Often formed as a support for the volunteer treasurer and the paid accounting/finance staff, a Finance Committee usually has a key role in establishing annual budgets, and in monitoring performance against the budget periodically – monthly or quarterly – during the year. Unless there is a separate Investment Committee, it will either provide advice on investment policies or make investment decisions on behalf of the organization. A Finance Committee may also be involved in issues concerning insurance coverage, unusual fundraising matters, expense reimbursements, and the pension plan.

An Audit Committee, on the other hand, has four main objectives:

  1. To help ensure the annual audit is conducted in an efficient, cost-effective and objective manner.
  2. To oversee the organization’s financial and control systems.
  3. To review and recommend to the board approval of the annual financial statements, including the selection of appropriate accounting policies and practices.
  4. To recommend the appointment of the external auditor, and the appropriate fee.

Some nonprofits with a well-established Finance Committee do not form a separate Audit Committee. Rather, the Finance Committee constitutes itself as an Audit Committee twice a year: once before the audit commences, and then after its completion. Of course, where the organization does not have an audit, it would not have an Audit Committee. (Some larger organizations have a team of internal auditors, and the Audit Committee may provide them with oversight, but such organizations will almost certainly have an external audit too.)

Financially literate, independent, with appropriate expertise

The Audit Committee should consist of at least three members, solely financially literate independent directors. At least one should have accounting or financial management expertise.

The issue of independence is important, as a director with financial, family, or other personal ties to management is unlikely to be able to evaluate objectively the appropriateness of management’s accounting, internal control and reporting practices. Financial literacy refers to the ability to read and understand fundamental financial statements, including an organization’s balance sheet, and statements of revenue and expenses, changes in fund balances and cash flows. Past employment experience in finance or accounting (including being a senior officer with financial oversight responsibilities), a professional certification in accounting, or any other comparable experience or background should qualify as accounting or financial management expertise.

Detecting fraud: performance vs. budget

If detailed budgets are carefully set, and if actual performance is compared with the budgets, the Finance Committee can play a major role in detecting fraud by following three steps:

  1. Know the accounts. At the time the budget is compiled, gaining a clear understanding of what is in each revenue and expense account.
  2. Compare actual vs. budget. As the actual results for each month or quarter are compiled, comparing these with the budgeted amounts.
  3. Understand the differences. Asking informed questions about the differences between budget and actual, and insisting on plausible explanations. These inquiries might lead to the conclusion that some differences cannot be satisfactorily explained, and need to be more closely monitored or investigated.

Of course, it is much easier to budget for some items than for others. One of the easiest is usually property rental expense, or utility expenses such as hydro. At the other end of the spectrum would be such items as the revenue from a door-to-door collection.

The Audit Committee’s role in detecting fraud will depend on the functions exercised by the Finance Committee. Should the Finance Committee not be effective in its inquiries about budget to actual differences, the Audit Committee may want to pursue these differences more diligently, or to investigate differences between the current and prior year actual amounts, as presented in the annual financial statement drafts.

The auditors’ Management Letter

A Management Letter includes, among other matters, the auditors’ observations on weaknesses in an organization’s financial and internal control systems, areas that an Audit Committee is required to oversee. A detailed review of the letter, along with discussions with management and the auditor, can help identify potential areas of fraud. Evidence of the latter may be lack of controls (or poor controls) over cash, such as no segregation of duties for the collection, receipting and depositing of cash, and the untimely preparation of bank reconciliations.

Preventing fraud

In fact, the mere existence of a strong Audit or Finance Committee in itself may act as a prevention of fraud, and may manifest itself in the following ways:

  • Diligent follow up of all significant variances between budget and actual amounts. A ‘drill-down’ to determine the reasons for such variances will send a strong message to potential perpetrators of fraud regarding management’s commitment in this area.
  • Continuous and open communication between management and the auditor to ensure that all financial and internal control systems issues are addressed on a timely basis. Matters raised by the auditor need to be fully discussed, their implications considered, and appropriate action taken immediately. Lack of action (or action taken late) can give the impression of indifference to internal control weaknesses.
  • Strong interest taken in, and oversight maintained for significant funding arrangements (such as grants), ensuring that all of the conditions involved (including appropriate reconciliations and filings) have been satisfied. A recent fraud committed by an employee of an organization funded by Human Resources Development Canada highlights the need for such a concern.
  • A member of the Audit or Finance Committee (usually the Chair) being one of the signatories on all large cheque payments. In addition, having a member of the Committee review all payments over a certain amount for validity (this may include agreeing the payment amount to the supporting documentation) may be an indication of the Committee’s commitment to fraud prevention.

Sam Persaud, CA, is a senior manager and Alister Mason, FCA, is a partner with Deloitte & Touche in Toronto. For a fuller explanation of an Audit Committee’s functions, see “Not-for-Profit Audit Committees: Terms of Reference”, published by Deloitte & Touche. Alister is co-author of “The Effective Not-for-Profit Board” and leads the firm’s not-for-profit practice. For more information, call (416) 601-6184, fax (416) 601-6151, or email almason@deloitte.ca.