Financial Reporting
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Financial Reporting Financial Reporting Document Transcript

  • BDO Seidman, LLP Accountants and Consultants Financial Reporting April 1999 Contents Report and Recommendations of Improving the Effectiveness of the Blue Ribbon Committee...............1 Corporate Audit Committees Independence ......................................2 Financial Literacy ................................2 Audit Committee Structure and Process..........................................2 Relationships with Management, Report and Recommendations of the the Internal Auditors and the Outside Auditors .................................3 Blue Ribbon Committee Enhancing the Outside Auditors’ A Blue Ribbon Committee appointed last fall by Communications with the Audit Committee ...........................................3 the New York Stock Exchange and National Instituting Audit Committee Disclosures...........................................3 Association of Securities Dealers recently Mandating Auditor Interim issued its Report and Recommendations to Financial Review..................................3 improve audit committee effectiveness. The Guiding Principles ...............................3 Illustrative Audit Committee Committee was formed in response to SEC Charter..................................................4 Chairman Arthur Levitt’s much publicized con- The Report views the audit committee of the board of direc- cerns about the quality of financial reporting, tors to be at the core of the corporate financial reporting fueled largely by a perceived need for compa- process. While the audit committee, along with the independent nies to “make the numbers” to meet or exceed and internal auditors, is part of what the Report calls a “three- legged stool” of the financial oversight process, it is viewed as Wall Street analysts’ expectations (see February the “first among equals” in that process. The recommendations 1999 issue of Financial Reporting – SEC Year in contained in the Report are not designed to create new respon- Review). Of course, this is not the first time that sibilities or liabilities for audit committee members; rather, they are intended to be “pragmatic, progressive” actions that can be concerns over financial reporting have trig- taken quickly. While responsive actions by regulators may take gered high level reports (e.g., 1987 Treadway time, companies can choose to adopt all of the recommenda- Commission). However, the speed at which the tions relatively quickly and are encouraged to do so. Committee’s report and recommendations was The recommendations are built on two essential blocks: • A professionally run audit committee. This requires sound produced is a testament to the significance of practices performed by members having certain core compe- present SEC concerns which, in turn, may signal tencies, including financial literacy, business experience, leadership, toughness and, above all, independence. prompt actions by regulators and others to • A legal, regulatory and self-regulatory framework emphasizing whom the recommendations are addressed. full disclosure. While the listing standards of the NYSE and
  • NASD already require companies to • A director being employed as an Audit Committee have audit committees, these stan- executive of another company dards need more specificity. where any of the company execu- Structure and Process tives serve on that company’s com- A well-functioning audit committee The Report outlines 10 recommen- pensation committee should define its specific duties and dations as follows: document them in a charter. An illus- Exceptions to these prohibitions trative charter for a large company is could be made by the board in limited Independence circumstances, in which case, certain included at the end of this letter. Independence is critical to the audit However, that model is only intended proxy statement disclosures would be committee’s role. In fact, recent studies required. as guidance. Each company’s audit have correlated audit committee inde- committee charter should be tailored Recommendation 2 to fit its particular circumstances. For pendence with increased active over- The NYSE and the NASD should require example, a small company may not sight and a lower incidence of fraud. listed companies with a market capital- need to make reference to an internal Recommendation 1 ization generally above $200 million to audit function. The NYSE and the NASD should adopt have an audit committee comprised In addition, disclosure to investors the following definition of indepen- solely of independent directors. of the audit committee’s practices may dence for purposes of service on the The NYSE and the NASD should foster discipline of the committee. audit committee for listed companies maintain their current audit committee with a market capitalization generally independence requirements as well as Recommendation 4 above $200 million: their definitions of independence for The NYSE and the NASD should require Members of the audit committee listed companies with a smaller market the audit committee of each listed would be considered independent, if capitalization. company to: (1) adopt a formal written they have no relationship to the com- charter that is approved by the full pany that may interfere with the exer- board and that specifies the scope of cise of their independence from man- Financial Literacy the committee responsibilities, and agement and the company. Examples Audit committee members need to be how it carries out those responsibili- of such prohibited relationships able to understand financial state- ties, including structure, processes and include: ments to carry out their duties effective- membership requirements; and (2) • A director being employed by the ly. Training could be given to members annually reassess the adequacy of the company or any of its affiliates for who have limited familiarity with audit committee charter. the current year or any of the past finance. 