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Update on the Blue Ribbon Committee on Improving the Effectiveness of Audit Committees. Chicago CFO Advisory Council December 9, 1999. Objectives. Improve audit committee effectiveness Increase oversight diligence by audit committees - PowerPoint PPT Presentation
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Chicago CFO Advisory CouncilChicago CFO Advisory Council
December 9, 1999December 9, 1999
Update on the Blue Ribbon Update on the Blue Ribbon Committee on Improving Committee on Improving
the Effectiveness of the Effectiveness of Audit CommitteesAudit Committees
• Improve audit committee effectivenessImprove audit committee effectiveness
• Increase oversight diligence by audit Increase oversight diligence by audit committeescommittees
• Reduce cases of improper financial reporting Reduce cases of improper financial reporting as a result of these improved audit committee as a result of these improved audit committee practices.practices.
Objectives
The Three Legged Stool of Financial Reporting
1. Company financial management2. Board including the audit committee3. External auditors
Each has a role. Each has certain specialties and capabilities in terms of expertise, time and depth of familiarity.
• Independence of Audit Committee Independence of Audit Committee
Members - Self Regulating Org :SROMembers - Self Regulating Org :SRO
• Composition of Audit CommitteeComposition of Audit Committee
• Qualifications of Audit Committee Qualifications of Audit Committee
membersmembers
• Adoption of Audit Committee Adoption of Audit Committee
CharterCharter
Blue Ribbon Panel Recommendations
– SROSRO
– SROSRO
– SROSRO
– SROSRO
• Disclosure in Proxy Statement about Disclosure in Proxy Statement about
Charter and compliance therewithCharter and compliance therewith
• Outside auditor is accountable to Outside auditor is accountable to
Board of DirectorsBoard of Directors
• Outside auditors provide Audit Outside auditors provide Audit
Committee with written Statement on Committee with written Statement on
IndependenceIndependence
Blue Ribbon Panel Recommendations
– SECSEC
– SROSRO
– SROSRO
• Outside auditors discuss with Audit Outside auditors discuss with Audit
Committee their judgement about Committee their judgement about
quality of accounting principlesquality of accounting principles
• Audit Committee Letter in Annual Audit Committee Letter in Annual
ReportReport
• Quarterly SAS 71 reviews and Quarterly SAS 71 reviews and
discussion of results with Audit discussion of results with Audit
CommitteeCommittee
Blue Ribbon Panel Recommendations
– AICPAAICPA
– SECSEC
– SEC/AICPASEC/AICPA
Quarterly SAS Reviews and Discussions of Results with Audit
Committee - #10 (SEC)• Requires that outside auditor conduct a SAS 71 interim Requires that outside auditor conduct a SAS 71 interim
financial review prior to company filing its Form 10-Qfinancial review prior to company filing its Form 10-Q
• Recommends that SAS 71 be amended to require outside Recommends that SAS 71 be amended to require outside
auditors to discuss significant issues with at least the auditors to discuss significant issues with at least the
chairman of the Audit Committee, including:chairman of the Audit Committee, including:• significant adjustmentssignificant adjustments• management judgements and accounting estimatesmanagement judgements and accounting estimates• significant new accounting policiessignificant new accounting policies• disagreements with managementdisagreements with management
• Proposed amending SAS 71 to require quarterly Proposed amending SAS 71 to require quarterly
discussions with the AC prior to the filing of the 10-Q discussions with the AC prior to the filing of the 10-Q
• Encourages this discussion prior to public Encourages this discussion prior to public
announcement of interim resultsannouncement of interim results
• The auditor would have to discuss the items The auditor would have to discuss the items
described in SAS 61 or be satisfied that those matters described in SAS 61 or be satisfied that those matters
have been discussed with the AC by managementhave been discussed with the AC by management
ASB Actions
• Interim financial statements should be Interim financial statements should be
reviewed by independent auditors before reviewed by independent auditors before
filing 10-Q and 10-QSB.filing 10-Q and 10-QSB.
SEC Actions
Letter should disclose whether or not:Letter should disclose whether or not:
Audit Committee Letter in Annual Report - #9 (SEC)
• Management has reviewed the audited financials Management has reviewed the audited financials
with the Audit Committee, including a discussion of with the Audit Committee, including a discussion of
the quality of the accounting principles applied, etc.the quality of the accounting principles applied, etc.
• The outside auditors have discussed with the Audit The outside auditors have discussed with the Audit
Committee their judgements regarding the quality of Committee their judgements regarding the quality of
principles applied, etc.principles applied, etc.
