Yesterday, SEC Chair Jay Clayton, SEC Chief Accountant Sagar Teotia and Corp Fin Director William Hinman posted a “Statement on Role of Audit Committees in Financial Reporting and Key Reminders Regarding Oversight Responsibilities.” As the year draws to a close, given the vital role of audit committees in the financial reporting system, the Statement is intended to provide “observations and reminders on a number of potential areas of focus for audit committees. Issuers and independent auditors also should be mindful of these considerations with an eye toward ensuring that audit committees have the resources and support they need to fulfill their obligations.”
Happy New Year Everyone!
Tone at the top. Among the trio’s general observations, they first stress the importance of setting the right tone at the top to promote “the integrity of the financial reporting process and the independence of the audit,” including expectations for “clear and candid communications to and from the auditor,” as well as expectations with “both management and the auditor that the audit committee will engage as reporting and control issues arise.” Audit committees must also “proactively communicate with the independent auditor to understand the audit strategy and status, and ask questions regarding issues identified by the auditor and understand their ultimate resolution.”
Auditor Independence. In their oversight role, audit committees share with the audit firm and the company the responsibility for compliance with the auditor independence rules. The Statement encourages audit committees to periodically examine “the sufficiency of the auditor’s and the issuer’s monitoring processes” in connection with auditor independence, which processes should timely communicate to the audit firm corporate changes or other events that could affect auditor independence. (For information about proposed ne auditor independence rules, see this PubCo post.)
GAAP. The “importance of the audit committee in promoting an environment for management’s successful implementation of new standards cannot be overstated.” When new standards, such as revenue recognition, are being implemented, the three officials “encourage audit committees to engage proactively with management and auditors in the implementation process of new standards to understand management’s implementation plan, including whether the plan provides sufficient time and resources to develop well-reasoned judgments and accounting policies. It is also important for an audit committee to understand management’s processes to establish and monitor controls and procedures over adoption and transition.”
ICFR. As part of their oversight responsibilities, particularly in connection with management’s assessment of ICFR effectiveness and the auditor’s attestation, audit committees should have a “detailed understanding of identified ICFR issues and engage proactively to aid in their resolution,” including understanding material weaknesses and monitoring and prioritizing “prompt, effective” remediation plans.
Communications to the Audit Committee from the Independent Auditor. Under PCAOB AS 1301, Communications with Audit Committees, auditors are required to make certain communications to the audit committee regarding the conduct of the audit and to obtain certain information from the audit committee. The Statement encourages “audit committees to incorporate this dialogue in carrying out their responsibilities.”
The statement also covered three more specific matters:
Non-GAAP Measures. Used appropriately in combination with GAAP, non-GAAP measures can provide “decision-useful information” from management’s perspective. How and why does management use these measures for internal decision making? The Statement encourages audit committees “to be actively engaged in the review and presentation of non-GAAP measures and metrics to understand how management uses them to evaluate performance, whether they are consistently prepared and presented from period to period and the company’s related policies and disclosure controls and procedures.” (In that regard, note that the SEC continues to focus on the use of non-GAAP financial measures that could be misleading to investors, particularly individually tailored performance measures—especially those that are unusual and complex, such as “adjusted revenue” or “adjusted earnings.”)
LIBOR. SEC representatives have warned early and often (see, e.g., this PubCo post) about the need to consider the impact of the expected discontinuation of LIBOR, especially “if the work necessary to effect an orderly transition to an alternative reference rate…is not completed in a timely manner.” The Statement encourages audit committees to understand management’s plan to identify and address these risks, especially “the impact on accounting and financial reporting and any related issues associated with financial products and contracts that reference LIBOR.”
Critical Audit Matters. The Statement indicates that, while the description of CAMs is the responsibility of the auditors, the CAM discussion in the auditor’s report is expected to “capture and be consistent with the auditor-audit committee dialogue regarding the relevant matter.” To that end, the Statement encourages audit committees to have a “substantive dialogue with the auditor” regarding the nature of the CAMs, basis for determining each CAM and the expected description of each CAM. (See this PubCo post.)