In January 2019, the board of the International Organization of Securities Commissions (“IOSCO”) published a report intended to promote audit quality. It outlines best practices for audit committees. Although external auditors have primary responsibility for audit quality, the audit committee plays an important oversight role in the financial reporting process.
Role of the audit committee
Audit committees act as gatekeepers over financial reporting by overseeing the accounting and financial reporting process.
In addition, the audit committee pays close attention to how a company manages risk and ensures compliance with relevant laws and regulations. The committee also evaluates whether the company’s control environment — including its internal and external audit processes — is effective.
Assessing external auditors
The IOSCO Report on Good Practices for Audit Committees in Supporting Audit Quality found that practices of audit committees can vary from company to the next. This creates a lack of consistency in the way audit committees carry out their responsibilities.
In general, audit committees oversee external auditors. In turn, external auditors form an opinion about whether a company’s financial report complies with relevant accounting standards and, where applicable, presents fairly the financial position, financial performance and cash flows of the entity in all material respects. Auditors must conduct their work in accordance with the relevant auditing standards.
IOSCO’s report discusses what audit committees should consider when they:
- Hire or retain an external auditor,
- Set audit fees,
- Facilitate the audit process,
- Assess auditor independence,
- Communicate with the auditor, and
- Assess audit quality.
Specifically, IOSCO says, when choosing an auditor, “The focus should be on audit quality and not fee reduction. Opinion shopping should be avoided and auditor independence should be a key consideration.”
In assessing the auditors, IOSCO recommends that audit committees consider such matters as:
- The auditor’s knowledge of the company’s business and industry,
- The extent of involvement of senior team members in the audit,
- The use of other auditors and specialist expertise,
- The capability accessible by the auditor in different geographic locations,
- Coverage of internal systems and controls, and
- How the engagement partner and team are accountable within their firm for audit quality.
To facilitate the audit process, audit committees should seek explanations and advice on the appropriateness of accounting treatments and estimates, proper books and records, and systems and controls. Such practices could also help avoid issues being missed or not adequately addressed because of deadline pressures.
In terms of auditor independence, IOSCO recommends that audit committees review and challenge management’s accounting treatments and estimates. Furthermore, audit committees should have open, timely and meaningful communication with auditors about risks, issues and other matters so they can help each other in performing their respective roles. When the auditor presents the financial results to the committee, he or she also should provide a management letter that highlights key risks and weaknesses, as well as possible corrective measures.
Audit committee qualifications
IOSCO believes that the audit committee should comprise only nonexecutive directors. Ideally, audit committee members should be independent with respect to financial and business interests with the company.
It is also critical that at least one member of the audit committee, preferably the chair, have a good knowledge of financial reporting and auditing. As a whole, audit committee members should have an appropriate understanding of financial reporting and audit and knowledge of the industry in which the company operates.
Build a stronger audit committee
IOSCO’s report comes as SEC Chief Accountant Wesley Bricker has also emphasized the vital role the audit committee plays as it enhances financial reporting with its oversight of external auditors.
“Audits and financial reporting more generally are … enhanced by strong, independent audit committees,” said Bricker in a December 2018 speech to the American Institute of Certified Public Accountants. “Companies and directors should carefully choose who serves on their audit committees, selecting those who have the time, commitment, and experience to do the job well. Just possessing financial literacy may not be enough to understand the financial reporting requirements fully or to challenge senior management on major, complex decisions. Audit committees must stay abreast of these issues through adequate, tailored, and ongoing education.”