Finance and Audit Committees can play a key role both in detecting fraud and in preventing itby Sam Persaud & Alister Mason
October 11, 2000; Canadian FundRaiser
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.
