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Audit committee

 
Accounting Dictionary: Audit Committee
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Body formed by a company's board of directors to oversee audit operations and circumstances. It selects and appraises the performance of the CPA firm. In accordance with Securities and Exchange Commission (SEC) regulation, the Committee must be composed of outside directors. Besides evaluating external audit reports, the Committee may evaluate internal audit reports as well. Management representations under the realm of the Foreign Corrupt Practices Act are also reviewed. The Committee may also get involved with public disclosure of corporate activities.

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Business Encyclopedia: Audit Committees
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Audit committees are a key institution in the context of corporate governance because they help boards of directors fulfill their financial and fiduciary responsibilities to shareholders. Through their audit committees, boards of directors establish a direct line of communication between themselves and the internal and external auditors as well as the chief financial officer. Such an organizational structure and reporting responsibility in an environment of free and unrestricted access enables full boards of directors not only to gain assurance about the quality of financial reporting and audit processes, but also to approve of significant accounting policy decisions. Moreover, strong and effective audit committees, through their planning, review, and monitoring activities, can recognize problem areas and take corrective action before such problems impact the company's financial statements and investors. Thus, audit committees have an important role in helping boards of directors avoid litigation risk because such committees provide due diligence related to financial reporting.

Requirement for Audit Committees

Audit committees have long been seen as an important group in assuring greater corporate accountability in the United States. The value of such committees has been noted by the U.S. Congress, the U.S. Securities and Exchange Commission, the New York Stock Exchange, and the American Institute of Certified Public Accountants. Audit committees are required by the New York Stock Exchange, American Stock Exchange, and National Association of Securities Dealers (NASDAQ/NMS issuers).

Key recommendations and decisions in the evolution of audit committees in the United States include the following

1940
The Securities and Exchange Commission (SEC) recommended the establishment of audit committees (Accounting Series Release No. 19). Specifically, the SEC recommended that shareholders elect the auditors at annual meetings and a committee of nonofficer directors nominate the auditors. Also, the New York Stock Exchange Board of Governors issued a similar recommendation.
1967
The executive committee of the American Institute of Certified Public Accountants (AICPA) recommended that publicly held corporations establish audit committees to nominate the auditors and discuss the audit.
1972
The SEC issued Accounting Series Release No. 123, "Standing Audit Committees Composed of Outside Directors."
1973
The New York Stock Exchange (NYSE) issued a white paper, "Recommendations and Comments on Financial Reporting to Shareholders and Related Matters," strongly recommending that each listed company form an audit committee.
1974
The SEC amended Regulation 14A dealing with the proxy rules. Registrants are required to disclose in their proxy statements the existence of audit committees and the names of the committee members.
1977
A NYSE audit committee policy statement required each domestic corporation listed on the exchange to establish and maintain an audit committee of outside directors before July 1, 1978.
1987
The National Commission on Fraudulent Financial Reporting recommended that the SEC require that all public companies have audit committees.
1987
The National Association of Securities Dealers required each NASDAQ/NMS issuer to establish an audit committee.
1991
Congress passed the Federal Deposit Insurance Corporation Improvement Act. The law provided for the establishment of audit committees for insured depository institutions that have total assets of $150,000,000 or more.
1993
American Stock Exchange required its listed companies to establish audit committees.
1994
The American Law Institute issued Principles of Corporate Governance: Analysis and Recommendations. The Institute strongly supported and endorsed the concept of audit committees.
1999
The Independence Standards Board issued its first standard, "Independence Discussions with Audit Committees," which requires independent auditors to issue an annual independence confirmation to the audit committee of the company.
1999
The SEC approved changes to its rules to implement several of the recommendations by the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees. Registrants are required to disclose information about audit committee composition and practices.

In addition to the presence of audit committees on U.S. stock exchanges, a number of stock exchanges in Canada, Europe, Africa, the Middle East, and the Asia/Pacific region have adopted audit committees. As worldwide financial markets expand and more companies are listed on major stock exchanges in different countries, the international investing public's demand for consistent and equal oversight protection through the use of audit committees will continue. In addition, international investors are concerned about the quality of corporate governance because of the impact of financial collapses and alleged frauds on securities markets.

In response, a number of stock exchanges have adopted audit committees to increase transparency and competence in the management of their listed member companies in order to deal effectively with attracting foreign equity investment.

Organization and Structure of Audit Committees

Boards of directors form their audit committees by either passing a board resolution or amending corporate bylaws. Audit committees' responsibilities should be clearly defined and documented in their charter. Although the scope of the audit committees' responsibilities is predetermined by boards, the committees should be allowed to expand their charge with board approval and investigate significant matters that impact financial reporting disclosures.

