Assurance and Advisory Business Services

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(No Transcript)
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Overview

• Enrons collapse has created a crisis of
  confidence in financial reporting
• Plenty of blame to go around
• Current debate on possible solutions includes
  those aimed at audit firms and audit committees
• Our presentation summarizes current issues and
  best practices relating to audit committees

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CPA Professions Views

• Little need for changes in audit committee
  guidance
• Room for improvements in implementation

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Responses to Calls for Change

• Financial community efforts
• Blue Ribbon Committee
• Blue Ribbon Commission
• Panel on Audit Effectiveness
• Independence Standards Board
• Regulatory and profession responses
• SEC, securities exchanges, and ASB rules in
  response to BRC
• Recent frauds, restatements, etc.

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Roles and Responsibilities

• Management financial reporting and internal
  control
• Internal audit assess internal control
• Independent audit attest to fairness of
  financial statements
• Committee oversight of the process and
  participants

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Reporting and Disclosure

• Audit Committee Report
• Proxy Disclosures
• Identify Committee members
• Number of meetings held
• Describe functions
• Consideration of nonaudit services
• Existence of charter
• Nonindependent directors

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Understanding the Business

• Knowledge of the Company
• Structure
• Financial reporting process
• Sophisticated or complex transactions
• Current environment
• Regulatory requirements
• Suppliers and customers
• Use of technology

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Understanding the Business

• Internal Control
• Control environment
• Code of conduct
• System of internal control

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Understanding the Business

• Risk of Fraud
• Earnings management issues
• Aggressive accounting policies
• Consider restructuring charges, RD costs,
  subjective estimates, and premature recognition
  of revenue

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Understanding the Business

• Legal and Ethical Matters
• Enterprise Risk Issues
• Emerging Issues

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Oversight of the Financial Reporting Process

• Need to understand
• Financial results
• Adequacy and completeness of MDA
• Significant changes or trends
• Critical accounting policies
• Significant issues, related party transactions,
  and accounting and auditing matters
• Unadjusted audit differences

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Interim Financial Reporting

• Interim periods generally include more estimates
  and judgments than annual financial statements
• Discussions with management and auditors may be
  via conference calls, meetings, or both

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Oversight of Audit Function

• Audit process
• Audit resources
• Quality, experience, and staffing of internal
  auditors
• Qualifications and performance of independent
  auditors
• Scope and fees
• Non-audit services

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Audit Committee Communications

• Discussions with independent auditors
• Audit planning and results
• Results of timely interim reviews
• Required communications
• Other meetings

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Other Characteristics of Audit Committees

• Audit Committee Charter
• Indicates responsibilities, including receipt of
  disclosures from auditor on independence
• States that independent auditors are ultimately
  accountable to Board and Committee

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Other Characteristics of Audit Committees

• Financially literate, independent members
• Diverse backgrounds of members
• Typically 3-6 members
• Qualified, experienced Chair
• Terms of members
• Structuring effective meetings

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Other Characteristics of Audit Committees

• Orientation and continuing education
• Provide background information to new members
• Obtain information on new accounting or auditing
  standards, financial reporting process, and
  significant issues affecting the Company

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Best Practices

• Ask questions of the internal and independent
  auditors about the Companys system of internal
  control
• Establish clear expectations with management and
  auditors about the Committees qualitative
  information needs about internal
  controlespecially controls in higher-risk areas

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Best Practices

• Ask detailed questions of management and the
  auditors when reviewing the financial statements
• Interim discussions occur prior to the earnings
  release and cover significant matters

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Best Practices

• Consider the presence of risk factors for
  potential fraudulent financial reporting
• Understand why management did not correct audit
  differences and what the effect would be on the
  financial statements if such differences were
  corrected in the current period

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Best Practices

• Develop a meeting planner to make sure that the
  Committee meets its responsibilities outlined in
  the Charter
• Add a disclosure to proxy that references the
  Audit Committee Report and Audit Committee
  Charter for detailed information
• Perform a self-assessment of the Committee to
  identify areas for improvement

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Legislation and Regulation Status

