ECFA Standard 3 - Financial Oversight

"Every organization shall prepare complete and accurate financial statements. The board or a committee consisting of a majority of independent members shall approve the engagement of an independent certified public accountant, review the annual financial statements, and maintain appropriate communication with the independent certified public accountant. The board shall be apprised of any material weaknesses in internal control or other significant risks."

The financial statements (and the disclosure of the financial statements) are key components of transparency, both within the ministry and to donors and the public. This flows directly from biblical principles: “This is the verdict:  Light has come into the world, but men loved darkness instead of light because their deeds were evil. Everyone who does evil hates the light, and will not come into the light for fear that his deeds will be exposed” (John 3:19–20 NIV).

Transparency serves to deter improper diversion of funds and other misdeeds. It also provides a defense to critics and a witness to both believers and nonbelievers. When Jesus was arrested, He said to the crowd, “Am I leading a rebellion, that you have come out with swords and clubs to capture me? Every day I sat in the temple courts teaching, and you did not arrest me” (Matthew 26:55 NIV). The openness of His public actions revealed a significant contrast to His middle-of-the-night arrest.

The Apostle Paul, too, did his deeds openly. He cites this fact as one basis for his authority over the Thessalonians. “You are witnesses, and so is God, of how holy, righteous, and blameless we were among you who believed” (1 Thessalonians 2:10 NIV). Being transparent with one another assures credibility and authority.

Financial oversight.  As part of its mandate for financial accountability, the board of an ECFA member or its authorized committee shall approve the engagement of an independent certified public accountant to perform the annual audit, review, or compilation. 

The board shall review the financial statements prepared by an independent certified public accountant (CPA) and any other reports prepared by the accountant. The board may also receive reports and recommendations from a board committee relative to the financial statements and related reports. The board shall be apprised of any significant deficiencies, material internal control weaknesses, or significant risks. In response, the organization should develop appropriate responses to the deficiencies, weaknesses, or risks.

The board shall maintain appropriate communication with the independent CPA. This communication may relate to planning and carrying out the engagement with respect to the annual audit, review, or compilation of the financial statements, the management letter, or other related matters.

Audits, reviews, and compilations.  The annual audit by an independent CPA firm—required for certain ECFA member organizations—helps ensure, and is evidence of, financial accountability to an organization’s constituencies. The independent auditor tests the data underlying the financial statements to form an opinion on the fairness of their presen­tation in accordance with U.S. generally accepted accounting principles (GAAP). The auditor’s standard report provides reasonable assurance that the financial statements are free of material misstatements. Knowing they can rely on the accuracy of the organization’s financial statements, the board and management can make wise and perceptive policy decisions. Note: Obtaining an audit may be required to comply with state law.

An annual review by an independent CPA firm is permitted for certain ECFA member organizations and provides limited assurance of the reasonableness of the financial statements presented. Although not as compre­hensive as an audit, a review provides more assurance on the financial statements than a compila­tion. A review report states that: 1) the accountants do not express an opinion on the financial statements, and 2) based on their review, they are not aware of any material modifica­tions that should be made to the financial statements.

The annual compilation by an independent CPA firm, permitted for certain ECFA member organizations, is simply the gathering of financial information and the development of financial statements for an organization. (An otherwise independent CPA firm that performs outsourced accounting functions for the organization meets this requirement.)  A compilation involves no assurance on the financial statements, as the accountant merely assembles the financial statements for the organization. The independent CPA’s participation with the financial statements will often help stakeholders feel that the statements are prepared with knowledge of applicable standards.

For compilations and reviews, the independent CPA must present the compiled or reviewed financial data according to GAAP or on the modified cash basis of accounting. If the modified cash basis of accounting is used, the financial statements must include the recognition of property and equipment as assets, depreciation as expense, and debt, other than trade payables and ordinary accruals, as liabilities. 

See the sections below describing ECFA's specific requirements for financial statements prepared by independent CPAs.

Federal laws governing tax-exempt organizations do not require audits unless federal funds are provided. However, many states, boards, and resource providers (such as donors, foundations, and financial institutions) see the involvement of an independent CPA firm as an essential and truly wise investment.

Obtaining a quality audit, review or compilation of financial statements. The professional bodies governing the practice of CPAs (including State Boards of Accountancy, State CPA Societies, and the American Institute of Certified Public Accountants) have sought to improve quality and require reviews of CPAs. Even with these rigorous efforts, however, not all audits, reviews, or compilations are created equal. The following factors directly impact the quality of this work:

  • the experience level of personnel assigned to the engagement (a higher ratio of qualified partner and manager time will normally increase quality and some of the value-added benefits),
  • the experience of assigned personnel with similar nonprofit organizations and the competencies of the personnel, as well as the extent of time devoted to nonprofit audit, review, and compilation and advisory services,
  • the emphasis and priority of the CPA firm on nonprofit audits, reviews, or compilations,
  • the firm’s commitment to competency and continuity of the engagement team from year to year to provide audit, review, or compilation efficiency and a high level of knowledge about the organization resulting in cost-effective services,
  • reasonable engagement fees that allow adequate time and attention to perform quality service and value-added benefits—unreasonably low fees may lower the services to the minimum requirements of professional standards.

