When nonprofit boards are deciding on the committees they need, one question to ask is whether finance and audit should reside together or be two separate committees. If you ask any nonprofit in the United States that is large enough to have an external audit, the answer will be “separate” because of the influence of the Sarbanes-Oxley Act which legislates publicly traded corporations. In Canada the answer is not as clear. From a legal perspective, it is not required that they be separate however it is still considered best practice.
The main reason for separating the two committees is that there is an inherent conflict of interest between the two functions. Among other things, the finance committee assists the board in overseeing the budget process and overseeing finance policies and procedures. The audit committee assists the board in overseeing the annual audit which includes auditing the organization’s financial controls and reviewing the effectiveness of the policies and procedures. Therein lies the conflict. If a committee helps to create the financial controls can they objectively critique them?
Some will argue that the two can reside together in nonprofits because they do not have the same revenue reporting issues that publically traded corporations do. Nonprofits also don’t have senior staff on the board who have a conflict of interest with what to report because of its effect on share price. High profile examples such as Enron and WorldCom are the reason Sarbanes-Oxley was developed. Even if you take these issues out of the equation, there is still the issue of whether a finance committee can objectively audit its own work.
A more practical argument is that most boards do not have the resources to staff two committees. This is a problem that is worth solving to ensure adequate governance oversight. There are a number of ways to address it.
The first is to decide whether the board needs either committee in the first place. For some boards, it might be possible for the auditor to report to the full board which can negate the need for an audit committee. Other boards might have the resources on the management team to perform the duties often delegated to the finance committee which can negate the need for a separate finance committee.
A second solution is to add non-board members to the finance committee. Best practice is that the audit committee members all sit on the board but the bylaws and Board Policy Manual could be amended to allow one or more members of the finance committee to be non-board members. This is a great way to engage former or potential board members or to engage someone with financial expertise that does not have time to serve on the board.
A third solution is for the board to have an audit committee that only meets once a year. Ideally the members of the audit committee should not be the same as the finance committee but they could sit on other committees throughout the year or the audit work could be taken on by another committee. It is not uncommon to have an Audit & Risk committee which oversees the audit once a year and monitors enterprise risk for the remainder of the year.
If a board decides to go the route of forming separate finance and audit committees then the charters of the committees need to be clearly spelled out to ensure there is no overlap and duplication of efforts.