Who's watching you how? Effective oversight by an audit committee can help nonprofits remain effective in addressing social issues.

The public has become increasingly focused on business oversight and corporate governance issues since Enron's collapse. However, these issues are not confined to the for-profit domain. In recent years, a number of nonprofit organizations--including the United Way, Red Cross and Adelphi University--have been highlighted in the press for questionable spending and compensation arrangements.

Given the size and economic importance of the nonprofit sector, not-for-profits shouldn't wait for legislators and regulatory bodies to develop preventative guidelines and procedures. Thus, nonprofits should take some proactive steps and look at their governing systems with a view toward promoting sound oversight practices that improve the quality and integrity of financial reporting and the attest function.

A suggested first step toward improving a nonprofit's oversight process begins with the adoption of a written audit committee charter.

EFFECTIVE OVERSIGHT

During the past three decades, the debate over corporate governance issues has changed dramatically. Much of the debate has focused on how to effectively implement an oversight process that will lead to better financial reporting.

During the late 1970s and early 1980s, many professional and regulatory bodies, including the AICPA and the SEC, made some general recommendations regarding audit committees and their relation to the oversight concept.

Then, in 1987, the Treadway Commission recommended that audit committees become more proactive in overseeing the financial reporting, internal control and legal and ethical processes of firms.

These recommendations--sometimes referred to as "good practice procedures"--have been used by many firms to develop their own audit committee guidelines.

This was followed in the late 1990s by a Blue Ribbon Committee sponsored by the New York Stock Exchange and NASDAQ, which issued 10 recommendations to the SEC and the accounting profession, all aimed at improving the effectiveness of audit committees. And in December 1999, the SEC adopted new rules for audit committees of listed companies that included a requirement that companies adopt a formal written audit committee charter.

In November 2000, international rating agency Standard and Poor's initiated a service for rating companies on corporate governance.

Finally, in July 2002, Congress enacted the Sarbanes-Oxley Act, which may be one of the most significant reforms to our securities laws since the 1930s. The act is intended to bring about fundamental changes in the way audit committees, management and auditors communicate and carry out their respective responsibilities.

THE BENEFIT OF EFFECTIVE OVERSIGHT AND A FUNCTIONING AUDIT COMMITTEE

In recent years, some of the most important nonprofit institutions in the United States have been embarrassed and negatively affected financially by scandals alleging, among other things, gross mismanagement and poor accountability. Given the huge amount of resources that flow through this sector, increased attention has been focused on the duties and responsibilities of nonprofit boards.

Though the concept of the audit committee is not new to the nonprofit sector, its application has remained fragmented due to the size and diversity of the sector and a general lack of guiding principles for best practices.

More than ever, the public continually seeks the assistance of the nonprofit sector to help address social issues that businesses and governments cannot resolve.

If nonprofits are to remain effective in this role, they must increase their operating efficiency; improve their accountability to donors and other constituents; successfully run the gauntlet of legal, ethical and regulatory processes; and seek proactive board members who recognize the critical role they play in the governance process.

An effective oversight process that incorporates the use of a functioning audit committee can help nonprofits achieve these goals.

Though the use of audit committees will no doubt impose certain burdens and costs on nonprofit organizations, such committees will improve communications among directors, auditors and management; enhance the quality of financial reporting; assist board members in fulfilling their stewardship responsibilities; foster an environment that will attract and retain high quality board members; and assist the organization in achieving its stated goals and objectives.

AUDIT COMMITTEE CHARTER

Audit committee charters cover three broad areas:

* Mission statement: While much of the financial reporting responsibility is with management, this section describes various areas where the committee may exercise oversight of the financial reporting process. Some of those include the system of internal controls, the audit process and the organization's process for monitoring compliance with laws and regulations. This section also explains that the audit committee works with the board of directors, management and external (or internal) auditors in carrying out its responsibilities.

* Organization and Structure: This area of the charter describes some of the basics--how many members will be on the audit committee; who can be on the committee; what documents and records will the committee have access to; and how often the committee will meet, for example.

* Responsibilities: This is the generally the largest portion of the charter and explains in more detail exactly what the committee will do as it assists the board of directors. For example, evaluate whether management stresses a sound internal control environment; review the effectiveness and performance of external and internal auditors; confirm the independence of external auditors; review financial statements to ensure completeness; and review with management and external (or internal) auditors significant accounting and reporting policies.

This section also contains specific tasks related to ensuring compliance with laws and regulations, as well as making sure the nonprofit is conducting its affairs ethically (particularly in the areas of lobbying and fund-raising practices) and confirming that major programs and activities are consistent with the organization's stated objectives.

WHY A WRITTEN AUDIT COMMITTEE CHARTER?

Effective oversight of any nonprofit organization rests with its board of directors. Board membership is no longer an honorary designation or reward based on outstanding life achievements.

Members must be committed, informed and possess sound business and professional judgment. They must also realize that board actions will likely be subject to increased scrutiny and attention these days.

Improving audit committee effectiveness within a best practices framework is a win-win for the organization, its board and society.

A documented process permits board members to utilize their fiduciary responsibilities effectively and confidently, and fosters an environment that builds trust between the organization, its constituents and society. A first step toward improving a nonprofit's oversight process begins with the adoption of a written audit committee charter developed within a best practices framework.

RELATED ARTICLE: SAMPLE CHARTER

The following can be used by nonprofit organizations as guide to develop or modify its written audit committee charters.

