In 2012, a group of nationally recognized U.S. corporate governance and policy organizations including the AICPA’s Center for Audit Quality formed the Audit Committee Collaboration. The Collaboration recently published a report or a "Call to Action" intended to assist audit committees in strengthening their public disclosures to more effectively convey the critical work of audit committees to investors and stakeholders. The published report or the Collaboration’s Call to Action includes examples of emerging, voluntary disclosures and cites studies that have examined recent trends in these practices. The recommendations do not require audit committees to take on any additional responsibilities; rather they are focused on encouraging audit committee members to provide greater transparency to investors and others about their work. The Audit Committee Collaboration previously published a tool to assist audit committees with their annual assessment of the external auditor. Access to the Audit Committee Collaboration’s tools can be found at AuditCommitteeCollaboration.org.
The Call to Action is based on the premise that, given the importance of the audit committee for overseeing the financial reporting process, including supervision of the work of external and internal auditors, it is important for investors and other stakeholders to understand and have confidence in the audit committee’s work. The annual audit committee report included in the proxy statement is the principal source of public audit committee related information other than the committee charter. The Audit Committee Collaboration believes that all public company audit committees ought to thoughtfully reassess their public reporting with stakeholders and, if need be, to strengthen them in the future.
External drivers of change include recent legislative and regulatory actions which have expanded the responsibilities of audit committees in recent years (starting with the Sarbanes-Oxley Act in 2002 (SOX) and culminating in the PCAOB’s outreach to, and interaction with, audit committees). As the scope of the audit committee’s responsibilities has grown, so too have regulators’ and investors’ interest in the way in which they are carried out.
The Call to Action provides examples of disclosure language obtained directly from 2013 proxy statements which demonstrate emerging practices in key areas.The examples are not intended to be prescriptive or an authoritative mandate; however, the examples serve as benchmarks that other audit committees can use to evaluate how effective their own disclosures are regarding:
- The scope of the audit committee’s duties
- The audit committee’s composition
- Relevant information about:
- Factors considered when selecting or reappointing an audit firm
- Selection of the lead engagement partner
- Factors considered when determining auditor compensation
- How the audit committee oversees the external auditor
- How the audit committee evaluates the external auditor
Emerging Practices Point Toward the Need for Enhanced Disclosures
A study conducted by Ernst & Young of the 2013 proxy statements of the Fortune 100 Companies to identify the percentage of audit committee disclosures that go beyond the minimum regulatory and securities exchange requirements show a significant opportunity for enhancement:
- Only 50% included an affirmative statement that the audit committee is responsible for the appointment, compensation and oversight of the external auditor
- Only 31% disclosed the length of the auditor’s tenure (a hotly debated issue both in the US and abroad)
- Only 17% disclosed that the audit committee was involved in the selection of the lead audit partner
The Scope of the Audit Committee's Duties
The audit committees of all NYSE and NASDAQ listed companies must include their specific duties in their charters. The NYSE requires that the charters be located on the company’s website and the company provide a link to the charter somewhere in the proxy statement. While disclosures related to the independent auditor are important given the statutory mandate for these duties, disclosures regarding the audit committee’s risk oversight have become an important topic of discussion.
An excerpt from one of the Call to Action’s disclosure examples regarding risk oversight states:
Among other duties, the Audit Committee also oversees:
- The integrity of our financial statements, our accounting and financial reporting processes, our systems of internal control over financial reporting and safeguarding our assets;
- Our compliance with legal and regulatory requirements;
- The performance of our internal auditors and internal audit functions; and
- Our guidelines and policies with respect to risk assessment and risk management.
The Audit Committee's Composition
While regulator and SEC required disclosures can vary, the audit committee should consider providing more clarity around such elements as its members’ qualifications and independence, and the basis upon which these qualities are determined.
An excerpt from one of the Call to Action’s disclosure examples regarding clarity around the composition of the audit committee states:
… The Audit Committee is composed of six non-employee directors and operates under a written charter adopted by the board of directors that was last amended on (date). The Board of Directors has determined that each member of the Audit Committee is “independent” and financially literate, and that at least one member has accounting or other related financial management expertise, in each case such qualifications are defined under the Listing Standards of the NYSE. The Board of Directors has also determined that Member A, Member B and Member C qualifies as an “audit committee financial expert” as defined by the SEC.
The Factors Considered When Selecting or Reappointing an Audit Firm;
In the context of appointing or reappointing the independent audit firm, the audit committee should consider discussing the quality and qualifications of the firm, and might include things such as capacity to staff the audit, geographical reach of the practice, and industry and sector specific expertise. In addition, the audit committee should consider providing relevant information from its annual evaluation of the external auditor. Providing the context around the decision making process can help build investor confidence by emphasizing the thoroughness of the process that led to the audit committee’s decision.