Boards of directors should carefully give consideration to the following points with respect to their appointments of directors to audit committees:

  1. Number of directors: The number of independent directors appointed to audit committees depends on the nature of the business and industry dynamics, the size of the company, and the size of the board of directors. The general consensus seems to be that three to five members are adequate.
  2. Composition: Because members of audit committees have varied backgrounds and occupations, they provide a mix of skills and experience. Although the members have different levels of expertise, it is strongly advisable to have at least one individual who has a financial accounting background.
  3. Meetings: Audit committees meet from one to four times each year, with three or four meetings being the most common schedules.

Nature of Audit Committees Responsibilities

Boards of directors define the role and responsibilities of their audit committees. This jurisdictional charge is usually disclosed in the audit committees' written charter, which includes the terms of reference, such as mission statement, membership (size and composition), term of service, frequency of meetings, scope of responsibilities, and reporting responsibilities. Audit committees are primarily responsible for the quality related to such matters as:

  • External auditing process
  • Internal auditing process
  • Internal controls
  • Conflicts of interest (code of corporate conduct, fraud presentation)
  • Financial reporting process
  • Regulatory and legal matters
  • Other matters (interim reporting, information technology, officers' expense accounts)

Although boards of directors have defined the responsibilities of audit committees, boards may expand the scope of the audit committees' charter; however, boards should avoid diluting the committees' charge with information over-load. Recognizing that audit committees operate on a part-time basis and serve in an advisory capacity to boards, it is essential that boards place limitations on the scope of the committees' charge. Such a scope limitation enables boards to evaluate the committees' performance as well as protect the committees against legal claims for their inactions that are outside their charge. An illustration of the roles and responsibilities of audit committees is disclosed in the annual proxy statement of a company.

Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees

On September 28, 1998, Arthur Levitt, chairman of the SEC, presented an address at the New York University Center for Law and Business entitled "The Numbers Game." He discussed matters related to the issues involving the quality of financial reporting (e.g., earnings management, reserves, audit adjustments, revenue recognition, creative acquisition accounting, in-process research and development, and restructuring charges). Because these issues impact a firm's quality of earnings and market capitalization (e.g., price-earnings ratios), Levitt requested a response from the entire financial community.

In response to Levitt's concerns, in October 1998, the New York Stock Exchange and the National Association of Securities Dealers created the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees. In February 1999, the committee issued its report, which contains ten recommendations designed to (1) strengthen the independence of audit committees; (2) increase the effectiveness of audit committees; and (3) improve the relationship between boards and their audit committees the activities of auditors and management. In December 1999, the SEC approved changes to its rules to implement several of the Blue Ribbon Committee's recommendations with respect to audit committee composition and practices.

In view of the aforementioned recommendations of the Blue Ribbon Committee, it is clearly evident that the scope for the responsibilities of audit committees will significantly increase. Therefore, it is essential that audit committees engage in an active continuous educational improvement program to help their boards discharge their fiduciary responsibilities to share holders.

The duties of the Audit Committee are (a) to recommend to the Board of Directors a firm of independent accountants to perform the examination of the annual financial statements of the Company; (b) to review with the independent accountants and with the Controller the pro posed scope of the annual audit, past audit experience, the Company's internal audit program, recently completed internal audits and other matters bearing upon the scope of the audit; (c) to review with the independent accountants and with the Controller significant matters revealed in the course of the audit of the annual financial statements of the Company; (d) to review on a regular basis whether the Company's Standards of Business Conduct and Corporate Policies relating thereto has been communicated by the Company to all key employees of the Company and its subsidiaries throughout the world with a direction that all such key employees certify that they have read, understand and are not aware of any violation of the Standards of Business Con duct; (e) to review with the Controller any suggestions and recommendations of the independent accountants concerning the internal control standards and accounting procedures of the Company; (f) to meet on a regular basis with a representative or representatives of the Internal Audit Department of the Company and to review the Internal Audit Department's Reports of Operations; and (g) to report its activities and actions to the Board at least once each fiscal year.

(See also: Auditing; Securities and Exchange Commission)

Bibliography

American Institute of Certified Public Accountants. (1978). Audit Committees, Answers to Typical Questions About Their Organization and Operations. New York: Author.

American Law Institute. (1994) Principles of Corporate Governance: Analysis and Recommendations. Philadelphia, PA: Author.

Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees. (1999). Report and Recommendations of the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees. New York: New York Stock Exchange and Washington, DC: National Association of Securities Dealers.

Braiotta, L. (1986). "Audit Committees: An International Survey." The Corporate Board May/June: 18-23.

Braiotta, L. (1994). The Audit Committee Handbook. New York: Wiley.

