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Corporate audit committees: an approach to continuous improvement. (Auditing).

Audit committees today are faced with the sizable task of overseeing both the auditing and financial reporting processes. The final rules of the SEC, national stock exchanges, and the AICPA's Auditing Standards Board cover corporate governance of audit committees, including independence, qualifications, charters, external auditor involvement, and reports.

Nonetheless, it remains up to audit committees to ensure that they continuously improve their oversight role. Continuous improvement requires a constructive relationship between audit committees and management, internal auditors, external auditors, and legal counsel. Audit committees should function as team members and be empowered by their boards to ask tough-minded questions about the audit and financial reporting processes as well as to probe into the entity's affairs. Continuous improvement helps minimize the costs of achieving quality in both financial management services and audit services. Thus, boards of directors are assured that such resources are allocated efficiently and effectively to prevent the costs of poor quality in the board's corporate accountability process.

Continuous improvement approach.

To achieve continuous improvement, audit committees should consider the following three-step approach:

* Complete a profile worksheet with details of the committee's role, responsibilities, and organization;

* Develop a customized review and action plan to achieve the committee's goals in the board-approved charter; and

* Develop a quality assurance review based on the elements that guide the committee in adopting quality assurance policies and procedures.

Audit Committee's Profile Worksheet

Audit committees are now required to disclose their written charter in the entity's annual proxy statement. This document provides a clear presentation of the committee's oversight role, responsibilities, and organization. It defines the jurisdictional charge to the committee, minimizing potential litigation risk as well as avoiding the dilution of the committee's activities. See Exhibit 1 for a suggested format for a profile worksheet.

Audit committees need knowledge about--

* the entity's business and industry,

* significant risks,

* internal control concepts,

* industry accounting practices, and

* complex business transactions.

Likewise, audit committees need to review the following:

* Industry and business data in terms of vulnerability of the industry to changing economic conditions and operating characteristics of the business. Such a review would usually include the annual stockholders' report, SEC filings (10Qs, 10Ks, annual proxy statement), the entity's website, analytical review procedures, absolute data comparisons, and financial ratio data.

* Management's risk assessment process

* The components of COSO's Internal Control-Integrated Framework (control environment, risk assessment, information and communication, control activities, and monitoring)

* Industry accounting practices, with particular emphasis on the appropriateness of accounting principles

* Complex business transactions (e.g., restructuring charges and pre-acquisition audits).

Additionally, audit committees should perform a review in connection with other matters, such as--

* code of conduct;

* conflict of interest statements (related party transactions);

* Corporate perquisites;

* computer security, business continuity plan, and planned systems modifications; and

* biographical information on senior management and financial management.

Audit Committee's Action Plan

Based on the audit committee's profile worksheet, the chair can develop a customized review and action plan (Exhibit 2). This plan serves as an oversight compass for the financial management, audit, legal, and communication processes.

Financial management. Responsibility for the integrity and objectivity of the information in financial reports rests with the entity's management. Audit committees should review background information on the competence and integrity of important members of the financial management group.

Likewise, management is responsible for a system of internal control. Audit committees may request management and auditors to present a review of the COSO components of internal control in order to ensure that internal controls provide a reasonable assurance that the financial accounts are maintained and accounted for under the entity's policies. For financial reporting purposes, audit committees need assurance that management is managing identified risks so that financial statement assertions will not be misstated.

Internal auditing. As part of the monitoring component of the entity's system of internal control, the scope of the internal audit effort extends to several types of audits: financial, operational, compliance, ethics and fraud, systems, and risk audits. Audit committees should review the internal audit plan as well as the organizational structure and composition of the internal audit group. Audit committees want assurance that the entity's comprehensive internal audit program evaluates the adherence to management's policies and procedures.

External auditing. The audit committee's meetings and agendas should be directly linked to the auditing cycle, consisting of a pre-audit interview, an optional interim audit interview, a post-audit interview, and a follow-up interview.

During the pre-audit interview, the agenda ordinarily includes a review and discussion of matters such as the audit plan, accounting and auditing developments that impact the financial statements, risk assessment and related risk control processes, an analytical review, the personnel assigned to the audit team, an internal financial audit plan, and estimated audit and nonaudit fees.

Audit committees or external auditors might request an interim audit interview to address problem areas and discuss the progress of the audit.

The major objective of the post-audit interview is to review the audit findings and the draft of the annual stockholders' report. Typically, audit committees focus on deviations from the audit plan, the analytical review, significant discoveries, resolved and unresolved matters, any disagreements with management, and material audit adjustments as well as immaterial uncorrected misstatements. Additionally, audit committees should review the appropriateness of accounting policies (e.g., conformity with industry practice and alternative accounting principles) and any changes in accounting principle.

