Assurance and Advisory
Business Services
Audit Committees:
Providing Oversight in Challenging Times
1
Audit Committees: Providing Oversight in Challenging Times
Overview




2
Enron’s collapse has created a crisis of
confidence in financial reporting
Plenty of blame to go around
Current debate on possible solutions includes
those aimed at audit firms and audit committees
Our presentation summarizes current issues and
best practices relating to audit committees
Audit Committees: Providing Oversight in Challenging Times
CPA Profession’s Views


3
Little need for changes in audit committee
guidance
Room for improvements in implementation
Audit Committees: Providing Oversight in Challenging Times
Responses to Calls for Change

Financial community efforts
Blue Ribbon Committee
 Blue Ribbon Commission
 Panel on Audit Effectiveness
 Independence Standards Board


Regulatory and profession responses


4
SEC, securities exchanges, and ASB rules in
response to BRC
Recent frauds, restatements, etc.
Audit Committees: Providing Oversight in Challenging Times
Roles and Responsibilities




5
Management – financial reporting and internal
control
Internal audit – assess internal control
Independent audit – attest to fairness of financial
statements
Committee – oversight of the process and
participants
Audit Committees: Providing Oversight in Challenging Times
Reporting and Disclosure


Audit Committee Report
Proxy Disclosures
Identify Committee members
 Number of meetings held
 Describe functions
 Consideration of nonaudit services
 Existence of charter
 Nonindependent directors

6
Audit Committees: Providing Oversight in Challenging Times
Understanding the Business

Knowledge of the Company
Structure
 Financial reporting process
 Sophisticated or complex transactions
 Current environment
 Regulatory requirements
 Suppliers and customers
 Use of technology

7
Audit Committees: Providing Oversight in Challenging Times
Understanding the Business

Internal Control
Control environment
 Code of conduct
 System of internal control

8
Audit Committees: Providing Oversight in Challenging Times
Understanding the Business

Risk of Fraud
Earnings management issues
 Aggressive accounting policies
 Consider restructuring charges, R&D costs,
subjective estimates, and premature recognition
of revenue

9
Audit Committees: Providing Oversight in Challenging Times
Understanding the Business



10
Legal and Ethical Matters
Enterprise Risk Issues
Emerging Issues
Audit Committees: Providing Oversight in Challenging Times
Oversight of the
Financial Reporting Process

Need to understand:
Financial results
 Adequacy and completeness of MD&A
 Significant changes or trends
 Critical accounting policies
 Significant issues, related party transactions, and
accounting and auditing matters
 Unadjusted audit differences

11
Audit Committees: Providing Oversight in Challenging Times
Interim Financial Reporting


12
Interim periods generally include more estimates
and judgments than annual financial statements
Discussions with management and auditors may
be via conference calls, meetings, or both
Audit Committees: Providing Oversight in Challenging Times
Oversight of Audit Function


Audit process
Audit resources
Quality, experience, and staffing of internal
auditors
 Qualifications and performance of independent
auditors



13
Scope and fees
Non-audit services
Audit Committees: Providing Oversight in Challenging Times
Audit Committee Communications

Discussions with independent auditors
Audit planning and results
 Results of timely interim reviews
 Required communications
 Other meetings

14
Audit Committees: Providing Oversight in Challenging Times
Other Characteristics of
Audit Committees

Audit Committee Charter
Indicates responsibilities, including receipt of
disclosures from auditor on independence
 States that independent auditors are ultimately
accountable to Board and Committee

15
Audit Committees: Providing Oversight in Challenging Times
Other Characteristics of
Audit Committees






16
Financially literate, independent members
Diverse backgrounds of members
Typically 3-6 members
Qualified, experienced Chair
Terms of members
Structuring effective meetings
Audit Committees: Providing Oversight in Challenging Times
Other Characteristics of
Audit Committees

Orientation and continuing education
Provide background information to new members
 Obtain information on new accounting or auditing
standards, financial reporting process, and
significant issues affecting the Company

17
Audit Committees: Providing Oversight in Challenging Times
Best Practices


18
Ask questions of the internal and independent
auditors about the Company’s system of internal
control
Establish clear expectations with management
and auditors about the Committee’s qualitative
information needs about internal control—
especially controls in higher-risk areas
Audit Committees: Providing Oversight in Challenging Times
Best Practices


19
Ask detailed questions of management and the
auditors when reviewing the financial statements
Interim discussions occur prior to the earnings
release and cover significant matters
Audit Committees: Providing Oversight in Challenging Times
Best Practices


20
Consider the presence of risk factors for
potential fraudulent financial reporting
Understand why management did not correct
audit differences and what the effect would be
on the financial statements if such differences
were corrected in the current period
Audit Committees: Providing Oversight in Challenging Times
Best Practices



