Improve the Effectiveness of Your Audit Committee

Audit committees face a challenging time in 2010. As the economy continues moving from recession to recovery, there are new dimensions to the oversight roles and responsibilities of the audit committees at public corporations, private companies and not-for-profit organizations. Here are some steps to consider and questions to ask to improve effectiveness.

STEPS TO EVALUATE AND ENHANCE PERFORMANCE

As the economy recovers, companies and not-for-profit organizations are faced with a host of new challenges. In order to prepare for those challenges and the risks they will create, audit committees should consider taking the following steps:

Get Back to Basics.

During the past 18 months, the recession has likely dominated the agenda of your audit committee. Consider revisiting the goals and expectations and develop an agenda for 2010 that directs the committee’s focus back to the fundamentals. An audit committee is typically responsible for oversight of financial reporting, disclosures, internal controls and the company’s audit process. Therefore, each agenda item before the audit committee should ideally relate to one of these four areas.

Assess the Composition of the Audit Committee.

Periodically, it is appropriate to assess the level of financial expertise that each member of the committee possesses, especially if the composition of the group has recently changed. If the company anticipates significant changes in the regulatory environment, now may be the time to add suitably qualified members to the audit committee. At least one member of the audit committee should possess in depth financial expertise. (Publicly traded companies have specific “financial literacy” requirements.)

If the company is heavily regulated, or subject to complex accounting policies and other requirements, it is prudent to require at least two members of the audit committee to have auditing or in depth accounting experience.

Get a Handle on Operational Risk.

The company’s risk profile may have changed in light of decisions made during the recession. For example, cutting staff or deferring capital investments might have been wise and appropriate a year ago. However, these decisions may now adversely affect the company’s long-term financial performance. The committee should consider asking management to review significant operational decisions made in the last 12 months in order to determine if excess risk was created.

Revisit Accounting Policies and Plan for any Upcoming Changes.

Any changes in accounting policies at the company that took place in the last 12 to 18 months should now be reviewed in greater detail. (It may not have been feasible during the recession.) Ideally, the audit committee should also take time to review proposed changes that are likely to impact the company in the next year.

The audit committee should take time to review significant accounting changes that are likely to impact the company in the next 24 to 36 months. For example, International Financial Reporting Standards will require considerable time, effort and expense to adopt. Determining whether the finance function has the appropriate expertise and resources to support IFRS is an important step to ensuring successful implementation. In addition, it is beneficial for audit committee members to begin developing an understanding of IFRS.

Consider Exposure to Companies Experiencing Financial Difficulties.

The effects of a recession can take years to ripple through an economy. Suppliers, as well as customers, may still be experiencing those effects. Ensure that management has identified the company’s material relationships and the potential financial and operational impact if any of those businesses go under.

Review All Disclosure Sources.

In addition to regular financial reporting, companies use a myriad of resources to disclose information. For example, they may issue press releases and post announcements on their Web sites. But many companies also now have a presence on online social networking sites such as Facebook, Twitter and LinkedIn, which tend to have less controls than traditional disclosures. Collectively, these sites reach millions of people. It is extremely important that social networking tools are used appropriately and that the information being shared is accurate and consistent with the company’s perspective.

Focus on Fraud.

As a result of the recession, and the related cost cutting, there may be an increased risk of internal and external fraud faced by your organization, including the theft of intellectual property. It is a good time to request that internal auditors commission a fraud risk assessment. Proactively assessing fraud risks can dramatically reduce the probability of losses occurring.

Consider Conducting a Review of Significant Findings uncovered by the company’s internal audit department during the last 12 to 18 months, as well as the resulting steps taken by the management to address those issues. Not only will this exercise potentially uncover unresolved issues, it will provide the audit committee with a “pulse check” on the company’s sense of urgency regarding the ability of risk mitigation and internal audits to address and track issue resolution.

FOUR KEY QUESTIONS FROM WARREN BUFFETT

Audit committees cannot actually perform audits, according to Warren Buffett, CEO of Berkshire Hathaway Inc. “The key job of the audit committee is simply to get the auditors to divulge what they know,” he wrote in one of his letters to shareholders back in 2003.

The way to accomplish this, Buffett argues, is for audit committees to make sure “auditors worry more about misleading its members than about offending management.”

He recommended audit committees ask four questions of auditors and report the answers to shareholders:

If the auditor were solely responsible for preparing the company’s financial statements, would they in any way have been prepared differently from the manner selected by management?

If the auditor were an investor, would he or she have received – in plain English – the information essential to understanding the company’s financial performance during the reporting period?

Is the company following the same internal audit procedure that would be followed if the auditor were the CEO? If not, what are the differences and why?

Is the auditor aware of any actions – either accounting or operational – that have the purpose and effect of moving revenues or expenses from one reporting period to another?

BUSINESS WISDOM FOR TODAY’S ECONOMY

Intellectual Property Theft Worth “Millions”

The February 11th indictment of a former Goldman Sachs employee for trade secret theft illustrates the need for companies to protect their intellectual property.

Facts of the case: The FBI announced that Sergey Aleynikov was employed at Goldman Sachs as a computer programmer for about two years. He worked on a high-frequency trading system for commodities and equities. In April 2009, Aleynikov resigned and accepted a job at Teza Technologies, a new Chicago company. The 40-year-old programmer was hired to develop Teza’s own version of a computer platform to engage in high-frequency trading.

Before leaving his job, Aleynikov transferred Goldman Sachs proprietary computer code to an outside server in Germany. He also secretly transferred proprietary files to his home computers, laptop, a flash drive, and other devices.

FBI Assistant Director-in-Charge Joseph Demarest stated: “Proprietary information and trade secrets are sometimes the most valuable assets of a business. The computer code Aleynikov copied was worth millions. But the theft of such assets is usually much harder to detect than the theft or embezzlement of tangible assets, because the thing stolen is not physically missing, it’s duplicated.”