Bristol-Myers Squibb Company. (1999). Notice of 1999 Annual Meeting and Proxy Statement. New York: Author.

National Commission on Fraudulent Financial Reporting. (1987). Report of the National Commission on Fraudulent Reporting. Washington, DC: Author.

New York Stock Exchange. (1983). "Corporate Responsibility: Audit Committee, Sec. 303.00." In New York Stock Exchange Listed Company Manual. New York: Author.

Securities and Exchange Commission. (1999). Audit Committee Disclosure, Release No. 34-42266. Washington, DC: Author.

[Article by: LOUIS BRAIOTTA, JR.]

Wikipedia: Audit committee
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In a U.S. publicly-traded company, an audit committee is an operating committee of the Board of Directors charged with oversight of financial reporting and disclosure. Committee members are drawn from members of the company's board of directors, with a Chairperson selected from among the committee members. A qualifying audit committee is required for a U.S. publicly-traded company to be listed on a stock exchange. To qualify, the committee must be composed of independent outside directors with at least one qualifying as a financial expert. Audit committees are typically empowered to acquire the consulting resources and expertise deemed necessary to perform their responsibilities. The role of audit committees continues to evolve as a result of the passage of the Sarbanes-Oxley Act of 2002. Many audit committees also have oversight of regulatory compliance and risk management activities. Not for profit entities may also have an audit committee.

Contents

Responsibilities

Boards of Directors and their committees rely on management to run the daily operations of the business. The Board's role is better described as oversight or monitoring, rather than execution. Responsibilities of the audit committee typically include:[1][2]

  • Overseeing the financial reporting and disclosure process.
  • Monitoring choice of accounting policies and principles.
  • Overseeing hiring, performance and independence of the external auditors.
  • Oversight of regulatory compliance, ethics, and whistleblower hotlines.
  • Monitoring the internal control process.
  • Overseeing the performance of the internal audit function.
  • Discussing risk management policies and practices with management.

The duties of an audit committee are typically described in a committee charter, often available on the entity's website.[3]

Role in oversight of financial reporting and accounting

Audit committees typically review financial reports quarterly and annually in publicly-traded companies. In addition, members will often discuss complex accounting estimates and judgments made by management and the implementation of new accounting principles or regulations. Audit committees interact regularly with senior financial management such as the CFO and Controller and are in a position to comment on the capabilities of these managers. Should significant problems with accounting practices or personnel be identified or alleged, a special investigation may be directed by the audit committee, using outside consulting resources as deemed necessary.

External auditors are also required to report to the committee on a variety of matters, such as their views on management's selection of accounting principles, accounting adjustments arising from their audits, any disagreement or difficulties encountered in working with management, and any identified fraud or illegal acts.[4]

Role in oversight of the external auditor

Audit committees typically approve selection of the external auditor. The external auditor (also called a public accounting firm) reviews the entity's financial statements quarterly and issues an opinion on the accuracy of the entity's annual financial statements. Changing an external auditor typically also requires audit committee approval. Audit committees also help ensure the external auditor is independent, meaning no conflicts of interest exist that might interfere with the auditor's ability to issue its opinion on the financial statements.

Role in oversight of regulatory compliance

Audit committees discuss litigation or regulatory compliance risks with management, generally via briefings or reports from the General Counsel, the top lawyer in the entity. Larger corporations may also have a Chief Compliance Officer or Ethics Officer that report incidents or risks related to the entity's code of conduct.

Role in monitoring the internal control process

Internal control includes the policies and practices used to control the operations, accounting, and regulatory compliance of the entity. Management and both the internal auditing function and external auditors provide reporting to the audit committee regarding the effectiveness and efficiency of internal control.

Role in oversight of risk management

Organizations have a variety of functions that perform activities to understand and address risks that threaten the achievement of the organization's objectives. The policies and practices used by the entity to identify, prioritize, and respond to the risks (or opportunities) are typically discussed with the audit committee. Having such a discussion is required for listing on the New York stock exchange. Many organizations are developing their practices towards a goal of a risk-based management approach called Enterprise risk management. Audit committee involvement in non-financial risk topics varies significantly by entity. Dr. Ram Charan has argued for risk management early warning systems at the corporate board level.[5]

Impact of the Sarbanes-Oxley Act of 2002

The Sarbanes-Oxley Act of 2002 increased audit committees’ responsibilities and authority. It raised membership requirements and committee composition to include more independent directors. Companies were required to disclose whether or not a financial expert is on the Committee. Further, the Securities and Exchange Commission and the stock exchanges proposed new regulations and rules to strengthen audit committees.

