The Role of Board Financial Monitoring Strength and Donor Pressure in Nonprofit Auditors’ Assessment of Changes in Program Expense Allocations

Abstract

SUMMARY Nonprofits face inherent risks from both donor pressure to increase program spending and a high propensity for reporting errors. Simultaneously, in contrast to for-profit settings, limitations of nonprofit governance can raise auditors’ concerns about a board’s effectiveness as a control mechanism. We experimentally examine how a nonprofit board’s stronger and weaker monitoring strength influences auditors’ assessments of a client’s program expense allocations under conditions of higher and lower donor pressure to increase program spending. Auditors assess management’s expense allocations as more appropriate, and document fewer risk factors, only when board financial monitoring is strong and donor pressure is lower. Further, auditors rely on strong boards to reduce errors, but not intentional misstatements related to management’s allocation of functional expenses. These findings suggest that, in contrast to how auditors use for-profit governance, auditors may question the ability of even strong nonprofit boards to mitigate instances of intentional functional expense allocation misreporting.