<<

. 12
( 82 .)



>>

the annual audited financial statements, including disclosures made in manage-
ment™s discussion and analysis, and recommend to the Board whether the audited
financial statements should be included in the Company™s Form 10-K.
3. Review and discuss with management, the Internal Auditors and the Outside Auditor
the Company™s quarterly financial statements, including disclosures made in man-
agement™s discussion and analysis, prior to the filing of its Form 10-K, including the
results of the Outside Auditor™s reviews of the quarterly financial statements.
4. Review and discuss quarterly reports from the Outside Auditor on:
(a) All critical accounting policies and practices to be used;
(b) All alternative treatments within GAAP for policies and practices related to
material items that have been discussed with management, including ramifica-
tions of the use of such alternative disclosures and treatments, and the treatment
preferred by the Outside Auditor;
(c) The internal controls adhered to by the Company, management, and the Com-
pany™s financial, accounting and internal auditing personnel, and the impact of
each on the quality and reliability of the Company™s financial reporting; and
(d) Other material written communications between the Outside Auditor and man-
agement, such as any management letter or schedule of unadjusted differences.
5. Discuss in advance with management the Company™s practice with respect to the
types of information to be disclosed and the types of presentations to be made in
earnings press releases, including the use, if any, of “pro forma” or “adjusted” non-
GAAP information, as well as financial information and earnings guidance provided
to analysts and rating agencies.
6. Review and discuss with management, the Internal Auditors and the Outside Auditor:
(a) Significant financial reporting issues and judgments made in connection with the
preparation of the Company™s financial statements;
(b) The clarity of the financial disclosures made by the Company;
(c) The development, selection and disclosure of critical accounting estimates and
the analyses of alternative assumptions or estimates, and the effect of such
estimates on the Company™s financial statements;
(d) Potential changes in GAAP and the effect such changes would have on the
Company™s financial statements;
(e) Significant changes in accounting principles, financial reporting policies and
internal controls implemented by the Company;
(f) Significant litigation, contingencies and claims against the Company and
material accounting issues that require disclosure in the Company™s financial
statements;
(g) Information regarding any “second” opinions sought by management from an
independent auditor with respect to the accounting treatment of a particular


(continued)
52 Audit Committees: Basic Roles and Responsibilities



Exhibit 2.1 (Continued)

event or transaction;
(h) Management™s compliance with the Company™s processes, procedures and
internal controls;
(i) The adequacy and effectiveness of the Company™s internal accounting and
financial controls and the recommendations of management, the Internal Audi-
tors and the Outside Auditor for the improvement of accounting practices and
internal controls; and
(j) Any difficulties encountered by the Outside Auditor or the Internal Auditors in
the course of their audit work, including any restrictions on the scope of activi-
ties or access to requested information, and any significant disagreements with
management.
7. Discuss with management and the Outside Auditor the effect of regulatory and
accounting initiatives as well as off-balance sheet structures and aggregate contrac-
tual obligations on the Company™s financial statements.
8. Discuss with management the Company™s major financial risk exposures and the
steps management has taken to monitor and control such exposures, including the
Company™s risk assessment and risk management policies.
9. Discuss with the Outside Auditor the matters required to be discussed by Statement
on Auditing Standards (“SAS”) No. 61 relating to the conduct of the audit. In partic-
ular, discuss:
(a) The adoption of, or changes to, the Company™s significant internal auditing and
accounting principles and practices as suggested by the Outside Auditor, Internal
Auditors or management; and
(b) The management letter provided by the Outside Auditor and the Company™s
response to that letter.
10. Receive and review disclosures made to the Audit Committee by the Company™s Chief
Executive Officer and Chief Financial Officer during their certification process for the
Company™s Form 10-K and Form 10-Q about (a) any significant deficiencies in the
design or operation of internal controls or material weakness therein, (b) any fraud
involving management or other associates who have a significant role in the Company™s
internal controls and (c) any significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent to the date of their evaluation.