Audit Committee Letter in Annual Report - #9 (SEC)
• Members of the Audit Committee have discussed Members of the Audit Committee have discussed
information disclosed to them by management and information disclosed to them by management and
outside auditorsoutside auditors
• The Audit Committee, in reliance on the above, believe The Audit Committee, in reliance on the above, believe
that the company’s financials are fairly presented, in all that the company’s financials are fairly presented, in all
material respects, in conformity with GAAP material respects, in conformity with GAAP
• It is recommended that the SEC adopt a “Safe Harbor” It is recommended that the SEC adopt a “Safe Harbor”
applicable to any disclosure in this recommendationapplicable to any disclosure in this recommendation
Letter should disclose whether or not:Letter should disclose whether or not:
• Proxy statements must include an AC report that Proxy statements must include an AC report that
discloses:discloses:
– whether the AC reviewed and discussed certain whether the AC reviewed and discussed certain
matters with management and the auditorsmatters with management and the auditors
– whether the AC recommended to the Board that the whether the AC recommended to the Board that the
audited financial statements be included in the Annual audited financial statements be included in the Annual
Report on Form 10-K or 10-KSBReport on Form 10-K or 10-KSB
SEC Actions
• Discuss quality, not just the acceptability of Discuss quality, not just the acceptability of
accounting principles as applied in financial reportingaccounting principles as applied in financial reporting
• Include:Include:
Outside Auditors Discuss with Audit Committee Their Judgement About Quality
of Accounting Principles - #8 (AICPA)
• clarity of financial disclosuresclarity of financial disclosures• degree of aggressiveness or conservatism of degree of aggressiveness or conservatism of
accounting principles and underlying estimatesaccounting principles and underlying estimates• other significant management decisions regarding other significant management decisions regarding
financial disclosuresfinancial disclosures
• The ASB has proposed amending SAS 61 which The ASB has proposed amending SAS 61 which
would require a discussion of the quality of would require a discussion of the quality of
accounting principles with the AC each yearaccounting principles with the AC each year
• The ASB deleted the terms “aggressive” and The ASB deleted the terms “aggressive” and
“conservative” due to the subjectivity of the “conservative” due to the subjectivity of the
termsterms
ASB Actions
• Charter to specify that Audit Committee is responsible Charter to specify that Audit Committee is responsible
for obtaining a formal written Statement of for obtaining a formal written Statement of
Independence from outside auditorsIndependence from outside auditors
• Statement should delineate all relationships between Statement should delineate all relationships between
auditor and company and be consistent with the auditor and company and be consistent with the
Independence Standards Board (Standard 1)Independence Standards Board (Standard 1)
Outside Auditors Provide Audit Committee with Written Statement
on Independence - #7 (SRO)
• Audit Committee is responsible for actively engaging Audit Committee is responsible for actively engaging
in a dialogue with the auditor with respect to any in a dialogue with the auditor with respect to any
disclosed relationships or services that may impact the disclosed relationships or services that may impact the
objectivity or independence of the auditorobjectivity or independence of the auditor
Outside Auditors Provide Audit Committee with Written Statement
on Independence - #7 (SRO)
NYSE/SEC Actions
• NYSE adopts this recommendationNYSE adopts this recommendation
• SEC requires proxy statements to include SEC requires proxy statements to include audit committee report discussing whether audit committee report discussing whether the audit committee has received disclosures the audit committee has received disclosures from independent auditors required by ISB from independent auditors required by ISB Standard No. 1, and discussed with the Standard No. 1, and discussed with the auditors the auditor’s independence (these auditors the auditor’s independence (these disclosures to be protected by safe harbor)disclosures to be protected by safe harbor)
• Charter to specify that outside auditor is ultimately Charter to specify that outside auditor is ultimately
accountable to Board of Directors and the Audit accountable to Board of Directors and the Audit
Committee as representatives of shareholdersCommittee as representatives of shareholders
• The above representatives have ultimate authority and The above representatives have ultimate authority and
responsibility to select, evaluate and where appropriate responsibility to select, evaluate and where appropriate
replace the outside auditor or to nominate an outside replace the outside auditor or to nominate an outside
auditor to be proposed for shareholder approval in Proxyauditor to be proposed for shareholder approval in Proxy
Outside Auditor is Accountable to Board of Directors - #6 (SRO)
• Similar to current practices/NYSE adopts Similar to current practices/NYSE adopts
this recommendationthis recommendation
NYSE Actions
• Company is required to have its Audit Committee Company is required to have its Audit Committee
disclose in its annual Proxy Statement whether Audit disclose in its annual Proxy Statement whether Audit
Committee has adopted a formal written CharterCommittee has adopted a formal written Charter
• Audit Committee to also state whether it satisfied its Audit Committee to also state whether it satisfied its
responsibilities in compliance with Charterresponsibilities in compliance with Charter
Disclosure in Proxy of Charter and Compliance Therewith - #5 (SEC)
• Charter is to be disclosed triennially in annual report or Charter is to be disclosed triennially in annual report or
proxy and in any year after significant amendments are proxy and in any year after significant amendments are
made to the Chartermade to the Charter
• It is recommended that SEC adopt a “Safe Harbor” It is recommended that SEC adopt a “Safe Harbor”
applicable to all disclosures in this Recommendation #5applicable to all disclosures in this Recommendation #5
Disclosure in Proxy of Charter and Compliance Therewith - #5 (SEC)
• A copy of the AC charter should be filed with A copy of the AC charter should be filed with
