BEST PRACTICES FOR AUDIT COMMITTEE EFFECTIVENESS Lessons from the real world: next steps April 11, 2012 Good morning, I hope you will enjoye the very informative Best Practices for Audit Committee Effectiveness conference over the next 2 days I am going to try to look at lessons from the real world and practical tips on serving on an Audit Committee and next steps in Audit Committee practices for 2012 and beyond. I encourage you to ask questions as I go along, and I will stop from time to time to ask you questions, so we can all learn from one another. So onward we go….
Transcript
BEST PRACTICES FOR AUDIT COMMITTEE EFFECTIVENESS
Lessons from the real world: next steps
April 11, 2012
Good morning, I hope you will enjoye the very informative Best Practices for Audit Committee Effectiveness conference over the next 2 days
I am going to try to look at lessons from the real world and practical tips on serving on an Audit Committee and next steps in Audit Committee practices for 2012 and beyond.
I encourage you to ask questions as I go along, and I will stop from time to time to ask you questions, so we can all learn from one another.
So onward we go….
Background
You will cover many technical aspects of audit committee governance during this course
Focus of this presentation is on a number of “real life” best practices and issues that you can consider for deployment to increase effectiveness of your committee
Thoughts are not “authoritative”, and this is not necessarily a complete list; these are thoughts and opinions arising from observations
Most audit committee members have a good understanding of their objective, but the practices employed to achieve that objective are varied and continue to evolve
This is a common phrase they teach at any Director education program, it really means that it your job to have an oversight function and not to be involved in the operations of the business. So remind yourself that anytime you want to dig in the weeds…
Your job is to balance the role as an advisor and counselor to management with you fiduciary duty to monitor and oversee management.
Also to ensure you have ongoing communication to build a trusting relationship between the audit committee and management.
You would like management to view the audit committee as an asset and seek input prior to, rather than after making decisions.
5 guiding principles for audit committees
Recognize one size does not fit all Have the “right” people on the committee Monitor and insist on the right “tone from
the top” Ensure the oversight process facilitates the
committee’s understanding and monitoring of key roles, responsibilities & risks
Articulate & exercise the committee’s direct responsibility for the external auditor
10 to-dos for Audit Committees in 2012
1. Stay focused on the audit committee’s top priority: financial reporting and related internal control risk.
2. Continue to monitor accounting judgments and estimates, and prepare for accounting changes.
3. Consider whether the financial statements and disclosures tell the company’s story.
4. Stay on top of IFRS first year audited financial statements.5. Focus on the company’s plans to grow and innovate.6. Reassess the company’s vulnerability to business
interruption, and its crisis readiness.
-Challenges of ongoing economic uncertainty & volatility, more complex regulatory environment will require the attention of every audit committee.
-Monitor fair value estimates, impairments and management’s assumptions underlying critical critical accounting estimates. Understand mgmt’s framework for making accounting judgements & estimates. Also understand major accounting changes on the horizon may impact the company, including implementation/resources and IT systems requirements.
-Given the importance of transparency to the investor community, as well as the ongoing regulatory focus on disclosure, consider how disclosures can be improved, perhaps going beyong what’s required to better address expectations.
-IFRS is here, and its bound to keep changing, Audit committees should stay close to IFRS issues this year by asking mgmt critical questions like,
-Growth, strategy & innovation will be front & centre as companies search for top-line growth and look forward…beyond recessionary environment. A key challenge will be monitor & calibrate growth plans to balance risk & reward._Understand the company’s position in the M&A ecosystem.
-In lgiht of earthquakes in Japan, European debt crisis, and other systemic disruptions over the past 24 months, the global interconnectedness of businesses, markets and risks poses challenges for every company. Ensure that mgmt is weighing a broad spectrum of what-if scenarios
10 to-dos for Audit Committees in 2011
7. Understand how technology change and innovation are transforming the business landscape- and impacting the company.
8. Consider the impact of the regulatory environment on compliance programs and business plans.
9. Understand the company’s significant tax risks and how they are being managed and modeled.
10. Monitor regulatory initiatives on auditor independence and transparency, and consider the implications for the audit committee.
-IT risk discussions should be moving beyond “defensive” issues to more transformational implications of IT & emerging technologies-cloud computing, social media, mobile technologies & data & the strategic issues they present.