Oversight of the Company™s Relationship with the Outside Auditor
11. Review the experience and qualifications of the senior members of the Outside
Auditor team.
12. Obtain and review a report from the Outside Auditor at least annually regarding (a)
the Outside Auditor™s internal quality-control procedures, (b) any material issues
raised by the most recent internal quality-control review, or peer review, of the firm,
or by any inquiry or investigation by governmental or professional authorities,
within the preceding five years respecting one or more independent audits carried
out by the firm, (c) any steps taken to deal with any such issues, and (d) all relation-
ships between the Outside Auditor and the Company, including the written disclo-
sures and the letter required by Independence Standards Board Standard 1, as that
standard may be modified or supplemented from time to time.
13. Evaluate the qualifications, performance and independence of the Outside Auditor,
including considering whether the Outside Auditor™s quality controls are adequate
and the provision of non-audit services is compatible with maintaining the Outside
Auditor™s independence, and taking into account the opinions of management and the
Organization of the Audit Committee 53



Internal Auditor. The Audit Committee shall present its conclusions to the Board.
14. Oversee the rotation of the lead (or coordinating) audit partner having primary
responsibility for the audit and the audit partner responsible for reviewing the audit
at least once every five years, and oversee the rotation of other audit partners, in
accordance with the rules of the Commission.
15. Recommend to the Board policies for the Company™s hiring of present and former
associates of the Outside Auditor who have participated in any capacity in the audit
of the Company, in accordance with the rules of the Commission.
16. To the extent the Audit Committee deems necessary or appropriate, discuss with the
national office of the Outside Auditor issues on which they were consulted by the
Company™s audit team and matters of audit quality and consistency.
17. Discuss with management, the Internal Auditors and the Outside Auditor any ac-
counting adjustments that were noted or proposed by the Outside Auditor, but were
not adopted or reflected.
18. Meet with management, the Internal Auditors and the Outside Auditor prior to the
audit to discuss and review the scope, planning and staffing of the audit.
19. Obtain from the Outside Auditor the information required to be disclosed to the
Company by generally accepted auditing standards in connection with the conduct
of an audit, including topics covered by SAS 54, 60, 61 and 82.
20. Require the Outside Auditor to review the financial information included in the
Company™s Form 10-Q in accordance with Rule 10-01(d) of Regulation S-X of the
Commission prior to the Company filing such reports with the Commission and to
provide to the Company for inclusion in the Company™s Form 10-Q any reports of
the Outside Auditor required by Rule 10-01(d).

Oversight of the Company™s Internal Audit Function
21. Ensure that the Company has an internal audit function.
22. Review and concur in the appointment, replacement, reassignment or dismissal of
the senior auditing executive, and the compensation package for such person.
23. Review the significant reports to management prepared by the internal auditing
department and management™s responses.
24. Communicate with management and the Internal Auditors to obtain information
concerning internal audits, accounting principles adopted by the Company, internal
controls of the Company, management, and the Company™s financial and accounting
personnel, and review the impact of each on the quality and reliability of the Com-
pany™s financial statements.
25. Evaluate the internal auditing department and its impact on the accounting practices,
internal controls and financial reporting of the Company.
26. Discuss with the Outside Auditor the internal audit department™s responsibilities,
budget and staffing and any recommended changes in the planned scope of the
internal audit.

Compliance Oversight Responsibilities
27. Obtain from the Outside Auditor the reports required to be furnished to the Audit
Committee under Section 10A of the Exchange Act and obtain from the Outside
Auditor any information with respect to illegal acts in accordance with Section 10A.
28. Obtain reports from management, the Company™s senior internal auditing executive
and the Outside Auditor concerning whether the Company and its subsidiary/foreign
affiliated entities are in compliance with applicable legal requirements and the
Statement of Ethics. Obtain and review reports and disclosures of insider and

(continued)
54 Audit Committees: Basic Roles and Responsibilities



Exhibit 2.1 (Continued)

affiliated party transactions. Advise the Board with respect to the Company™s
policies and procedures regarding compliance with applicable laws and regulations
and the Statement of Ethics.
29. Establish procedures for (a) the receipt, retention and treatment of complaints re-
ceived by the Company regarding accounting, internal accounting controls or audit-
ing matters, and (b) the confidential, anonymous submission by associates of the
Company of concerns regarding questionable accounting or auditing matters.
30. Discuss with management and the Outside Auditor any correspondence between the
Company and regulators or governmental agencies and any associate complaints or
published reports that raise material issues regarding the Company™s financial state-
ments or accounting policies.
31. Discuss with the Company™s Chief Legal Officer legal matters that may have a
material impact on the financial statements or the Company™s compliance policies.

