Economics 101 teaches us that time can be quantified in dollars and cents, and that if you want to measure the value of your time—i.e., your opportunity cost—start by looking at your hourly wage.
Applying the opportunity cost idea to audit committees can make an audit committee seem like a hugely expensive venture.
Effective audit committees for public companies, large and/or regulated private companies, and not-for-profit organizations include members who have significant financial and business management experience, and presumably, salaries that reflect that expertise. In other words, audit committee members incur significant opportunity costs by participating in your audit committee meetings. With the time that goes into these audit committee meetings, it is critical that your organization and its audit committee members get a good return on the investment.
The benefit to merely having a good audit committee may not show up as a direct boost to your bottom line or your current market value. A study published in the November 2017 edition of the Accounting Review examined the difference in market value of public companies before and after the implementation of the audit committee requirements. The study found no evidence that audit committees improved a company’s market value.
But an audit committee can still be meaningful, even if it doesn’t bring a direct and immediately visible financial benefit to your organization. In truth, an effective audit committee can contribute, in a meaningful way, to improving the long-term value of an organization by helping it to design processes, procedures and controls to operate more effectively and efficiently, thereby allowing the organization to provide more reliable information about its business to its creditors and investors. Providing reliable information that is complete and accurate also builds credibility with third parties who might be interested in the organization or its results. Alternatively, an ineffective audit committee can cause the opposite to occur and allow an organization to take actions that cause it to lose credibility in the marketplace, which ultimately can negatively impact how investors view and, therefore, value the organization. The right approach, tools, and strategy can enhance the value and purpose behind your audit committee.
Go Beyond the Core Functions
Audit committees are put in place to provide additional oversight into an organization’s financial reporting and financial statement audit process. Public companies are required to have them, and many not-for-profit organizations and regulated private companies choose to have them.
Committee members are to be independent from the organization’s financial reporting process so that they can provide objective insight into the selection of the organization’s financial statement or employee benefit plan auditor, as well as into the pre-audit planning meetings and post-audit discussions.
One of the criticisms of the audit committee is that although audit committees can weigh in on the process, management teams are ultimately the ones that make the key decisions. Any significant findings in the audit, for example, are also presented to management teams, so there is a risk that going over the results with the audit committee is just viewed as an added step in the process.
Ensuring the audit committee meets its core functions is important, but organizations can get the most out of their audit committees when they tap into the advisory potential of their committee members. To get to that level of insight, management teams may want to consider restructuring their audit committee meetings to encourage more dialogue among the various members. Audit plans are often written, for example. Instead of going line-by-line through something committee members can read for themselves, audit committees may want to spend meeting time looking at how and what risks have been identified and how they are being addressed as well as where efficiencies could be implemented in the plan that would make the audit more effective or more streamlined. This dialogue becomes even more critical with the implementation of the PCAOB’s new requirements for the auditors’ report, which requires the auditor to disclose the Critical Audit Matters (or CAMs) in its report. It is imperative that audit committees discuss these requirements and how they will impact the company with the auditors and the organization’s management team to understand the nature of the CAMs and how they are being addressed.
Spend More Energy on What’s Coming Next
While audit committees will need to be involved in the current year’s audit process and financial reporting findings, they should also be heavily focused on future years’ efforts. Preparation for accounting changes is an area where audit committees could offer more future-oriented support for their organization.
Revenue recognition changes under ASC Topic 606, for example, required an extensive overhaul in how organizations applied their accounting policies for revenue recognition to the accounting for their contracts. Public companies have already adopted these rules, but private companies are still implementing the new standards in 2019. Audit committees for private companies and not-for-profit organizations have an opportunity to help their organization adopt ASC Topic 606 by asking for concrete information on how the new revenue recognition standard will affect the organization before the adoption date arrives. Several of our clients had to get a jump start on their adoption analysis to meet audit committee or board requests for information. That early analysis helped identify changes our clients needed to make—such as creating a process to track performance obligations satisfied over time—so that the organization could meet its compliance requirements long before it had to demonstrate it had those processes in place as part of its financial statement audit.
Internal controls and risk management is another area where audit committees could help their organization think more about its future needs than what it has in place currently. What are those emerging issues that may be coming down the line? Audit committees for financial services organizations, for example, may want to be monitoring the discussions around Blockchain technologies. If the organization were to adopt Blockchain as part of its accounting and transaction process, how would internal controls and processes need to be adjusted? Similarly, the possibility that the London Interbank Offering Rate (“LIBOR”) may be replaced in the future could be another issue that organizations would want to consider. How would such a change affect the organization them and how should the organization prepare for that change?
Risk management can take many forms. As the use of technology becomes more and more prevalent and organizations become more and more interconnected with their suppliers and customers, the cybersecurity risks that arise can be significant, as can the costs of managing a security breach. Audit committees may want to ask some key questions around their organizations information security protection, including how does your organization detect cybersecurity threats and breaches and prevent them from occurring?
Audit committees may also want to monitor news items about regulatory actions taken against other companies and consider whether those issues are occurring within their organization. Fraud prevention and financial oversight are just pieces of that puzzle. Other business practices could be potentially risky, such as the use of side letter arrangements. When audit committees raise these types of questions, they may be able to identify risks that are not currently on their organization’s radar.
Revisit Audit Committee Charters
The effectiveness of your audit committee may be limited by an outdated charter. It’s a good practice for the audit committee to periodically review its defined roles and responsibilities to ensure the written descriptions align with the tasks the committee is performing. External auditors may also have suggestions for improvements to audit committee charters or ideas for best practices that the organization could implement.
For more information about audit committee improvements, please contact us.
Published on May 14, 2019