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Auditing audit committees: an education opportunity for auditors.

Following is an adaptation of an article by A. A. Sommer, Jr., that appeared in the June 1991 issue of Accounting Horizons. Sommer is the chairman of the public oversight board of the American Institute of CPAs SEC practice section.

Audit committees are now a firmly established element in U.S. corporate governance. Since 1940, they have enjoyed the endorsement of the Securities and Exchange Commission, which has often insisted on their establishment or strengthening as a part of settlements.

However, a corporation having an audit committee as part of its governance structure and having an effective audit committee are, of course, two different matters. While these committees routinely recommend the engagement of the auditors, listen to the outside auditors review their audit program and cursorily discuss internal controls with appropriate corporate personnel, they do not appear to be asking the hard questions or fulfilling the full range of expectations.

Many losses result from this failure. Boards that have ineffective audit committees are denied the legal protections that can accrue to them from an effective one, and shareholders, too, are denied the benefits and safeguards committees provide.

The scarcity of audit committees in the governance structures of savings and loans may have resulted in another type of loss. Had S&Ls had such committees--functioning effectively--some of those institutions might have avoided disaster, or at least reduced the magnitude of the losses suffered.

One of the less obvious losers is the external auditor. The National Commission on Fraudulent Financial Reporting (the Treadway commission) identified an audit committee as an essential part of any system designed to prevent fraudulent financial reporting. The audit committee, with its constant access to the internal auditor and other corporate personnel, often is the first nonmanagement group to catch a whiff of irregularity. And if it does, it can direct the external auditor to scrutinize the problem, thereby forestalling a faulty audit.

Auditors are in a unique position to judge audit committees' effectiveness, as they encounter committees in nearly every audit of a publicly held company.

Auditors can not only assist their clients in having effective corporate governance but also in protecting themselves in a significant way. Simply, they should share knowledge about audit committees--gained from experience--with their clients: the optimum size, the most desirable composition, the necessary duties and how to fulfill them and the inquiries that must be made.

Obviously, no audit committee is compelled to listen to auditors' advice. Properly proposed, however, collaboration with the auditor to assess committee members' performance could result in improvements. A starting point might be the Treadway commission report, which contains a description of the basic audit committee duties. The auditor, and perhaps the internal auditor, should prepare a matrix on which are listed the report proposals, including the guidelines in appendix 1. Information indicating compliance with the recommended practice is entered next to each item. Next to that is any information suggesting the Treadway guidance was inappropriate or unnecessary. A fourth column holds entries suggesting action to bring the audit committee practices into conformity with the Treadway recommendations. An audit committee reviewing the completed matrix with the external and internal auditors would have a clear notion of what it should be doing and how it fails to match a well-developed model.

If American business is to meet the demand that its governance structures and practices match public expectations, it is vital for audit committees to do a better job. And if auditors are to reduce the hazards posed by litigation, they must avail themselves of every resource. Clearly the audit committee is one such resource. It is in auditors' interests to ensure that resource is as effective as possible.

The AICPA brochure, Communication with Audit Committees, is directed to audit committees and contains concise information on communication requirements. For a free sample, write to the American Institute of CPAs, P.O. Box 1003, New York, New York 10108.
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Copyright 1992, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Author:Sommer, A.A., Jr.
Publication:Journal of Accountancy
Date:Jun 1, 1992
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