Fraud and the audit committee Featured

8:00pm EDT April 26, 2006
With the wave of financial scandals hitting the economy, audit committees are facing enhanced scrutiny from investors and the media. In this environment, the challenges facing the audit committee are (1) to ask the right questions and (2) to get the right information to obtain reasonable assurance that there are effective procedures in place to detect and prevent fraud.

Jyoti Pai, CPA, CA, is a manager with Tauber & Balser, P.C. in the Forensic Accounting and Litigation Services Group. She has extensive experience in the financial reporting and auditing of both public and private companies. Because of Pai’s background working with national and local large-sized accounting firms, Smart Business talked to her about audit committees.

What is the role of the audit committee?
Audit committees are an important component of corporate governance. The audit committee independently reviews and oversees the overall financial reporting process, the internal control system and the audit functions (internal and external). The committee obtains advice and assistance from independent accounting, legal or other advisers as it deems necessary to carry out its duties.

Which organizations should have audit committees?
The Sarbanes Oxley Act of 2002 (SOX) mandates that all public companies have an independent audit committee. Under SEC rules, companies cannot be listed on a national securities exchange if they do not comply with the SOX audit committee requirements. The SOX and the Securities & Exchange Commission also have specific requirements for audit committees for not-for-profit organizations. Although there is no legal requirement, nonpublic companies, local, state and federal government entities and other organizations can benefit from the effective oversight of an audit committee.

What are some of the procedures that an audit committee needs to place in an organization to deter and detect fraud?
The audit committee should ensure that management has implemented an effective code of conduct/ethics and that the organization has antifraud programs and controls.

The audit committee should maintain an open line of communication with internal and external auditors to ensure that audit concerns regarding identified risk areas, weak internal controls and other matters are addressed in a timely manner.

The committee should also ensure that there are ‘whistle-blowing’ processes in place to question accounting issues, and thoroughly investigate such communications. Prosecution and penalties for persons who are found guilty of committing fraud can act as deterrents to future fraudulent acts.

Additionally, the committee should discuss with management the guidelines and policies to govern how management assesses risk and the adequacy and effectiveness of these procedures.

What should be the audit committee’s approach to prevent management’s override of controls?
The best internal controls can be overridden by management. Many of the corporate frauds which have come to light in the last few years were perpetrated when management circumvented controls. Committee members should gain an understanding of the extent of incentives and pressures faced by management; identify opportunities to override existing controls; and exert an increased amount of monitoring and attention over these areas. Management’s adherence with the corporate code of conduct should be monitored and reviewed periodically. Any instances of improper conduct by senior management should be dealt with appropriately to help prevent and deter repetition.

What resources are available to the audit committee?
External auditors familiar with financial reporting controls can be a great source of help regarding identification of fraud risk areas. A review of the organization’s regular financial statements and discussions with independent auditors about accounting quality and acceptability will provide valuable insights to the committee.

The audit committee should discuss any internal control deficiencies noted during the course of the audit. This will help the committee understand the risk areas where procedures should be implemented to mitigate the risk of fraud.

Internal auditors are another resource. The internal audit function should report directly to the audit committee and provide feedback regarding the effectiveness of key internal controls and other controls that need to be strengthened or implemented.

Finally, the skills supplied by forensic accounting consultants for preventing and detecting fraud can supplement the work of the internal and external auditors. Forensic accounting consulants can serve a proactive role in assessing risks where susceptibility to fraud exists. Also, where fraud is suspected, the audit committee should hire forensic consultants to conduct an investigation.

JYOTI PAI, CPA, CA, is a manager at Tauber & Balser, P.C. with expertise in the real estate and manufacturing industries. Reach her at (404) 814-4908 or