EXECUTIVE SUMMARY
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To ensure that your
committee is up to its mission, you must
first define the mission by
drafting a strong charter that identifies
audit committee functions, authority and
responsibilities, along with the skills
and experience its members must possess.
Success is not
automatic. Specify critical
success factors as competencies audit
committee members must possess for the
committee to discharge its duties and
function effectively.
Committees need to
know what their core values are.
Open communication, equitable
dispute resolution and the active
participation of all members are critical.
The committee needs
to be free and willing to interview
anyone it chooses. This can be
aided by providing a “safe haven” for
interviewees, but the committee should not
avoid asking incisive questions and taking
action on its findings.
All members should be
involved in setting the agenda.
Meetings should be carefully
planned so that priority business is acted
upon in a timely manner.
Decision-making
processes need to be determined before a
crisis occurs. Each committee
needs to evaluate its unique needs when
laying out its ground rules.
Meetings should start
and end with summaries so that
all members have a common understanding of
what has transpired and what the
priorities are.
John F. Morrow, CPA, is
the AICPA vice president–business,
industry and government. His e-mail
address is
jmorrow@aicpa.org . Joan
Pastor holds a Ph.D. in
industrialorganizational psychology and
clinical psychology and has consulted
extensively for the AICPA on
organizational and leadership issues. Her
e-mail address is JPAjoan@aol.com.
The authors wish to thank Robert
Tie of the AICPA’s
Communications team and Kayla
Briggs of the Business,
Industry and Government team for their
assistance in preparing this article |
In the five years that have passed since the
Sarbanes-Oxley Act gave audit committees greater
responsibility for overseeing public companies’
accounting, financial reporting, internal controls
and audits, many of these corporate governance
watchdogs have become quite adept at performing
their expanded duties. Others, though, have not
developed this expertise as rapidly as others.
This article offers eight time-tested best
practices for improving numerous aspects of audit
committee performance, as well as insights from
three seasoned CPAs who have led or served on the
audit committees of many organizations .
1. Create and adhere to a written charter
that identifies audit committee functions,
authority and responsibilities and the skills
and experience its members must possess for the
committee to discharge its duties and function
effectively. Without a strong
written charter to guide it, an audit committee is
unlikely to know where it’s going, much less how
to get there. The charter should specify what
skills and experience audit committee members need
to help the group achieve its goals. At least one
member should be a “financial expert,” as defined
by SOX and the SEC (see Exhibit 1). The charter
also should specify frequency of meetings, topics
to be covered, and the nature and frequency of the
committee’s communication with the organization’s
senior managers, as well as its internal and
external auditors. One of the charter’s
most important functions is its record of the
various powers and authorities the committee must
possess, independent of the organization’s senior
management. The audit committee should be free to
obtain the information it needs to assess
adherence to rules, regulations and the
organization’s core values. An audit committee
that has adequate authority to ask appropriate
questions and get informative answers is in a
better position to provide useful commentary and
recommend necessary action. This ensures the
organization and management are responsive to
stakeholders, whether they are shareholders in an
SEC-registered corporation or bond-holders with a
stake in the fiscal management of a municipal
government agency. The SEC requires audit
committees of listed companies to prepare an
annual audit committee report. When applicable,
this requirement should be written into the
charter. Although an annual report may not be
required for some organizations, it is good
practice for a committee to resolve to prepare
one. Other audit committee functions and
powers laid out in its charter should include:
n Hiring outside counsel and
consultants whenever necessary.
n Reviewing and concurring in the
appointment, replacement, reassignment or
dismissal of the chief audit executive and
internal and independent auditors.
n Monitoring and ensuring the
external audit partner in charge is rotated as
required by regulations.
n Ensuring external auditors do not
provide nonaudit services prohibited by
independence rules or those that require prior
audit committee approval.
The charter also should give the audit
committee the right to monitor officers’ expense
accounts and use of corporate assets and consider
the results of audits in these areas, and to
ensure the adequacy of the scope of and plan for
internal and external audits, internal controls
over mandatory financial reporting as well as
earnings statements contained in press releases.
In addition, the charter should codify the audit
committee’s authority to periodically review the
organization’s code of conduct for adequacy and
recommend changes as necessary and its right and
responsibility to review any complaints the
organization receives about its accounting,
internal controls or financial reporting and
monitor their resolution. This includes
confidential, anonymous reports by employees and
others regarding questionable accounting, auditing
or other matters. Finally, it is essential
for the committee to conduct an annual review of
the charter’s adequacy in light of new business
conditions, laws or regulations and recommend
changes to the board of directors as necessary.
The charter should clearly state the audit
committee’s responsibility to periodically review
its own effectiveness. The charter should require
the committee to plan its agenda a year in
advance, leaving room for unanticipated items to
be added, and that certain standing topics be
included every year. For example, the one standing
agenda item could be to review and approve the
chief audit executive’s annual plan.
Leadership Principles for
Audit Committees
Run the audit committee in a
professional manner.
