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Should your company have an audit committee?

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Effective internal control emanates from the top and permeates throughout an organization. Senior management must set the tone for internal control, and the audit committee can be an important piece in the internal control puzzle.

committee hands

Remember Enron? Before the massive fraud, the company was suffering with “ethical drift” as termed by Harvard professor Malcolm S. Salter. Enron drifted to the point where 96 percent of its net income and 105 percent of its reported funds flow were attributed to accounting violations.

All too frequently in the past, audit committees were stacked with cronies of the chairman and president. They tended to be rubber stamps of the chief executives that met the letter, but certainly not the spirit, of the rules. In such an environment, they tended to disguise control rather than contribute to it.

You are too busy to play such games with your company. And you don’t even want to consider another headache unless it will contribute to the success and profits of your company.

But an audit committee established with the proper attitude and responsibility will accomplish exactly that. If you’re a skeptic, you naturally may wonder how more bureaucracy can contribute to profits.

The following is the purpose statement of Wal-Mart’s audit committee as an example of what is expected of an audit committee:

Purpose

The Audit Committee is appointed by the Board to: (1) assist the Board in monitoring (a) the integrity of the financial reporting process, systems of internal controls and financial statements and reports of the Company, (b) the performance of the Company’s internal audit function, and (c) the compliance by the Company with legal and regulatory requirements; and (2) be directly responsible for the appointment, compensation and oversight of the Company’s independent auditor employed by the Company for the purpose of preparing or issuing an audit report or related work (the “Outside Auditor”).

Good management is all about matching key tasks with the appropriate person(s) to achieve better results. With that in mind and the above example as an audit committee’s purpose, here are five ways your company can derive the most benefit from an audit committee:

1. Leverage your time. Financial reporting is becoming more important and complicated every year. An audit committee should be led by a designated “financial expert” and staffed with a select group of people knowledgeable about financial matters. Even if that is one of your strengths, the details are not where you should focus your attention. Do what you do best, and delegate to others what they do best.

2. Improve your internal control. Internal control may not be at the top of your list of important objectives, but it should be. Internal control is more than dual signatures on checks and segregation of duties. Properly designed, it will support every aspect of your company. Proper internal controls will lead to higher efficiencies in all processes, less waste of resources, more objective evaluation methods and more timely and accurate management measurements. Think how valuable such improvements would be for your organization and how much you would be willing to pay a consultant to guide you in the right direction. This is another role an effective audit committee can fill.

3. Improve your financial management.The audit committee focuses on the financial management and reporting of the company. This group provides a high level of specific expertise in a very difficult yet critical area of your company. Financial management and reporting determine your creditworthiness to outsiders and growth targets and successes to insiders. They are the key determinants in establishing the market value of your company – the ultimate scoreboard for management’s results. Does your board actively manage your company’s financial and reporting functions – or delegate them to the outside auditor? You and your board have the responsibility and are held accountable for these functions.

4. Clarify the roles and responsibilities of your board of directors. A common myth is that a company can get by without an audit committee. The truth is the board is already doing – or at least is responsible for doing – the work of an audit committee. As with any important task, without clear responsibilities, the risk is that the task will be poorly, inefficiently or ineffectively executed, or perhaps not executed at all. Having an audit committee clarifies key responsibilities for your board.

5. Bring value to your audit dollar. An audit is an expensive endeavor, which all too many view as a “necessary evil” or another cost of borrowing. An active audit committee stays involved with the auditors throughout the year. The audit committee’s relationship with the auditor is similar to a willing and engaged patient who makes the physician better and more effective. Hidden problems can be discovered early and dealt with before they grow into something dangerous.

The fiscal health of your company is a key benefit of an effective audit committee.
For more information about audit committees, excellent materials are available from the American Institute of Certified Public Accountants Audit Committee Effectiveness Center.