by Cydney Posner
In a recent speech at the University of Tennessee, “Advancing the Role and Effectiveness of Audit Committees,” SEC Chief Accountant Wes Bricker discusses his recommendations for — wait for it — improving the effectiveness of audit committees. The speech addresses issues such as diversity, work overload, tone at the top, staying current, implementing new GAAP standards, internal control over financial reporting, non-GAAP measures, external auditor oversight and enhanced audit committee reporting.
Bricker agrees with a number of investors that diversity offers benefits to audit committee effectiveness and believes “there is an opportunity to increase the level of diversity on U.S. boards and audit committees.” In particular, he maintains that “[d]iversity of thoughts diminishes the extent of group thinking, and diversity of relevant skills (for example, industry or financial reporting expertise) enhances the audit committee’s ability to monitor financial reporting. Academic research tells us that boards with diverse members allocate more effort to monitoring, have better financial reporting quality, and are more likely to hold management accountable after poor performance.”
A lot is expected of audit committee members, Bricker says, and periodic assessment of their workloads is necessary to ensure that they are able to stay current and otherwise perform their responsibilities. Bricker cites recent surveys that “indicate that some audit committees are finding it difficult to perform its core responsibilities while covering other major risks on its agenda. For example, a recent Corporate Directors survey by an audit firm suggests that while 75% of Board directors say their workload is manageable, only 57% of audit committee members say their workload is manageable.” That percentage is even smaller in some sectors, such as banking and capital markets. Bricker emphasizes the importance of the board’s identifying the risk of audit committee overload: “[w]hile audit committees may be equipped to play a role in overseeing risks that extend beyond financial reporting, such as cybersecurity and portions of enterprise risk management, [Bricker believes] it is important for audit committees to not lose focus on their core roles and responsibilities….Audit Committee members must help each other test their judgement and instincts in landing on the important issues. Factors that lead to greater audit committee effectiveness include group dynamics, training, information reporting, and focus on substantive issues.”
Tone (at the top)
The board and audit committee have a significant influence on the control environment, including tone at the top, which Bricker believes affords foundational discipline and structure for effective internal control over financial reporting. The control environment is “especially critical” because “accounting judgments are increasingly required to be formed by many levels of individuals in the organization” under new GAAP standards. In a recent survey, approximately one in four audit committee members “ranked tone and culture as a top challenge” in the committee’s oversight role. Citing management guru Peter Drucker for the concept that “[w]hat gets measured gets improved,” Bricker advocates that audit committees and management perform assessments of the adequacy of the control environment, including tone at the top. In addition, he suggests that “audit committees can focus on tone and culture… by working with management to obtain a clear and common understanding of what tone means, why tone is important, and what mechanisms are in place to assess the adequacy of control environment, including across any relevant divisions and geographies.” Moreover, “open and candid discussions” between the external auditor and the audit committee are critical to assessing tone and culture.
Staying Current on Accounting and Financial Reporting Developments
Bricker recommends that, to stay current, the audit committees should consider training and education programs for members.
New GAAP standards
The Office of Chief Accountant continues to monitor companies’ implementation of new accounting standards, including revenue recognition, which is intended to improve the financial reporting of revenue and enhance comparability, as well as other standard,s such as the new lease standard. Because investors need time to absorb the effect of new GAAP standards, “OCA has encouraged investor outreach, emphasized investor expectations for disclosure, and updated our transition disclosure guidance. OCA also has encouraged companies, their audit committees, and their auditors to assess the quality and status of implementation to ensure that the new standards meet their objectives to better inform investors. As part of the assessment, we encourage audit committees to anticipate, and require, dialogue with the auditor about the auditor’s views of implementation progress.”
Bricker emphasizes the importance of effective and updated internal control over financial reporting as companies implement the new accounting standards: “OCA is committed to appropriately and timely addressing any emerging questions related to ICFR assessments and the application of the related guidance, including in coordination with the PCAOB as necessary.”
Non-GAAP and Key Operational Metrics
Audit committees should “exercise healthy oversight” over non-GAAP measures by “understanding management’s process and controls to calculate the non-GAAP and other key operational measures. For example, what procedures are in place over the accuracy of the calculations and consistency of the measures with those of prior periods?” Audit committees should also understand disclosure controls and procedures regarding non-GAAP measures, including who administers the policy, the number of changes in reporting that have been approved and why, and whether the changes have been communicated to investors. (See this PubCo post for a discussion of a tool developed by The Center for Audit Quality, Questions on Non-GAAP Measures: A Tool for Audit Committees, designed to help audit committees cope with non-GAAP financial measures.)
Oversight of External Auditors
Audit committee authority and responsibility to oversee the external auditor promotes auditor independence and “positions the auditor to be able to raise any contentious issues to the audit committee, in a candid, frank, and professional relationship.” That role is especially important to ensure that auditors are “accountable to the company’s shareholders, through the board of directors and its audit committee, not to management.” Audit committees should monitor that company cost-reduction plans or procurement policies and processes are not implemented in ways that are at cross purposes with the company’s financial reporting responsibilities or the external auditor’s appropriate audit scope, engagement terms and compensation.
Audit Committee’s Own Reporting
Bricker is pleased by recent voluntary efforts to enhance audit committee reporting. He reports that, in a recent survey, “82% of audit committees of Fortune 100 companies disclosed in 2016 that the audit committee is responsible for appointment, compensation and oversight of the external auditor. This has increased significantly from 42% just four years ago.” He recommends that audit committees continue to consider further enhancements to their disclosures regarding their oversight of the independent auditors and the financial reporting process, noting in particular the ideas described in the 2015 SEC concept release, such as a description of the nature of the audit committee’s involvement in evaluating and approving the auditor’s compensation, including how compensation is determined and evaluated. (For a discussion of the concept release, see this PubCo post.)