HomeMy WebLinkAboutNew Business #4 7-20-87j~ ~ ~, ! ~ ~ , ~ NEW BUSINESS
DATE: JULY 20. 1987 '
TO:
FROM:
SUBJECT:
HONORABLE NAYOR & MEMBERS OF 11JE CITY COUNCIL
WILLIAN A. HUSTON, CITY I~.NAGER
AUDIT COMMITTEE
RECOI~DATZON
Pleasure of the City Council.
DISCUSSION
At the July 6, 1987 City Council meeting Councilman Kelly requested that this
item be placed on the July 20, 1987 Agenda. Councilman Prescott had previously
proposed that the City Council consider creation Of an audit committee.
If the City Council desires to create an audit committee, staff recommends that
it be modeled after the attached guidelines for nonprofit corporations
suggested by the accounting firm of Price Waterhouse. These guidelines also
conform to those suggested by the Municipal Finance Officers' Association.
In _summary, the committee would consist of three to five members (appointed by
the City Council). The committee would meet with the City's independent
auditor at least twice a year and review the annual audit. Any findings and/or
recommendations of the'committee would be submitted to the City Council. The
committee could also be involved in selection of the City's auditors.
If the City Council chooses to create an audit committee, the most practical
time would be late 1987 in order to have the committee in place for the 1987-88
audit. It would not be practical to create the committee in time for the
1986-87 audit since it is currently underway.
William A. Huston
City Manager
WAH:jh
The Audit Committee
The Board of Trustees of
Nonprofit Organizations and the
Independent Accountant
lncrease(I attention ha~ I.'('n I'~l('us(.(I ill the lasl few years on tile dh- '
ties and resl,)usibililies ,,t' the b.ards of trustees of nOnl)rolh organi-
zations. What once was i)rimarily an hunorary designation has now
become an iml.)rhml i.~sili.n .f Irt,si. whh potential serious liabili-
ties i~r the trustee who takes the job too lightly or otherwise fails to
perform adequatel):
Oue of tile kev areas of iml~orlance fi~r members of a nonprofit enti-
tv's hoard, of course, is the review and approval of tile organization's
financial rel,~rts. To some extent, this responsihility is discharged
through the al,l,ointment of iudependent accountants and tile suhse-
quent review nf their findings. While the ultimate responsibility for
approval of financial reports rests with the entire board, a separate
eommi'ttee established by the board can ohen serve as a better means
of dealing with this increasingly complex and Sol,hislicaled area.
Recommendations of Price Waterhouse
The institntion of audit committees has now become as comn]on a
praclice fi~r nonprofit organizatious as it is for publicly hehl, enmmer-
eial orgauizations. A properly functioning audit committee goes a
long way toward demonstrating that the board of trustees has taken
I)rudent steps to perform iLs administrative and control functions.
Thus, with regard to audit committees, Price Waterhouse reeom-
mehds that:
· Every nonprolit orgaoization that raises funds from the general public
or that receives grants or membership dues should have an active
and functioning audit committee. ...
· l"or mnsl effective operation, audit committees should be composed
of Ilu'ee to five directors, with the majority (including tile chairman)
heing trustees who are not employees.
· Audit committees should be responsible for recommending the ap-
pnintmenl of tile independent accountaots and for discussion of their
work with them.
· Audit committees should he responsihle for tile review and evalualion
of the repnrts prepared by the independent accountants that describe
any weakuesses in the organizalion's internal acconnting and man-
agement controls and that contain recommendations for improve-
ments in such controls. Audit committees should also determine if
management has taken appropriate action on these recommendations.
· Audit committees should be delegated responsibility to review the
annual financial statements with the independent accountants.
Composition of the committee
Tile underlying rationale for most organizations' having an audit com-
millee is simply timt tile full board is usually too large and has too
many other responsihililies tbr it to review the nrganizatiou's limmcial
and acconnting reports with optimum effectiveness. Generally, at, dit
commiltees of at leasl Ihree members provide Ihe diversily of views
essenlial to effective fuuctioning, while haviug more than live me]n-
hers increases the in'obability that efficiency and the sense of per-
sonal involve]nent of committee meinbers will suffer.
