Since the advent of Sarbanes-Oxley, the role and the responsibilities of the audit committee have become vital.
“The audit committee must act in a proactive manner to monitor and assess risk mitigation activities within the company,” says Diane Wittenberg, CPA, partner for Audit and Business Advisory Services at Haskell & White LLP. “Members should ask hard questions of auditors and management and have authority to effectively execute their charter.”
Smart Business spoke with Wittenberg about how to build and engage an effective audit committee.
What constitutes an effective committee charter?
The charter defines the authority, functions and mission of the audit committee. Weak charters define only the minimum duties, such as simply reviewing financial statements, whereas strong charters spell out committee responsibilities in detail and encourage member participation. These are the major areas of responsibility that should be included in the committee’s charter:
- Oversee the accounting and financial reporting processes and the financial statement audits of the organization.
- Appoint, compensate and oversee the external auditor and ensure that his or her skill set is matched commensurately with the complexity level of the organization.
- Establish procedures for receipt and treatment of complaints in accounting, internal control or auditing matters, including anonymous submissions from employees.
The charter should stop short of directing the committee on how to carry out its duties; members should use interpretation and judgment in executing the committee’s mission.
Which tactics lead to effective execution?
Audit committee members should ask candid, frank questions of the external auditors about their assessment of the skills, controls and attitudes of management and others within the organization. Every quarter the committee should meet with the auditors without management present to ask questions and solicit opinions. Members should feel confident that management is aware of the financial reporting risks and has instituted the necessary internal controls to mitigate the risks and then implemented monitoring procedures to ensure effective operation of those controls. The committee chair must establish a culture that allows each member to act independently so the members can ask the critical questions to assure the proper level of stakeholder security.
How does member composition impact committee effectiveness?
In a perfect world, the audit committee would be composed of individuals who have audit, accounting and industry knowledge, but in reality, most committees have a blend of members with different strengths. Members who don’t have industry or product knowledge should go through training so they understand the risks and the financial statements. For example, audit committee members in a manufacturing company should understand the metrics for that industry, such as days sales in inventory and accounts receivable turnover, to assess if the company’s performance is in line with its peers. At least one member of the committee should be an independent financial expert who possesses the following attributes:
- Knowledge of GAAP and financial statements and the ability to use GAAP principles in connection with estimates, accruals and reserves
- Experience in preparing, auditing, analyzing or evaluating financial statements with a level of complexity that is comparable with the organization
- Understanding of internal control processes and audit committee functions
What are the most effective committee and meeting structures?
Three to four members is an ideal size so discussions and decision-making processes are streamlined. Note that having an odd number of members is preferable for reaching a quorum. In public companies, the audit committee should meet at least quarterly so it can have the required communications with the external auditors and maintain its momentum and continuity. Set an annual meeting schedule at the start of the year and send committee members the minutes from the prior meeting and the next agenda two to three weeks before the next meeting. This practice ensures that discussions remain strategic and that the committee spends less time on administrative tasks.
How should the committee assess its performance?
The committee should monitor its performance and assess its effectiveness at least annually, perhaps as part of a retreat, especially as it relates to the appropriateness of its charter in order to make recommended changes to the board of directors. In addition, the committee should review the performance of its individual members through self-evaluation checklists or by hiring an outside firm to do an evaluation. In private companies or non-profit organizations, the committee usually conducts a self-assessment and public companies often use an outside evaluator. The committee should use a continuous improvement process to implement changes after reviewing evaluation feedback.
DIANE WITTENBERG, CPA, is a partner for Audit and Business Advisory Services at Haskell & White LLP and audit committee chair for the Discovery Science Center in Santa Ana. Reach her at (949) 450-6334 or firstname.lastname@example.org.