5 years Recommendation 5 Recommendation 3 The SEC should adopt rules that • A director accepting any compensa- The NYSE and the NASD should require tion from the company or any of its require the audit committee for each listed companies with a market capital- affiliates other than compensation reporting company to disclose in the ization generally above $200 million to for board service or benefits under a company proxy statement for its annual have an audit committee comprised of a tax-qualified retirement plan stockholders meeting whether the audit minimum of three directors, each of • A director being a member of the committee has adopted a formal writ- whom is financially literate (i.e. able to immediate family of an individual ten charter and, if so, whether the audit understand financial statements) or who is, or has been in any of the committee satisfied its responsibilities becomes financially literate within a past 5 years, employed by the com- reasonable period of time after their during the past year in compliance with pany or any of its affiliates as an appointment to the audit committee. At its charter. The charter should be dis- executive officer least one member of the audit commit- closed at least triennially in the annual • A director being a partner in, or a tee should have accounting or related report or proxy statement, and in the controlling shareholder or an execu- financial management expertise. The next annual report or proxy statement tive officer of, any for-profit business NYSE and the NASD should maintain after any significant amendment. to which or from which the company their current audit committee size and The SEC should also adopt a “safe made or received significant pay- membership requirements for compa- harbor” applicable to all such disclo- ments in any of the past 5 years nies with a smaller capitalization. sures. BDO SEIDMAN, LLP, FINANCIAL REPORTING 2
  • Relationships with matters as estimates, new transactions (3) the members of the audit commit- and voluntary changes in accounting tee have discussed this information Management, the principles. The quality of financial among themselves without manage- Internal Auditors and reporting can be enhanced by having ment or the outside auditors present; the Outside Auditors the audit committee question such and (4) the audit committee, relying on judgments. the review and discussions with man- In light of the need for each part of the agement and the outside auditors, “three-legged stool” to function most Recommendation 8 believes that the company financial effectively, the nature and direction of Generally accepted auditing standards statements are fairly presented in con- relationships among management, the should require the outside auditors to formity with generally accepted internal auditors and the outside audi- discuss with the audit committee their accounting principles. tors should be clearly delineated. judgments about the quality, not just The SEC should adopt a “safe har- Above all, these relationships the acceptability, of the company’s bor” applicable to any of the above dis- should be direct, strong and candid, accounting principles reflected in its closures. providing a free flow of information. financial reporting. The discussion should include such issues as the clari- Recommendation 6 The listing rules for the NYSE and the ty of the financial disclosures, and Mandating Auditor degree of aggressiveness or conser- NASD should require that the audit vatism of the accounting principles, Interim Financial committee charter specify that the out- and underlying estimates and other sig- Review side auditors are accountable to the nificant decisions made by manage- Increased involvement by the outside board of directors and the audit com- ment in preparing the financial disclo- auditors in the interim reporting mittee, which have the ultimate author- sures. This requirement should be writ- process can lead to more accurate ity and responsibility to select and eval- ten in a way to encourage open, frank interim reporting and fewer year-end uate them. discussion and to avoid boilerplate. adjustments. Recommendation 7 The listing rules for the NYSE and the Recommendation 10 NASD should require that the audit Instituting Audit The SEC should require the outside committee charter specify: (1) that the Committee Disclosures auditors to conduct a formal review of audit committee is responsible for the quarterly financial statements prior General disclosure about the audit to filing the Form 10-Q. receiving from the outside auditors a committee’s review of the entire audit written statement describing all rela- In addition, the professional stan- process will highlight the importance of dard relating to reviews should be tionships between them and the com- its oversight role and relationship to amended to require the outside audi- pany consistent with professional stan- the other participants in the process. tors to discuss with the audit commit- dards; and (2) that the audit committee is also responsible for actively dis- Recommendation 9 tee and a representative of financial cussing with the auditors any disclosed The SEC should require all reporting management, in person or by phone, relationships or services that may companies to include a letter from the certain matters prior to the filing of the impact the auditors’ objectivity and audit committee in the annual stock- 10-Q (and preferably prior to the earn- independence, and for taking appropri- holders’ report and Form 10-K disclos- ings press release), including signifi- ate action to ensure the independence ing whether or not with respect to cant adjustments, management judg- of the outside auditors. the prior year: (1) management has ments and accounting estimates, sig- reviewed the audited financial state- nificant new accounting policies and ments with the audit committee, disagreements with management. Enhancing the including a discussion of the quality of Outside Auditors’ the accounting principles applied and Guiding Principles Communication with significant judgments affecting the financial statements; (2) the outside Recognizing that the roles and conduct the Audit Committee auditors have discussed with the audit of each audit committee should be self- There are many subjective judgments committee their judgments of the qual- determined and tailored to the compa- that arise on audits concerning such ity of such principles and judgments; ny, the Report provides the following 3 COPYRIGHT 1999, BDO SEIDMAN, LLP
