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Audit Committee:Interaction with External Auditors, Training and Evaluation of Internal Controls
September 17, 2004
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Today’s Discussion
The Current Environment
Interaction with the Audit Committee, Management and the External Auditor
Audit Committee Training
SOX 404 Matters
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The Current Environment
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What They Were Saying in 1926
“ … There can be no hope for the independent audit unless and until it be tied in with the positive creation of some body independent of management to which the auditor shall be accountable.”
– William Ripley, “Main Street and Wall Street” - 1926
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Many of the Corporate Governance Reforms Are Far Reaching
Resulting in redefined roles, responsibilities and accountabilities of:
Boards of Directors (including the Audit Committee)
Senior Management
Internal Auditors
External Auditors
Legal Counsel
Other Participants in the Capital Markets
In some cases, these reforms are the most dramatic, rapidly-enacted and far reaching changes to ever affect corporate accountability and financial reporting oversight.
© 2004 KPMG International. KPMG International is a Swiss cooperative of which all KPMG firms are members. KPMG International provides no services to clients. All rights reserved.
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Audit Committee Definition – Redefined?
A committee (or equivalent body) established by and amongst the board of directors of an issuer for the purpose of overseeing:
The accounting and financial reporting processes of the issuer, and
audits of the financial statements [“financial reporting process”] of the issuer.
“Under the PCAOB’s proposed standard, the audit of a public company is now an audit of the company’s financial reporting process.”
Douglas R. Carmichael, Chief Auditor PCAOB
Speech to the American Accounting AssociationJanuary 2004
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Reporting Relationships and Interaction with the Audit Committee, Management and the External Auditor
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The Three Legged Stool
“The board, including the Audit Committee, management (which includes Internal Audit), and outside auditors form a "three-legged stool" of responsible disclosure and active oversight, laying the foundation for financial integrity and greater accountability.”
- SEC Chairman Arthur Levitt
December 12, 2000
Audit Committee
Internal Audit Management
External Auditor
Provide oversight, challenge & influence
“Tone at the Top” Risk and control environment Reporting process
- Estimates - Unusual transactions
Direct responsibility for external auditor
Management and internal audit Evaluate process Encourage continual
improvement
Reporting & Risks Design Implement Test and maintain Communicate 302 Certification
Evaluate Test financial reporting
– Internal control Risk management process Improvement suggestions
Audit of financial statements and internal control over financial reporting in accordance with PCAOB auditing standards Render opinion Integrated audit for Public Co. SAS 61 communications Test and challenge elements of
Financial reporting processRisk and control environment
Improvement suggestions
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Audit Committee’s Direct Responsibility for External Auditor
Appointment, compensation and oversight
Pre-approval of services
Resolution of disputes with management
Annual evaluation of qualification, performance and independence of auditor and communication requirements including quality controls (NYSE)
Review with the external auditor the responsibilities, budget and staffing of the Internal Audit Department (NYSE)
Hold executive sessions with management, internal and external auditors (NYSE)
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Oversight of the External Auditors
Audit Committee:
“…Must be directly responsible for the appointment, compensation, retention, and oversight of the work of [the Company’s independent auditor]”
Independent Auditors :
“…Must report directly to the audit committee”
SEC Standards Relating to Listed Company Audit Committees
April 9, 2003
“…The audit committee should be the external auditor’s biggest fan and harshest taskmaster.”
SEC Chief Accountant Donald T. Nicolaisen
December 11, 2003
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Audit Committee Organization and Operation – Issues to Consider
Membership
Annual and “New Member” Orientation
Charter
Setting “The Tone” with Management and External and Internal Auditors
Process for the Selection of the Independent Auditor
Whistleblower Procedures
Resources and Interdependencies
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Audit Committee Training
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Audit Committee Training:KPMG’s Audit Committee Survey
NYSE listing standards require Corporate Governance Guidelines that address director orientation and continuing education
Groups that grade corporate governance are tracking continuing education of directors
Survey of Audit Committee Roundtable participants in Spring 2003
33% expected a company-specific education session to be provided to the Audit Committee during the next year
34% did not expect this type of session, 33% were not sure
Respondents at companies with revenue in excess of $5 billion were more likely to expect an education session
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Audit Committee Training:Business Roundtable Survey
“Business Roundtable” surveyed its 150 members in June 2003
90% of Roundtable companies encourage, require or have in place director education programs for new or all directors (vs. 76% in 2002)
33% of Board members surveyed felt a board educational retreat was a minimum requirement for board education
45% expected governance experts to educate at board meetings and 46% expected to attend director education seminars, as a minimum requirement
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Framework for Audit Committee Education
Provide company-specific education targeted to key financial accounting and reporting risks. The framework and content is focused on the Audit Committee’s oversight role – as follows:
Provide a general overview of the focus area and relevant accounting guidance
Present the risk assessment process conducted by management
Discuss the internal controls, monitoring practices, and responsible parties
Describe significant estimates and judgments involved in the focus area
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Approach to Audit Committee Education
Audit Committees are expecting much more internal and external support concerning developing trends and issues (company-specific, in the boardroom)
Some Audit Committees have been requesting tailored modules led by:
Management
Internal Audit
In-house Counsel or External Counsel
External Auditor
Other Third Parties
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Format/Frequency of Education
Tailored education modules could be held periodically in a variety of formats:
Single topic sessions led by management prior to Audit Committee meetings
Educational workshops held twice a year
Invited specialists to educate at Board meetings
External education in areas such as Corporate Governance and Director Responsibilities could supplement company-specific modules
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Management Led Sessions
Typical management led training session, tailored to the Audit Committee oversight role, can address various aspects of the Financial Accounting and Reporting Process, including:
Financial Reporting Risk Management
Internal Controls Over Financial Reporting
Critical Judgments and Estimates
Information Security Risks
Disclosure Controls and Procedures
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Potential Training Topics
Reserve Estimation
Accounting for Derivatives
Stock Compensation
Restructuring and Discontinued Operations
Asset Impairment and Retirement Obligations
Revenue Recognition
Accounting for Acquisitions
Consolidation of Variable Interest Entities (VIEs)
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Potential Training Topics continued
Goodwill and Intangible Assets
Income Taxes
Contingencies (environmental, legal, etc.)
Depreciation, Depletion and Amortization
Pension Accounting
M, D & A Requirements/Disclosures
Internal Controls over Financial Reporting and Linkage to COSO
© 2004 KPMG International. KPMG International is a Swiss cooperative of which all KPMG firms are members. KPMG International provides no services to clients. All rights reserved.
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Internal Control Reporting (SOX 404) Matters
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Internal Control Reporting – Audit Committee’s S-O 404 Matters
Is it worth the effort?
Can we get it done in time?
Is the cost too high?
Will it matter to our shareholders (and others) – what will market reaction be to “bad news”?
Will it make management (and the audit committee) more effective?
What will be required to sustain it?
What involvement should the audit committee have in this process?
What issues exist regarding the evaluation of the audit committee’s effectiveness as part of the control environment?
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Final Thoughts – Audit Committees should…
Receive proper orientation and continuing education
Set expectations with management, internal, and external auditors concerning responsibilities and accountabilities
Work to receive the right information, from the right party, at the right time, and in the right context
Focus the nature and timing of Audit Committees activities based on the company’s key financial reporting risks (not driven by a “check the box mentality”)