1. Assurance and Advisory Business Services
Audit Committees: Providing Oversight in Challenging Times

2. Overview
Enron’s collapse has created a crisis of confidence in financial reporting
Plenty of blame to go around
Current debate on possible solutions includes those aimed at audit firms and audit committees
Our presentation summarizes current issues and best practices relating to audit committees
Audit Committees: Providing Oversight in Challenging Times

3. CPA Profession’s Views
Little need for changes in audit committee guidance
Room for improvements in implementation
Audit Committees: Providing Oversight in Challenging Times

4. Responses to Calls for Change
Financial community efforts
Blue Ribbon Committee
Blue Ribbon Commission
Panel on Audit Effectiveness
Independence Standards Board
Regulatory and profession responses
SEC, securities exchanges, and ASB rules in response to BRC
Recent frauds, restatements, etc.
Audit Committees: Providing Oversight in Challenging Times

5. Roles and Responsibilities
Management – financial reporting and internal control
Internal audit – assess internal control
Independent audit – attest to fairness of financial statements
Committee – oversight of the process and participants
Audit Committees: Providing Oversight in Challenging Times

6. Reporting and Disclosure
Audit Committee Report
Proxy Disclosures
Identify Committee members
Number of meetings held
Describe functions
Consideration of nonaudit services
Existence of charter
Nonindependent directors
Audit Committees: Providing Oversight in Challenging Times

7. Understanding the Business
Knowledge of the Company
Structure
Financial reporting process
Sophisticated or complex transactions
Current environment
Regulatory requirements
Suppliers and customers
Use of technology
Audit Committees: Providing Oversight in Challenging Times

8. Understanding the Business
Internal Control
Control environment
Code of conduct
System of internal control
Audit Committees: Providing Oversight in Challenging Times

9. Understanding the Business
Risk of Fraud
Earnings management issues
Aggressive accounting policies
Consider restructuring charges, R&D costs, subjective estimates, and premature recognition of revenue
Audit Committees: Providing Oversight in Challenging Times

10. Understanding the Business
Legal and Ethical Matters
Enterprise Risk Issues
Emerging Issues
Audit Committees: Providing Oversight in Challenging Times

11. Oversight of the Financial Reporting Process
Need to understand:
Financial results
Adequacy and completeness of MD&A
Significant changes or trends
Critical accounting policies
Significant issues, related party transactions, and accounting and auditing matters
Unadjusted audit differences
Audit Committees: Providing Oversight in Challenging Times

12. Interim Financial Reporting
Interim periods generally include more estimates and judgments than annual financial statements
Discussions with management and auditors may be via conference calls, meetings, or both
Audit Committees: Providing Oversight in Challenging Times

13. Oversight of Audit Function
Audit process
Audit resources
Quality, experience, and staffing of internal auditors
Qualifications and performance of independent auditors
Scope and fees
Non-audit services
Audit Committees: Providing Oversight in Challenging Times

14. Audit Committee Communications
Discussions with independent auditors
Audit planning and results
Results of timely interim reviews
Required communications
Other meetings
Audit Committees: Providing Oversight in Challenging Times

15. Other Characteristics of Audit Committees
Audit Committee Charter
Indicates responsibilities, including receipt of disclosures from auditor on independence
States that independent auditors are ultimately accountable to Board and Committee
Audit Committees: Providing Oversight in Challenging Times

16. Other Characteristics of Audit Committees
Financially literate, independent members
Diverse backgrounds of members
Typically 3-6 members
Qualified, experienced Chair
Terms of members
Structuring effective meetings
Audit Committees: Providing Oversight in Challenging Times

17. Other Characteristics of Audit Committees
Orientation and continuing education
Provide background information to new members
Obtain information on new accounting or auditing standards, financial reporting process, and significant issues affecting the Company
Audit Committees: Providing Oversight in Challenging Times

18. Best Practices
Ask questions of the internal and independent auditors about the Company’s system of internal control
Establish clear expectations with management and auditors about the Committee’s qualitative information needs about internal control—especially controls in higher-risk areas
Audit Committees: Providing Oversight in Challenging Times

19. Best Practices
Ask detailed questions of management and the auditors when reviewing the financial statements
Interim discussions occur prior to the earnings release and cover significant matters
Audit Committees: Providing Oversight in Challenging Times

20. Best Practices
Consider the presence of risk factors for potential fraudulent financial reporting
Understand why management did not correct audit differences and what the effect would be on the financial statements if such differences were corrected in the current period
Audit Committees: Providing Oversight in Challenging Times

