Top 10 Topics for Directors in 2016: Audit Committees

• Enhanced audit committee disclosures. In July 2015, the SEC issued a concept release seeking comment on whether additional disclosures should be required on how audit committees work and how they engage and oversee the company’s independent auditor. Emphasizing the importance of the audit committee’s oversight of the auditor, the disclosure would require companies to disclose more information about their process and criteria for selecting an outside auditor, how often they meet with the auditor and how they review the auditor’s performance. At the same time, the Public Company Accounting Oversight Board (PCAOB) issued a concept release focusing on possible indicators of audit quality and whether such information would be useful to stakeholders. The SEC and PCAOB are still poring over the comments they received on these releases, but many companies, encouraged by initiatives of regulators, investors, corporate governance leaders and other stakeholders, have already begun significantly increasing their voluntary proxy statement disclosures.ⁱⁱ For the 2015 proxy season, the pension fund of the United Brotherhood of Carpenters sent letters to 91 S&P 500 companies, seeking enhanced disclosures relating to the audit committee’s ownership and oversight of the audit relationship.ⁱⁱⁱ And BlackRock’s 2015 proxy vote guidelines indicate that it looks to a company’s audit committee report for insight into the scope of the audit committee’s responsibilities.^iv In light of these developments, audit committees should consider enhancing their audit committee reports and related proxy statement disclosures by providing more robust information on the audit committee’s processes and activities.
• Developments in accounting rules. Audit committees need to stay abreast of accounting changes that are on the horizon and understand the implications they may have, not only on a company’s financial reporting and accounting, but also on a company’s IT systems and data and accounting processes and controls. One such change is the principles-based standard of revenue recognition finalized in 2014 by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB), which will change the way many companies recognize revenue from customer contracts. The effective date of the new revenue recognition standard was recently delayed by one year and will now apply for annual reporting periods beginning after December 15, 2017. FASB also recently voted to move forward with new lease accounting standards that would require companies to include lease obligations on their balance sheets, a majority of which are not currently reported on a lessee’s balance sheet. These new standards still require final approval and would not take effect until 2019. If adopted, however, the new standards will likely require changes to company lease systems and related controls, as well as revisions to financial covenants in debt instruments to avoid inadvertent defaults. Audit committees need to monitor these and other accounting changes on the horizon so that they are prepared for how such rules could impact the company going forward.
• Increased scrutiny. The SEC’s Division of Enforcement has renewed its focus on financial reporting of public companies and is more closely scrutinizing internal controls and the audit committee’s engagement of external auditors. Audit committees should understand the SEC’s investigation and enforcement process so that they are aware of what arouses the suspicions of securities regulators. The SEC’s Financial Reporting and Audit Task Force uses a variety of tools and data analytics when reviewing a company’s financial statements, including the Corporate Issuer Risk Assessment Program, which is a database of public company filings programmed to flag certain identified factors and events for the SEC’s investigation team to review. Companies in particular industries or sectors (especially where foreign operations are involved), companies whose financial statements have indicated unusual growth, and companies that have recently changed auditors or made late SEC filings are likely to raise a flag. The goal of the Task Force is to proactively identify financial reporting irregularities and internal control weaknesses so that companies can remedy such weaknesses before inaccurate financial statements are prepared.

Boards can also expect greater scrutiny of the process and factors used when engaging and retaining external auditors. Audit committees should assess individual members of any audit team to ensure that such individuals possess the necessary skills and experience for their company. The audit team needs to understand the economic landscape of the company, as well as its business and industry, both on a regional and global level. Before engaging an auditor, the audit committee should carefully consider the auditor’s technical competence, as well as the auditor’s objectivity and independence and how each may affect the auditor’s scrutiny of information throughout audit. Audit committees should also discuss with the auditor the audit team’s approach to internal quality control issues and inquiries and comments from regulators in inspection reports.

This post was excerpted from our annual Top 10 Topic for Directors in 2016 alert. To read the full alert, please click here.

ⁱ 2015 Spencer Stuart Board Index, at p. 26.

ⁱⁱ EY Center for Board Matters, “Audit Committee Reporting to Shareholders in 2015” (September 2015).

ⁱⁱⁱ Id.

^iv Id.