We believe that audit committees shouhl be composed principally of
outside trustees, ,me of whom shophl be the chairman. Otherwise, a
committee composed exclusively of trustees who a~ also part of
managemenl will either be, or appear to be, in lhe posilion of review-
lng its own decisions.
Occasionally the duties of an audit conunittee will be assigned to a
finance or to an executive committee, and a separate audit eonnnittee
will not be established. There is no objection to this, provided such a
committee has the time required and, as discussed above, consists at
least iu part of outside trustees.
The qualifications of committee mem,bers need ]lot differ from tilose
required of all trustees. The primary considerations shoukl lie that
those selected to serve mnst be convinced of the benefits to be de-
rived fi'om active participation iu such a committee and must have
tile time available to devote to this important duty. Financial experi-
ence hy al least one me~nber has heen found to be helpful. Although
it is usually desirable to rotate the chairmanship, this should not be
done at the expense of an active, enthusiastic committee.
Responsibilities of the committee
The two primary responsibilities the audit committee should assume
are:
1. To provide assistance to the board in fulfilling its fiduciary respon-
sibilities relating to accounting and reporting practices, and
2. To maintain, by way of regularly scheduled ~neetings, a direct line
uf cunmnmication between the trustees and independent accountants
to provide tbr exchanges of views and inlbrmation.
We recommend that andit committees be resi~onsible for recommend-
ing tile appointment of the independent accountants and for discfs-
sion 0f their work with them. If necessary, the audit committee
should consider recommending tile appointment of a different firm.
Arbitrary rotation of firms, when tile incumbent is rendering satisfac-
tory service, is nsually not in th~ orgamzatlnn s best interests, how-
ever. Although an audit committee must take care not to encroach on
the duties and prerogatives or the reponsibilities of management, the
committee can he effective in a broad range of activities beyond the
sitnple reporting to the board of the findings of_the independent ac-
countant and of the llnancial reporting decisions of management. Its
discussions can be designed to enable the committee to report its ap-
praisal of the adeqt, acy of the audit effort by the independent ac-
countants, the accounting policies adopted by management (where
alternative practices are available), tile adequacy of disclosnre of in-
formation essential to a fair presentation of the financial affairs of the
organization and the quality of the organization's system of manage-
ment and internal accounting controls.
The committee should ascertain whether there were any significant
diffict, lties encountered by the independent accountants, any impor-
tant discove.ries, any changes in accounting principles or any devel-
opments in accounting which ~nay have an effect on the organiza-
tion's, financial statements. It should obtain all other information
necessary for tile committee to report fully to the board of trustees.
Functions of the committee
The activity of a typical audit committee includes the foll6wing:
1. Review of the iinancial statements with the independent account-
ants prior to recommending app"oval by the board. The purpose of
such a review is to determine that the independent accountants are
satisfied with the disclosure and content of the financial statements
and to ubtain suilicient information from the auditors to facilitate
analysis of tile financial statements submitted to the entire board of
trustees.
2. Appraisal of the effectiveness of.the audit effort. This includes a
discussion of the overall approach to and scope of the examination,
with particular attention focused on those areas where either the
committee or tile independent accountants believe special emphasis
is desirable or necessary. The responsibility for determination of tile
detailed scope of auditing necessary for the formation of an opinion
on the liuancial statements resides with the independent aceonnlanls,
and Ihat decision must be leti to tbem. For this reason, Ihe commit-
tee should not ask tin' nor be given detailed audit programs.
3. Determination tbrough discussions with the independent account-
anls thai no restrictions were placed by management on Ihe scope of
the examination or on its implementation. It is olien al~propriate for
management representatives to allow the committee at some point to
meet alone with the independent accountams. This is nol intended iu
any sense to rellect adversely on the integrity of management; in-
stead, il p~vides an additioual margiu of security ia that there will
be an opportuuity G~r a complete intenqmnge, wilhnut the inhibitions
or restrictions that might exist if members of the managemenl team
were present. It also eslablishes for the record thai the independent
accountants we~ presented a chance to discuss wilh the committee
any topics they might choose.
