Good corporate governance is still looming large in the minds of investors as the government has increased regulations and scrutiny as the result of pressure from those who lost retirement savings or homes to predatory lenders and asset advisors. And customers are taking a harder look at businesses’ financial information before signing contracts with them.
As a result, audit committees are no longer the committee of last resort but instead are now a significant presence that can strengthen your company’s financial credibility and bring in new business.
“An audit committee’s objective is to ensure that there’s integrity and reliable financial information based on good internal control systems.” says Tullus Miller, Bay Area partner-in-charge at Moss Adams, who works with and serves on audit committees.
Smart Business spoke with Miller about how to create a successful audit committee that is an asset to your company.
What is the role of an audit committee and why should a company establish one?
An audit committee assists the board of directors with its fiduciary responsibilities by providing independent oversight through the integrity of the financial reporting process, which includes internal and external financial information.
For public organizations – whether publicly traded, publicly held or for the public good, such as with a governmental or not-for-profit – audit committees usually are mandated to help ensure the integrity and reliability of their financial information. Those mandates, which dictate the committee’s composition and structure, can come from GAGAS standards, Sarbanes-Oxley or the exchange the company is listed on, such as NASDAQ, the New York Stock Exchange or Eurex.
For private organizations, audit committees are not required but can play an important role if a company has shareholders and stakeholders who aren’t involved with the day-to-day governance of the organization. These committees generally take best practices of public companies in a similar industry, adapting items such as creating a fully independent board.
What steps should an organization take when creating an audit committee?
The business risks and needs of the company will dictate the composition, structure and focus of the committee. Then, define the scope and objectives of the audit committee on the charter as mandated by the board of directors. Some decisions, such as hiring an auditor, can be delegated fully to the audit committee, while other boards may prefer that the committee recommend an auditor but retain the right to approve that person. The charter allows the audit committee to know what’s expected of it and how to define success, while also communicating to constituents.Finally, consider what qualities and skills members must have to ensure that a company’s needs and risks are addressed. Do they have experience with the organization’s industry? Are they familiar with financial information and how it is extricated? Do they have the time commitment necessary?
How has the role of audit committees changed with heightened regulations and scrutiny?
Over the past five to seven years, the amount of information available to audit committee members has increased. This is a positive in that it helps audit committee members stay abreast of increased regulation and scrutiny, but it also adds to the time commitment. Being on an audit committee is no longer a matter of just attending meetings. The time commitment could be as much as one day per month, for eight to 10 hours, or for a more complicated company, two to three days per month, excluding the meeting.
In addition, accounting rules have become so sophisticated, with more fair values, estimates and judgment, that committee members must take the time to understand how those items affect the financial statements and decision-making of the company. Risks are higher today, and boards have been sued, and this changes the behavior of committee members.
What are some common challenges of audit committees?
Committees should have succession, continuity and rotation planning. You need to ensure that leadership can step up and take over if an audit committee chair must step away or if a member becomes incapacitated.
Leave enough time to vet real issues, getting information out at least a week in advance of making a decision Also, limit the agenda. Less is better, especially when talking about significant decision-making and judgment in areas of increased risk.
It can present a challenge if the CEO is also chairman of the board. If an audit committee has concerns about estimates that are too aggressive, it can be difficult for a CEO who is also the chair to determine which hat to wear. The audit committee chair needs to understand that, and where necessary challenge, the risk-taking tolerance and tone at the top.
Additionally, define who manages enterprise risk management – the governance committee, audit committee or board of directors, etc. The audit committee is already responsible for managing risk on a financial reporting level, whether internal or external, so, in some cases,this may bog the audit committee down with items that aren’t within its purview.
How should the relationship among the audit committee, board of directors and management be approached?
The key is communication on all sides in order to understand risks and decisions that are being recommended and approved, including with board members who are not financially oriented. Don’t wait until a meeting to communicate what is happening. The decision-making processes should be transparent, with no surprises. If you encounter dissent, it should be noted and discussed thoroughly at approval time, whether it’s from auditors or audit committee members.
Tullus Miller is the partner-in-charge of Bay Area at Moss Adams. Reach him at (415) 956-1500 or [email protected].
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