The Job of the Audit Committee

ThePoint
July 6, 2005

In businesses across America, skepticism surrounding audit committees is up, meetings are longer, and agenda items are considered more intently. But there's still a need for more director education and dialogue, reports Financial Executive magazine.

Most organizations need a better understanding between the directors, management team, and the auditor as to the mission and workflow of the audit committee. Like a championship sports team, the objective must be clear and the communications have to be frequent.

What's the overall purpose of the audit committee? It's not to oversee everything related to finance, and it's definitely not to drive down the auditor's fee—probably the most common unstated agenda before recent reforms. The purpose and authority of the committee comes from the board in the form of the committee charter. The board delegates certain functions to its committees, and the audit committee's key responsibilities are to:

• Oversee the financial reporting
• Promote an effective independent audit of the financial statements
• Oversee the system of internal controls
• Monitor the process of risk identification and management

Let's bring each of these points into practical focus

Financial Reporting

Overseeing financial reporting is really about cutting through the complexity of accounting and making sure the organization's performance is clearly communicated. Are the statements readable and useful? Stakeholders expect, and should get, a good summary of the same important business trends and concerns that come out in boardroom discussions. Inherently, financial statements require many judgments, accounting principle choices, and valuation estimates. The committee should be made aware of the choices that management has made in compiling the financial reports. Aggressive application of accounting principles should be discouraged, and the use of reasonable estimates encouraged.

Effective Audits

An audit committee doesn't audit! It's not a standing investigative panel, either. It should be empowered to conduct investigations within its scope of responsibilities and to get the resources it needs. If a major problem does arise, however, the board will probably set up a "special committee" to oversee the review.

The committee's value and impact is significant in setting the tone for the auditor's work. It can emphasize that management must be candid with the auditor. The auditor should know that the committee wants clear and correct financial statements above all else. The committee can query the auditor to be sure they're hearing about the same business risks and issues that arise in the board meetings.

Internal Control

In general, an audit committee's concerns about internal controls should center on understanding the fundamentals. Does the business have formal and written policies and procedures for handling and approving routine and non-routine transactions? Are there written accounting policies? Are there adequate resources in the finance function? What is the background and competency of the finance and accounting personnel?

Risk Management

The audit committee's role in risk management is significant. In many organizations, the only time a formal risk assessment is done is annually under the auspices of internal audit and the committee's initiatives. Formal interviews or surveys of all board members and senior management are typically summarized, often with surprisingly candid and common responses. Such a process feeds the external and internal auditors' planning, as well as providing a framework for the acquisition of formal insurance products.

Risk assessment often generates significant management succession issues that are rightly referred to the board's compensation or human resources committees. Overall, it's a healthy process that heightens the sensitivity to pitfalls of the company's business and industry.

An effective audit committee is one focused on its purpose, as assigned to it by the board of directors and, ultimately, the stakeholders. A good framework of understanding between the directors, management, and the auditors about financial reporting, the independent audit, internal control and risk management is the clearest and most direct way to align the committee's work with that purpose.

This article was prepared by the staff at the Point for Credit Union Research and Advice and is published online at http://thepoint.cuna.org/. Reprinted with permission.