-The increasing complexity of the global regulatory environment will require continued attention. The right tone at the top & throughout the organization is critical.
-As tax authorities are ratcheting-up their enforcement efforts and more aggressively sharing information with a view to increasing the effectiveness of their tax audits, audit committee should ensure they understand the company’s tax appetite and management’s process for managing tax risks.
Know your mandate Some committees include some, or all of, the following
Diversity in practice; some committees are “audit and risk management”, some are “audit and finance”, some are simply “audit”
Orientation for new members Best to ensure scope is clear, and mandate/charter
reflects scope, composition, roles and responsibilities and authority
Evaluate mandate/charter annually-determine if charter is appropriate and whether discharging all their responsibilities
All Audit Committee have charters and I know that xxx covered creating an effective Audit Committee charter
So you must know your mandate if you are to follow it-some committee include some or all of the following mandates:,-risk management, environmental disclosures, primary responsibility for annual budget, press releases-Diversity in practice. Some committees area audit and risk management, some are audit and finance and some are simply audit.
-Best to ensure scope is clear and mandate reflects scope, composition, roles and responsibilities and authority_Evaluate mandate/charter annually determine if charter is appropriate and whether discharging all their responsiblities._Just want to highlight how important it is to follow your mandate and very often charters are not fulfilled, meetings can go off-track without effective chairing.
-You want to make sure you focus on key mandate elements like your oversight functions, due diligence on f/s, regulatory filings, disclosure, internal controls.
Follow your mandate Charters are often not fulfilled; meetings
can often go “off track” without effective chairmanship
Well intentioned interest in the business and its operations can sometimes lead to tangents
Ensure focus is on key mandate/charter elements – governance, oversight, due diligence on financial statements, regulatory filings, disclosure, internal
Evaluate your performance Compare audit committee’s activities
against its charter Compare committee’s activities against
leading practices Assess individual members performance:
Objectivity and independence Insight, tenacity, judgment, communication
skills Understanding of the business and commitment
to the duties/resp. of the committee Willingness to devote time necessary to prepare
When it comes to your audit committee performance you should evaluate on an annual basis for effectiveness
-You want to compare the committee activities against leading practices to determine effectiveness
-Leading practice is to assess individual member performance, determine objectivity & independence-insight, tenacity, judgment and communication skills-understanding of the business and commitment to the duties/resp. of the committee-Willingness to devote to necessary steps.
Who here has annual audit committee performance on the committee first and then who does individual member performance?-
Educate yourself…. Frequent feedback from governance surveys is insufficient
orientation, knowledge and understanding of the business Consider using “off-cycle” meeting to orient new members,
as well as to conduct continuous learning about new developments; generally insufficient time at quarter-ends, year-end
Auditors, management can do joint orientation sessions annually, as well as ongoing learning about key topics, current issues
Various other websites, and publications that can provide concise learning, ongoing knowledge about key issues; a few examples include the securities commissions, which post disclosure review program results, the CICA, legal firms and other professional bodies
_as member of a Board you should always be educating yourself and in particular in the case of the audit committee you want to ensure you are keeping technical in your financial literacy.
-General feeedback is that there is insufficient orientation, knowledge and understanding of the business
-Consider using off-cycle meeting to orient members as was conduct continuous learning about new developments, generally insufficient time at quarter-end and year-end meetings
-Auditors and management can do joint orientation sessions, annually as well as ongoing learning about key topics, current issues,
-Keep yourself current with websites, newsletters, publicationsWhat are some examples that you keep linked into?
Get the right advisors…. You have many resources at your disposal; ability to engage
experts if necessary, as well as ongoing support from your auditors, internal auditor, legal counsel
Encourage periodic attendance of tax, internal control, risk management or other applicable specialists involved in audit
Develop relationships with them - they have an interest in serving you and enjoy doing so; service level is higher when you keep them engaged – invite their comments in meetings
Periodic lunches, dinners are great opportunities to gather additional “informal” insights, discuss business aspects of particular interest to you with less time constraint
Encourage ongoing communication – emails, periodicals and other knowledge sharing, occasional phone calls, etc.
