A Quick, Non-Expert Tutorial on Audits

Audits may not interesting to anyone but accountants, but I’ve just started serving on the Finance Committee for a local faith-based group, and I’ve realized that there are a few things everyone should know. So, below are some basics everyone should know.

First, let me start by saying that I’m not an expert. If you want a good resource written by experts, consult Church Finance: The Complete Guide to Managing Ministry Resources, by Michael Batts, CPA and Richard Hammar, JD, LLM, CPA.

1. Why an external audit?

It seems as if an instance of embezzlement is reported every few weeks in the local news – usually having affected a small civic or school group. An external audit provides the reassurance we all need regarding the reliability of a congregation’s financial statements. Even when a congregation is too small to be able to afford an annual external audit and chooses instead to conduct informal internal reviews most years, it should still conduct an external audit periodically, and especially at times of transition such as when a new senior minister is being called or a loan is being sought.

2. What does an audit include?

An auditor will provide:

• An opinion on the financial statements
• Audited financial statements, including notes and disclosures
• A management letter or report addressing material weaknesses or significant deficiencies
• A report on the audit process itself, including any difficulties in performing it.

These elements should all be present. If all you see is a financial statement with no accompanying management report, for example, you’re not seeing the whole audit. In my experience, the audit also includes a face-to-face meeting between the auditor and the board. It is not sufficient for the auditor to meet only with the senior minister and/or other staff, as this does not provide the board with the knowledge it needs in order to meet its fiduciary duty of careful oversight of the organization’s finances. If no one on the board is hearing directly from the auditor, you should ask why.

3. What kind of committee manages the audit process?

In a perfect world, every congregation will have an Audit Committee that is separate from the congregation’s Finance Committee and is not controlled by or unduly influenced by the senior minister or other staff. Members of the Audit Committee should also be independent from the normal functioning of the organization’s financial systems. The Audit Committee ensures that an annual audit happens, seeks bids from and makes recommendations regarding the engagement of an auditing firm, and reviews the audit with the auditor prior to its going to the board. It is helpful if at least one member of an Audit Committee is trained as an accountant.

4. What are material weaknesses and significant deficiencies?

The management report will include a section on whether the auditor found any of the dreaded “significant deficiencies” or “material weaknesses.” A “significant deficiency” has to do with an organization’s internal controls, and it exists when the controls do not normally allow management or employees to prevent or detect misstatements of the congregation’s financials. Especially in smaller congregations, these kinds of deficiencies often arise when there aren’t enough personnel to sufficiently segregate financial duties. For example, the same person is often expected to both write checks and reconcile bank accounts, which creates the potential for embezzlement. A significant deficiency is noted when the auditor thinks a problem is important enough to be brought to the attention of the board. The more severe “material weakness” is determined to exist when there is a more than remote likelihood that a material misstatement of the financials will not be prevented or detected. The point is that these are not good. Ideally, both should be corrected when they are identified.

5. What, then, are internal controls?

Internal controls are “the checks and balances that protect the church from intentional or unintentional acts that could cause a loss of the church’s financial assets or that could result in misreporting of the church’s financial information” (Batt and Hammar, p. 186). In other words, internal controls are the processes and procedures we create to keep bad things from happening to good congregations’ assets. Good internal controls typically include the following, but I recommend a conversation with an accountant regarding your congregation’s specific needs:

• Conducting background checks before hiring financial staff
• Hiring financial staff who are trained in accounting procedures
• Providing the resources for additional training when it is needed
• Requiring that the person physically handling incoming funds and preparing the deposit be different from the person who posts deposits to the accounting or donor records
• Insuring that no single person has the authority to initiate and complete a cash disbursement
• Insuring that no single person is responsible for all phases of payroll processing

Congregations should be willing to invest in trained, and hence more highly paid, financial staff if they want to ensure member trust, but it will still be true that most congregations, because they are small, won’t have enough staff to create the ideal system of internal controls. In such cases, congregations may want to make use of trusted lay leaders to provide additional review of financial procedures (for instance, asking the treasurer to review cash disbursement activity online) or they may want to outsource some of the accounting and payroll functions to accounting firms.

Anyone who’s been through an external audit will tell you that they’re a bit of a trial – they take time and an annoying level of attention to detail for those of us who don’t like details. However, they help to create the culture of trust and transparency to which every congregation should aspire. We want to do the very best that we can with the assets our members entrust to us so that we can achieve our mission and goals. If we’re not clear about our mission and transparent about our assets, then we shouldn’t be surprised when our members go.