The Importance of an Annual Financial Audit in Emergency Services

March 26, 2012

By John P. Tucker, CNAP, Director of Finance, Firemen’s Association of the State of New York

Reprinted with permission from The Volunteer Firefighter

The fire service is extremely diverse. Some fire service organizations deal with hundreds of millions of dollars each year, whereas others’ budgets are only in the thousands. But regardless of size and scope, one of the many commonalities that all in the fire and emergency services should be concerned with is financial governance. In fact, many organizations still need to be convinced that they need an annual financial audit. For fire service organizations that are exploring the implementation of an annual financial audit — or for those with ongoing audits — it is extremely important for all to understand the importance an effective annual financial audit plays in fire and emergency service organizations.

Greater focus has been placed on financial governance of nonprofits, including the nonprofits in the emergency services sector. Ever since the Office of the State Comptroller gained the authority to examine the financial affairs of a fire company in 2007, specific requirements were laid out for fire companies and their auditors regarding assurances that must be provided on internal controls. Many members of the accounting community and the public at large are now saying that these same rules should apply to all nonprofits included in the emergency services sector, citing a greater focus on stronger fiscal accountability.

These factors, along with frequent criticism of emergency service nonprofits for having weak internal controls due to lack of understanding, staffing, poor training, and the lack of segregation of financial duties, have now moved the emergency services sector to attempt to compensate by establishing effective annual financial audits. This development has thrust emergency service individuals who typically may not be financial watchdogs into a realm in which they may not be familiar or comfortable.

Today, the annual financial audit has become a key aspect of many in the emergency service sector that exhibit good financial governance and adequate internal control. A critical function of the annual financial audit is to review an organization’s financial reports, internal controls, and risk-management procedures.

To carry out the function, the person(s) responsible for the financial audit should meet with the organization’s directors, officers, and treasurer to gain an understanding of the significant risks and exposures facing the organization. It is also important to understand how the organization is reducing its exposure through adequate financial reports, internal controls, and the annual financial audit.

Boards, officers, treasurers, and the auditor need to understand the differences between emergency service nonprofits and other types of organizations to serve effectively. These differences include:

• an emergency service nonprofit’s focus is to achieve a community  mission or a vision rather than to gain profit;
• an emergency service nonprofit’s funding and support comes from the public, fundraising, foundations, and government rather than customers and clients;
• an emergency service nonprofit usually operates under a tax-exempt status versus paying taxes; and
• an emergency service nonprofit has an obligation to the public and donors rather than stockholders to acquire, manage, and allocate financial resources to accomplish its community mission, and make available effective financial reports of its efforts.

The annual financial audit becomes an extension of the board and the treasurer to assure that proper financial reporting and fiscal management are in place. Both the board members and the treasurer have the same “duty of care” (or fiduciary duty) benchmark to meet, which is to exercise the level of care “that an ordinary prudent person would exercise in a like position under similar circumstances.”

The auditor(s) should be considered “financially literate.” The criteria to consider are that he or she must:

• understand financial statements,
• understand financial risks,
• understand the impact of decisions on the financial statements,
• be able to identify financial risks, and
• understand how risk can affect the reputation of the organization in the community it serves.

If that type of person does not exist within the emergency service organization, then an outside consultant should be retained to fill the void. A critical consideration is to determine that the auditor(s) can be independent to ensure an objective and impartial audit and to ensure that there are no conflicts of interest.

An annual financial audit will help all nonprofit emergency service organizations meet their accountability goals to the community it serves and benefits the organization with:

• improved financial practices and reporting,
• better deterrents to fraud, and
• enhanced external and internal audit functions.

Even in such a diverse world as the nonprofit emergency services sector, there remain the common issues of fiscal responsibility. Good financial governance is one way to enable the emergency service nonprofits meet their commitment of community service.