Understanding the key players in the auditing process is crucial for nonprofit organizations to ensure financial transparency, regulatory compliance, and organizational integrity. Whether you’re delegating audit committee roles for the first time or improving existing procedures, this comprehensive guide covers everything you need to know about audit committee roles and responsibilities.
Overview of the Auditing Process and Audit Committee Roles
The nonprofit auditing process involves multiple stakeholders working together to ensure financial accuracy, compliance with regulations, and proper stewardship of donor funds. According to the American Institute of CPAs (AICPA), effective auditing requires clear roles, independence, and professional oversight.
A well-structured audit process not only ensures compliance but also builds donor confidence and organizational credibility.
For nonprofit organizations, annual audits serve several critical purposes:
- Regulatory Compliance: Meeting state and federal requirements for tax-exempt status
- Donor Assurance: Providing transparency to funders and stakeholders
- Internal Controls: Identifying weaknesses in financial processes
- Board Governance: Fulfilling fiduciary responsibilities
- Grant Requirements: Satisfying funder audit requirements
The Role of External Auditors
External auditors serve as independent third parties who provide objective assessment of an organization’s financial statements. These professionals must be licensed CPAs with specific expertise in nonprofit accounting and auditing standards.
Key Responsibilities of External Auditors
External auditors perform comprehensive reviews that go beyond simple number-checking. Their responsibilities include:
- Financial Statement Examination: Reviewing all financial records, transactions, and supporting documentation to verify accuracy and completeness according to Generally Accepted Accounting Principles (GAAP)
- Compliance Testing: Ensuring adherence to both Generally Accepted Auditing Standards (GAAS) and specific nonprofit regulations
- Risk Assessment: Identifying areas of potential financial risk, fraud, or mismanagement
- Internal Control Evaluation: Testing the effectiveness of financial controls and procedures
- Management Letter Preparation: Providing detailed recommendations for improving financial processes and controls
Independence Requirements
To maintain objectivity, external auditors must meet strict independence criteria:
- No financial interests in the organization
- No family relationships with board members or key staff
- No previous employment with the organization within the past year
- No non-audit services that could create conflicts of interest
Learn more about becoming a qualified auditor to understand the professional standards required.
Internal Audit Committee Responsibilities
The audit committee serves as the board’s primary oversight mechanism for financial reporting and compliance. This committee acts as an intermediary between the board, management, and external auditors. Organizations should also understand internal auditing practices to complement external audit requirements.
Core Functions of the Audit Committee
According to federal legislation and best practices established by the AICPA, audit committees must:
| Function | Description | Frequency |
|---|---|---|
| Auditor Selection | Interview and recommend external auditors to the board | Annually or as needed |
| Financial Review | Review quarterly financial statements and annual reports | Quarterly |
| Audit Oversight | Monitor audit progress and review findings | During audit season |
| Risk Management | Assess financial risks and internal controls | Ongoing |
| IRS Compliance | Review Form 990 before submission | Annually |
Committee Composition
Effective audit committees require diverse expertise and perspectives. The ideal composition includes:
- Financial Expert: At least one member with accounting or financial management expertise (CPA, CFO, or similar background)
- Board Treasurer: Provides continuity with board financial oversight
- Independent Directors: Members without conflicts of interest or operational involvement
- Industry Knowledge: Understanding of nonprofit sector and specific mission area
Audit Committee Requirements by Organization Size
Audit committee requirements vary based on organizational budget size and state regulations. The following guidelines represent common thresholds, though specific requirements may differ by jurisdiction:
| Organization Size | Annual Budget | Audit Committee Required? | Minimum Members | External Audit Required? |
|---|---|---|---|---|
| Small | Under $300,000 | No | N/A | Generally No* |
| Medium | $300,000 – $500,000 | Recommended | 3 | Often Required |
| Large | $500,000 – $2 million | Yes | 3-5 | Yes |
| Major | Over $2 million | Yes | 5-7 | Yes |
*Requirements vary by state and may be triggered by federal funding thresholds. Organizations receiving $750,000+ in federal funds require a Single Audit regardless of size.
Important Note: These are general guidelines. Always consult with a qualified auditor or attorney to understand specific requirements in your state. Some states have additional requirements based on:
- Solicitation of public donations
- Registration as a charitable organization
- Specific funding sources
- Type of nonprofit designation
How to Select an External Auditor
Choosing the right external auditor is crucial for a successful audit experience. The audit committee should lead this process with input from management. Consider firms with expertise in government accounting standards if you receive federal funding.
