of the External Auditor

One of the primary responsibilities of the audit committee is the selection of an independent external auditor for the organization. Normally, the external auditor is proposed by management, with the audit committee confirming management's selection. Several issues that may need to be considered by the audit committee in the selection of the external auditor include the following:

• Management's opinion of the external auditor's performance,
• The audit engagement letter, including the proposed fee,
• The expected level of participation by a partner and other management personnel in the engagement, skills and experience of staff, and staff rotation policy, and
• If a new public accounting firm is to be engaged or is being considered, the steps planned to ensure a smooth and effective transition of external auditors to guard against unexpected complications.

In reviewing various external audit firms, the audit committee should consider the public accounting firm's latest peer review conducted under a professional quality-control program, the litigation problems or disciplinary actions involving the firm, and the firm's overall credentials, capabilities, and reputation, together with the firm's experience serving clients from the same industry and/or geographical area.

Oversight of the External Auditor's Independence

• The audit committee should review management's evaluation of the independence of the external auditor.
• The audit committee should review management's plans for engaging the external auditor to perform consulting services, including consideration of the types of services and projected fees.

Guidelines for Pre-Audit Review

Statement on Auditing Standards (SAS) 114, The Auditor's Required Communication With Those Charged With Governance, requires the outside auditor to determine that certain matters relating to the audit of the financial statements are communicated to those charged with governance, which, at a minimum, includes the audit committee, and may include the full board of directors.

Pursuant to SAS 114, the auditor should have access to the audit committee, the chair and other members of the audit committee should meet with the auditor periodically, and the audit committee should meet with the auditor without management present at least annually.

Some considerations for pre-audit communications with the external auditor include the following:

• Establishing the terms of the engagement through an engagement letter which outlines the auditors' responsibilities under U.S. Generally Accepted Accounting Principles.
• The committee members' views about the organization's governance.
• Objectives and strategies relating to risks that may result in material misstatement.
• Internal controls and the committee's oversight of internal controls.
• The possibility of fraud or illegal acts.
• Communications with regulators.
• The committee's actions in response to previous communications with the auditor and developments in financial reporting, laws, accounting standards, and governance practices.
• The auditors' responsibilities regarding supplementary information accompanying the financial statements.
• The planned scope and timing of the audit. These discussions should include the areas of testing, sampling, and other areas which require auditor judgment.

Guidelines for Post-Audit Review

Pursuant to SAS 114, the auditor should also communicate significant findings from the audit, such as significant difficulties, qualitative aspects of the accounting practices and significant accounting estimates, uncorrected misstatements, disagreements with management, material corrected misstatements, and other significant issues that come to the auditor's attention. Statement on Auditing Standards 114 specifically states that the auditor should evaluate whether the two-way communication between the auditor and those charged with governance has been adequate for the purpose of the audit. Inadequate two-way communications may indicate an unsatisfactory control environment, which may influence the auditor's assessment of the risks of material misstatement, or the auditor's ability to perform that audit.

Some other recommended procedures the audit committee should perform include the following:

• Obtain explanations from management for all significant variations in the organization's financial statements between years (consider performing this review at a meeting of the entire board).
• Obtain from financial management and the external auditor an explanation about changes in accounting standards or rules having an effect on the financial statements.
• Inquire about the existence and substance of significant accounting accruals, reserves, or estimates made by management that had a material impact on the financial statements.
• Inquire of management and the external auditor about any significant financial reporting issues discussed during the accounting period and how they were resolved.
• Hold a private meeting with the external auditor to request the external auditor's opinion on various matters, including the quality of financial accounting personnel and the internal audit staff.
• Ask the external auditor about his or her greatest concerns about the organization and if the external auditor believes anything else should be discussed with the committee.
• Review the management representation letter given to the external auditor and inquire as to whether the external auditor encountered any difficulties in obtaining the letter or any portion thereof.
• Discuss with management and the external auditor the substance of significant issues relating to litigation, contingencies, claims, or assessments, and understand how such matters are reflected in the financial statements.
• Consider whether the external auditor should meet with the full board to discuss any matters relating to the financial statements and to answer any questions the other directors might have.

(Source — CCH: Accounting Research Manager — Audit Committees: A Guide for Directors, Management, and Consultants)

For More Information

For more information about not-for-profit services offered by SC&H Tax & Advisory Services, LLC, contact Michael Young or Lori Burghauser.

Michael Young
Audit Director
(410) 403-1513

Lori Burghauser
Tax Principal
(410) 403-1616

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