Members of the audit
committee are role models. Shareholders,
the board of directors and senior
management are watching you.
The audit committee chairman
establishes the “emotional tone” of the
group.
The audit committee chairman
is especially responsible for preventing
“groupthink” and “collusion.”
Ask the hard questions to
connect the dots. Make sure you know how
(that is, by what procedures) different
areas of the organization reached the end
results and summaries before you.
Regularly assess your
performance.
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2. Specify critical success factors as
competencies audit committee members must
possess for the committee to discharge its
duties and function effectively .
First learn the business and its risks. Then
become familiar with the accounting treatments
unique to the business and prepare for all
meetings. “It can be very challenging to read a
10-K three or four times, but it’s necessary,”
says Paula Cholmondeley, CPA, who has been an
audit committee chairwoman for three public
companies—Ultralife Batteries, Albany
International and Denstply International—and one
investment company, Gartmore Mutual Funds.
Cholmondeley strongly recommends that audit
committee members spend time building
relationships and diligently maintain their
skepticism about issues and topics within their
purview. One of her greatest concerns is that
audit committee members stay abreast of the latest
developments relating to accounting rules,
legislation, industry and the company. “We need
two levels of knowledge,” she says. The general
level is addressed by a lot of courses business
schools offer audit committee members on how the
committee should function. “But it’s more
difficult to keep up with specific accounting
knowledge,” she says. “The key accounting policy
reviews by my committees enable the companies and
their management to educate us on a few issues a
year.” She and her fellow committee members also
study literature from auditors and attend
presentations on new accounting pronouncements.
3. Identify committee core values that
reflect those of the organization and establish
written procedures that foster open
communication, equitable dispute resolution and
active participation by all committee members.
Audit committees need to encourage
mutual respect and cooperative interaction with
auditors and the organization’s staff and senior
management. According to Dennis H. Chookaszian,
CPA, who serves on three audit committees and is
chairman of the Financial Accounting Standards
Advisory Council, “the chair should provide the
appropriate ‘tone at the top’ to help instill a
control orientation within the organization.” He
says the chairman also should identify priorities
for the entity’s audit team and oversee the
evaluation of the personnel, quality, frequency
and scope of the entity’s financial and internal
audit functions. The chairman also must prepare
the committee for significant challenges, whether
relatively new, like understanding enterprise risk
management and its corporate governance
implications, or longstanding and growing, such as
the struggle to build and retain a high quality
staff of financial professionals. Similar
challenges and responses are in play in the
government sector, says Colleen Waring, CPA, who
was deputy city auditor in Austin, Texas, prior to
her retirement at the end of 2006. In Austin the
city auditor is appointed by and reports to the
city’s audit and finance committee, which the
mayor chairs. The city charter and the ordinance
governing the city auditor’s role and
responsibilities guide the committee’s actions.
Waring says the city auditor meets regularly with
individual committee members to hear their
questions, comments and concerns.
4. Reserve the right to invite any group
or individual to an audit committee meeting
. As the audit committee chairman
of the Chicago Mercantile Exchange, Chookaszian
has helped the committee establish good working
relationships with the exchange’s CEO, CFO, chief
audit executive, external auditors and other
members of the board of directors. “These
connections are essential to the audit committee’s
success,” he says. The chairman must
establish regular communications with these senior
managers to obtain their views on what the audit
committee should focus on and keep them apprised
of audit committee activities. In his view, the
closest relationship the chairman should have is
with the head of internal audit. “And,” he
emphasizes, “that position should be a direct
report to the audit committee.” Additionally, the
head of internal audit should have an
administrative reporting relationship to someone
not involved in financial reporting, such as the
general counsel. While Austin’s audit
committee offers a “safe haven” to individuals it
interviews in executive session, Waring says, it
still asks incisive questions, objectively
evaluates answers and takes whatever action is
necessary to resolve issues within its purview.
5. Ensure all members actively participate
in setting the committee agenda, and whenever
possible avoid conducting committee business
between meetings. When it comes
to audit committee effectiveness, advance
planning, members’ technical skills and relations
with senior management are of paramount
importance. Audit committees should request that
the organization’s chief audit executive and
senior financial officer attend each meeting and
address the committee as a whole. Interactions
between the committee and management should not be
limited to written correspondence or interaction
with only the audit committee chairman between
meetings. “It’s essential that the audit
committee create a schedule of meetings for the
coming year, including an agenda for each
meeting,” Chookaszian says. The agenda should
identify the highest priority items for each
meeting, such as reviewing the company’s SEC form
10-K. He also strongly recommends holding
quarterly meetings with the external auditor, the
CEO, the CFO and the head of internal audit.
Further, he says, a good way to evaluate the audit
committee’s performance is to conduct an annual
confidential survey that elicits committee
members’ views on the committee’s effectiveness.
