October 1999
Earnings Management Update
SEC Proposes Audit Committee Rules
Auditing Standards Board Also Responds
By Danielle D'Angelo
tp2
The Securities and Exchange Commission proposed new rules on October 6 to improve disclosure about the functioning of corporate audit committees. In a related move, the AICPA's Auditing Standards Board issued an exposure draft on October 4 proposing that independent auditors must discuss with audit committees the auditors' judgment about the quality, and not just the acceptability under generally accepted accounting principles, of the company's accounting principles as applied in its financial reporting.
The AICPA and SEC actions coincide with proposed rule changes by the New York Stock Exchange, the American Stock Exchange, and the National Association of Securities Dealers that would define independence more rigorously for audit committee members; require audit committees to include at least three members and be comprised solely of independent directors who are financially literate; require companies to adopt written charters for their audit committees; and require at least one member of the audit committee to have accounting or financial management expertise.
"Sadly, stories abound of committees whose members lack expertise in the basic principles of financial reporting as well as the mandate to ask probing questions," SEC Chair Arthur Levitt said. "There is no reason why every public company in America shouldn't have an audit committee made up of the right people, doing the right things, and asking the right questions."
The SEC proposals require, among other things, that:
independent auditors review companies' interim financial statements before companies file their 10-Q and 10-QSB forms with the commission;
companies provide in their proxy statements a report from the audit committee that discloses whether the audit committee has reviewed and discussed certain matters with management and the auditors and whether anything came to the attention of audit committee members that caused them to believe that the audited financial statements contain any materially misleading statements or omit any material information;
companies disclose in their proxy statements whether the audit committee has a written charter, and file a copy of their charter every three years; and
companies whose securities are listed on the NYSE or AMEX or are quoted on Nasdaq disclose certain information about any audit committee member who is not "independent" within their proposed definition. (All other companies, if they have an audit committee, must disclose whether the members are independent based on the definition proposed by the self-regulatory organizations.)
According to the SEC, the commission's proposed disclosures will help inform investors about the role audit committees play in preparing financial statements and the financial reporting process in general. By requiring companies to have their auditors review interim financial statements, the SEC believes the proposals should facilitate early identification and resolution of significant accounting issues.
The proposals are part of a broader effort by the securities exchanges and the accounting profession to improve the oversight of the financial reporting process in general, and the role of corporate boards in particular. Proposals for action by each of the different groups were set forth in the report of the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees--a group of business, accounting, and securities professionals created at Levitt's request.
ASB Proposes Improving Audit Communication
The ASB's proposal--Amendments to Statement on Auditing Standards No. 61, "Communication with Audit Committees," and Statement on Auditing Standards No. 71, "Interim Financial Information"--would be effective for fiscal years beginning in 2000.
"Communication between the auditor and the client is an essential part of the audit process," ASB Chair Deborah Lambert said. "We fully support the Blue Ribbon Committee's recommendation for candid dialogue. We also recognize that the effectiveness of the standard depends upon everyone involved, including the auditor, management, and the audit committee."
The proposed discussion between independent auditors and audit committees would address the consistency of the client's accounting policies' applications; the clarity, consistency, and completeness of the accounting information contained in the financial statements and related disclosures; and other areas that have a significant impact on the accounting information included in the financial statements, such as changes to accounting policies and unusual transactions.
Society Committees to Respond
The NYSSCPA SEC Practice Committee, chaired by Robert Waxman, plans to respond to the commission's proposals. The Society's Auditing Standards and Procedures Committee, chaired by Vincent Love, will comment on the AICPA proposal. Watch www.nysscpa.org and upcoming issues of The Trusted Professional for details on these committees' actions and other updates on the SEC's and the accounting profession's efforts to improve financial reporting.
Also see http://www.nysscpa.org/prof_library/Ethics/edraftAICPA.htm to access the full text of the both proposals. The commission requests public comment on the proposals by November 19 and the ASB comment deadline is November 30. *
