CPAs' Role in Fighting Fraud in Nonprofit Organizations

By McNeal, Andrea; Michelman, Jeffrey | The CPA Journal, January 2006 | Go to article overview

CPAs' Role in Fighting Fraud in Nonprofit Organizations


McNeal, Andrea, Michelman, Jeffrey, The CPA Journal


Fraud in the nonprofit sector has been the object of increasing scrutiny by the U.S. Congress, notably the U.S. Senate Finance Committee, as well as by New York State Attorney General Eliot Spitzer. Recent studies indicate that frauds occur in nonprofits of all sizes and in every area of the country with astounding frequency. Furthermore, the cost of these frauds appears to be increasing at an alarming rate (see Exhibit I). With small organizations suffering the most extreme losses from fraud and embezzlements, small, community-based nonprofits must be especially diligent in enacting fraud prevention and detection measures. Specifically, good board governance and internal control policies in these organizations are imperative to prevent or mitigate the negative impacts of fraudulent activity within the organization. Financial officers and CPAs advising nonprofits also have a role to play in facilitating and ensuring effective internal controls.

Board Governance

The implications of the Sarbanes-Oxley Act (SOA) for all organizations are farranging. Typically, the boards of small nonprofit organizations tend to comprise a few volunteer community members that know each other well and have established a level of trust and rapport. Additionally, nonprofit boards frequently experience a high turnover of members, and individuals that volunteer are often untrained or unqualified to properly perform the oversight function. Combined, these factors can result in a board that is unwilling or unable to ask the tough questions necessary to detect financial mismanagement or fraud.

SOA requires public companies to establish an independent audit committee with the presence of at least one "financial expert." For nonprofits that undertake external audits, implementing this provision represents an opportunity to enhance the oversight function and strengthen the benefits received from the independent audit. Many small nonprofits, however, lack the resources to conduct a full audit, and therefore do not need a formal audit committee.

The role of a CPA volunteer, even if merely as an independent board member providing check-signing oversight, may be critically important in both substance and form. Small nonprofits should still consider retaining an independent accountant to perform a review or compilation of the entity's financial records to supplement any fraud detection activities. Furthermore, nonprofits that choose to forgo an external audit should at least establish an independent finance committee to oversee the organization's financial employees and transactions.

Given the high turnover of board members and officers, as well as the volunteer nature of these positions, small nonprofits may experience difficulty finding volunteers with adequate business and financial qualifications. Furthermore, the turnover of these individuals makes continuity of oversight and fiscal initiatives more difficult. Nonetheless, nonprofits should attempt to engage "financial experts," or at least financially knowledgeable individuals, to serve on the finance committee. Active involvement of such individuals in the oversight function may provide additional scrutiny and accountability for the financial officers and employees and therefore aid in not only detecting, but also deterring, fraudulent activity. Although nonprofits may be stratified into perhaps three categories-those receiving no CPA services, those using CPAs to complete a review, and those using a CPA to complete a full audit-the role of the CPA remains important in all three instances.

Internal Control Issues

The classic fraud triangle (Exhibit 2) illustrates the three factors that are necessary for a fraud to occur: pressures or incentives, rationalization, and opportunity. Although the convergence of these factors is what ultimately results in frauds, organizations can address the opportunity component, and thus reduce the likelihood of fraudulent activity, by establishing adequate internal controls. …

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