Ensure they know and understand your expectations, service preferences
_it is very important to have the right advisors advising the Audit Committee
-you know that you can engage experts if necessary, as well as ongoing for your auditors, internal auditor, and legal counsel
-Encourage you to have periodic attendance of tax, internal control, risk management or other applicable specialist involved in audit
-Encourage ongoing communication
-Ensure they know and understand your expectations, service preferences
-Periodic lunches, dinners are great opportunities to gather additional information “informal” insights, discuss business aspects of particular interest to you with less time constraint
Organize your meetings well…. Somewhat surprising how many meetings are not well
organized Agenda is your agenda; make certain successive meetings
are designed to meet your charter through the course of the year
Have start and finish times for the meeting; include time estimates for each item, and indicate who the speaker is
Ensure the in-camera session ordering (more about this later) is clear, and laid out in the agenda
Work with legal counsel to know which items require resolutions; have resolutions and wording pre-prepared
Be prepared to “actively chair” meetings Have a corporate calendar of meetings and work plan
_it is very important to have the right advisors advising the Audit Committee
-you know that you can engage experts if necessary, as well as ongoing for your auditors, internal auditor, and legal counsel
-Encourage you to have periodic attendance of tax, internal control, risk management or other applicable specialist involved in audit
-Encourage ongoing communication
-Ensure they know and understand your expectations, service preferences
-Periodic lunches, dinners are great opportunities to gather additional information “informal” insights, discuss business aspects of particular interest to you with less time constraint
Be strong in your financial reporting knowledge
Lots of issues to consider – internal controls, press releases, governance processes, etc., but quality financial reporting – accounting and disclosure – is the core mandate of the committee
Restatements, or major revisions to financial disclosures as a result of securities commission or other reviews, is key risk to govern against
Confidence and performance in questioning, providing oversight is higher when knowledge is current, strong
Critical that all audit committee members today are actively learning IFRS; not sufficient to have “C” level of knowledge; need at least “B”, or potentially “A” for certain companies, certain issues
Use your auditors, management, professional firm programs, etc.
Meet with others in the Finance department
Good practice to have periodic presentations, participation in meetings by others in finance department, disclosure committee, certain operational personnel
Tax, internal control specialists, financial reporting director (“GAAP” specialist), major divisional controllers/finance directors are important to consider hearing directly from periodically
Gauge for succession and depth of organization Gather additional perspectives from various levels of
organization Be watchful for good delegation, involvement of finance
department staff by CFO; insight into leadership and team development skills
Understand major transactions Critical to understand economics, cash flow implications,
accounting and disclosure elements of major, complex transactions like acquisitions, multi-element sales contracts, complex financial instruments, non-standard financing deals, hedging deals, multi-party joint ventures, pension curtailments, stock option re-pricings, tax structuring deals, etc.
Restatements are most common on complex revenue transactions, complex transactions in general
Be confident in asking all questions necessary to understand; many deals are not subjected to sufficient sensitivity analysis to illustrate upside and downside implications
Key balance between corporate governance and audit committee oversight; balance between effective knowledge of transaction accounting and reliance on auditor, management experts
Balance will depend on depth of management, complexity of deal, your own experience and knowledge
Understand financial condition of the company
More important in today’s environment than last decade
Critical financial matters to know and understand: Terms and covenants of current debt; schedule
of debt re-financings and current covenant analysis a key one to have
Status of financing commitments; many commitments are being cut
Cash flow forecast for coming year on rolling basis
Understand financial condition of the company
Working capital position, and forecast for coming year on rolling basis
Credit risk analysis – all exposures – not just receivables; in the money derivative and other contracts as well
General liquidity and solvency indicators, analysis Credit ratings; most current ratings, any issues
being raised by rating agencies – know current status and timing of ratings
Tax issues, audits – current reassessments of prior years when earnings may have been strong; there is a lag time in audit performance and last several years have seen many structured deals to shelter strong corporate earnings
Understand financial condition of the company
Working capital position, and forecast for coming year on rolling basis
Credit risk analysis – all exposures – not just receivables; in the money derivative and other contracts as well
General liquidity and solvency indicators, analysis Credit ratings; most current ratings, any issues
being raised by rating agencies – know current status and timing of ratings
Tax issues, audits – current reassessments of prior years when earnings may have been strong; there is a lag time in audit performance and last several years have seen many structured deals to shelter strong corporate earnings
Understand financial condition of the company
Importance of obtaining, reviewing key financial issues is primarily to provide a level of governance that appropriate accounting is applied and disclosures are made; emphasis of audit committee is not to “manage” or provide advice on financial structure – usually a board level matter, but consider scope of committee (finance and audit?)