During the follow-up interview, audit committees generally focus on recommendations for improvement in internal control, approving the internal audit plan for the following year, and recommending the appointment of the external auditors. They might also engage in a performance review of management, the internal audit group, or the external auditors. Audit committees might also review the external audit and nonaudit fees that must now be disclosed in the annual proxy statement.

Legal process. Both in-house general counsel and outside legal counsel interact with audit committees on various issues:

* The standard of independence for the audit committee members

* The committee's written charter, as described in the entity's annual proxy statement

* Significant litigation, claims, and assessments against the entity

* Any pending litigation against the external auditors, as well as any impairment of their independence

* Compliance with key legislative acts (e.g., the Foreign Corrupt Practices Act, the Private Securities Litigation Reform Act)

* Proposed special investigations

* Material contracts, related party transactions, and contingencies

* Compliance with the entity's code of conduct and conflict of interest statements.

Communications. During the audit committee's audit cycle interviews, the internal communication process consists of both executive and joint sessions. Executive sessions may be used for the audit committee's performance reviews of management, the internal auditing group, and the external auditors, as well as a discussion of external audit and nonaudit fees, and any disagreements with management.

With respect to external communications, audit committees are required to disclose the following items in the entity's annual proxy statement:

* A review and discussion of the entity's consolidated financial statements with management and the independent auditors

* A review of management's representations that the consolidated financial statements were prepared in accordance with GAAP

* Discussion with the independent auditors about SAS 61 matters

* Written disclosures and the ISB 1 letter from the external auditor regarding their independence from the entity

* A consideration of whether the external auditors' provision of nonaudit services is consistent with independence

* A recommendation of whether the audited financial statements should be included in SEC filings

* A recommendation as to the selection of the audit firm

* Presentation of an audit committee charter

* A letter to the appropriate stock exchange certifying the number and qualifications of independent audit committee members.

Audit Committee's Quality Assurance Review

The major objective of this third step in the evaluative process is to effectively strive for zero defects in performing the first two steps. The audit committee's oversight role is to ensure efficiency and effectiveness in these processes, which, in turn, should lead to a high level of assurance of the board's corporate accountability. Given the demand for strong boards and audit committees, the audit committee should reflect and assess their overall operating performance and that of each committee member. This assessment process may be accomplished through a series of targeted questions that effectively address financial accounting and auditing issues affecting the financial statements. For example, audit committees might benchmark their performance review against their formal written charter. Exhibit 3 contains six quality assurance elements that enable the committee to develop an effective oversight strategy. Comprehensive reporting, combined with an ongoing dialogue between audit committee members and al l interested parties, is the key to effective performance.
EXHIBIT 1

AUDIT COMMITTEE'S PROFILE WORKSHEET

                                              Services available from:

                                                      Internal  External
                                          Management  Auditors  Auditors
Audit Committee Practice Area


Organizational Structure and Composition

 Formation *

 Membership
  Number of members (size)
  Appointments
  Term of service
  Qualification
  Composition

 Meetings
  Frequency
  Type

 Knowledge Areas
  Type of business and industry               *
  Internal audit process                                  *
  External audit process                                            *
  Internal control concepts                               *         *
  Management's risk assessment                *           *         *
  Industry accounting practices               *           *         *
  Complex business transactions               *           *         *
  Financial reporting process                 *           *         *
  Internal communication process **           *           *         *
  External communication process

                                           Services available
                                                  from:

                                           Legal    Board of
                                          Counsel   Directors
Audit Committee Practice Area


Organizational Structure and Composition

 Formation *

 Membership
  Number of members (size)                              *
  Appointments                                          *
  Term of service                                       *
  Qualification                                         *
  Composition                                           *

 Meetings
  Frequency                                             *
  Type                                                  *

 Knowledge Areas
  Type of business and industry
  Internal audit process
  External audit process
  Internal control concepts
  Management's risk assessment
  Industry accounting practices
  Complex business transactions              *
  Financial reporting process
  Internal communication process **          *          *
  External communication process                        *

                                            Services
                                           available
                                             from:
                                          Compliance
                                          with SEC,
                                          SROs, ASB
Audit Committee Practice Area                         Comments:


Organizational Structure and Composition

 Formation *

 Membership
  Number of members (size)                    *
  Appointments
  Term of service
  Qualification                               *
  Composition                                 *

 Meetings
  Frequency
  Type

 Knowledge Areas
  Type of business and industry
  Internal audit process
  External audit process
  Internal control concepts
  Management's risk assessment
  Industry accounting practices
  Complex business transactions
  Financial reporting process
  Internal communication process **           *
  External communication process              *

* Board resolution or corporate by-laws and a formal written charter

** Related to the above areas
EXHIBIT 2

AUDIT COMMITTEE'S REVIEW AND ACTION PLAN

                                              Services available
                                                    from:

                                                        Internal
Audit Committee Practice Area               Management  Auditors

Agendas

Pre-audit Meeting (Audit Scope)
  Audit plan                                    *           *
  Analytical review
  Accounting and auditing developments          *           *
  Financial reporting matters                   *           *
  Risk assessment                               *           *
  Risk control processes                        *           *

Interim meeting (optional)
  Problem areas                                 *           *
  Audit progress                                            *

Post-audit Meeting
  Audit findings                                            *
  Analytical review
  Annual financial statements                   *
  SEC Form 10-K Report                          *

Other Concerns
  Unresolved matters                            *           *
  Disagreements with management                             *
  Significant audit adjustments                             *
  Completeness of disclosure and                *           *
   risks and uncertainties
  Appropriateness of accounting policies        *           *
  Management's representations                  *
   (client representation letter)
  Lawyer's letter

Follow-up Meeting
  Management letter                             *           *
  Evaluation of the external auditors           *           *
  Appointment of the external auditors
  Audit and nonaudit fees
  Auditor's independence letter
  Evaluation of the internal auditors           *
   and selection or reappointment
  Internal audit plan for the next                          *
   fiscal year
  Outsourcing activities                                    *
  Evaluation of financial management                        *
  Compliance with laws and regulations
   (disclosure matters)
  Impact of proposed legislation on the
   financial statements

Other Matters
  Special investigations
  Information technology (computer              *           *
   security, EDI, business continuity
   plan)

Conflicts of Interest
  Corporate prerequisites (officers'                        *
   expense accounts, etc.)

   Corporate contributions                  *           *
   Code of conduct                          *           *
   Related party transactions               *           *
   Illegal, improper or sensitive payments

Quarterly Reporting Process
   Quality of earnings and disclosures      *
   Income tax assessments
   Pre-acquisition audits                   *
   Material transactions and contracts
    (e.g. restructuring charges, etc.)

Reporting to the Board of Directors
   Formal report

Reporting to the Stockholders
   Proxy-statement disclosures

Reporting to the national stock
exchange(s)

                                             Services available
                                                   from:

                                            External   Legal
Audit Committee Practice Area               Auditors  Counsel

Agendas

Pre-audit Meeting (Audit Scope)
  Audit plan                                    *
  Analytical review                             *
  Accounting and auditing developments          *
  Financial reporting matters                   *
  Risk assessment                               *
  Risk control processes                        *

Interim meeting (optional)
  Problem areas                                 *
  Audit progress                                *

Post-audit Meeting
  Audit findings                                *
  Analytical review                             *
  Annual financial statements                   *
  SEC Form 10-K Report                          *

Other Concerns
  Unresolved matters                            *        *
  Disagreements with management                 *
  Significant audit adjustments                 *
  Completeness of disclosure and                *
   risks and uncertainties
  Appropriateness of accounting policies        *
  Management's representations                  *
   (client representation letter)
  Lawyer's letter                               *        *

Follow-up Meeting
  Management letter                             *
  Evaluation of the external auditors
  Appointment of the external auditors
  Audit and nonaudit fees                       *
  Auditor's independence letter                 *
  Evaluation of the internal auditors           *
   and selection or reappointment
  Internal audit plan for the next
   fiscal year
  Outsourcing activities                        *
  Evaluation of financial management            *
  Compliance with laws and regulations          *
   (disclosure matters)
  Impact of proposed legislation on the         *
   financial statements

Other Matters
  Special investigations
  Information technology (computer              *        *
   security, EDI, business continuity
   plan)

Conflicts of Interest
  Corporate prerequisites (officers'            *
   expense accounts, etc.)

   Corporate contributions                  *         *
   Code of conduct                                    *
   Related party transactions               *         *
   Illegal, improper or sensitive payments  *         *

Quarterly Reporting Process
   Quality of earnings and disclosures      *
   Income tax assessments                   *
   Pre-acquisition audits                   *
   Material transactions and contracts
    (e.g. restructuring charges, etc.)

Reporting to the Board of Directors
   Formal report

Reporting to the Stockholders
   Proxy-statement disclosures                        *

Reporting to the national stock                       *
exchange(s)

                                              Services available
                                                     from:
                                                       Compliance
                                            Board of   with SEC,
Audit Committee Practice Area               Directors  SROs, ASB

Agendas

Pre-audit Meeting (Audit Scope)
  Audit plan
  Analytical review
  Accounting and auditing developments
  Financial reporting matters
  Risk assessment
  Risk control processes

Interim meeting (optional)
  Problem areas
  Audit progress

Post-audit Meeting
  Audit findings
  Analytical review
  Annual financial statements
  SEC Form 10-K Report

