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The Role of Audit Committes in Corporate Governance

Audit Committees, Internal Controls, and Reliable Financial Reporting

In the aftermath of accounting scandals at companies such as Enron and WorldCom, Congress passed the Sarbanes-Oxley Act in 2002 that strengthens corporate governance mechanisms. One important requirement is for the audit committee of the board of directors to be completely independent of management. In the accounting scandals, the audit committee either didn't know about the fraud or chose to look the other way. A conscientious and diligent committee is an essential ingredient of an effective corporate governance system -- one that takes its role in financial statement oversight to heart and follows basic principles of responsibility, accountability, and transparency.

The Audit Committee Institute at the international accounting firm KPMG, issued "Ten To-Do's for Audit Committees in 2011." The most important are: (1) Focus on financial reporting and strong internal controls; (2) Review the company's whistleblower processes and compliance program; (3) Understand the significance of risks to  the company's operations and financial reporting; (4) Consider whether the company's disclosures provide investors with the information needed to understand the state of the business; (5) Set clear expectations for the internal audit function and communication with the external auditors; and (6) Understand the audit committee's role in information technology.

Traditionally, the audit committee's primary role has been to monitor the integrity of the financial statements produced by management. Deloitte and Touche, the international accounting and financial services firm, elaborates on the role of audit committees in financial reporting. They provide helpful advice for audit committees to discharge their expanded responsibilities under Sarbanes-Oxley including:

  • Audit committees should be aware of the universe of corporate reporting and its various financial and non-financial components.
  • Audit committees should review the financial statements, Management Discussion & Analysis (MD&A) and related news releases as a single package of information.
  • The effectiveness of the audit committee's review of earnings news releases, financial statements and MD&A depends not only on its understanding of accounting standards and regulations, but to a great extent on the committee's knowledge of the company's business and the industries in which it operates.
  • In addition to approving the financial statements, MD&A and earnings news release, the audit committee must understand and agree with the process by which these documents were prepared.
  • The audit committee should seek assurances from the CEO and CFO as part of the CEO/CFO financial statement certification process that they have put in place effective disclosure controls and procedures to ensure that all reports have been prepared  properly and filed with the appropriate authorities in accordance with applicable requirements.
  • Audit committees should regularly review their oversight responsibilities to determine whether they should include additional financial and/or non-financial disclosures

There can be no doubt that financial reports would be more reliable if audit committees adhered to these guidelines. The goal should be to establish an ethical corporate culture that supports good corporate governance. In addition to a watchful audit committee, an organization must establish effective internal controls to ferret out fraud, a strong internal audit oversight role to deal with fraud, diligent members of the board of directors to oversee management, and a management group that recognizes its primary responsibility is to conduct business operations in a responsible manner and report financial information in accordance with established accounting rules. Organizations that create such an environment are better prepared to deal with the challenges of maintaining an effective corporate governance system.   

Blog posted by Steven Mintz, aka Ethics Sage, on April 18, 2012