New Guidance on Audit Committees

By Gauthier, Stephen J. | Government Finance Review, April 2006 | Go to article overview
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New Guidance on Audit Committees


Gauthier, Stephen J., Government Finance Review


In light of recent private-sector developments, GFOA's Executive Board approved a revised and expanded recommended practice on audit committees.

In 1997, the Government Finance Officers Association (GFOA) formally approved for the first time a recommended practice (RP) on Audit Committees. That guidance was revised and updated in 2002. More recently, the GFOA Executive Board directed the standing Committee on Accounting, Auditing, and Financial Reporting (CAAFR) to consider whether further changes were necessary or desirable in light of recent private-sector developments. The result was a substantially new and greatly expanded RP that the GFOA Executive Board approved at its spring 2006 meeting.

BACKGROUND

The Enron and WorldCom scandals raised serious questions regarding the respective responsibilities of management, independent auditors, and the governing board for the reliability of financial reporting. One of the key points to emerge from the ensuing discussion was the notion that the governing board, through the audit committee, had a unique and irreplaceable role to play. Accordingly, the SarbanesOxley Act of 2002 and the related Rule 33-8220 of the securities and Exchange Commission (sec) established strict rules to govern the structure and operation of corporate audit committees.

State and local governments, of course, fall outside the scope of the Sarbanes-Oxley Act and SEC Rule 33-8220. All the same, the CAAFR, at the direction of the GFOA Executive Board, carefully reviewed the provisions of both to determine to what extent, if at all, they might be relevant to state and local governments. The CAAFR also considered the Report and Recommendations of the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees (February 1999), sponsored by the New York Stock Exchange and the National Association of securities Dealers, which significantly influenced the federal legislation and regulation on corporate audit committees. Ultimately, the CAAFR concluded that GFOA's guidance on Audit Committees should be substantially reworked and expanded to fully profit from these developments.

CONCEPTUAL FOUNDATION

Three essential concepts underlie the specific guidance incorporated in the newly revised RP on Audit Committees:

* The governing body is ultimately responsible for the quality of financial reporting. While management is primarily responsible for financial reporting, the governing body is ultimately responsible for ensuring that management meets that responsibility (much as a student is primarily responsible for doing homework, but a parent is ultimately responsible for seeing to it that the student does so).

* The governing body cannot transfer or delegate its responsibility for financial reporting to others. The governing body cannot divorce itself from its responsibility for financial reporting because that responsibility is inherent in its oversight role (much as taxpayers remain legally responsible for tax forms filed on their behalf by a paid preparer).

* An audit committee is essential to ensure adequate independent review and oversight of the financial reporting process. An audit committee is an indispensable tool if a governing body is to fulfill its financial reporting obligations.

SPECIFIC GUIDANCE

The newly revised RP on Audit Committees offers 12 recommendations:

1 Every government needs an audit committee. An audit committee is essential, whatever the size of the government.

2 The audit committee should be properly established and the independent auditors should report directly to it. The audit committee needs to be established formally and its structure and operations should be fully documented. (The audit committee itself should assess the adequacy of this documentation at least once every five years.

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