Selection Criteria
When evaluating potential auditors, consider these key factors:
- Nonprofit Expertise: Look for firms with significant experience auditing similar organizations in size and sector
- Professional Credentials: Verify CPA licensure and membership in AICPA’s Not-for-Profit Section
- References: Contact other nonprofits they’ve audited, particularly those of similar size and complexity
- Capacity and Timeline: Ensure they can meet your audit deadline and have adequate staff resources
- Communication Style: Assess their willingness to educate and guide your organization
- Fee Structure: Understand all costs, including potential additional charges
The RFP Process
For organizations with budgets over $500,000, best practice suggests issuing a Request for Proposal (RFP) every 3-5 years. The RFP should include:
- Organization background and mission
- Scope of audit services needed
- Timeline and deadlines
- Budget range
- Evaluation criteria
- Submission requirements
Audit Committee Best Practices
Successful audit committees follow established best practices that enhance their effectiveness and ensure proper oversight.
Meeting Structure and Frequency
Effective committees typically meet:
- Quarterly: For regular financial review and updates
- Pre-Audit: To plan the upcoming audit and review prior findings
- Post-Audit: To review results and management letter
- As Needed: For special circumstances or concerns
Executive Sessions
The committee should hold executive sessions without management present to:
- Discuss sensitive findings with auditors
- Evaluate management’s response to audit issues
- Address any concerns about internal controls
- Ensure open communication channels
Documentation Requirements
Maintain comprehensive records including:
| Document Type | Purpose | Retention Period |
|---|---|---|
| Meeting Minutes | Record decisions and discussions | Permanent |
| Audit Reports | Document findings and opinions | 7 years minimum |
| Management Letters | Track recommendations and responses | Until resolved + 3 years |
| RFP Documentation | Support auditor selection | 3 years |
Common Mistakes to Avoid
Understanding common pitfalls helps organizations establish more effective audit processes:
1. Lack of Independence
Mistake: Including staff members or major donors on the audit committee
Solution: Ensure all committee members are independent board members without financial interests
2. Insufficient Financial Expertise
Mistake: Forming committees without members who understand financial statements
Solution: Recruit at least one member with accounting or finance background
3. Rubber-Stamp Mentality
Mistake: Passively accepting audit reports without questioning or discussion
Solution: Encourage active engagement and prepare questions in advance
4. Poor Communication
Mistake: Limited interaction between committee, auditors, and management
Solution: Establish clear communication protocols and regular check-ins
5. Reactive Rather Than Proactive
Mistake: Only addressing issues after audit findings
Solution: Implement continuous monitoring and improvement processes
Case Study: Effective Audit Committee Formation
The River Valley Community Foundation (annual budget: $1.2 million) transformed their audit process by implementing best practices:
- Challenge: Previous audit findings indicated weak internal controls and delayed financial reporting
- Action: Recruited a retired bank CFO and nonprofit accounting professor to the audit committee
- Process: Established quarterly meetings with structured agendas and executive sessions
- Result: Clean audit opinion within two years and improved donor confidence
- Key Success Factor: Committee chair met monthly with finance staff to monitor progress
Additional Resources and Tools for Understanding Audit Committee Roles
To support your audit committee development, consider these resources:
- AICPA Not-for-Profit Section: Professional standards and guidance
- National Council of Nonprofits: State-specific requirements and resources
- BoardSource: Governance best practices and training
- Your State Association of Nonprofits: Local requirements and referrals
Frequently Asked Questions
What qualifications should audit committee members have?
At least one member should have financial expertise such as CPA certification, CFO experience, or similar financial background. Other members should be able to read and understand financial statements and have strong governance experience. All members must be independent from management and free from conflicts of interest.
How often should the audit committee meet?
Best practice suggests quarterly meetings at minimum, with additional meetings during audit season. Most effective committees meet 4-6 times annually, including at least one executive session with external auditors where management is not present.
Can staff members serve on the audit committee?
No. To maintain independence, staff members (including the CEO/Executive Director) should not serve as voting members of the audit committee. They may attend meetings to provide information but should excuse themselves during executive sessions.
What’s the difference between internal and external auditors?
External auditors are independent CPAs hired to provide an objective opinion on financial statements. Internal auditors (or audit committees) are part of the organization’s governance structure responsible for oversight. External auditors report their findings to the audit committee, not management.
When do nonprofits need to conduct a Single Audit?
Nonprofits that expend $750,000 or more in federal awards during their fiscal year must have a Single Audit conducted in accordance with federal regulations. This is in addition to regular financial statement audits and has specific compliance testing requirements.
How much do nonprofit audits typically cost?
Audit costs vary based on organization size, complexity, and location. Small nonprofits might pay $5,000-$15,000, while larger organizations could pay $25,000-$50,000 or more. Single Audits typically add 25-50% to base audit costs. Always get multiple quotes through an RFP process. Audit costs can be managed through proper forensic accounting practices and internal controls.