the SEC every 3 yearsthe SEC every 3 years
• The SEC did NOT propose to require The SEC did NOT propose to require
companies to disclose whether the AC was in companies to disclose whether the AC was in
compliance with its charter to avoid “skimpy, compliance with its charter to avoid “skimpy,
broadly-worded and vague charters”broadly-worded and vague charters”
• SEC adopts safe harborSEC adopts safe harbor
SEC Actions
• Adopt a formal, written Charter that is approved by Adopt a formal, written Charter that is approved by
the full boardthe full board
• Specify the scope of responsibilities and how those Specify the scope of responsibilities and how those
responsibilities are carried out, including structure, responsibilities are carried out, including structure,
processes and membership requirementsprocesses and membership requirements
• Review and reassess the adequacy of the Charter on Review and reassess the adequacy of the Charter on
an annual basisan annual basis
Adoption of Audit Committee Charter - #4 (SRO)
• NYSE adopts this recommendationNYSE adopts this recommendation
• NYSE requires annual confirmation of NYSE requires annual confirmation of
any determination that board makes any determination that board makes
regarding the annual review of the charterregarding the annual review of the charter
NYSE Actions
• Audit Committee should be comprised of a minimum Audit Committee should be comprised of a minimum
of three directorsof three directors
• Each member should be financially literate or become Each member should be financially literate or become
financially literate within a reasonable period of time financially literate within a reasonable period of time
after appointmentafter appointment
• One member of Committee should have accounting or One member of Committee should have accounting or
related financial management expertiserelated financial management expertise
Qualifications of Audit Committee Members - #3 (SRO)*
* For Companies with market capitalization over $200 million
• NYSE adopts this recommendation, but REJECTS NYSE adopts this recommendation, but REJECTS
$200 million market cap recommendation$200 million market cap recommendation
• NYSE requires annual confirmation of any NYSE requires annual confirmation of any
determination that board makes regarding the determination that board makes regarding the
financial literacy of audit committee members and the financial literacy of audit committee members and the
accounting or financial management background of at accounting or financial management background of at
least one audit committee memberleast one audit committee member
NYSE Actions
• All listed companies with market capitalization All listed companies with market capitalization
above $200 million should have Audit Committee above $200 million should have Audit Committee
comprised solely of independent directorscomprised solely of independent directors
Composition of Audit Committee - #2 (SRO)
In addition to compliance with definition of independence (in Recommendation #1):
Independence of Audit Committee Members - #1 (SRO)*
Committee members are considered independent Committee members are considered independent if they have no relationship with the corporation if they have no relationship with the corporation that may interfere with the exercise of their that may interfere with the exercise of their independence from management.independence from management.
* For Companies with market capitalization over $200 million
• Director being employed by corporation (or affiliates) Director being employed by corporation (or affiliates)
for current and any of the past 5 yearsfor current and any of the past 5 years
• Director receiving compensation other than for Board Director receiving compensation other than for Board
serviceservice
• Director being related to anyone who has been Director being related to anyone who has been
executive officer of the corporation in any of the past 5 executive officer of the corporation in any of the past 5
yearsyears
Independence of Audit Committee Members - #1 (SRO)
Examples of conflicts of independence are:
• Director being a principal or executive officer of an Director being a principal or executive officer of an
entity to which the corporation made or received entity to which the corporation made or received
payments in amounts that are significant to the payments in amounts that are significant to the
corporation or entitycorporation or entity
• Director being employed as executive of another Director being employed as executive of another
company where any of the corporation’s executives serve company where any of the corporation’s executives serve
on that company’s Compensation Committeeon that company’s Compensation Committee
Independence of Audit Committee Members - #1 (SRO)
Examples of conflicts of independence, continued:
• Each exchange adopted a tougher definition of Each exchange adopted a tougher definition of
independenceindependence
• Each provide for a “board override” for one Each provide for a “board override” for one
member to be appointed to the AC who fails the member to be appointed to the AC who fails the
definition of independentdefinition of independent
NYSE/NASD/AMEX Actions
• NYSE/AMEX/NASDAQ companies should NYSE/AMEX/NASDAQ companies should
disclose certain information about any AC disclose certain information about any AC
member who in not “independent”, as defined in member who in not “independent”, as defined in
listing requirementslisting requirements
• Despite concerns, small businesses NOT Despite concerns, small businesses NOT
EXEMPT from the new requirementsEXEMPT from the new requirements
NYSE/NASD/AMEX Actions
• The Audit Committees key role in monitoring The Audit Committees key role in monitoring
the other component parts of the audit processthe other component parts of the audit process
• Independent communication and information Independent communication and information
flow with internal auditorsflow with internal auditors
• Independent communication and information Independent communication and information
flow with outside auditorsflow with outside auditors
Audit Committees Best Practices
• Candid discussions with management, the Candid discussions with management, the
internal auditor and outside auditors regarding internal auditor and outside auditors regarding
issues implicating judgement and imparting issues implicating judgement and imparting
qualityquality
• Diligent and knowledgeable membershipDiligent and knowledgeable membership
Audit Committees Best Practices