Audit committees play a crucial oversight role within any company. The audit committee can be a tremendous assistance to the board in establishing, implementing, monitoring and sustaining good corporate governance for the benefit of the Company and its stockholders. The responsibility for assessing the audit committee’s effectiveness is gaining greater importance. The assessment of the audit committee’s performance and effectiveness is best achieved through a self-assessment process, with the results being submitted to the full board for review and follow-up. This process should be performed at least on an annual basis. The Company’s board of directors should also share in the responsibility for this process. Its charter should indicate that all of the board’s committees should evaluate their effectiveness. Further, the approach should be agreed to by the board and committee. In assessing the committee’s performance, two fundamental questions should be answered;
- Is the committee satisfied that it has effectively fulfilled its responsibilities as set out in its charter?
- How can the committee improve its operating effectiveness and efficiency?
This process even in times of growth and stability is not a simple matter for an audit committee. Add in the global recession, uncertainty in the markets, sweeping regulatory reforms and expectations by investors and regulators for transparency and accountability it is becoming a daunting task. The 2010 Report of the Blue Ribbon Commission on the Audit Committee offers practical perspectives, suggestions and leading practices on what makes an audit committee effective. In this report, it offers ten principles to help guide audit committees in their oversight role which are;
- Be proactive in focusing the agenda on what’s
important and make the most of audit committee meetings. The challenges
of the recent economic times, whether being the access to capital, cash
flow, impairments, etc have dominated audit committee agendas. With
signs of recovery the committee should focus on key reporting risks. The
committee should ensure that the agenda addresses issues that require
the audit committee’s attention and keeps it focused on its primary
oversight responsibility. To improve the efficiency of meetings,
materials should be received in advance; less time should be devoted on
low-value or checklist activities and engage in discussion rather than
listening to presentations. Compliance activities should not dominate
substantive discussions. This can be accomplished by separately
identifying items which are applicable for a “consent agenda”, so they
can be handled without discussion.
- Insist on transparency, both internal and external
amongst the audit committee, management and internal and external
auditors. Candor is tremendously important to the audit committee in its
oversight role. That is why executive sessions are now standard
procedure for committees. They provide a forum for open discussion
without members of management present. In these sessions, committee
members should pose questions to elicit concerns about management,
auditor competency, resources, as well as general concerns about
financial-reporting and control issues. It allows committee members an
opportunity to discuss difficult issues.
- Focus closely on external financial communications.
This process goes beyond the 10-K and 10-Q’s but to the earnings
releases and analyst calls since they contain important business
information. Engage early in reviewing the proxy disclosures,
particularly the new disclosures regarding risk, compensation and
corporate governance. Understand the Company’s policy regarding the use
of the new social media of Twitter and other networks to reach investors
and customers. The committee should assess how management is addressing
SEC’s calls for transparency and improved disclosures about the
on-going effect of the economic environment of the Company, in
particular its impact on operations and business risks (e.g.,
restructuring activities, liquidity disclosures) and the need to
consider foreshadowing disclosures (e.g. “early warning” about future
- Question the continuing validity of key assumptions
that underlie critical accounting judgments and estimates and be current
on key financial-reporting issues and developments affecting the
company. These issues can include such areas as fair value, impairments,
going concern considerations, tax valuation allowances and pension
funding shortfalls. Also the committee should be aware of new financial
reporting developments including IFRS or transfers of financial assets.
At each meeting, the committee should dive into a specific financial
reporting development impacting the company.
- Assess the audit committee’s role in the oversight
of risk management with an eye to clarifying the scope. The tremendous
focus on risk today and the SEC’s new rules requiring disclosures about
the board’s role in risk oversight is an opportunity for the board to
reassess the role of the audit committee (and the full board and other
standing committees) in overseeing risk. A determination should be made
whether the audit committee has the expertise and time to deal with
strategic, operational and as well as other risks. Along these lines is
the expertise of other board members being leveraged especially since
audit committees tend to have their plates full with oversight of the
financial reporting risk.
- Set and manage clear expectations for external and
internal auditors. The committee should help to refine the internal
audit’s role and focus internal audit’s activities on key areas of risk,
as well as risk management. Internal audit should not be accountable or
responsible for risk management but it should provide added assurance
regarding the adequacy of the company’s risk management processes.
Internal audit is most effective when it is focused on risk. Ensure that
the internal audit plan is risk-based and focuses on the critical risks
to the business and not just compliance and financial risks.
- Make sure the chief financial officer and the entire
finance organization, as well as internal audit, have what they need to
succeed and be sensitive to the strains on these organizations. Cost
cutting has been a key response of most companies to the economic
crisis. Every board and audit committee member should be asking whether
the cost-reduced model can be maintained and what is its impact on the
- Assess the tone at the top and throughout the
organization, including the effectiveness of compliance and anti-fraud
programs. The economic crisis continues to put pressure on management to
achieve operating results simultaneous with cutting costs and reducing
the workforce. A comprehensive review of the company’s anti-fraud and
compliance programs, including its Foreign Corrupt Practices Act
compliance program may be in order. The right tone at the top and
throughout the finance organization is critical.
- Help to link the change and risk management and
monitor critical alignments. Change creates risk. During times of
dramatic change, the risk of misalignment of the company’s strategy,
goals, risk, controls and compliance increases substantially. Given the
audit committee’s role in overseeing risk, internal controls, compliance
and ultimately the impact of significant changes on the company’s
financials, the committee is in a unique position to help to alleviate
the risk of misalignment.
- Take a hard look at the audit committee’s effectiveness including its composition and leadership and find ways to continuously improve. The audit committee’s effectiveness and accountability hinges on meaningful self-assessments of the committee as a group as well as individual members. Take a hard look at the committee’s composition, independence and leadership. Audit committees must be accountable for their actions and should report regularly to the chairman of the board. They should continually assess their performance and improve their effectiveness.
In summary, an audit committee can be a critical oversight mechanism, but to be successful, each of its members must devote the necessary time, educate themselves, be demanding and diligent and insist on timely and appropriate information and responses from management, internal and external auditors.
Michael Naparstek reviewed this article.