• On July 24, agreement was reached by Congress on
  a compromise corporate crime bill
• The SEC has been very active
• On June 27 issued an order requiring the CEO and
  CFO of 1000 companies to certify their most
  recent filings
• On June 17 proposed a permanent certification
  requirement
• proposed changes in financial disclosure rules
  earlier this year
• proposed new rules creating an accounting
  oversight board on June 26
• intends to propose changes in auditor
  independence and corporate governance rules later
  this summer
• On June 6, the NYSE published a working draft of
  proposed corporate governance listing requirements

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Among The Issues Being Debated

• Corporate Governance Increased responsibilities
  for corporate officers, boards of directors, and
  audit committees
• Accounting Profession Reform The power and
  composition of a new auditor oversight board and
  the scope of services that may be provided to
  audit clients
• Financial Disclosures Proposals intended to
  enhance corporate transparency and require
  real-time disclosure of important financial
  information

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Corporate Governance Reform
House Senate SEC NYSE
Certification of Financial Reports N/A CEO/CFO must certify that financial statements and disclosures fairly represent the companys financial condition CEOs and CFOs must certify that financial reports include all information of which they are aware that is important to a reasonable investor CEO must certify that the financial reports are accurate and complete in all material respects
Audit Committee Composition N/A Audit committee members must be independent from management N/A Proposed independence requirements for audit committee members and financial expertise requirement for the Committee chair
Disgorgement Gives SEC authority to require disgorgement of bonuses, stock profits or other incentive pay if misconduct results in accounting corrections Same as House bill Currently using enforcement actions to seek disgorgement N/A
Ban on Officers/Directors Gives the SEC administrative authority to bar substantially unfit corporate officers Gives the SEC authority to seek court orders banning unfit corporate officers and directors Using court system to to seek orders banning substantially unfit corporate officers and directors N/A
Shareholder Approval of Stock Options N/A N/A N/A Requires shareholder approval of equity compensation plans
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Accounting Profession Reform
House Senate SEC NYSE
Regulatory Board
Composition Five members, two of whom must be CPAs, and two additional who may be CPAs Five members, two, and only two, may be CPAs Nine members, a minimum of six of whom must be public members. Maximum of three CPAs N/A
Powers Disciplinary and investigative powers, but no standard setting powers The Board would set audit, quality control, ethics, and independence standards, or could approve standards set by a professional group Set standards or rely on private sector groups with oversight N/A
Scope of Services
Prohibited Services Directs SEC to bar the provision of IT consulting and internal audit services to audit clients Statutorily bars services already restricted under SEC rule, with additional prohibition of IT, internal audit, and expert services N/A N/A
Audit Committee Approval No provision (defeated in committee 31-19) All non-audit services are deemed unlawful unless pre-approved by audit committee Audit committees would pre-approve non-audit services Similar to SEC, except audit committee approval limited to significant non-audit engagements
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Financial Disclosure Reform
House Senate SEC NYSE
Real Time Disclosures
Accelerated Filing Deadlines N/A N/A Proposed accelerating filing deadlines of annual reports from 90 to 60 days after close of fiscal year, and quarterly reports from 45 to 30 days after the end of the quarter N/A
Insider Transaction Disclosure SEC directed to adopt rules Requires accelerated reporting of insider transactions and loans Proposed rulemaking that would require companies to report insider transactions, including loans, within 1-10 days N/A
Expansion of Information Reported SEC directed to conduct an analysis of need for rulemaking Requires an audit of managements assessment of internal controls and also requires auditors to test and report on compliance with certain laws and regulations Proposed requiring more frequent 8-K disclosures (filed when listed events occur between annual reports and quarterly reports that would be of significance to investors) N/A
Improved Transparency
Critical Accounting Procedures SEC directed to conduct an analysis of need for rulemaking N/A Proposed rulemaking requiring disclosure of critical accounting procedures in annual and quarterly reports. Soliciting comments on disclosures when a companys accounting policies diverge from those used by other industry members. N/A
Pro Forma Earnings N/A Companies must reconcile pro forma information with GAAP and not omit information that makes it misleading Issued cautionary advice on appropriate use of pro forma financials in earnings press releases N/A
Off Balance Sheet Transactions SEC directed to adopt rules SEC directed to adopt rules Issued cautionary advice regarding need to disclose in 2001 financial reports N/A