History

Below are a few key milestones in the evolution of audit committees[6]:

  • 1939: The New York Stock Exchange (NYSE) first endorsed the audit committee concept.
  • 1972: The U.S. Securities and Exchange Commission (SEC) first recommends that publicly held companies establish audit committees composed of outside (non-management) directors.
  • 1977: NYSE adopts a listing requirement that audit committees be composed entirely of independent directors.
  • 1988: AICPA issues SAS 61 "Communication with Audit Committees" addressing communications between the external auditor, audit committee and management of SEC reporting companies.
  • 1999: NYSE, NASD, AMEX, SEC and AICPA finalize major rule changes based on Blue Ribbon Committee on Improving the Effectiveness of the Corporate Audit Committee.
  • 2002: Sarbanes-Oxley Act is passed in the wake of corporate scandals and includes whistleblower and financial expert disclosure requirements for audit committees.

Best practices

Managing the audit committee's agenda

Audit committees typically use a full year agenda to ensure coverage of the various topics they are required to address. The agenda for each meeting, which is typically quarterly or more often, is then adjusted as necessary. Establishing the agenda is a collaborative effort between the Board, senior management, legal counsel, and both the internal and external auditors. It is important that the committee have its own perspective on what key issues it should address and these should be reflected in the agenda.

Frequency of interaction with management

Many audit committee chairpersons conduct interim calls with key members of management between quarterly meetings. Key contacts may include the CEO, CFO, Chief Auditor, and external audit partner. Many boards also schedule dinners prior to formal meetings that allow informal interaction with management. Some companies also require their boards to spend a certain amount of time learning their operations beyond board meeting attendance.

Executive sessions

These are formally scheduled private meetings between the audit committee and key members of management or the external auditor. These meetings typically are unstructured and provide the opportunity for the committee to obtain the feedback of these managers in private. A key question audit committee members ask in such sessions is: "Is there anything you would like to bring to our attention?"

Evaluation

Audit committees should complete a self-evaluation annually to identify improvement opportunities. This involves comparing the committee's performance versus its charter, any formal guidelines and rules, and against best practices. Such a review is confidential and may or may not include evaluations of particular members.[7]

Survey results

Various consulting and public accounting firms perform research on audit committees, to provide benchmarking data.[6][8][9]Some results are identified below:

  • 54% of committee members surveyed felt the audit committee was "very effective," while 38% indicated "somewhat effective."
  • Risk management, internal control, and accounting estimates and judgments were the top priority areas for 2007.
  • Most audit committees have 3-4 members and are usually chaired by persons with experience as a CFO, external auditor, or CEO.
  • Audit committees meet 6-10 times per year, either face-to-face or via teleconference, with the former lasting from 1-4 hours and the latter 1-2 hours.
  • Audit committee members devoted 50-150 hours to their responsibilities each year.
  • The percentage of audit committees with oversight responsibility for: IT compliance (66%), business continuity (50%), and information security(45%).
  • 41% were "very satisfied" with the internal audit function, while 52% were "somewhat satisfied."
  • Two-thirds felt the Chief Internal Audit position was for a professional internal auditor, rather than as a "stepping stone" to other roles.
  • 93% indicated the audit committee was "somewhat" or "much more" effective since the Sarbanes-Oxley Act was implemented in 2002.
  • 58% of committee members were "somewhat satisfied" that they understood management's processes to identify and assess significant business risks.
  • Only 17% of audit committees had primary responsibility for oversight of non-financial risk; the full board had this responsibility in 56% of companies.

References

  1. ^ AICPA "The Audit Committee Toolkit" New York; 2004.
  2. ^ CPA Journal AC Responsibilities
  3. ^ Sample Charter
  4. ^ "Audit Committee Effectiveness: What Works Best-2nd Edition." Institute of Internal Auditors and Price Waterhouse. Altamonte Springs, FLA; 2000.
  5. ^ Charan, Ram (2005). Boards That Deliver. Jossey Bass. ISBN 978-0787971397. 
  6. ^ a b KPMG AC Journey 2005-2006
  7. ^ "Audit Committee Effectiveness: What Works Best-2nd Edition" Institute of Internal Auditors and Price Waterhouse. Altamonte Springs, FLA; 2000.
  8. ^ KPMG AC Survey 2007
  9. ^ KPMG AC Study 2008

External links

See also


This entry is from Wikipedia, the leading user-contributed encyclopedia. It may not have been reviewed by professional editors (see full disclaimer)

 
 

 

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Accounting Dictionary. Dictionary of Accounting Terms. Copyright © 2005 by Barron's Educational Series, Inc. All rights reserved.  Read more
Business Encyclopedia. Encyclopedia of Business and Finance. Copyright © 2001 by The Gale Group, Inc. All rights reserved.  Read more
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