  • common sense “Guiding Principles” to 3. There should be independent com- these guidelines are too numerous to serve as building blocks for developing munication and information flow include in this letter. For more detailed specific practices: between the audit committee and discussions of model audit committee 1. The audit committee should oversee the outside auditors. agendas and examples of questions to the other component parts of the 4. There should be candid discussions be asked of management, and the out- audit process (i.e. management, and with management, the internal side and internal auditors, we refer you the outside and internal auditors). auditors and the outside auditors to our booklet How to Form and Run an 2. There should be independent com- regarding issues implicating judg- Effective Audit Committee. For a copy, you munication and information flow ment and impacting quality. may contact the BDO Seidman, LLP between the audit committee and The specific activities and questions partner serving you. the internal auditors. that would be developed by applying Illustrative Audit Committee Charter1 There shall be a committee of the Board of Directors known as Continuous Activities – Reporting the Audit Committee. Only independent directors may serve on the Audit Committee. The primary function of the Committee Specific Policies shall be to assist the Board of Directors in fulfilling its oversight 1. Advise financial management and the independent audi- role regarding the company’s financial reporting process, its tors that they are expected to provide a timely analysis of system of internal control and its compliance with applicable significant current financial reporting issues and practices laws, regulations and company policies. Activities of the Audit 2. Provide a medium for financial management and the inde- Committee are as follows: pendent auditors to discuss with the audit committee their qualitative judgments about the appropriateness, not just the acceptability, of accounting principles and financial dis- Continuous Activities – General closure practices used or proposed to be adopted by the 1. Provide an open avenue of communication between the company and, particularly, about the degree of aggressive- independent auditors, internal auditors and the Board of ness or conservatism of its accounting principles and Directors underlying estimates 2. Meet at least three times per year or more frequently as cir- 3. Determine, as it relates to new transactions or events, the cumstances require; the Committee may ask members of auditors’ reasoning for the appropriateness of the account- management or others to attend meetings and provide per- ing principles and disclosure practices adopted by manage- tinent information as necessary ment 3. Confirm and ensure the independence of the independent 4. Assure that the auditors’ reasoning is described in deter- auditors and the objectivity of the internal auditors mining the appropriateness of changes in accounting prin- 4. Inquire of management, the independent auditors and the ciples and disclosure practices Director of Internal Audit about significant risks or expo- 5. Assure that the auditors’ reasoning is described in accept- sures, and assess the steps management has taken to mini- ing or questioning significant estimates by management mize such risks to the company 5. Meet periodically with the independent auditors, the Director of Internal Audit and management in separate Scheduled Activities executive sessions to discuss any matters that the 1. Recommend the selection of the independent auditors for Committee or these groups believe should be discussed approval by the Board of Directors, and approve the com- privately with the Committee pensation of the independent auditors 6. Report periodically to the Board of Directors on significant 2. Consider, in consultation with the independent auditors and results of the foregoing activities the Director of Internal Audit, the audit scope and plan of 7. Instruct the independent auditors that the Board of the independent auditors and the internal auditors to assure Directors, as the stockholders’ representative, is the audi- completeness of coverage, reduction of redundant efforts tors’ client and the effective use of audit resources 1 Derived substantially from one of the samples in the Report. BDO SEIDMAN, LLP, FINANCIAL REPORTING 4
  • 3. Review with management and the independent auditors Director of Internal Audit: the results of annual audits and related comments in con- a. The adequacy of the company’s internal controls, sultation with other committees as deemed appropriate, including computerized information system controls including: and security a. The annual financial statements, accompanying foot- b. Related findings and recommendations of the indepen- notes and the independent auditors’ report thereon dent auditors and Internal Audit Department, together b. Any significant changes required in the independent with management’s responses auditors’ audit plans 8. Review annually with the independent auditors and the c. Any difficulties or disputes with management encoun- Director of Internal Audit the results of the monitoring of tered during the course of the audit compliance with the company’s code of conduct d. Other matters related to the conduct of the audit, which 9. Describe in the company’s annual report the Committee’s are to be communicated to the Committee under gener- composition and responsibilities, and how they were dis- ally accepted auditing standards charged 4. Consider and review with management and the Director of 10. Arrange for the independent auditors to be available to the Internal Audit: full Board of Directors at least annually a. Significant internal audit findings during the year and 11. Review and update the Committee’s Charter annually management’s responses to them b. Any difficulties encountered in the course of internal audit work, including any restrictions on the scope of “When Necessary” Activities activities or access to required information 1. Review and concur with the appointment of the Director of c. Any changes required in the planned scope of the Internal Audit Internal Audit plan 2. Review and approve requests for any management consult- d. The Internal Audit Department charter, budget and ing engagement to be performed by the independent audi- staffing tors, and be advised of any other study undertaken at the 5. Review the interim financial reports with management, the request of management that is beyond the scope of the independent auditors and the Director of Internal Audit audit engagement letter before those interim reports are released to the public or 3. Review periodically with legal counsel any regulatory mat- filed with the SEC ters that may have a material impact on the company finan- 6. Review the results of the annual audits of directors’ and cial statements, compliance policies and programs officers’ expense accounts, and management perquisites 4. Conduct or authorize investigations into any matters within prepared by the Internal Audit Department and the inde- the Committee’s scope of responsibilities; the Committee pendent auditors, respectively shall be empowered to retain independent counsel and other 7. Consider and review with the independent auditors and the professionals to assist in conducting any investigation Material discussed is meant to provide general information and should not be acted upon without first obtaining professional advice appropriately tailored to your individual circumstances. 5 COPYRIGHT 1999, BDO SEIDMAN, LLP
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