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Nonprofit Audit Committees by sammyc2007

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									                             Nonprofit Audit Committees:
                             Factors Associated with their Composition,
                             Meetings and Interactions with External Auditors




                                          Promoting Financial Stewardship in the Public Sector
                                               Government & Nonprofit Section Mid-year Meeting
                                                             American Accounting Association
                                                                   Cambridge, Massachusetts
•Thomas E. Vermeer, Ph.D., CPA                                                  April 1–2, 2005
   University of Baltimore
•Kannan Raghunandan, Ph.D., CMA
   Florida International University
•Dana A. Forgione, Ph.D., CPA, CMA, CFE
   Florida International University
     Corporate Failures, Governance and the NP Sector



• Recent corporate failures
   – Underscores the importance of governance as a public policy
     issue
• Role of Audit Committees
   – Has attracted significant attention from
      • Legislators
      • Regulators
      • Media
• Legislators and regulators
   – Have started to examine governance issues
      • In the Nonprofit (NP) sector
       Governance-Related Scandals in the NP Sector




• “A/Gs from California to Massachusetts are pursuing
  nonprofits and their board members with allegations that
  sound every bit as unsavory as the charges leveled
  against Enron Corp.” —Hempel & Borrus (2004)

• “Unfolding list of questionable dealings ... has caused
  public confidence in charities to plummet.” —Salmon
  (2002)
      Purpose




• Provide empirical evidence for large US NPs about their
  audit committees
   – Existence
   – Composition
   – Functioning
   Role of NPs in the National Economy




• NPs account for
  –   5.8% of all organizations in the US
  –   6.7% of national income
  –   7.1% of the workforce employment
  –   $665 billion in annual revenues
       Extension of the Provisions of SOX to NPs




• “At least 13 states are mulling new laws that apply SOX-
  type regulations to [non-profits]” —Hempel & Borrus
  (2004)
• A/G of California proposed that NPs must establish and
  maintain independent audit committees
• SOX viewed as de facto standard of best practice for
  NPs
   Contributions




• Provide
  – Descriptive evidence about audit committees of large NP
    organizations
• Use Resource Dependency framework to examine
  factors associated with
  – Audit committees’ composition
  – Meetings
  – Interactions with external auditors
       Audit Committee Issues Examined



• Audit committee composition
   – Independence:
       • SOX § 301 mandates that all members of the audit
         committee must be independent
   – Financial expertise:
       • SOX § 407 requires SEC registrants to disclose whether
         the audit committee has at least one financial expert
      Audit Committee Issues Examined



• Frequency of audit committee meetings
   – Treadway Commission (1987) noted that to be effective, audit
     committees must be diligent
   – Proxy: Number of audit committee meetings
• Length of audit committee meetings
   – Proxy: Time spent in audit committee meetings (Collier &
     Gregory 1999)
      Audit Committee Issues Examined



• Interaction with auditors
   – SOX § 301 mandates that audit committees “shall be directly
     responsible for appointment, compensation, and oversight”
   – SOX § 204 requires that auditors discuss accounting and
     financial reporting issues with audit committees
   – Examine:
       • Number of meetings per year
       • Whether audit committee
          – Has sole authority to hire the auditor
          – Meets privately with the auditor
     Development of Hypotheses


• Given absence of owners, Principal-Agent framework
  must be modified for NP setting
• Resource Dependency theory framework
   – NPs need for resources is a determinant of its structure and
     activities
• Expect resource differences in
   – Type
   – Composition
• Will be associated with differences in audit committee
   – Composition
   – Activities
   – Interactions with auditors
       Development of Hypotheses



•   Government grants
    – Receipt of government grants brings additional
      reporting and internal control requirements
       •    Leads to increased demand for monitoring
    – H1: NPs that receive governmental grants will be
      more likely to have audit committees with
       a)   Solely independent members
       b)   A financial expert
       c)   More frequent and longer audit committee meetings
       d)   Better interaction with external auditors
      Development of Hypotheses



•   Restricted donor funds
    – NPs with greater donor-restricted funds are likely to
      receive greater scrutiny from donors because donors
      want to ensure their funds are used for the intended
      purposes
    – H2: NPs with a greater proportion of their net assets in
      the form of restricted funds will be more likely to have
      audit committees with
       a) Solely independent members
       b) A financial expert
       c) More frequent and longer audit committee meetings
       d) Better interaction with external auditor
     Development of Hypotheses



•   Debt
    – Agency theory suggests that the existence of
      debt produces agency costs, and a demand for
      monitoring
    – H3: NPs that have long-term debt will be more
      likely to have audit committees with
       a) Solely independent members
       b) A financial expert
       c) More frequent and longer audit committee
          meetings
       d) Better interaction with external auditor
     Development of Hypotheses



• Auditor type
   – Organizations respond to the need for greater monitoring
     by selecting a higher quality auditor
   – Type of auditor and audit committee are substitute
     monitoring mechanisms
   – H4: NPs that have a Big 4 auditor will be no different from
     other NPs in terms of audit committees that have
      • Solely independent members
      • A financial expert
      • More frequent and longer audit committee meetings
      • Better interaction with external auditor
    Development of Hypotheses



• NP Organizational type
  – Hospitals and educational institutions tend to
    have greater complexity in their operations
    compared to other NP organizations
  – H5: NPs that are hospitals or universities will be
    more likely to have audit committees with
     •   Solely independent members
     •   A financial expert
     •   More frequent and longer audit committee meetings
     •   Better interaction with external auditor
    Development of Hypotheses




