Auditor Rotation

12-0825 - musical chairsAuditor rotation is again receiving a lot of attention. Many board members from publicly-traded companies encourage the nonprofit boards they serve to explore audit firm rotation as a best practice. While there is not a standard for mandatory audit firm rotation, some believe it is necessary for audit objectivity. Many others believe the costs would significantly outweigh any benefits.

Generally, the main reason organizations look at audit firm rotation is to provide a “fresh look” at their organization and operations. This is a valid issue, and one that audit firms regularly address in their procedures. Independence and objectivity are the basis of the audit process. Auditors are required to perform and document their work in accordance with auditing standards and firms are subject to a peer review process every three years to ensure the processes are followed.

Audit committees can help ensure the audit they are receiving brings value. They should meet with their auditors regularly to understand the processes and procedures used in the audit, how the auditors maintain their objectivity, and to discuss matters that come to the auditor’s attention. When there is a continuing interest in gaining a different perspective, many audit firms are able to rotate the engagement team – partner and/or staff. This allows the organization to retain the expertise, industry knowledge, and service they receive from the incumbent firm.

The drawbacks of frequent audit firm rotation include the costs incurred by the organization and its staff in the procurement process and initiation of a new firm, an increase in audit costs due to additional time spent in the first years of an audit relationship, and a potential decrease in service level as the end of the audit tenure approaches. The GAO surveyed hundreds of companies and auditors about audit firm rotation. The general conclusion from those responding was that rotation increases costs and has very little, if any, effect on the quality of audits.

When is rotation of auditors appropriate? Organizations that are not receiving the level and quality of service they expect should discuss the issues with their auditors. When the current auditors are no longer able to meet the high standards of the organization, a change may be in order.

A Plea to Board Members

questionRecently I participated in the presentation of our audit to the executive committee of a client – something we do with regularity. The presentation was fairly typical – an overview of the financial statements, explanation of the required communications, and suggestions for improvements in operations and internal controls. There wasn’t really anything in the meeting that was out of the ordinary. Unfortunately, the response of the committee members was not all that uncommon either. It was dead silence. In spite of multiple requests for comments or questions, not a single member had a question or comment.

How can this be? Those charged with governance of an organization have a responsibility to gain an understanding of the financial operations of the organization and to familiarize themselves to the best of their ability. Not every member is a financial expert, and they don’t have to be. But each member should do their best to understand what is going on.

So please, if you are on a board, audit or finance committee, or participating in other ways in the governance of an organization, ASK QUESTIONS! If you don’t know something, ask. If something isn’t clear, ask. If references are made to situations or activities that you are unaware of, ask. An inquisitive mind and willingness to ask questions is one of the greatest attributes you can bring to your organization.

Nonprofit Executive Compensation

IRS Form 990 has a number of items requiring information regarding the compensation of the executives of the nonprofit organization. One of the questions asks for details regarding the methods used to establish compensation for the CEO/Executive Director.

It is often recommended that nonprofits organizations establish a compensation committee to establish executive compensation. Organizations without a compensation committee may use the executive committee for this task. Most nonprofit organizations involve the board in some way (through committee or as a whole), in order to fulfill the fiduciary responsibilities as a board member. Often this includes a board vote on the compensation.

Those charged with the determination of compensation can use a number of tools to accomplish this task. Many organizations use their human resources personnel or independent consultants to analyze comparable salaries. It is common to use various salary studies to compare the organization with other nonprofits. It is less common to compare the organization with similar for-profit entities. The analysis is most commonly performed on an annual basis.

Strong nonprofit governance includes a policy that enables the board to make fair and reasonable compensation decisions.