An excerpt from one of the Call to Action’s disclosure examples regarding the factors considered when selecting or reappointing and audit firm states:
…in determining whether to reappoint (Independent Auditor) as our independent auditor, the Audit Committee took into consideration a number of factors, including the length of time the firm has been engaged, the quality of the Audit Committee’s ongoing discussion with (independent auditor) and an assessment of the professional qualifications and past performance of the Lead Audit Partner and (Independent Auditor)…
The Factors Considered When Selecting the Lead Audit Partner
SOX requires the mandatory rotation of the lead audit partner after a period of five years.Therefore, when the period for rotation is near, the audit committee ought to consider providing more effective disclosure about its process and involvement in the selection of the new lead audit partner.
An excerpt from one of the Call to Action’s disclosure examples regarding the factors considered when selecting the lead audit partner states:
…in accordance with SEC rules and (Independent Auditor) policies, audit partners are subject to rotation requirements to limit the number of consecutive years an individual partner may provide service to our Company. For lead and concurring audit partners, the maximum number of consecutive years of service in that capacity is five years. The process for selection of the Company’s lead audit partner pursuant to this rotation policy involves a meeting between the chair of the Audit Committee and the candidate for the role, as well as discussion by the full Committee and with management…
The Factors Considered When Determining Auditor Compensation
The audit committee, not management, determines auditor compensation which is designed to promote auditor independence. Auditor compensation is disclosed on an annual basis in the company’s annual report on Form 10-K. However, disclosure of the key factors the audit committee considers in this process could help investors understand the direct and primary role the audit committee plays in determining that the auditor is paid a reasonable amount that is consistent with the delivery of a quality audit.
An excerpt from one of the Call to Action’s disclosure examples regarding the factors considered when determining auditor compensation states:
The Committee has reviewed and approved the amount of fees paid to the independent auditors for audit, audit related and tax compliance services. The Committee concluded that the provision of services by the independent auditors is compatible with the maintenance of their independence. (Independent Auditor) has served as the independent auditor of the Company and its predecessors since 20xx. As in prior years, the Committee has engaged in a review of (Independent Auditor) in connection with the Committee’s consideration of whether to recommend that the shareholders ratify the selection of (Independent Auditor) as the Company’s independent auditor for the following year. In that review, the Committee considers both the continued independence of (independent Auditor) and whether retaining (Independent Auditor) is in the best interests of the Company and its stockholders…
The Factors Considered in Overseeing the Independent Auditor
The audit committee should also consider whether additional disclosure about its general oversight of the external auditor would provide shareholders and potential investors with useful context. These might include discussions of the degree of the audit committee’s interaction with the external auditor, the types of issues discussed at those meetings, and other activities that are central to the audit committee’s oversight. PCAOB Auditing Standard No. 16 requires the auditor to communicate a number of important matters pertaining to the conduct of the specific engagement to the audit committee. The audit committee might wish to discuss certain of these matters in their annual disclosure report.
An excerpt from one of the Call to Action’s disclosure examples regarding the factors considered in overseeing the independent auditor states:
…We discussed with the independent auditors the overall scope and plan for their audit and approved the terms of their engagement letter. We also reviewed the company’s internal audit plan. We met with the independent auditors and with the company’s internal auditors, in each case, with and without other members of management present, to discuss the results of their respective examinations, the evaluation of the company’s internal controls and the overall quality and integrity of the company’s financial reporting…
The Factors Considered in Evaluating the Performance of the External Auditor
Most audit committees have practices in place to assess the effectiveness of their independent auditor throughout the year. The audit committee should consider providing information about its evaluation process, or providing key conclusions from that evaluation with regard to any discussions about auditor reappointment.
An excerpt from one of the Call to Action’s disclosure examples regarding the factors considered in how the audit committee evaluates the external auditor states:
…in its meetings with representatives of the Independent Auditors, the Audit Committee asks them to address, and discuss their responses to, several questions that the Audit Committee believes are particularly relevant to its oversight. These questions include:
- Are there any significant accounting judgments or estimates made by management in preparing the financial statements that would have been made differently had the Independent Auditor’s themselves prepared and been responsible for the financial statements?
- Based on the Independent Auditor’s experience and their knowledge of the Company, do the Company’s financial statements fairly present to investors, with clarity and completeness, the Company’s financial position and performance for the reporting period in accordance with GAAP and SEC disclosure requirements?
- Based on the Independent Auditors ‘experience and their knowledge of the Company, has the Company implemented internal controls and internal procedures that are appropriate for the Company? The Audit Committee believes that, by thus focusing its discussions with the Independent Auditors, it can promote a meaningful dialogue that provides a basis for its oversight judgments…
The effective communications of high quality information among key players in the financial markets promotes investor confidence, which is the engine that drives capital formation and the efficiency of the markets. Marcum strongly encourages audit committees to respond to the Call to Action by exploring way to improve the information provided in the marketplace. We would be pleased to consult with audit committees on enhancing their communication processes and helping to implement the tools developed by the Audit Committee Collaboration.