© 2004 KPMG International. KPMG International is a Swiss ...

© 2004 KPMG International. KPMG International is a Swiss cooperative of which all KPMG firms are members. KPMG International provides no services to clients. Each member firm is a separate and independent legal entity and each describes itself as such. All rights reserved.

Audit Committee:Interaction with External Auditors, Training and Evaluation of Internal Controls

September 17, 2004

© 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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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.


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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


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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”)

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