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SEC Proposed Rule: Revision of the Commissions Auditor Independence Requirements TIME WARNER James W. Barge Vice President and Controller.

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Presentation on theme: "SEC Proposed Rule: Revision of the Commissions Auditor Independence Requirements TIME WARNER James W. Barge Vice President and Controller."— Presentation transcript:

1 SEC Proposed Rule: Revision of the Commissions Auditor Independence Requirements TIME WARNER James W. Barge Vice President and Controller

2 2 Table of Contents zOverview zSummary of Views Relating to Non-Audit Services yProperly Designed Internal Audit Outsourcing Does Not Impair Independence yProposal Raises Practical Issues yInternal Audit Outsourcing with the External Audit Firm Results in Efficient and Effective Audits yChanging Service Providers Would Be Burdensome zTime Warner Proposed Solution zAnticipated Results of Time Warner Proposed Solution

3 3 Overview zIndependence is critical to promote investor confidence and efficient capital markets zGenerally, we agree with the SECs four governing principles. Our comment letter provides some suggestions zThis presentation focuses on experience that we have had in the area of internal audit outsourcing

4 4 Summary of Views Relating to Non- Audit Services zGenerally, support precluding non-audit services as proposed zSupport proposed disclosure of fees relating to non-audit services zAlso, would support a requirement to communicate with the audit committee all decisions to outsource internal audit zHowever, we believe properly designed internal audit outsourcing arrangements do not impair independence zProposal raises practical issues zChanging service providers would be burdensome zIn addition, we believe outsourcing internal audit with the external audit firm is more efficient and effective than outsourcing to another firm

5 5 Properly Designed Internal Audit Outsourcing Does Not Impair Independence zWith regard to internal audit outsourcing, we agree with the AICPA Ethics Committees Interpretation Section (ET ) yThe AICPA concluded properly designed internal audit outsourcing arrangements provided by the external auditor do not impair independence zET states that internal audit outsourcing can be provided by the external auditor without impairing independence, if a member of management is: yresponsible for the internal audit function ydetermines the scope, risk and frequency yevaluates the findings and results yevaluates the adequacy of the procedures performed

6 6 Properly Designed Internal Audit Outsourcing Does Not Impair Independence (cont.) zFor purposes of evaluating the potential impact on independence, we believe internal audit consists of two meaningful functions: yManagement function - develops plan, oversees execution, evaluates results of internal audit plan and communicates significant findings to operating management and the audit committee yProcedural function - performs the work necessary to execute the predetermined internal audit plan xThe procedural function is not performing the original work-- only attesting to the appropriateness of the original work xThe procedural function represents selective testing and review of what is an already effective system of internal controls

7 7 Properly Designed Internal Audit Outsourcing Does Not Impair Independence (cont.) zWe agree that outsourcing the management function would impair independence as the auditor would be perceived to be acting in a management capacity zHowever, the outsourcing of the procedural function does not impair independence as such procedures are attest in nature and are routinely performed in the normal course of any external audit zThe external auditors are uniquely qualified to perform these attest procedures

8 8 Proposal Raises Practical Issues zThe outsourcing of the procedural function of internal audit is no different than: ythe external auditor performing agreed-upon procedures at the direction of management (e.g., TW requests an annual review of transactions surrounding its securitization facility. TW also has requested a review of compliance with rate contracts entered into with external vendors) yexpanded external audit procedures performed at the direction of management (e.g., TW asked for extra procedures focusing on our implementation of FAS 133)

9 9 Proposal Raises Practical Issues (cont.) zIt seems awkward to preclude services provided as a part of the procedural function of internal audit, which is under the direction of management and the audit committee, that are similar to services permitted to be provided as part of extended external audit procedures or agreed upon procedures

10 10 Proposal Raises Practical Issues (cont.) zExample: TW has a center in Florida that services customer fulfillment for TW subsidiaries as well as outside third parties zTo satisfy requests from third parties, TW could request external auditors to review system to ensure it is functioning as intended as part of an agreed upon procedures engagement. In this circumstance, a report covering such procedures would be formally issued by the external auditor zAlternatively, if TW management wanted general comfort on the operations of the system, TW management could request that the scope of the external audit be expanded to perform certain procedures. In this circumstance, no formal report would be issued relating to such procedures zIronically, the proposed release would prohibit such a review to be done by the external auditors if it were performed under the banner of an internal audit outsourcing engagement

11 11 Proposal Raises Practical Issues (cont.) zThe Commission requires an adequate system of internal controls zRegistrants establish an effective internal control system subject to their own ongoing monitoring zAn internal audit function is not required in order to have an adequate system of internal controls zHowever, best practices endorse comprehensive testing of the internal control system, including the establishment of an internal audit function zWe think the Commission should be encouraging best practices (whether achieved through outsourcing or otherwise) rather than placing restrictive limitations over the pursuit of such practices zEveryone benefits from more extensive testing whether performed by internal or external auditors

12 12 Internal Audit Outsourcing with the External Audit Firm Results in Efficient and Effective Audits zOutsourcing with the external auditors provides for more efficient and effective audit coverage zSeamless coordination between internal and external audits zConsistent audit processes and methodologies zIncreased and more efficient use of knowledge of the company zNo competitive posturing

13 13 Internal Audit Outsourcing with the External Audit Firm Results in Efficient and Effective Audits (cont.) zBenefits and strengths carry over to external audit service: yIncreases external auditors understanding of the company yIncreases the likelihood that external auditor will detect errors yImproved suggestions from external auditor about strengthening internal controls

14 14 Changing Service Providers Would Be Burdensome zNew vendor needs to acquire knowledge of the companys businesses and systems zHigher external audit fees due to yReview of internal audit work prepared in an unfamiliar approach and format yLess integration of internal and external audit efforts zOverall audit effort is less efficient

15 15 Time Warner Proposed Solution zGenerally support precluding non-audit services as proposed, including complete outsourcing of internal audit zRecommend permitting the outsourcing of the procedural function of internal audit yInternal audit team reports to company management and audit committee who is responsible for the internal audit function yInternal audit mission, strategy and plan are all created by management and approved by the audit committee yAuditors only execute attest procedures pursuant to an internal audit plan which has been developed by management and approved by the audit committee yManagement and audit committee evaluate findings

16 16 Time Warner Proposed Solution (cont.) zRecommend developing a requirement to communicate with the audit committee all decisions to outsource internal audit zSupport proposed disclosure of non-audit services

17 17 Anticipated Results of Time Warner Proposed Solution zCompanies and audit committees will make informed judgments about internal audit outsourcing and independence zCompanies and audit committees will be able to consider using the external auditors for internal audit outsourcing thereby achieving more efficient and effective audit coverage zDisclosure will give investors the ability to decide whether perceptions of auditor independence have been affected by the external auditor providing non-audit services zCost of capital will reflect investors comfort level with judgements about independence and force efficient behavior


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