Selection of a CPA firm. Some organizations routinely request proposals from different CPA firms to evaluate the cost of their audit, review, or compilation. While it is important to be certain that the cost is reasonable in light of the quality and value of an audit, focusing too much on cost can be detrimental to the health of the audit and ultimately to the organization.

If an organization truly values the audit, review, or compilation and desires the benefits that can come from an independent firm in helping it assess its performance, maintain best practices, and anticipate and avoid problems, then cost should be secondary to quality. Value is a correlation of both quality and cost.

Initial screening of potential CPA firms may be based solely on their industry experience; professional qualifications; expertise of the engagement team; and ability to provide the highest quality and best value of audit, review, or compilation services. Following that screening, the cost of the services can be better assessed as to true “value,” leading to a selection that is prudent based on both quality and cost.

Rotation of CPAs. The rotation of CPAs may not be the key to effectiveness of services and in some cases may actually be counterproductive. Expertise in the respective industry coupled with objectivity may be the most important aspect.

The board, or a committee consisting of a majority of independent members, should annually assess the performance and effectiveness of the independent CPA firm and its engagement team. This should include, but not be limited to: considering the CPA team’s objectivity; assessing key risk areas; evaluating the strategy for the services—including its scope and the nature of testing, if appropriate; innovative thinking rather than reliance on prior results and assumptions; maintaining professional skepticism; and understanding relationships that could impair objectivity.

CPA independence. The board should be certain that the CPA firm is independent and objective in performing its duties. The board should identify any threats to such objectivity and analyze the significance of such threats. Objectivity does not require that the CPA firm is completely free of all factors that might affect the ability to make unbiased audit decisions but rather that the CPA firm is free from those factors that rise to the level of compromising that ability.

Factors that may pose threats to independence and objectivity include self-interest (CPA acts in his or her own emotional, financial, or other personal interest), self-review (CPA audits, reviews, or compiles his or her own work or the work of a colleague), and familiarity (CPA is influenced by a close relationship with a client). The following may constitute a conflict of interest for the CPA: 1) performance of management functions, 2) close family relationships, or 3) financial involvement in other service providers or investments. If a CPA serves on the board or is an employee of an organization for which the CPA is providing services, the CPA is not considered by ECFA as independent with respect to the organization.

ECFA permits CPAs who perform outsourced accounting for an organization to also prepare its compiled financial statements. In these situations, the compilation must include an explanatory note regarding the reason the CPA lacks independence. For all other audits, reviews, and compilations, CPAs must be entirely independent with respect to the organization to comply with this standard.

Auditing standards.  Auditing standards generally accepted in the United States of America (GAAS) are policies, guidelines, and procedures that an auditor is required to follow in performing an audit in order to render an opinion on an organization’s financial statements. This series of pronouncements is set forth by the American Institute of Certified Public Accountants (AICPA). Among many factors to be considered is the “scope” of the audit, which neither the organization nor the particular circumstances of its operations should limit.

Accounting principles.  Accounting principles generally accepted in the United States of America (GAAP) are those written principles established by the Financial Accounting Standards Board (FASB), the AICPA, and other published literature. These principles set forth the way specific transactions should be reported; e.g., investments should be reported at fair value, while property and equipment should be reported at depreciated cost. In contrast to other forms of accounting, such as the modified cash basis, GAAP financial statements are prepared on the accrual basis. Certain standards and disclosures are required additionally.

Review and compilation standards.  Statements on standards for accounting and review services (SSARS) are policies, guidelines, and procedures that a CPA is required to follow in performing a compilation or review. This series of standards is set forth by the AICPA. These standards establish the relationship, level of care, and procedures to be established by the CPA firm conducting the compilation or review services for an organization. 

Presentation of financial statements to satisfy ECFA requirements.  For ECFA purposes, a complete set of financial statements of a nonprofit organization shall include:

  • a statement of financial position as of the end of the reporting period (also referred to as a balance sheet),
  • a statement of activities for the reporting period (also referred to as a statement of revenues and expenses),
  • expenses reported by their functional classification in the statement of activities, a statement of functional expenses, or the notes to the financial statements,
  • a statement of cash flows for the reporting period, and
  • accompanying notes to the financial statements.

Summary.  Financial statements prepared by an independent CPA, with the CPA approved by the board, are a key element in informing donors and other constituencies about the organization’s financial affairs and its worthiness to receive support.


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