21. Best Practices
Develop a meeting planner to make sure that the Committee meets its responsibilities outlined in the Charter
Add a disclosure to proxy that references the Audit Committee Report and Audit Committee Charter for detailed information
Perform a self-assessment of the Committee to identify areas for improvement
Audit Committees: Providing Oversight in Challenging Times

22. Legislation and Regulation Status
On July 24, agreement was reached by Congress on a compromise corporate crime bill
The SEC has been very active`
On June 27 issued an order requiring the CEO and CFO of 1000 companies to certify their most recent filings
On June 17 proposed a permanent certification requirement
proposed changes in financial disclosure rules earlier this year
proposed new rules creating an accounting oversight board on June 26
intends to propose changes in auditor independence and corporate governance rules later this summer
On June 6, the NYSE published a working draft of proposed corporate governance listing requirements
Audit Committees: Providing Oversight in Challenging Times

23. Among The Issues Being Debated
Corporate Governance: Increased responsibilities for corporate officers, boards of directors, and audit committees
Accounting Profession Reform: The power and composition of a new auditor oversight board and the scope of services that may be provided to audit clients
Financial Disclosures: Proposals intended to enhance corporate transparency and require real-time disclosure of important financial information
Audit Committees: Providing Oversight in Challenging Times

24. Corporate Governance Reform
House
Senate
SEC
NYSE
Certification of Financial Reports
N/A
CEO/CFO must certify that financial statements and disclosures “fairly represent” the company’s financial condition
CEOs and CFOs must certify that financial reports include “all information of which they are aware that is important to a reasonable investor”
CEO must certify that the financial reports are “accurate and complete in all material respects”
Audit Committee Composition
Audit committee members must be independent from management
Proposed independence requirements for audit committee members and financial expertise requirement for the Committee chair
Disgorgement
Gives SEC authority to require disgorgement of bonuses, stock profits or other incentive pay if misconduct results in accounting corrections
Same as House bill
Currently using enforcement actions to seek disgorgement
Ban on Officers/Directors
Gives the SEC administrative authority to bar “substantially unfit” corporate officers
Gives the SEC authority to seek court orders banning “unfit” corporate officers and directors
Using court system to to seek orders banning “substantially unfit” corporate officers and directors
Shareholder Approval of Stock Options
Requires shareholder approval of equity compensation plans
Audit Committees: Providing Oversight in Challenging Times

25. Accounting Profession Reform
House
Senate
SEC
NYSE
Regulatory Board
Composition
Five members, two of whom must be CPAs, and two additional who may be CPAs
Five members, two, and only two, may be CPAs
Nine members, a minimum of six of whom must be public members. Maximum of three CPAs
N/A
Powers
Disciplinary and investigative powers, but no standard setting powers
The Board would set audit, quality control, ethics, and independence standards, or could approve standards set by a professional group
Set standards or rely on private sector groups with oversight
Scope of Services
Prohibited Services
Directs SEC to bar the provision of IT consulting and internal audit services to audit clients
Statutorily bars services already restricted under SEC rule, with additional prohibition of IT, internal audit, and expert services
Audit Committee Approval
No provision (defeated in committee 31-19)
All non-audit services are deemed “unlawful” unless pre-approved by audit committee
Audit committees would pre-approve non-audit services
Similar to SEC, except audit committee approval limited to significant non-audit engagements
Audit Committees: Providing Oversight in Challenging Times

26. Financial Disclosure Reform
House
Senate
SEC
NYSE
Real Time Disclosures
Accelerated Filing Deadlines
N/A
Proposed accelerating filing deadlines of annual reports from 90 to 60 days after close of fiscal year, and quarterly reports from 45 to 30 days after the end of the quarter
Insider Transaction Disclosure
SEC directed to adopt rules
Requires accelerated reporting of insider transactions and loans
Proposed rulemaking that would require companies to report insider transactions, including loans, within 1-10 days
Expansion of Information Reported
SEC directed to conduct an analysis of need for rulemaking
Requires an audit of management’s assessment of internal controls and also requires auditors to test and report on compliance with certain laws and regulations
Proposed requiring more frequent 8-K disclosures (filed when listed events occur between annual reports and quarterly reports that would be of significance to investors)
Improved Transparency
Critical Accounting Procedures
Proposed rulemaking requiring disclosure of critical accounting procedures in annual and quarterly reports. Soliciting comments on disclosures when a company’s accounting policies diverge from those used by other industry members.
Pro Forma Earnings
Companies must reconcile pro forma information with GAAP and not omit information that makes it misleading
Issued cautionary advice on appropriate use of pro forma financials in earnings press releases
Off Balance Sheet Transactions
Issued cautionary advice regarding need to disclose in 2001 financial reports
Audit Committees: Providing Oversight in Challenging Times