Directors can play a very important “sober second thought” in these challenging times; important to be optimistic, but good governance can ensure that optimism doesn’t over-ride appropriate and timely disclosure if there are critical financial matters in a company - debt being called, asset write-downs and impairments, receivable write-offs, goodwill write-downs, potential going concern issues , etc. will afflict many companies, unfortunately, in current environment
Make the most of in-camera sessions
2 step” approach – address formal aspects, and then move to informal discussion with open ended questions
Formal aspects – covering due diligence and good governance practice of ensuring auditors, management have no other matters to bring to your attention
Informal aspects – excellent opportunity to gather information, advice, counsel on issues that are of interest, but that may be awkward to discuss in a group meeting
Potential topics/questions – strengths and weaknesses, key risks, “any advice to offer”, “any questions we should have asked”, “any comments surprise you”, invite participants to speak openly about working relationships, general issues arising during quarter/year end
Make the most of in-camera sessions
Other question ideas - “on a scale of 1 to 10….”, “compared to other organizations….”, stay awake issues, issues that auditors, CFO, CEO believe the audit committee could or should bring focus to, financial condition questions will be topical in this environment
Objective of informal discussions is to gather insights, tips to plan ahead, develop professional relationships further, work as a committee together more effectively – important, though, not to mix immediate governance matters with advice and insight
Important that any actions taken as a result of in camera discussions are not directly attributed to participants; better to gather viewpoints, advice, and then act as a committee on issues – “we think”, as opposed to “XXX told us”
Other misc. tips Schedule meetings 15 months in advance Distribution of materials at least 5 business days in advance
– expect some black-line Determine a clear policy for non-audit services, and practical
techniques for applying it Avoid “word-smithing” edits in meetings; pass on comments
to controller, CFO for separate consideration of grammatical, other nits, and use meetings for productive, major issues
Develop a consistent approach towards taking meeting minutes
Use the “top questions for directors to ask” – better yet, have management respond in advance when various issues arise
Have fun! It’s the most engaging, interesting, challenging committee of the board
Other misc. tips for Effective Audit Committee practices
-try to schedule meetings 15 months in advance
-Distribution of materials at least 5 business days in advance-expect some blackline
-Determine a clear policy for non-audit services, and practical techniques for applying it.
-Avoid wordsmithing edits in meetings, pass on comment to controller, CFO in advance of the meeting
-Develop a consistent approach towards taking meeting minutes
-Most all have FUN, it’s the most engaging, interesting and challenging committee of the Board.
Tips for the Chair of the Audit Committee
Be prepared and discharge your reporting back to the Board and provide a summary to the Board of your Audit committee
Benefit to the Chair to have a in-camera before the Audit committee meeting begins so you get the hot topics/issues in advance of the meeting
Ensure annual evaluation of the Audit Committee and evaluation of the Chair
Ensure you take control the agenda Ensure all Boards members have access to respective
committee materials to discharge responsibilities: Board portal Copy all Board members on agendas/materials etc. All Board members are invited to attend committee
meetings as observers
Some times for the Chair of the Audit Committee
-Be prepared and discharge your reporting back to the Board by providing a summary to the Board on behalf of your Audit Committee
-Ensure annual evaluation of the Audit Committee and evaluation of the Chair
-Ensure you control the agenda.
-Ensure all Board members have access to respective committee materials to discharge responsibilities:Board portalCopy all Board members on agendas/materials etc.All Board members are invited to attend committee meetings as observers
4 tough questions to ask the auditors…
If you were solely responsible for the preparation, would they be prepared differently?
If you were an investor, would you have received-in plain English-the information essential to understanding the company’s financial performance?
Is the company following the same internal audit procedure that would be followed if you were the CEO?
Are you aware of any actions-either accounting or operational-that have had the purpose and effect of moving revenues or expenses from one reporting period to another?
Source: Warren Buffet’s annual letters
If you were solely responsible for the preparation, would they be prepared differently?If you were an investor, would you have received-in plain English-the information essential to understanding the company’s financial performance?Is the company following the same internal audit procedure that would be followed if you were the CEO?Are you aware of any actions-either accounting or operational-that have had the purpose and effect of moving revenues or expenses from one reporting period to another?