4. Inquiry iuto the effectiveness of the organization's management of
financial and accounting Gmctions, through discussions with the in-
dependent accountants and appropriate office~ of the organization.
Parliealar atteutiou shoukl be paid to the adequacy of internal con-
trol over contributions and other sensitive areas.
5. Review of reports prepared by the independent accountants dis-
cussing weaknesses in internal control, organizational stn~cture and
ol~ratious and containing recommendations to improve such
weaknesses. There should be careful consideration of the action
taken by ~nanagement on tbe independent accountants' suggestions.
6. Reconnnendation of the appointment of independent accountants
for the ensuing yeah The actual appointment of the accountants
should remaiu the responsibility of the 6dl board. Manage~nent,
tbrougb it9 day-to-day dealings with the independent accountants,
normally is in the best position Io evalume the services provided,
and its input to the committee should be given careful consideration
when reco~nmendations for independem accountants are being con-
sidered. On the 0tber hand, the committee should be certain that
management's ~commendatious are objective and not designed to
serve its own self-interest.
Summary
While the possihility ~xisls thai an audit committee will not serve a
mcaningfid i)url)ose and will simply perform an annual ritual of
proving' the finan(,ial slah,ltlellls, Itlally trustees, particularly outside
trustees, have tbun(I au(lit commiflees of great assistance in dischat~-
lug the hoard's resl,msihilitics in relaliou lo financial rel)orting.
the final analysis, the eft~ctiveness of an audit committee is del)en-
(h.nl m~ mal~v I~t('h~rs, i~l('luding the nature of the organization, the
philoSol)liy of mallagemenl, and the experience aud interests of its
members.
It has heen our exl)erience that audit committees function most effec-
lively when Ih~'y arc COml)osed uf enlln.siastic truslees who work in
cooperation with management and the independent accouutants and
who haw, a ch,ar undcrslanding ~)f their resl,,~sihilili~,s a,d h.w h)
discharge them. The tbllowing section has been prel)ared as a work-
lng gt,i(le 1o assist Ihe audit commiltee memhers and as a ready re-
minder of subjects they may wish to discuss to oh]alu a tull under-
slandiu-g uf the lhm,cial reporting of their organization.
5
A Working Guide for
Audit Committee Members
of Nonprofit Organizations
'6
The following material provides an informal guide to memb_ers of
trustees' audit committees. It contains suggested topics which may be
discussed during meetings with independent accountants, financial
management representatives, internal auditors and others. The topics
are not intended to be all-inclusive or appropriate in all circum-
stances. Knowledge of the specific topics to be discussed at a given
meeting and a general understanding of the organization and its envi-
ronment are essential if committee members are to acquire the infor-
mation they need to fulfill their responsibilities.
Review of Financial Statements with
Independent Accountants
Broad areas of inquiry
1. Changes in those accounting principles or practices (or in their
applications) which have had a significant impact on (a) the amounts
reported for the current year, or (b) future amounts to be reported,
including the independent accountants' concurrence with the
changes and the reasons therefor.
2. Possible adjustments to the financial statements that were dis-
cussed with and/or proposed to management but that were subse-
quently not recorded, and the underlying reasons for the decision.
3. Overall evaluation of the degree of comparability and conserva-
tism reflected in preparation of the current financial statements as
compared to recent prior years.
4. Adequacy of the disclosures in the financial statements which are
necessary for a fair presentation. Some additional recommended dis-
closures include: '
· Litigation that management or the organization's legal counsel believe
may have possible significant effect.
· Circumstances such as possible regulatory actions, the loss or antici-
pated loss of contracts, or other sources of revenue, which, while not
affecting the financial position or activities of the current year, may
have a serious impact on the organization's future existence.
· Unusual transactions with officers, board members or affiliated
organizations.
5. Adherence to lhe appr. priale imd'~.ssi~,m~l accounliug standards or
to principles generally fidlm~'cd by similar nnnprolit organizatiods.