• Size
  – Larger organizations are more complex, and hence can
    have increased demand for monitoring
  – H6: NPs that are larger will be more likely to have audit
    committees with
     • Solely independent members
     • A financial expert
     • More frequent and longer audit committee meetings
     • Better interaction with external auditor
       Model



ACX = a0 + a1*SIZE + a2*GRANT + a3*FUNDBAL +
       a4*BONDS + a5*BIG4 + a6*HOSPTL + a7*UNIV

Where:
• ACX          = Audit committee related dependent variable
• SIZE         = Natural log of total assets
• GRANT        = 1 if NP reported government grants, 0 otherwise
• FUNDBAL      = Ratio of temporarily restricted + permanently
                 restricted fund balance to total fund balance
•   BONDS      = 1 if NP reported tax-exempt bond liabilities, 0 otherwise
•   BIG4       = 1 if audited by Big 4 accounting firm, 0 otherwise
•   HOSPTL     = 1 if NP is a hospital, 0 otherwise
•   UNIV       = 1 if NP is a university or college, 0 otherwise
     Data




• Survey of CFOs for the 1,000 largest NPs in
  GuideStar, Inc.
   – Received responses from 144 CFOs
   – Yielding 128 usable responses
• Financial data from GuideStar, Inc. database
• Non-response bias:
   – Included an early/late respondent variable
   – Examined whether the 128 usable respondents differed in
     any dimension from the other 872 CFOs for the largest
     1,000 non-profits
    NP Audit Committee Descriptive Data



• Audit Committees:
   – 96 of 128 (75%) had audit committee
   – 22 of 128 (17%) had similar committee
   – 10 had neither
• Mean number of members: 6.5
• All members of audit committee are independent: 76
  of 118 (64%)
• At least one CPA as a member: 68 of 118 (58%)
• Additional 36 (30%) had at least one other (non-
  CPA) member deemed a financial expert
       NP Audit Committee Descriptive Data




• Audit Committee meetings:
   – Mean number of per year: 4.5
   – Met three or less times per year: 52 of 118 (44%)
   – Mean length of meetings: 98.5 minutes
• Responsible for hiring external auditor and met privately
  with external auditor: 84 of 118 (71%)
• Mean number of meetings with external auditor per year:
  2.0
Regression Results:
  Solely Independent Members




•   Χ2 = 16.33; p < 0.05; Pseudo R2 = 0.09
•   SIZE: positive and significant (0.08)
•   GRANT: positive and significant (0.09)
•   BIG4: positive and significant (0.03)
•   HOSPTL: negative and significant (0.01)
•   UNIV: negative and significant (0.08)
•   Not significant:
    – FUNDBAL
    – BONDS
    Regression Results:
      At Least One CPA or Other Financial Expert



•   Χ2 = 15.25; p < 0.05; Pseudo R2 = 0.12
•   BIG4: positive and significant
•   HOSPTL: positive and significant
•   UNIV: positive and significant
•   Not significant:
     –   SIZE
     –   GRANT
     –   FUNDBAL
     –   BONDS
 Regression Results:
   Frequency and Length of Audit Committee Meetings




• Frequency of meetings
   – F = 1.10; p < 0.37; R2 = 0.06
   – None of the variables are significant
• Length of meetings
   – F = 1.38; p < 0.22; R2 = 0.07
   – GRANT: positive and significant (0.03)
   – BIG4: positive and significant (0.08)
    Regression Results:
      Number of Audit Committee Meetings with External Auditor




•    F = 4.00; p < 0.01; R2 = 0.21
•    SIZE: positive and significant (0.00)
•    FUNDBAL: positive and significant (0.01)
•    BIG4: positive and significant (0.08)
•    HOSPTL: positive and significant (0.05)
•    UNIV: positive and significant (0.00)
•    Not significant:
      – GRANT
      – BONDS
    Regression Results:
      AC Hires and Meets Privately with External Auditor



•    Χ2 = 12.66; p < 0.09; Pseudo R2 = 0.08
•    FUNDBAL: positive and significant (0.08)
•    BONDS: positive and significant (0.07)
•    HOSPTL: positive and significant (0.09)
•    Not significant:
      –   SIZE
      –   GRANT
      –   BIG4
      –   UNIV
     Conclusions




• Many NPs are yet to implement best practice
  guidelines with respect to audit committee
  composition
• Resource Dependency framework can help explain
  variations in NP audit committee practices
• Legislative one-size-fits-all requirements may not
  be appropriate for NP organizations
    Limitations and Suggestions for Future Research




• Survey-based study: self selection bias
• Concentration on large NP organizations
  – Future research should examine
     • Smaller NPs
     • NP audit committees across different countries
• Examine in more detail differences across
  different types of NPs and the possible
  reasons for observed differences
         Nonprofit Audit Committees:
         Factors Associated with their Composition,
         Meetings and Interactions with External Auditors




• Corresponding author:
   Thomas E. Vermeer, Ph.D., CPA

   Merrick School of Business
   University of Baltimore
   1420 North Charles Street
   Baltimore, MD 21201 USA
   Tel.: +1.410.837.5114
   Fax: +1.410.837.5722
   tvermeer@ubalt.edu
   www.ubalt.edu

								
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