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Top Issues for Audit Committees in 2013 - Melissa Reid, Colm McDonnell and Ailbhe Moynihan

Mon, Jan 7, 2013


Traditionally the primary role of an Audit Committee was the oversight of the financial reporting process, although the scope of this role did vary depending on the organisation. One aspect that is always constant is the need for the Committee to respond to a complex and fast changing business environment. Whether dealing with regulatory changes, additional risk-related responsibilities or uncertainty in the financial reporting process the Audit Committee needs to be ready to adapt to the changing environment. This article addresses some of the key issues and considerations that members of Audit Committees need to be aware of when looking forward in 2013.

1.   Managing through uncertainty

The continued credit and economic crisis has created a new business reality for organisations, causing significant challenges to which both organisations and Audit Committees have to respond. Volatile global economic conditions may create increased financial risk in the form of emerging market, credit and currency risk, as well as limiting growth opportunities. When assessing the potential impact of deteriorating economic conditions, Audit Committees should encourage executives to undertake stress testing of business and strategic plans to ensure they are reasonable and realistic. Plans should take into account different scenarios, including the likelihood and severity of certain risks which may be created by changes to market liquidity and financing. The Audit Committee should obtain assurance from the executives on the process for the setting of such plans in order to be satisfied that the plan is sufficiently robust.

2.   Financial reporting process

Overseeing the financial reporting process remains one of the Audit Committee’s top priorities. Monitoring the integrity of the financial statements requires challenging accounting methods where necessary, an appropriate focus on financial reporting risks, monitoring accounting judgments and estimates, reviewing significant or unusual transactions as well as preparing for technical accounting policy changes. There are a number of changes expected within the next three years that are likely to have an impact on most companies. The Audit Committee should assess management’s understanding of the impact of these changes and their strategy for adopting these new standards. Understanding the key challenges management will face – whether related to the quality of the finance function talent, systems or impact on underlying financials – will be a critical monitoring activity for Audit Committees.

3.   Audit market reform

The European Union’s audit reform proposals, led by the Internal Markets Commissioner Michel Barnier, has suggested various changes to statutory audit mandates which may affect the interaction between the Audit Committee and the statutory auditor. The debate will continue in 2013 and will include consultation on the proposals. In addition to this, in October 2012 the Financial Reporting Council introduced a number of changes to the UK Corporate Governance Code including a requirement for FTSE 350 companies to put the external audit contract out to tender at least every ten years.  Audit committees should stay up-to-date of all such potential changes and should be in a position to act if expected changes are brought into force. These amendments may result in a significant amount of disruption if a company is unprepared for them.

4.   Finance talent management

People are arguably the most important asset for every organisation. Given the level of assurance required by the Audit Committee from a finance function, it is no surprise that the Committee should have a key role in assessing the resources and abilities within the company’s finance talent. The Audit Committee should review the finance function to ensure that it has the appropriate level of technical skills, competence and integrity. The talent management strategy for the finance function and any learning programmes in place should also be reviewed and continued development of the talent should be encouraged. With continued accounting technical complexities and changes to accounting standards, attracting and retaining strong talent for the finance function will be important in 2013 and Audit Committees should ensure they have an appropriate level of involvement.

5.   Interaction with external auditor

Given the increased focus on the audit market, the relationship with the company’s external auditor will continue to remain under close scrutiny. The Audit Committee should focus on enhancing the efficiency of the audit which requires regular interaction with the external auditor, including meetings without management present. The Committee should expect to discuss the following with the auditor: the audit strategy, key accounting policies considered critical, audit results in detail, significant risks considered by the auditor, and any areas of disagreement with management. It is critical that the Audit Committee oversees the conducting of a review of the independence of the external auditors. The effectiveness of the external audit process should also be evaluated. These items should be included as an annual agenda item of the Audit Committee.

6.   Interaction with internal audit

As highlighted above, interaction with the external auditor is important, however, it is also critical that an Audit Committee interacts effectively with internal audit. Audit committees should set high expectations of internal audit which are clearly communicated to the function, and most importantly hold the function to account for them. It has become increasingly important for the Audit Committee to assess whether the function (including any outsourced partners) is performing the appropriate activities, has adequate resources and is proactively identifying risks and monitoring critical controls.  By performing a periodic assessment of the function, the Audit Committee can obtain assurance on the activities of the function, ensure they are aligned with other stakeholders and support the Head of Internal Audit in meeting the expectations of the function. The Audit Committee may wish to consider engaging an experienced external party to perform a strategic assessment of Internal Audit which focuses on optimising the function to bring enhanced value to the organisation and the Audit Committee.

7.   Oversight of internal controls and risk management

The 2008 financial crisis exposed severe weaknesses in many organisations’ risk management practices. This, in addition to the continued uncertainty facing organisations in the current climate, means that risk management systems and related control systems will remain one of the key cornerstones of governance to be maintained for all organisations. Audit Committees should be cognisant of the importance of effective risk management in the organisation as these processes should identify, mitigate, remediate and report on risk in real time. This allows an organisation to respond to new risks as they arise before they adversely affect the organisation.  The Audit Committee should be aware of the non-financial risks facing the organisation and establish a holistic view of the key current and emerging risks as well as challenges facing the organisation. The Committee should review the risk profile of the organisation and be satisfied that appropriate plans are in place to manage the key risks.

