Following is an adaptation of an article by A. A. Sommer, Jr., that appeared in the June 1991 issue of Accounting Horizons. Sommer is the chairman of the public oversight board of the American Institute of CPAs SEC practice section.
Audit committees are now a firmly established element in U.S. corporate governance. Since 1940, they have enjoyed the endorsement of the Securities and Exchange Commission, which has often insisted on their establishment or strengthening as a part of settlements.
However, a corporation having an audit committee as part of its governance structure and having an effective audit committee are, of course, two different matters. While these committees routinely recommend the engagement of the auditors, listen to the outside auditors review their audit program and cursorily discuss internal controls with appropriate corporate personnel, they do not appear to be asking the hard questions or fulfilling the full range of expectations.
Many losses result from this failure. Boards that have ineffective audit committees are denied the legal protections that can accrue to them from an effective one, and shareholders, too, are denied the benefits and safeguards committees provide.
The scarcity of audit committees in the governance structures of savings and loans may have resulted in another type of loss. Had S&Ls had such committees--functioning effectively--some of those institutions might have avoided disaster, or at least reduced the magnitude of the losses suffered.
One of the less obvious losers is the external auditor. The National Commission on Fraudulent Financial Reporting (the Treadway commission) identified an audit committee as an essential part of any system designed to prevent fraudulent financial reporting. The audit committee, with its constant access to the internal auditor and other corporate personnel, often is the first nonmanagement group to catch a whiff of irregularity. And if it does, it can direct the external auditor to scrutinize the problem, thereby forestalling a faulty audit.
Auditors are in a unique position to judge audit committees' …