The Board’s Responsibility Regarding the Financial Statements
Although members of the management team typically prepare the financial statements, it is the board’s responsibility to review and evaluate the statements. Most boards delegate this oversight responsibility to a committee within the board. In pubic organizations, this responsibility has increasingly fallen to the audit committee whose major task is to monitor the preparation and auditing of financial statements. In nonprofit organizations, these responsibilities typically fall to the finance committee, which has a broader charge. Since preserving the integrity of the financial statements is such an important responsibility, a nonprofit organization should consider forming a separate audit committee that can focus on the organization’s financial reporting practices, work directly with the external auditor, and develop policies to enhance the organization’s internal accounting system.
Establishing an Appropriate Relationship with the Auditor
Prior to the accounting scandals at organizations such as Enron and World-Com, many nonprofit board members erroneously believed that having the accounting auditors give the financial statements an unqualified opinion was all that was necessary to oversee the financial activities and safeguard assets. Now, however, many realize that putting absolute trust in the external auditor’s report is imprudent and may put the organization at financial risk. In the best-case scenario, the auditor’s opinion regarding the financial statements is only an independent opinion regarding the degree to which the financial statements fairly present the organization’s financial position for a defined accounting period. “Fairness” in this case means that the auditor found no evidence that there was any substantial inaccuracy in the financial statements and that the statements comply with GAAP. If the statements were fair, a reasonable person reading the financial statements would not draw incorrect conclusions about the financial position of the organization. Having an unqualified audit does not mean that the organization is neces-
sarily in a good financial position; it only means that the financial statements fairly present the position, whatever that position may be. In the worst-case scenario, the auditor’s opinion may be biased, not objective, and not independent of the organization being audited. The auditor may have an incentive to misrepresent the fairness of the financial statements. For example, if the auditing firm performing the audit also receives substantial compensation for providing consulting, tax work, or other services to the nonprofit, the audit may be biased to reflect a more positive financial position than exists. In recent years, several accounting firms such as Price Waterhouse, Ernst & Young, and Arthur Andersen have been involved in lawsuit cases that alleged biased auditors’ reports. Biased auditor reports can also occur when a too cozy relationship exists between the management of the nonprofit and the auditor. The loyalty of the auditor may lie with the ED instead of with the board, and the auditor’s evaluation of the statements may be biased by that loyalty.
Titles II and III of SOX seek to assure the independence of the auditor and the independence and competence of the members of the audit committee. In addition, SOX requires that the audit committee have at least one member who qualifies as a financial expert. Part of establishing the independence of the auditor limits the amount of non-audit services the auditor may provide and requires the mandatory rotation of the lead audit or coordinating partner every five years. SOX also prohibits any officer or director of the organization to influence, coerce, manipulate, or mislead any auditor working on the audit of a company’s financial statements for the purpose of rendering the statements materially misleading. In addition, a registered public accounting firm is not allowed to provide audit services if the company’s CEO, CFO, chief accounting officer, or any equivalent employee was employed by the auditing firm and participated in the audit of the company in the previous year.
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