8.   Information technology risk         

The rate of technological change and innovation continues to increase rapidly and is transforming how businesses operate. As new and improved technologies emerge (for example cloud computing and mobile technologies) the Audit Committee should have a clear understanding of their impact on the organisation. Considering the related risks, such as cyber security threats and privacy risks, controls and checks, and the reporting of the results of these controls and checks, should be in place to ensure that the committee has appropriate oversight. As the Committee members potentially lack direct experience with the complex IT structures in place, they must develop appropriate strategies to enable members of the Committee to understand and assess these risks. This should allow the members to establish their potential impact on the quality of the financial reporting process. Frequent and robust reporting from the CIO and assistance from internal audit through IT risk assessments are examples of mechanisms which can provide valuable support to the Committee.

9.   Regulation and compliance

Regulatory requirements are ever-increasing. For a long period of time, these changes mainly affected the financial services industry; however, there are now additional compliance requirements for other organisations not falling within the remit of the Central Bank of Ireland. The Companies Bill 2012 initiated in December 2012 contains additional compliance requirements that an Audit Committee needs to be aware of.    The Bill includes a requirement for the directors of a company to make a “Compliance Statement” that the company is in compliance with regulatory requirements. The introduction of additional compliance requirements go beyond any previous requirements relating to non-financial services organisations. Regardless of the regulatory environment in which the organisation is operating, the Audit Committee should be mindful of the level of knowledge of management with regard to compliance requirements and how management are trained and kept abreast of all compliance amendments which affect the organisation. Audit Committees could consider requesting that management map out where they can obtain the appropriate assurance in order that the directors can make necessary statements with regard to compliance.

10. Evaluation of the effectiveness of the committee

Audit committees should undertake an annual assessment of the performance and effectiveness of the Audit Committee. The assessment should review the appropriateness of terms of reference for the Committee and consideration of whether the Committee has effectively discharged its responsibilities. The process should also consider the Committee’s agenda, forward planning and meeting processes and consider if any operational efficiencies can be gained. One of the most important aspects is the assessment of the composition of the committee, in particular, the level of recent and relevant financial accounting expertise in view of the complex regulatory and business environment. Leading practice Committees take a proactive approach to the governance of the committee and may also introduce mechanisms to continuously monitor the performance of the committee, for example by reviewing the effectiveness of each committee meeting or seeking feedback from the Board or stakeholders on the work of the committee.

In summary there are a number of significant matters requiring consideration by the Audit Committee in 2013. The changing economic, business and regulatory environment will require committees to be on top of developments and quick to respond to the challenges ahead.

 

Top issues for Audit Committees in 2013
Managing through uncertainty
  • What is the Audit Committee’s role in reviewing funding and liquidity issues?
  • What information does the Audit Committee receive in relation to the stability of key business partners?
  • How regular are scenario plans presented to the Committee for review?
Financial reporting process
  • How does management monitor accounting policy changes and assess the impact on business and financial statements? How do they keep the Audit Committee informed?
  • Is there a strategy or plan in place for adopting new standards and what are the biggest challenges with this?
Audit market reform
  • How does the Committee keep abreast of EU developments?
  • Has the Committee considered the impact of auditor rotation?
Interaction with the External Auditor
  • Does the external auditor adequately challenge significant management estimates?
  • Has the Audit Committee utilised the annual evaluation of the external auditor as part of the reappointment process?
Interaction with Internal Audit
  • Does Internal Audit have a clear set of performance expectations that are aligned with the expectations of the Audit Committee, and that are measured and reported to the Audit Committee?
  • Is the Internal Audit plan aligned to the key risks of the organisation and other assurance activities?
  • Are issues identified and reported by Internal Audit appropriately highlighted to the Audit Committee, and is their progress to effective completed management actions tracked and reported?
Finance talent management
  • Does management have a strategic succession plan in place specific to the finance function? Has the committee had the opportunity to evaluate and contribute to this?
  • What specific measures are in place to attract, develop and retain financial talent?
Oversight of internal controls and risk management
  • What tools does management use to monitor emerging risks? What are the early warning mechanisms and how effective are they?
  • Are business goals aligned with risk management priorities?
Information technology risk
  • How does management stay apprised of IT security risks and develop timely responses?
  • Does the Audit Committee receive sufficient information to discuss IT strategy and adequate MI to monitor performance against the strategy?
Regulation and compliance
  • Are committee members comfortable that they are aware of the key compliance requirements of the organisation?
  • Does the Committee obtain appropriate assurance from management with regard to the meeting of compliance requirements?
  • Does management have appropriate controls in place to stay abreast of emerging compliance requirements?
Evaluation of the effectiveness of the committee
  • Does the annual assessment process cover all responsibilities of the committee?
  • What does the committee do with the results of the evaluation? Is there an action plan developed and monitored?

 

Colm McDonnell, FCA is the Head of Enterprise Risk Services in Deloitte.

Ailbhe Moynihan, ACA is Senior Manager in Enterprise Risk Services in Deloitte.

Melissa Reid, is a qualified Company Secretary and Corporate Governance Consultant in the Insurance Audit department in Deloitte, London.

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