Audit Committees in Corporate Annual Reports

Article excerpt

Events during 2001 and 2002, such as the bankruptcies of WorldCom and Enron and the criminal conviction of one of the "big five" accounting firms, Arthur Andersen, have exposed severe problems with the financial accounting and reporting system in the United States. The goal of high quality financial accounting and reporting requires that each of the major participants fulfill their responsibilities. For publicly traded corporations, these participants normally include the board of directors, the audit committee of the board, senior management, the internal auditor, and the outside independent auditor. The corporate audit committee is in a position to oversee the activities of management, the internal auditor, and the outside independent auditor. A properly functioning corporate audit committee is an essential component in the financial accounting and reporting system. The purpose of this article is to examine the development of audit committees including their composition, duties, and reporting requirements. This article will also disclose the status of reporting by audit committees that is currently occurring in the annual financial reports and proxy statements of the companies in the Standard and Poor's 100 Index.

DEVELOPMENT OF AUDIT COMMITTEES

Audit committees rose to prominence in 1978 when the New York Stock Exchange (NYSE) made it a requirement for the companies trading on the NYSE to have audit committees of their boards of directors.

National Commission on Fraudulent Financial Reporting

In 1987 the National Commission on Fraudulent Financial Reporting (Treadway Commission) stressed the importance of audit committees and urged the use of audit committee reports in corporate annual reports. In addition to discussing the audit committee report, the Treadway Commission described good practice guidelines for the audit committee. These guidelines were divided into three areas: general guidelines, selection of the independent auditor, and post-audit review. (1) The general guidelines address such things as the size of the committee. It recommended that the audit committee consist of at least three members, but not be so large that it prevents each member of the committee from being an active participant. The committee members should be outside independent directors of the board and their terms on the committee should be staggered. It was recommended that the audit committee meet on a regular basis and provide reports to the entire board of directors.

The audit committee should oversee the audits of the internal and external auditors. The audit committee should ensure that the two groups of auditors coordinate their audit plans and identify for the committee how their audit scope might lead to the detection of fraud or internal control weaknesses. The internal auditor and the independent public accountant should meet privately with the audit committee. If the independent public accountants intend to rely on the work of other independent auditors, the audit committee needs to insist their independent public accountants review the work of the other outside auditors. The audit committee must conclude that the use of the additional outside auditors is appropriate.

The audit committee should review the corporation' s internal policies concerning officers' expenses and use of company assets. Both the internal and independent auditors should be instructed to keep the audit committee informed of any areas they discover that would require special attention by the audit committee.

The selection of the independent public accountant is part of the good practice guidelines. The audit committee should review the proposed audit fee and the independent accountant s engagement letter. It should note the level of both audit partner and staff participation on the audit. If a successor independent accountant is chosen, the audit committee must review the steps to insure a smooth transition from predecessor to successor auditor. …