On critical accounting issues, CFOs can add value: as audit committees' responsibilities and pressures grow, they are now looking to the CFO to help them understand the complex area of oversight of accounting judgments and estimates.

If not the case already, CFOs may soon find their audit committee's interest in the company's critical accounting policies, judgments and estimates heightened significantly. With Sarbanes-Oxley Act Section 404 compliance processes widely in place, many audit committees are refocusing on the issues they view as critical to the integrity of the company's financial reporting process.

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Oversight of internal controls remains a top issue, as does risk management. But many audit committees have identified accounting judgments and estimates as their top priority, and they're looking to the CFO to help them better understand this increasingly complex area of oversight.

Accounting: Audit Committee's Top Priority

In a recent survey by KPMG's Audit Committee Institute (ACI), audit committee members identified oversight of critical accounting policies, judgments and estimates as their highest priority this year. In related survey findings, a majority of audit committee members also said:

* They were only somewhat or not satisfied that management provides them with the information they need to oversee critical accounting judgments and estimates (67 percent); and

* They need to spend more time discussing critical accounting judgments and estimates (80 percent).

In short: audit committees want to have a better understanding of the company's critical accounting issues; and they need--and expect--management to help them become better informed on this issue.

A High-Pressure Environment

CFOs can readily appreciate the challenging environment in which audit committees are working today. The dramatic increase in the number of restatements in recent years--414 filed in 2004, and nearly three times that number reported in 2005--points to the powerful combination of pressures that audit committees must grapple with: increasingly complex accounting standards, management's drive to "make its numbers" and demands by investors and regulators for integrity and transparency in financial statements.

In this environment, audit committees are developing a greater appreciation for the tentative and "fragile" nature of critical accounting judgments and estimates and their effect on the company's financial statements. They also must consider a number of regulatory requirements affecting their oversight of this issue.

Under Sarbanes-Oxley Section 204, the external auditor must review with the audit committee all critical accounting policies and practices used by the company, as well as generally accepted accounting principles (GAAP) alternative treatments discussed with management, the ramification of each treatment and the treatment preferred by the auditor.

Additionally, New York Stock Exchange listing standards (Sec. 303A.07(c)) require the audit committee to review major issues and changes regarding accounting principles and financial statement presentations. The committee also must review analyses prepared by management or the independent auditor regarding significant issues and judgments related to financial statements (including the effects of alternative GAAP methods on the financial statements).

Also, audit committee members have an obligation to exercise their "duty of care" responsibilities--essentially, staying informed of company matters by asking probing questions, critically evaluating the information they receive and being actively engaged.

Given these responsibilities and pressures, audit committees are saying they want to take a "deeper dive" into the company's critical accounting issues.

During ACI's Fall 2005 Roundtable series on critical accounting judgments and estimates, audit committee members in 34 cities around the U.S. shared the following insights:

* Forty-one percent were only "somewhat satisfied" that the company's financial disclosures, including management's discussion and analysis (MD & A), present a clear and accurate picture of the company's finances. Fourteen percent said their disclosures "need improvement."

* Approximately 60 percent said they were only "somewhat satisfied" or "not satisfied" with the external auditor's communications regarding its consideration of the company's critical accounting policies, judgments and estimates.

* Nearly 90 percent said management at their company is "not likely" to inappropriately modify accounting judgments and estimates; yet, 47 percent believe that management at other companies is "somewhat likely" to do so.

Participants believe the greatest pressures on management to inappropriately modify accounting judgments and estimates stem from analysts' earnings estimates and forecasts (40 percent), incentive compensation targets (20 percent) and unrealistic plans and budgets (16 percent).

When asked informally to what they attributed the increase in restatements, ACI roundtable participants cited the complexities of accounting issues as the primary reason, with errors and earnings management being contributing factors. Others pointed to an increased focus on technical accounting "accuracy" by auditors and regulators in the current "rules-based" environment as another underlying pressure.

Whatever the actual cause of a restatement, the growing intolerance--by investors, regulators and others--for management miscues has put a premium on "getting the numbers right."

Can CFOs Do More?

Between Section 404 and 302 requirements, ever-accelerating reporting cycles and the everyday challenges of their position, most CFOs don't have a lot of extra time on their hands. Yet, with critical accounting judgments and estimates at the top of many audit committee agendas, every CFO should take time to consider the audit committee's level of understanding of this issue, and how the CFO currently supports the committee, by asking:

* Does the audit committee understand what the company's critical accounting judgments and estimates are--and the process management uses to develop those judgments and estimates?

* Does the audit committee recognize the tentative and fragile nature of many of the judgments and estimates?

* Are audit committee members asking "good questions" about critical accounting issues? (If not, this may be an indication of the quality--or the committee's understanding--of the information they are receiving.)

* Is the audit committee comfortable that the footnotes and, where appropriate, the MD & A, provide a clear and accurate picture of the company's critical accounting judgments and estimates?

* Is the audit committee chair comfortable with the timeliness and format of the information the committee receives from the CFO? Can the CFO's communications with the committee be improved?

* Given the importance of judgments and estimates, is sufficient time devoted to discussing the issue (during and/or outside of audit committee meetings)?

* Is the audit committee chair satisfied with the quality of the committee's discussion of critical accounting issues with management?

* Has the desire (or need) for additional audit committee education on critical accounting issues been discussed?

Some CFOs will be comfortable that their efforts to support the audit committee are adequate and effective; however, based on the survey findings, most audit committees believe the CFO can do more.

To determine whether--and what--more can be done, a good place to start is with the audit committee chair.

Is he or she satisfied that the committee's members have the understanding and knowledge they need to ensure their effective oversight of critical accounting issues? (The questions listed above can be the framework for the CFO's discussion with the chair.) If so, is there sufficient time during regular audit committee meetings to address the committee's additional educational needs? Or should the committee devote additional time--outside of regular meetings--to explore the issue in greater depth? (The CFO can also help identify suitable educational programs offered by third-party organizations.)

The bottom line: Oversight of critical accounting policies, judgments and estimates is the top priority for many audit committees today--and CFOs can help ensure the committee's members have the knowledge they need to satisfy their oversight responsibilities. After all, the audit committee's confidence in management's judgments and estimates--when based on informed discussion and a real understanding of underlying issues and processes--can ultimately translate into greater marketplace confidence in the company's financial statements and disclosures.

Kenneth Daly is Executive Director of KPMG's Audit Committee Institute (ACI). He can be reached at [e-mail] or 267.256.1740

RELATED ARTICLE: takeaways

* Section 404 of the Sarbanes-Oxley Act has heightened the audit committee's responsibilities regarding the critical and complex area of oversight that relates to accounting judgments and estimates.

* CFOs are in the position to help audit committee members understand this area, and how he/she supports these efforts. A KPMG survey finds that most audit committee members believe the CFO can do more to help.

* Among the questions CFOs can ask the audit committee chair is if he or she is satisfied that committee members have the understanding and knowledge they need to ensure effective oversight of critical accounting issues.