6. New pronouncemenls by Ihe AICPA or FASB having an effective
date subsequent to the year-end lhat will require accounting policy
changes or additional disclosures in future financial statements, and
the anticipated effect; the independent accountants' views as to the
desirability of early adoption for reporting in the current year.
7. Sensitive accounling or reporting practices or judgments that may
generale adverse comments from business writers, regulators, eon-
tribnlors or others.
8. Deviations fixnn tile standards established by rating bureaus such
as The Philanthropic Advisory Service of the Council of Better
Business Bureaus, Inc., The Natiomd Charities Information
Bureau, Inc., etc.
9. Status of tile completion of the examination and the expected form
of opinian.
10. Any other matters that the independent accountants wish to dis-
cuss with the cmnmittee or the full board prior to the release of the
annual report.
Other topics that may be relevant
depending on the organization and its activities:
l. Adequacy of tile accounting for and disclosure of fundraising
expenses:
· Appropriateness of the methods of allocating costs to tile fundraising
function including, where applicable, an allocation of the salaries of
the executive director and other members of management.
· Appropriateness of the allocation between functions of the cost of
multipurpose literature which includes a fundraising function, such
allocation being made on a rational and reasonable basis, based on
the facts and circumstances of individual mailings.
· Adequacy of the disclosure of fundraising costs.
2. Appropriateness of the bases used to allocate expenses among
other functional cmegories.
3. Compliance with tile filiug requi, rements of city anti state regula-
tory agencies where the organization is either doing busittess nr
soliciting contributions (including solicitation by mailL
4. Compliance with all payrofl tax filing requirements, including pay-
ment of withholding taxes when due.
5. Compliance on a timely basis with the filing requirements of the
IRS (Form 990).
6. Extent of unrelated bt,siness income activities and compliance
with related federal anti state reporting requirements.
7. Bases of accounling fi~r tnarke~able securities, changes in Ihe mar-
ket value since year-cud, method of determining market vah!e of se-
curities not publicly traded anti marketability of all items included in
this classilicatiou.
8. Adequacy of like allowance for doubtfl~l ~ceivables and tile status
of collection of receivables, particularly large individual alnounts.
9. Extent of amounts due the organization from officers or other em-
ployees, other than routine travel advances.
10. Steps taken to afford physical safeguards over inventories, office
equipment and other portable items; methods nf valuation and the
adequacy of procedures to identify obsolete inventory.
11. Brief description of the organization's policies regarding capitali-
zation and depreciation of property, plant and equipment and meth-
ods of depreciation; the method of recording leases and related amor-
tization when such leases are capitalized.
12. Restrictions on the organization's activities i~nposed by lenders
and compliance with loan covenants; the extent of compensating bal-
auces required on bank loans.
Relations with the Independent Accountants
Scope and plan of the audit:
1. Areas where the independent accountants found it necessary to
extend scope because of unsatisfactory results from tests of internal
control or selected transactions.
2. Extent to which changes in the internal accounting controls within
the organization have been reflected in the audit plan.
3. Extent to which organizalional changes or increases in activit~
have Been considered inqhe plan tbr lhe examination.
4. Extent to which eleclronic dala lU',,cessiug (EDP) is utilized in
processing infi,rmaliou SUl,porling Ihe linancial slatements; the extent
of the independem accomltauts' review of the EDP function.
5. As applicai,h., file cxlcnl lu which the internal audit stMf of the
orgmfization has been utilized to reduce the scope of work performed
by the indel~cndenl accountants.
Internal accounting controls, personnel and organization:
1. Independent accountants' evaluation of the overall adequacy of in-
ternal controls, inchnling an evaluation ~ff whether there is a proper
balance between cost of controls and risks assumed.
2. Adequacy of internal controls over contributions.
3. Any areas where ahernative or extended audit procedures have
been reqt~fired because of unsatisfactory records or inadequate
controls.
4. Recommendations relating to internal controls or any procedures
that the independent accountants believe will enhance the safeguard-
ing of the organization's assets; the actions taken by management or
reasol~s for lack thereof.