As chairman, Chookaszian accepts
responsibility for providing information to the
committee and, as necessary, getting the CFO and
internal audit chief’s help to do so. “The chair
has to ensure that committee members have all the
information they need on new issues and company
activities,” he says. One way he delivers such
information is by preparing for the audit
committee and senior management an annual status
report on the company’s financial and internal
audit functions. When meeting with the
audit committees she chairs, Cholmondeley uses a
checklist that tracks all the regulatory tasks
that must be completed during the current year.
“We also have an annual calendar with all the
topics for each meeting in the year,” she says.
The calendar has a section for fixed agenda items
(for example, ethics, internal audit, SOX issues,
executive sessions and financial reports). It also
has a section for meeting specific fixed
items—usually items from the checklist, such as a
review of the yearend auditor’s report. And there
are sections on key accounting policy reviews and
functional presentations. Cholmondeley
plans her audit committees’ agendas at the
beginning of the year by identifying the topics to
be covered. Just before each meeting she also
requests topics from audit committee members and
management, and then she adds to the original
agenda new topics that require discussion.
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AICPA Audit Committee
Effectiveness Center
Recognizing the need for increased
support for audit committees, the AICPA
created the Audit Committee Effectiveness
Center, an online center available through
the AICPA Web site at www.aicpa.org/audcommctr
. The center was created in the public
interest and includes the following key
features:
The AICPA Audit Committee
Toolkit was created to help guide
audit committees. The Toolkit ,
which is available in versions for
corporate, not-for-profit and government
entities, includes a variety of programs,
checklists, matrices and questionnaires
designed to help the audit committees
understand and execute their
responsibilities. New tools are
continually developed and released when
available.
Over 40,000 copies of the
print versions of the Toolkit are
in circulation. Each tool in the
Toolkit is available in the
online center in various formats including
Word, so users can download and customize
it for use in their own organization for
free—the AICPA asks only that users
include a notation acknowledging the
AICPA’s copyright on the tools. Print
versions of the Toolkit can be
purchased. This allows the AICPA to
recover its production costs.
The Audit Committee
Matching System is another key
feature of the center. This is a free
searchable database of AICPA members who
are willing to serve on audit committees
and boards of directors. While each party
(candidate and searching organization)
must perform its own due diligence on each
other, the matching system is an ideal way
to bring the CPA skill set to audit
committees. More than 2,000 AICPA members
are registered in the database, and
searches are conducted regularly.
A third feature of the center
is the E-Alert System created for visitors
to the site to register for an e-mail
notification of updates to the site,
release of new tools, and other matters of
interest to audit committee members. The
E-Alerts are also a free service and
available to AICPA members and non-members
alike. |
6. Formulate decision-making processes and
procedures for resolving stalemates.
Committee members have to agree to
some ground rules, which should relate back to the
charter. All audit committees are unique, and so
is each organization’s culture, says Cholmondeley.
Procedures should reflect the specific needs of
the individual committee and organization.
Objective criteria should be developed in
advance for evaluating prospective external
auditors or internal audit executives. This helps
the committee overcome personal preferences and
pressure from management when evaluating a
particular audit firm, consultant or job
candidate. Another inhibitor to timely
decision making can be a lack of knowledge on
particular issues facing the organization.
Committees should obtain additional information
from the organization whenever necessary to
facilitate informed deliberation. “You have to
learn the business,” Cholmondeley says. “That
takes time and a willingness to read product
literature, visit company facilities and meet
employees. But it’ll make you a more effective
member of the audit committee.”
7. At the beginning of each meeting,
review the previous meeting’s highlights.
Guiding principles and focus easily
can be lost in the details of a complicated
business. In addition to highlighting results from
previous meetings, start by reviewing the
company’s written organizational vision, core
values and critical success factors. Continue
referring to them as you review documents.
Working with her colleagues on each audit
committee she chairs, Cholmondeley measures the
committees’ effectiveness in several ways. On a
fundamental level, she reviews the checklist to
see whether all the tasks were completed. “But
more important,” she says, “is our collective
sense of whether we’ve improved the organization
over the past year. Is the finance team better
able to deal with complex issues than it was a
year ago? Have we improved our relationship with
management? Do they consider our suggestions and
act promptly on our requests?”
8. At the end of each meeting, summarize
it. After a meeting is over,
each member should have a common understanding of
key aspects of the meeting without referring to
notes or minutes. For this purpose, summarize key
decisions, actions to be taken, who will perform
them and when, and the expected results. Require
each meeting attendee to specify what aspects of
the meeting he or she felt was successful or
helpful and what requires improvement. Discuss
whether the organization’s vision and objectives
are being fulfilled. Also committee members should
encourage each other to organize and share in
writing any thoughts they have following the
meeting that would be helpful to the committee.
Exhibit 1 | Financial Expert Decision
Tree | | | | Source: The AICPA
Audit Committee Toolkit . Copyright
© 2004 by the American Institute of
Certified Public Accountants, Inc., New
York. For the full text of the SEC rule
regarding audit committee financial
experts, visit www.sec.gov/rules/final/33-8177.htm
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