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1 The Audit Committee Purpose, Process, Professionalism

2 A New World of Corporate Governance Boards of directors and committees must be: –Proactive –Informed –Investigative –Accountable

3 Clarifying Governance Governance is the system by which organizations are directed and controlled. It includes the rules and procedures for making decisions on corporate affairs to ensure success while maintaining the right balance with the stakeholders interest.

4 The IIA Corporate Governance Model Effective Governance

5 The Bad News Stakes are greater No figure head board members allowed Public trust has diminished Greater challenges More director liability

6 Clarifying Liability Directors need to be realistic about their personal liability under state and federal law, neither exaggerating nor ignoring their exposure.

7 Fiduciary Duties The duties of care and loyalty, and the expectation that directors will act in good faith. These are the primary source of director liability under state law. Source: Director Liability: Myths, Realities And Prevention – National Association of Corporate Directors

8 Fiduciary Duties (cont.) Board members who wish to become empowered guardians and builders of corporate value must: –Learn and follow best practices, –avoid conflicts of interest, –pay strict attention to board matters, –drawing on appropriate expertise, including their own. Source: Director Liability: Myths, Realities And Prevention – National Association of Corporate Directors

9 Director Evaluations and Qualifications 38% of companies performed director evaluations in 2005 and 45% are planning to do so in % of companies have established director qualifications up from 87% in 2005 Harvard Business School

10 What is the ACs Role in Governance? Oversight of financial reporting Risk management Internal control Compliance Ethics Management Internal auditors External auditors

11 Committee Meetings 52% of companies report a significant increase in the number or length of meetings of the Audit Committee in the past two years. Harvard Business School

12 Tone at the Top Management, the board, and the audit committee all play critical roles in an organizations tone at the top.

13 Best Practices in Code-of- Conduct Oversight: Ensure: –A code of conduct has been developed, reviewed and updated as needed. –All employees receive the code of conduct, understand it, and receive training. –Management exhibits ethical behavior and reported violations receive action.

14 Best Practices in Compliance and Ethics Oversight: Ensure: –Compliance with laws and regulations –Financial reporting of significant issues –Management monitoring of program effectiveness –Staying informed and recognizing trends to ensure appropriate action –Internal audit includes assessment of compliance and ethics risks in their audit plan –AC meetings with program manager to discuss key risks, status, issues, investigations, disciplinary action and effectiveness.

15 Noses In. Fingers Out. The lines of authority for audit committees and management should be clear and understood. AC members must communicate openly with management. They must also challenge management as appropriate.

16 Communications Checklist Management is easily accessible. Management reaches out to the audit committee regularly. Management answers audit committee questions fully and completely. Management provides factual information to support responses.

17 Communications Checklist (continued) Management admits not knowing an answer. Management supports the audit committee by contacting additional resources and specialists. Management advises the audit committee of significant issues in a timely manner. Management seeks audit committee input in advance of key decisions.

18 Key Issues of Concern Financial Accuracy Risk Management Control Assessment External Auditor Oversight Effective Use of Internal Auditing

19 Statistics on First Full Year of Filings As of March 30, Opinions 3710 filers 591 (15.9%) received adverse opinions from their public accountants 90 (2.4%) of all filers restated their first years Section 404 opinion; 59 (10%) of filers with adverse opinions restated their first years Section 404 opinion Source: Section 404 Internal Control Material Weakness Dashboard Audit Analytics

20 GAAP/Accounting Areas of Failure for Adverse Opinions Tax-related issues – 32% Revenue recognition – (31.3%) Inventory – (27.4%) Source: Section 404 Internal Control Material Weakness Dashboard Audit Analytics

21 Internal Controls Over Financial Reporting Issues – Adverse Opinions Material year-end adjustments (53.1%) Personnel issues (48.1%) Restatements of financials (49.6%) Source: Section 404 Internal Control Material Weakness Dashboard Audit Analytics

22 Clarifying the Value of Internal Auditing Audit committees must understand internal auditings role if they are to work effectively and share a healthy interdependence.

23 Understanding Internal Audit Objectivity Reporting structure Risk management Staffing Prioritization Adding Value

24 Asking the Right Questions Audit committee members must maintain an in-depth understanding of internal audit best practices and how internal audit is functioning.

25 Consider… How does the audit committee live up to its significant governance responsibilities and meet the high expectations of shareholders and other outside parties?

26 Charting the Course An audit committee charter is a blueprint for its operation and should address: –Processes –Procedures –Responsibilities

27 For More Information on Audit Committees and Governance IIA website Research/Publications –Audit Committee Effectiveness: What Works Best –Tone at The Top (corporate governance newsletter) –The Professional Practices Framework –The IIA Bookstore Guidance –Audit Committee: Purpose, Process, Professionalism –Audit Committee: Discussions on Performance (self-assessment) –20 Questions Directors Should Ask About Internal Audit

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