What Should Audit Committees Be Focused on in Consideration of Reliable and Transparent Financial Reporting?
The audit committee must have an unwavering mandate for financial statements that transparently and meaningfully portray the organization’s circumstances.
Identifying and managing risk across an organization is one of the chief aspects of sound corporate governance. Risk management is the process by which management, subject to oversight by the board and audit committee, assesses the nature and scope of risks applicable to the organization, designs and applies appropriate controls to minimize risks and monitors the controls to ensure that they are working effectively.
In order to achieve its goal of risk management and combatting financial fraud, the audit committee must have an unwavering mandate for financial statements that transparently and meaningfully portray the organization’s circumstances. Some steps in achieving this include:
Ensure adequate review of the annual audited financial statements and the Federal Form 990 and other required tax returns before they are finalized. The audit committee should clearly understand the following:
- Significant accounting judgments made and estimates included in the financial statements
- Accounting treatment of significant or unusual transactions
- Impact of changes in accounting rules
- Required disclosures
- Evaluate the appropriateness of management seeking a second opinion on significant accounting or auditing issues.
- Look for “red flags” which may signal improper revenue recognition management or worse, fraudulent financial reporting, misappropriation of funds or illegal acts. In that regard, question management and the auditors about such matters as unusual fluctuations in revenue and expenses, inexplicable reserves, changes in accounting principles or business terms, and significant new sources of revenue.
- Review audit adjustments made and those waived because of immateriality. The audit committee should understand the quantitative, as well as qualitative, factors used to make this decision.
- Ensure that the financial reports clearly reflect true organization performance. In doing so, the committee should be familiar with critical performance indicators such as industry trends and ratios.
Critical accounting estimates are under closer scrutiny than ever before. Given the current economic environment, all parties are paying close attention to estimations of fair value and impairment; reserves for excess inventory/obsolescence; allowances for doubtful accounts and uncollectible pledges; liabilities for employee benefit plans; liquidity; as well as other sensitive areas. Audit committees need to focus their attention on how management is applying judgment within accounting standards and, specifically, on the assumptions that underlie these critical accounting estimates.
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