Update: Enhancing the Audit Committee Report
In the May 2014 issue of SEC Insights, I reported on the AICPA’s Center for Audit Quality Audit Committee Collaboration’s recently published Enhancing the Audit Committee Report: A Call to Action. The Call to Action was intended to assist audit committees in strengthening their public disclosures to more effectively convey their critical work to the investing public and other stakeholders. Since that time, much has happened to keep the topic in the public light:
- The Center for Audit Quality and Audit Analytics jointly published an Audit Committee Transparency Barometer presenting the results of a deeper analysis of 2014 audit committee disclosures applying a “barometer” for the first time to measure the robustness of these disclosures among the S&P Composite 1500.
- The Securities and Exchange Commission (“SEC”) published a Concept Release regarding Possible Revisions to Audit Committee Disclosures. The Concept Release sought input regarding a comprehensive set of potential changes to existing disclosures intended to establish further transparency in the way audit committees manage the oversight of the auditor.
- The Public Company Accounting Oversight Board (“PCAOB”) published a Concept Release on Audit Quality Indicators noting 28 potential quantitative indicators falling into three categories: (1) measurements dealing with audit professionals; (2) measurements dealing with the audit process; and (3) measurements dealing with the audit results.
We will report on the progress of the SEC and PCAOB proposals at a later date. However, the purpose of this article is to summarize the results of the Audit Committee Transparency Barometer, and the overall positive improvements noted regarding the extent and transparency of audit committee disclosures.
Many companies are disclosing more that what is currently required, and many of the required disclosures are either consolidated in the audit committee report or in a dedicated, labeled section of the proxy. However, a complete understanding of the audit committee’s activities may still require reviewing information that is in various other locations (including the Company’s website). Consolidating information, where possible, and providing a direct link to the audit committee charter facilitates access to this information by stakeholders.
A table of the survey author’s detailed findings regarding auditor oversight disclosures is presented within the body of this article. However, it is clear that companies and their audit committees are “answering the call” by expanding their disclosures. However, there is a significant lack of consistency in disclosures across all company size sectors and a diminishing level of auditor oversight disclosures within the S&P SmallCap sector, which are some of the reasons why the SEC and PCAOB have both published concept releases to further the dialogue regarding the extent of audit committee disclosures.
Basis for the Study
A barometer is defined as both a measuring instrument and something that reflects changes in circumstances and opinions. The barometer of audit committee transparency is focused on measuring the content of audit committee disclosures in certain key areas, including auditor oversight and audit committee scope of duties. The survey authors expect that this information will serve as a baseline reference point for measuring improvements in the disclosure of the work of audit committees in future proxy seasons.
Prior to the joint study leading to the publication of the Audit Committee Transparency Barometer (the “Barometer”), EY’s Center for Board Matters (the “EY Center”) published its 2014 proxy season update, noting that companies and their audit committees are “answering the call”, as many revised their disclosures in several key ways, particularly in the areas of auditor oversight as compared to 2012 proxy disclosures.
The EY Center reviewed the most current proxies (filed through the end of June 2014) of the 1500 S&P Composite companies. More than a third of the companies disclosed the same information in multiple locations, categorized for purposes of the study to include the audit committee report, other sections of the proxy and/or the audit committee charter.
The oversight of the auditor is an extremely important function of the audit committee and many stakeholders have expressed their desire to have increased visibility into how this function is performed. Some companies included incremental information, including how the audit firm is selected, evaluated and compensated and its connection to audit quality.
A discussion of the pre-approval process regarding the performance of non-audit services is also a required SEC disclosure. However, a discussion in the proxy of how non-audit services may impact independence is not. A substantial majority of the surveyed companies across all three sectors discussed how non-audit services may impact independence.
Scope of Duties
Only a small number of surveyed companies provided a direct link to the audit committee charter in the proxy, while the majority linked to the company’s overall website or a dedicated section of that website. Given the role of the audit committee, companies could ensure that their audit committee’s charter is easy to locate. Most companies in the survey also took the additional step of including some elements of their charter in the audit committee report or other section of the proxy.
Auditor Oversight Disclosures Among S&P Companies
The following table summarizes the key survey findings by size sector arranged from most frequently encountered disclosure to least frequently encountered disclosure:
|DISCLOSURE MADE IN THE PROXY INCLUDING AUDIT COMMITTEE REPORT||S&P MIDCAP||S&P SMALL CAP||S&P 500|
|Is there a discussion of how non-audit services may impact independence?||58%||69%||83%|
|Do they disclose the length of time the auditor has been engaged?||42%||50%||47%|
|Is there a discussion of audit committee considerations in appointing the auditor in terms of:€ qualifications, geographic reach, firm expertise?||10%||8%||13%|
|Is there a discussion of criteria considered when evaluating the audit firm?||7%||15%||8%|
|Is there a discussion of audit fees and its connection to audit quality?||4%||1%||13%|
|It is stated that the engagement partner rotates every five years?||3%||4%||16%|
|Is there a disclosure of significant areas addressed with the auditor?||2%||1%||3%|
|Is it explicitly stated that the audit committee is involved in selection of the audit engagement partner?||1%||1%||13%|
|Is there a discussion of how the audit committee considers auditor compensation?||1%||0%||1%|
The survey trend is clear that many listed companies have “answered the call” by expanding the disclosure that the audit committee plays in overseeing the auditor and in managing risk within their organizations. While improvements have been documented, there is still much to improve. As a result, both the SEC and PCAOB have published Concept Releases to address what is perceived to be a continuing need for further transparency regarding the important work of audit committees. Marcum encourages audit committees to respond to the standard setter’s request for comments in order to express their views as to the future direction that new policies may be developed. We would be pleased to consult with audit committees on enhancing their communication processes and help implement positive changes in audit committee disclosure.