5. Adequacy of the organization's use of budgeting techniques, in-
cluding preparation procedures, allocation of annual budgets into
monthly increments and the use of budget deviations to trigger man-
age~nent action.
6. Observations ahout the organization's system of management re-
porting or operational c0utrols that are not strictly within the scope of
the independent accountants' engagement, including the financial
stalements snhmilled Io Ihe board on an interim hasis.
7. Independent accountants' evaluation of the appropriateness of the
size, and organizational structure of the accounting staff.
8. Internal controls and procedures relating to EDP:
· Brief explanation of what financial data is processed in whole or in
part by EDR either in-house or by a service bureau.
· Generally, the types of input-output cootrols established to facilitate
the accuracy of processed data.
· Organization, stalling and supervision of the EDP department, in-
cluding an evaluation of whether there is effective control over the
use of computer services throughout the organization.
· Whether the review of the EDP function indicated that internal con-
trois over processing and the procedures for safeguarding records and
files are adequate.
· Comments on tile cost effectiveness of the EDP area.
9. Adequacy of the organization's employee fidelity bond coverage.
10. Adequacy of tile time accumulation records used to allocate pay-
roll costs among program categories.
11. Adequacy of procedures surrounding Ihe receil,I and dishurse-
ment of restricted gifts, bequests and contributions.
12. Adequacy of procedures surrounding control and collection of
pledges, whed~er or not formally record6d in the accounting records.
13. Adequacy of accounting control over grants from the government
or other organizations, including compliance with reporting reqtlire-
ments and allocation of overhead..
Other topics related to the independent accountants' services:
1. Steps taken by the independent accountants to ensure sufficient
continuity of their staff to enable the examination to be efficiently
conducted.
2. Steps taken by the independent accountants to ensure that staff
members at all levels are rotated in a systematic manner to provide
fresh ideas and approaches as well as to maintain the proper inde-
pendence of thought.
3. Services available through the independent accountants' firm
which enable them to effectively perform the audit of the organization
and to provide other assistance when necessary.
Cooperation of management:
1. All information requested by the independent accountants
promptly furnished.
2. Whether tl~¢, indcl..ndeut a('('otultalll~ ;ire satisfied that man.age-
ment advised them of ~hallers thai may have a bearing on the organi-
zation's financial posilion and activities for tile year.
3. Adequacy of improvemenls in Ihe syslem of internal control that
have been implemented as a result of recmnmendations made during
lite ct~rrenl or prior year's exanlinalion.
Meetings and agenda
Tile re,tuber of meetings to be held with the independent accountants
is a matter each at,dit committee should decide based on its particu-
lar circumstances. Our experience is that when a nonprofit organiza-
tion has an audit committee separate from its budget or finance com-
mittee, this committee meets once or twice a year. A planning
meeliug may I,c hchl alier the annmd ejection of directors. The meet-
lng to discuss the resuhs of the audit and the annual financial state-
menls shnohl he hehl immediately prinr to the board meeting at'
which tile financial statements will be approved.
The committee should request tile presence of the organization's
tnanagement or any others who could contribute substantially to the
meeting, l%r example, in a meeting dealing with disclosure of contin-
gent liabilities, it may he desirable to have legal counsel present for
the 15ortion of the meeting dealing with that subject.
lit preparing tile agenda for a meeting the chairman should solicit the
views of tile independent accountants, management and~gthers as to
subjects to be covered and may ask the assistance of one of these
groups in the preparation of a tentative agenda. If considered appro-
priate, the independent accountants and management should be
asked to provide (prior to the meeting) reports dealing with the
agenda topics. This allows committee members an opportunity for
In'Cl)aralion and ,'es~,lls in more informed discussions. At some point
during one or more of the meetings, it is desirable for the committee
to meet separately with management and with the independent ac-
countants in order to maintain a forum for discussing matters that
either mighl he reluctant to discuss freely with the others presenl.
The chairman should confirm with the audit partner and the chief
financial officer that they may call him if a problem arises that re-
quires the committee's attention.' The result of such a call may be a
special ineeting of the committee to deal with the matter.
il