21
Develop a meeting planner to make sure that
the Committee meets its responsibilities outlined
in the Charter
Add a disclosure to proxy that references the
Audit Committee Report and Audit Committee
Charter for detailed information
Perform a self-assessment of the Committee to
identify areas for improvement
Audit Committees: Providing Oversight in Challenging Times
Legislation and Regulation Status
 On July 24, agreement was reached by Congress on a
compromise corporate crime bill
 The SEC has been very active`
On June 27 issued an order requiring the CEO and CFO of
1000 companies to certify their most recent filings
 On June 17 proposed a permanent certification requirement
 proposed changes in financial disclosure rules earlier this year
 proposed new rules creating an accounting oversight board on
June 26
 intends to propose changes in auditor independence and
corporate governance rules later this summer
 On June 6, the NYSE published a working draft of proposed
corporate governance listing requirements

22
Audit Committees: Providing Oversight in Challenging Times
Among The Issues Being Debated
 Corporate Governance: Increased responsibilities
for corporate officers, boards of directors, and audit
committees
 Accounting Profession Reform: The power and
composition of a new auditor oversight board and
the scope of services that may be provided to audit
clients
 Financial Disclosures: Proposals intended to
enhance corporate transparency and require realtime disclosure of important financial information
23
Audit Committees: Providing Oversight in Challenging Times
Corporate Governance Reform
House
Senate
SEC
NYSE
Certification of Financial
Reports
N/A
CEO/CFO must certify that
financial statements and
disclosures “fairly represent”
the company’s financial
condition
CEOs and CFOs must certify that
financial reports include “all
information of which they are aware
that is important to a reasonable
investor”
CEO must certify that the
financial reports are “accurate
and complete in all material
respects”
Audit Committee
Composition
N/A
Audit committee members
must be independent from
management
N/A
Proposed independence
requirements for audit committee
members and financial expertise
requirement for the Committee
chair
Disgorgement
Gives SEC authority to
require disgorgement of
bonuses, stock profits or
other incentive pay if
misconduct results in
accounting corrections
Same as House bill
Currently using enforcement actions
to seek disgorgement
N/A
Ban on
Officers/Directors
Gives the SEC
administrative authority to
bar “substantially unfit”
corporate officers
Gives the SEC authority to
seek court orders banning
“unfit” corporate officers and
directors
Using court system to to seek
orders banning “substantially unfit”
corporate officers and directors
N/A
Shareholder Approval of
Stock Options
N/A
N/A
N/A
Requires shareholder approval
of equity compensation plans
24
Audit Committees: Providing Oversight in Challenging Times
Accounting Profession Reform
House
Senate
SEC
NYSE
Regulatory
Board
Composition
Five members, two of
whom must be CPAs, and
two additional who may
be CPAs
Five members, two, and only
two, may be CPAs
Nine members, a minimum of
six of whom must be public
members. Maximum of three
CPAs
N/A
Powers
Disciplinary and
investigative powers, but
no standard setting
powers
The Board would set audit,
quality control, ethics, and
independence standards, or
could approve standards set
by a professional group
Set standards or rely on private
sector groups with oversight
N/A

Prohibited
Services
Directs SEC to bar the
provision of IT consulting
and internal audit services
to audit clients
Statutorily bars services
already restricted under SEC
rule, with additional
prohibition of IT, internal audit,
and expert services
N/A
N/A
Audit
Committee
Approval
No provision (defeated in
committee 31-19)
All non-audit services are
deemed “unlawful” unless preapproved by audit committee
Audit committees would preapprove non-audit services
Similar to SEC,
except audit
committee approval
limited to significant
non-audit
engagements


Scope of
Services

25
Audit Committees: Providing Oversight in Challenging Times
Financial Disclosure Reform
House
Senate
SEC
NYSE
Real Time
Disclosures

Accelerated Filing
Deadlines
N/A
N/A
Proposed accelerating filing deadlines of annual reports
from 90 to 60 days after close of fiscal year, and
quarterly reports from 45 to 30 days after the end of the
quarter
N/A

Insider Transaction
Disclosure
SEC directed to adopt
rules
Requires accelerated reporting
of insider transactions and loans
Proposed rulemaking that would require companies to
report insider transactions, including loans, within 1-10
days
N/A
Expansion of
Information Reported
SEC directed to conduct
an analysis of need for
rulemaking
Requires an audit of
management’s assessment of
internal controls and also
requires auditors to test and
report on compliance with
certain laws and regulations
Proposed requiring more frequent 8-K disclosures (filed
when listed events occur between annual reports and
quarterly reports that would be of significance to
investors)
N/A
SEC directed to conduct
an analysis of need for
rulemaking
N/A
Proposed rulemaking requiring disclosure of critical
accounting procedures in annual and quarterly reports.
Soliciting comments on disclosures when a company’s
accounting policies diverge from those used by other
industry members.
N/A

N/A
Companies must reconcile pro
forma information with GAAP
and not omit information that
makes it misleading
Issued cautionary advice on appropriate use of pro
forma financials in earnings press releases
N/A
Off Balance Sheet
Transactions
SEC directed to adopt
rules
SEC directed to adopt rules
Issued cautionary advice regarding need to disclose in
2001 financial reports
N/A

Improved
Transparency
Critical Accounting
Procedures

Pro Forma Earnings

26
Audit Committees: Providing Oversight in Challenging Times