Audit Committees: Providing Oversight in Challenging Times Assurance and Advisory Business Services...

Audit Committees:Audit Committees:

Assurance and Advisory Business Services

Audit Committees: Providing Oversight in Challenging Times

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Providing Oversight in Challenging Times


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OverviewOverview

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

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


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CPA Profession’s ViewsCPA Profession’s Views

Little need for changes in audit committee guidance

Room for improvements in implementation

Little need for changes in audit committee guidance

Room for improvements in implementation


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Responses to Calls for ChangeResponses to Calls for Change Financial community efforts

Blue Ribbon Committee Blue Ribbon Commission Panel on Audit Effectiveness Independence Standards Board

Regulatory and profession responses SEC, securities exchanges, and ASB rules in

response to BRC Recent frauds, restatements, etc.

Financial community efforts Blue Ribbon Committee Blue Ribbon Commission Panel on Audit Effectiveness Independence Standards Board

Regulatory and profession responses SEC, securities exchanges, and ASB rules in

response to BRC Recent frauds, restatements, etc.


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Roles and ResponsibilitiesRoles and Responsibilities

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

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


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Reporting and DisclosureReporting 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

Audit Committee Report Proxy Disclosures

Identify Committee members Number of meetings held Describe functions Consideration of nonaudit services Existence of charter Nonindependent directors


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Understanding the BusinessUnderstanding the Business

Knowledge of the Company Structure Financial reporting process Sophisticated or complex transactions Current environment Regulatory requirements Suppliers and customers Use of technology

Knowledge of the Company Structure Financial reporting process Sophisticated or complex transactions Current environment Regulatory requirements Suppliers and customers Use of technology


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Internal Control Control environment Code of conduct System of internal control

Internal Control Control environment Code of conduct System of internal control


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Risk of Fraud Earnings management issues Aggressive accounting policies Consider restructuring charges, R&D costs,

subjective estimates, and premature recognition of revenue

Risk of Fraud Earnings management issues Aggressive accounting policies Consider restructuring charges, R&D costs,

subjective estimates, and premature recognition of revenue


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Legal and Ethical Matters Enterprise Risk Issues Emerging Issues

Legal and Ethical Matters Enterprise Risk Issues Emerging Issues


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Oversight of the Financial Reporting Process

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

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


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Interim Financial ReportingInterim Financial Reporting

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

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


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Oversight of Audit FunctionOversight of Audit Function

Audit process Audit resources

Quality, experience, and staffing of internal auditors

Qualifications and performance of independent auditors

Scope and fees Non-audit services

Audit process Audit resources

Quality, experience, and staffing of internal auditors

Qualifications and performance of independent auditors

Scope and fees Non-audit services


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Audit Committee CommunicationsAudit Committee Communications

Discussions with independent auditors Audit planning and results Results of timely interim reviews Required communications Other meetings

Discussions with independent auditors Audit planning and results Results of timely interim reviews Required communications Other meetings


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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

Audit Committee Charter Indicates responsibilities, including receipt of

disclosures from auditor on independence States that independent auditors are ultimately

accountable to Board and Committee


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Financially literate, independent members Diverse backgrounds of members Typically 3-6 members Qualified, experienced Chair Terms of members Structuring effective meetings

Financially literate, independent members Diverse backgrounds of members Typically 3-6 members Qualified, experienced Chair Terms of members Structuring effective meetings


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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

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


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Best PracticesBest Practices

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

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


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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

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


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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

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


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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

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


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Legislation and Regulation StatusLegislation 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

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


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Among The Issues Being DebatedAmong 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 real-time disclosure of important financial information

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 real-time disclosure of important financial information


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Corporate Governance ReformCorporate Governance ReformHouse 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


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Accounting Profession ReformAccounting Profession ReformHouse 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

Scope of Services

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 pre-approved by audit committee

Audit committees would pre-approve non-audit services

Similar to SEC, except audit committee approval limited to significant non-audit engagements


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Financial Disclosure ReformFinancial Disclosure ReformHouse 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

Improved Transparency

Critical Accounting Procedures

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

Pro Forma Earnings 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

Audit Committees: Providing Oversight in Challenging Times Assurance and Advisory Business Services...

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