Other Concerns
  Unresolved matters
  Disagreements with management
  Significant audit adjustments
  Completeness of disclosure and
   risks and uncertainties
  Appropriateness of accounting policies
  Management's representations
   (client representation letter)
  Lawyer's letter

Follow-up Meeting
  Management letter
  Evaluation of the external auditors
  Appointment of the external auditors          *
  Audit and nonaudit fees                       *          *
  Auditor's independence letter                            *
  Evaluation of the internal auditors
   and selection or reappointment
  Internal audit plan for the next
   fiscal year
  Outsourcing activities
  Evaluation of financial management
  Compliance with laws and regulations
   (disclosure matters)
  Impact of proposed legislation on the
   financial statements

Other Matters
  Special investigations
  Information technology (computer
   security, EDI, business continuity
   plan)

Conflicts of Interest
  Corporate prerequisites (officers'
   expense accounts, etc.)

   Corporate contributions
   Code of conduct
   Related party transactions
   Illegal, improper or sensitive payments  *

Quarterly Reporting Process
   Quality of earnings and disclosures
   Income tax assessments
   Pre-acquisition audits
   Material transactions and contracts
    (e.g. restructuring charges, etc.)

Reporting to the Board of Directors
   Formal report                            *

Reporting to the Stockholders
   Proxy-statement disclosures                         *

Reporting to the national stock                        *
exchange(s)




Audit Committee Practice Area               Comments:

Agendas

Pre-audit Meeting (Audit Scope)
  Audit plan
  Analytical review
  Accounting and auditing developments
  Financial reporting matters
  Risk assessment
  Risk control processes

Interim meeting (optional)
  Problem areas
  Audit progress

Post-audit Meeting
  Audit findings
  Analytical review
  Annual financial statements
  SEC Form 10-K Report

Other Concerns
  Unresolved matters
  Disagreements with management
  Significant audit adjustments
  Completeness of disclosure and
   risks and uncertainties
  Appropriateness of accounting policies
  Management's representations
   (client representation letter)
  Lawyer's letter

Follow-up Meeting
  Management letter
  Evaluation of the external auditors
  Appointment of the external auditors
  Audit and nonaudit fees
  Auditor's independence letter
  Evaluation of the internal auditors
   and selection or reappointment
  Internal audit plan for the next
   fiscal year
  Outsourcing activities
  Evaluation of financial management
  Compliance with laws and regulations
   (disclosure matters)
  Impact of proposed legislation on the
   financial statements

Other Matters
  Special investigations
  Information technology (computer
   security, EDI, business continuity
   plan)

Conflicts of Interest
  Corporate prerequisites (officers'
   expense accounts, etc.)

   Corporate contributions
   Code of conduct
   Related party transactions
   Illegal, improper or sensitive payments

Quarterly Reporting Process
   Quality of earnings and disclosures
   Income tax assessments
   Pre-acquisition audits
   Material transactions and contracts
    (e.g. restructuring charges, etc.)

Reporting to the Board of Directors
   Formal report

Reporting to the Stockholders
   Proxy-statement disclosures

Reporting to the national stock
exchange(s)
EXHIBIT 3

AUDIT COMMITTEE'S QUALITY ASSURANCE ELEMENTS, POLICIES, AND PROCEDURES

                                                       Quality
                                                      Assurance
Quality Assurance                                     Policies &
Elements              Purpose                         Procedures

Independence          Avoid a relationship with the       A
                      entity that would interfere
                      with the director's exercise
                      of independent judgment.

Financial knowledge   Directors need to be                B
                      financially literate.

Written charter       Provides a clear understanding      C
                      of the committee's oversight
                      role, responsibilities, and
                      organization.

Performance review    Work performed meets the audit      D
                      committee's charter.

Continuing education  Directors need an ongoing           E
                      program of additional courses.

Monitoring            Annual review for each of the       F
                      above elements.

Examples of related policies and procedures that an audit committee
might implement include:

A: Provide for legal counsel's monitoring compliance with independent
rules.

B: Establish review procedures for information about new accounting and
auditing standards.

C: Communicate the scope of oversight responsibilities to audit
committee members.

D: Establish procedures for benchmarking the audit committee's
performance review.

E: Establish review procedures for a continuing education program.

F: Provide for reporting monitoring activities to the full board of
directors.


Louis Braiotta, Jr, CPA, is an associate professor of accounting at the State University of New York at Binghamton and author of The Audit Committee Handbook, 3rd Edition, John Wiley & Sons, Inc. (1999).
COPYRIGHT 2002 New York State Society of Certified Public Accountants
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 2002 Gale, Cengage Learning. All rights reserved.

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Author:Braiotta, Louis, Jr.
Publication:The CPA Journal
Geographic Code:1USA
Date:Jul 1, 2002
Words:2698
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