Audit Committee Reporting to Shareholders

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Sunday May 5, 2013 at 10:25 am
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Editor’s Note: The following post comes to us from Ernst & Young, and is based on an Ernst & Young study by Ruby Sharma and Allie M. Rutherford. The full publication, including table and footnotes, is available here.

Ernst & Young supports effective audit committees and believes that audit committee transparency can promote greater investor confidence in financial reporting. A number of companies currently disclose more information about their audit committees than is required under relevant rules. With this post, we seek to alert audit committees and other stakeholders to current disclosure practices, and also to proposals that have been made for additional disclosures, in order to facilitate consideration and discussion.

Going Beyond the Minimum

Audit Committee Transparency

In general, investor demand and regulatory changes are driving boards of directors of public companies to be more transparent about their activities.

More specifically, investor interest – and policy debate around the role of audit committees and auditor independence – are generating discussion about audit committee disclosures that go beyond the minimum requirements. For example:

  • In August 2011, the US Public Company Accounting Oversight Board (PCAOB) issued its Concept Release on Auditor Independence and Audit Firm Rotation, in which it sought comments on ways to improve auditor independence, objectivity and skepticism, including mandatory audit firm rotation. While most respondents opposed mandatory firm rotation, they also offered alternatives to address concerns about auditor independence. These included greater transparency about the audit committee’s oversight of the audit engagement, in light of the audit committee’s role in overseeing the audit process.
  • During the 2012 and current 2013 proxy seasons, the pension funds of the United Brotherhood of Carpenters have sought enhanced disclosures from some companies regarding the audit committee’s ownership and oversight of the audit relationship, and many companies are responding by providing such disclosures.

Greater audit committee transparency is also a theme in a series of recent policy initiatives, comment letters and other policy responses relating to audit committee oversight of the auditor. These include:

  • Audit Committee Annual Evaluation of the External Auditor,  produced by a collaboration among the Association of Audit Committee Members, Inc., Center for Audit Quality, Corporate Board Member/NYSE Euronext, Independent Directors Council, Mutual Fund Directors Forum, National Association of Corporate Directors and Tapestry Networks
  • Enhancing Audit Quality: Canadian Perspectives, a collaborative project of the Canadian Public Accountability Board and the Canadian Institute of Chartered Accountants
  • UK Corporate Governance Code, updated in 2012 by the UK Financial Reporting Council
  • Ernst & Young Point of View on enhancing transparency of the audit committee auditor oversight process

These resources generally support expanding audit committee disclosures of certain committee-related information and activities for the benefit of investors and other stakeholders.

Current disclosure practices of US Fortune 100 companies

A review by Ernst & Young’s Corporate Governance Center found that expanded audit committee disclosure has already been embraced by a number of public companies. This review, which examined audit committee-related disclosures by the US Fortune 100 companies, showed that many companies exceed the minimum disclosure requirements, although the nature and manner of these disclosures varied significantly from company to company. The review also observed the significant variation in where and how disclosures are made. Audit committee disclosures are often located in several places in proxy statements and annual reports, as well as on corporate web sites. For example, the following audit committee-related disclosures are typically found in different places in company proxy statements and presented in different formats:

  • The audit committee must provide a separate report in the proxy statement indicating whether it has discussed certain matters with the auditor, including overall audit strategy, matters significant to the financial statements and auditor independence.
  • The company must also disclose in the proxy statement the audit committee’s pre-approval policies for services from, and the amount of fees paid to, the external auditor, but these disclosures are not required to be located with the audit committee report or with other auditor-related information.
  • Audit committees of listed companies are required to have charters identifying the committee’s purpose and responsibilities among other things, but these could be located in one of several places, depending on the listing rules that apply to the company.
  • In addition to the required disclosures previously mentioned, more than 90% of companies seek annual shareholder ratification of the auditor chosen by the audit committee. These companies frequently provide information about the auditor in the proposal section to ratify the auditor, which can be separate from other audit committee and audit fee-related disclosures.
  • Also, the section of the proxy statement related to board composition and membership usually includes disclosures regarding the identities of members of the audit committee, whether they are independent, functions of the committee, and whether the committee has a financial expert.

The full study, including a table summarizing certain current disclosure requirements, is available here.

  1. The role of the Audit Committee in corporate governance entrenchment at firm level cannot be over-emphasised. It is imperative that there is adequate disclosure concerning Audit Committees in Annual Reports of companies to ensure transparency and secure comfort for investors regarding the state of affairs in their companies. The study is valuable and commendable.

    Comment by The Corporate Prof. — May 7, 2013 @ 3:38 am

 

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