What to Expect and What to Ask Auditors

“If you have a job without aggravations, you don’t have a job.” — Malcolm Ford

1965 = $5 for small lawns, $10 for large lawns

1966 = Times Union delivery boy = $10 per week

1968-72 = Usher/Doorman at Shine Theaters = $1.60 per hour

1971 = Maintenance crew, Tobin’s Meatpacking = $3.72 per hour, graveyard shift

1972 = Genesee Hospital = Clinical-lab technician, $4.25 per hour

1973 = Arthur Andersen = auditor, $11,400 annually

There you have it, the not-so illustrious career beginnings for yours truly.

In looking back, I find that the youth of today have nowhere near the variety of opportunities that I had. All of my early employment opportunities required me to interact with people at all levels of the socio-economic ladder. I attribute who and where I am today, after 40 years in public accounting, to have been the direct result of these employment experiences.

We now have an extremely tight job market and our youth communicate via social media rather than directly communicating with others. Not surprisingly, the youth of today face far greater challenges in forging career success.

As a segue to the topic of this column, I want to state that I had nothing to do with the Enron scandal that resulted in the demise of my once great employer, Arthur Andersen. The demise of Arthur Andersen resulted in Congress adopting the Sarbanes-Oxley Act in 2002 and launched a government obsession with board governance and oversight responsibilities.

As I mentioned in a previous column several months ago, New York Gov. Andrew Cuomo signed the “Non-Profit Revitalization Act of 2013” into law. The provisions of this legislation represent the most significant modifications to New York’s nonprofit laws in the past 40 years. The new law, effective July 1, 2014, expands board-governance responsibilities in many areas, including conflicts of interest, related-party transactions, executive compensation, and board interactions with external auditors. Now, more than ever, every auditor must have the ability to clearly communicate in an articulate and informative way to satisfy the needs and expectations of a volunteer tax-exempt board.

I know and have 40 years’ experience as an auditor in the tax-exempt sector. Therefore, the purpose of this column is to raise the awareness of board volunteers and management team members in the nonprofit sector regarding interactions, communications, and transparency with your external audit firm. All members of the CPA audit profession must be approaching their tax-exempt client audits with the knowledge that the bar of regulatory and client expectations has been raised considerably.

Since many tax-exempt organizations are completing their year-end financial statement audits, this column is devoted to recommendations regarding the proper involvement and communication between board members and external auditors. Use this year’s meetings with your audit committee and board to ensure that your nonprofit is in compliance with these new regulatory requirements.

Nonprofit board and management team members need the following information to understand, evaluate, and modify current board governance and fiscal-oversight policies. One thing is clear from the requirements of the Non-Profit Revitalization Act and the federal Sarbanes-Oxley Act — the strategic requirements for establishing and maintaining effective board governance require the following.

• Establish and maintain an effective internal-control environment.
• Implement or modify appropriate board governance and oversight policies and procedures in accordance with the Non-Profit Revitalization Act.
• Maintain an appropriate focus on your regulatory-compliance function.
• Last, but certainly not least, increase your expectations and interactions with your external auditors to ensure your organization obtains maximum value for your audit costs

The following is a brief summary of what to expect from your auditors, and more importantly, what to ask them.

What to expect
1. Under the Non-Profit Revitalization Act, auditors are required to meet with the full board or its designated audit committee twice each year. Once to review the audit scope, plan, and risk areas identified by the audit firm. The second meeting is typically focused on a presentation and analysis of results, as described further below.

2. Auditors are required to communicate certain matters mandated by auditing standards — SAS No. 114. This report will cover many areas, including important disclosures related to audit adjustments, management estimates used in preparing the financials, fraud/illegal acts discovered in the audit, internal control weaknesses, and any unusual accounting adjustments reflected in the financial statements. This required document is a qualitative assessment of the audit process.  

3. Auditing standards have continued to emphasize the auditor’s responsibilities in communicating internal-control recommendations. If you receive a material weakness or significant deficiency comment, it should include specific discussion with the auditor and a prescribed timeframe for corrective action.

4. Auditors are required to report internal-control weaknesses and recommendations identified during the audit process. If your organization has not received internal-control recommendations in a formal management letter, ask the auditors why. The absence of a management letter should not be interpreted as perfection in your internal-control procedures.

5. The audited financial statements, with required footnote disclosures, are virtually unintelligible and mind-numbing to the typical reader lacking formal accounting expertise. At a minimum, the board should understand what type of audit opinion has been provided — unmodified or modified — and whether any new or revised footnote disclosures have been included.

6. In addition to these required reports, many quality oriented audit firms will provide value-added information to board and management, as follows:

• Discussion and analysis of financial results for the year by program/service component.
• Multi-year comparison of key financial ratios and operating indicators in comparison to industry targets/benchmarks.
• Summary of additional audit procedures performed to address the risk of fraud and illegal acts.
• An assessment of the quality and level of audit preparation by internal financial staff.
• A summary of operating and/or strategic issues that the board should consider for further discussion.

A clear and comprehensive audit report communicated to the board or its designated committee is a critical component of effective board governance and oversight.

What to ask your auditors?
Finally, board members should ask questions of their auditors. The following is my “Top 10” list of questions to ask auditors:

1. What was the surplus (deficit) for the year by program or service component and how were deficits subsidized?

2. Is there a balance on the bank line of credit at year-end and why?

3. How many days revenue are outstanding in accounts receivable, and is the number appropriate for our industry segment?

4. What percentage of total expenses has been incurred for administration and overhead, and are we in compliance with the governor’s Executive Order No. 38?

5. Are vendor payments, required payroll-tax deposits, and retirement-plan contributions being made in a timely fashion?

6. What was the amount of capital purchases for the year and the net change in outstanding debt obligations (that is, how much was financed of total capital purchases)?

7. What government-sponsored regulatory reform initiatives (example: managed care) and/or enforcement audits (example: OMIG/OIG) are in process, and has any liability settlement been recorded?

8. How does the external auditor assess our financial statements in the spectrum from conservative to aggressive in terms of accounting presentation (example: bad-debt reserve)?

9. What concerns, if any, do you have regarding the adequacy of our internal controls or the competency of our financial staff?

10. Are there any new or pending accounting pronouncements or standards that will have an impact on our organization?

The questions above represent examples of the types of discussion that are important dialogue between board members and audit representatives. In addition, at least once each year, the auditors should meet with the independent board members/audit committee in executive session. As a standard process, this approach establishes a healthy environment for communication directly between the board and your audit firm.

Finally, make sure that you have implemented the necessary policy and procedure changes to be in compliance with the Non-Profit Revitalization Act prior to July 1, 2014.

Your bottom-line objective should be to achieve transparency and accountability in a practical and SAFE manner.

• Scalable
• Affordable
• Feasible
• Enforceable

Gerald J. Archibald, CPA, is a partner in charge of the management advisory services at The Bonadio Group. Contact him at (585) 381-1000, or email: garchibald@bonadio.com