(Name of nonprofit) AUDIT COMMITTEE CHARTER

1. MISSION STATEMENT

While primary responsibility for the financial reporting process vests in the management of (nonprofit organization's name), the audit committee (hereinafter referred to as the "Committee") will assist the board of directors in fulfilling its oversight responsibilities. This process oversees the following areas as they relate to the financial reporting process:

* the system of internal control;

* the' audit' process;

* the organization's process for monitoring compliance with laws and regulations; and

* maintaining consistency between the annual report and the organization's stated mission and objectives

In performing its duties, the Committee will maintain effective working relationships with the board of directors, management, (insert internal auditors where applicable) and external auditors. To effectively perform his or her role, each committee member will obtain an understanding of (i) the responsibilities of Committee membership, (ii) the organization's mission and (iii) the organization's general operating environment 

II. ORGANIZATION AND STRUCTURE

This charter has been approved by the organization's board of directors (or trustees), hereinafter referred to as the "Board." The Committee shall have access to the organization's records, documents and personnel, and will be provided with appropriate resources to diligently discharge its responsibilities.

The Committee shall consist of not less than (insert number) members of the Board who are not officers, salaried employees or consultants (either paid or otherwise) of the organization. Members of the Committee must have a working knowledge of the organization's operating environment and, in the sole judgment of the Board, demonstrate proficiency in general business practices. One member shall be appointed by the Board chair.

The Committee shall meet at least two times per fiscal year (via face-to-f face meetings, video conferencing or conference calls) or more frequently as circumstances dictate. One such meeting shall include separate sessions with the organization's management and external auditors;

SAMPLE CHARTER

The Committee shall maintain minutes of its meetings and report periodically to the Board on the results of Committee activities.

The Committee shall review and recommend updates of its charter annually.

III. RESPONSIBILITIES

The Committee shall assist the Board in overseeing the following:

Internal Control

* Evaluate whether management has established a tone that stresses the importance of a sound internal control environment. Ascertain that a mechanism is in place to ensure that all individuals within the organization are made aware of this philosophy.

* Ascertain whether recommendations received from external auditors (insert internal auditors if applicable) and other consultants for improving the internal control structure have been adequately addressed by management.

* Gain an understanding as to the degree of computerization utilized in the financial reporting process, including the extent to which security systems and contingency plans (in the event of system failure) have been implemented.

* Become familiar with the organization's budgetary, investment and risk management policies. Ascertain whether such policies have been applied consistently and appropriately.

Internal Auditors

* Ascertain the activities and organizational structure of the internal audit function.

* Review the effectiveness of the internal audit function as it relates to the overall control environment. Consider audit functions that, address not only compliance with the organization's financial and budgetary processes, but also non-financial areas to compliance with regulatory guidelines and organization-specific, mission driven processes.

* Assess the performance of the internal audit function and provide input regarding the appointment, removal or re-assignment of the director of internal audit.

External Auditors

* Review the performance of external auditors and recommend to the Board the selection, retention or discharge of the external auditors. Ascertain the scope of the auditors' engagement, as delineated in the engagement letter, and the anticipated compensation arrangement. Document a clear understanding with external auditors that they are accountable to the Committee and the Board.

* Confirm the independence of the external auditors, it being understood that external auditors are responsible for the accuracy of such an assertion. Also' review any nonaudit services provided to the organization by the external auditors, both pastor anticipated.

* Review the external auditors' comments and recommendations and management's responses, as well as any other matters related to the conduct of the audit that are required to be communicated to the Committee under Generally Accepted Auditing Standards.

* Report the results of the annual' audit to the Board.

Financial Reporting

* Review with management, (insert the internal auditors if applicable) and the, external auditors significant accounting and reporting policies, including recent professional and regulatory standards. Obtain a general understanding of their potential impact on the organization's financial statements.

* Inquire of management (insert the internal auditors if applicable) and the external auditors about significant risks and exposures and what plans have been initiated to mitigate their effects.

* Review annual financial statements and ascertain that they appear complete and consistent with information known to the Committee.

* Ascertain that the accounting for and disclosure of fund raising expenses appears reasonable. Focus on the appropriateness' of cast allocations among other functional categories.

* Review other sections of the organization's annual report prior to its release. Pay special attention to whether the information included in these sections is consonant with information known to the Committee and consistent with the financial statements.

Compliance with Laws and Regulations

* Review the effectiveness of the system for monitoring compliance with laws and regulations. Focus on the results of management's investigation and follow-up procedures related to fraudulent acts, defalcations and accounting irregularities.

* Ascertain that the organization is, conducting its affairs ethically, particularly in the areas of lobbying and fund-raising practices, and that employees (either paid or otherwise) and board members are aware of the organization's policies regarding conflicts of interest and fraud.

* Obtain updates from management, general counsel and tax counsel on compliance issues.

* Be satisfied that all compliance related issues have been adequately addressed in the organization's financial statements.

* Review the findings of any examinations conducted by regulatory agencies.

Mission and Objectives

* Ascertain that the organization's s stated goals are consistent with its formation document, as well as its financial resources.

* Review the organization's annual report for consistency with its stated purpose.

* Confirm that major programs and activities are consistent with the organization's stated objectives.

Other

* The Committee shall have the authority to retain independent counsel and other professionals to assist in the conduct of any investigation related to the diligent discharge of its oversight responsibilities.

* The Committee may require that counsel for the organization pre pare a report detailing legal and regulatory matters that may materially impact the organization's financial statements.

* The Committee will perform other ad hoc oversight functions as assigned by the Board.

Charles A. Barragato, CPA, CFE, is an accounting professor at the C. W. Post School of Professional Accountancy at Long Island University You can reach him at [e-mail].