Additional Responsibilities
32. Prepare annually a report for inclusion in the Company™s proxy statement relating to
its annual shareholders meeting. In that report, the Audit Committee will state
whether it has: (a) reviewed and discussed the audited financial statements with
management; (b) discussed with the Outside Auditor the matters required to be
discussed by SAS No. 61, as that statement may be modified or supplemented from
time to time; (c) received from the Outside Auditor the written disclosures and the
letter required by Independence Standards Board Standard 1, as that standard may
be modified or supplemented from time to time, and has discussed with the Outside
Auditor, the Outside Auditor™s independence; and (d) based on the review and
discussions referred to in clauses (a), (b) and (c) above, recommended to the Board
that the audited financial statements be included in the Company™s Annual Report
on Form 10-K for the last fiscal year for filing with the Commission.
33. Conduct or authorize investigations into any matters within the Audit Committee™s
scope of responsibilities.
34. Review the Company™s Related-Party Transaction Policy and recommend any
changes to the Compensation, Nominating and Governance Committee and then to
the Board for approval. Review and determine whether to approve or ratify transac-
tions covered by such policy, as appropriate.

Source: Wal-Mart Stores, Inc., Notice of Annual Meeting of Shareholders, June 6, 2003
(Bentonville, Arkansas: Wal-Mart Stores, Inc., April 15, 2003); www.walmartstores.com.




(C) EXEMPTION AUTHORITY”The Commission may exempt from the re-
quirements of subparagraph (B) a particular relationship with respect to audit
committee members, as the Commission determines appropriate in light of the
circumstances.
(4) COMPLAINTS”Each audit committee shall establish procedures for”
(A) the receipt, retention, and treatment of complaints received by the issuer re-
garding accounting, internal accounting controls, or auditing matters; and
(B) the confidential, anonymous submission by employees of the issuer of con-
cerns regarding questionable accounting or auditing matters.
Organization of the Audit Committee 55


(5) AUTHORITY TO ENGAGE ADVISERS”Each audit committee shall have the
authority to engage independent counsel and other advisers, as it determines neces-
sary to carry out its duties.
(6) FUNDING”Each issuer shall provide for appropriate funding, as determined
by the audit committee, in its capacity as a committee of the board of directors, for
payment of compensation”
(A) to the registered public accounting firm employed by the issuer for the pur-
pose of rendering or issuing an audit report; and
(B) to any advisers employed by the audit committee under paragraph (5).14
The standard of independence is also disclosed in the Federal Deposit Insur-
ance Corporation Improvement Act (FDICIA) as noted in the historical perspec-
tive. See Appendixes D and F on this book™s website.
With respect to additional SEC and SRO audit committee independence re-
quirements, the next section of this chapter contains the Standards Relating to
Listing Company Audit Committees.
One academic study provides empirical evidence on the status of the standard
of independence and demonstrates the need for regulatory reforms. Recognizing
the importance of the standard of independence rules, David Vicknair, Kent Hick-
man, and Kay C. Carnes investigated proxy statement data from the period 1980
to 1987 of 100 New York Stock Exchange companies to determine “grey” area di-
rector representation on audit committees. Proxy statements report such grey areas
as interlocking directorships, related-party transactions, affiliations with the firm™s
bank, lawyers receiving fee income, service by retirees of corporation, consulting
fees, and kinship relationships. They found that “approximately one-third of the
418 audit committee members could be classified as ˜grey™ area directors. Inter-
locking directorships (12 percent) and other related-party transactions (11.5 per-
cent) individually account for more than ten percent of the directors.” The
remaining categories individually account for approximately 3 percent or less.
They concluded that such directors may be a potential source of violations of
audit committee independence.15
In addition to those outlined in the Sarbanes-Oxley Act, other basic qualifica-
tions of the audit committee are:

• A general understanding of the company™s industry and the social, political,
economic, and legal forces that affect the industry
• A knowledge of the company with respect to its history, organization, and op-
erational policies
• An understanding of the fundamental problems of planning and control, as
well as the fundamentals of the functional aspects of the company

14
Sarbanes-Oxley Act of 2002, H.R. Rep. No. 107-610, July 25, 2002. See also remarks by Commis-
sioner Paul S. Atkins, Securities and Exchange Commission, “The Sarbanes-Oxley Act of 2002:
Goals, Content, and Status of Implementation,” University of Cologne, Germany, February 5, 2003
(www.sec.gov/news/speech/spch020503psa.htm).
15
David Vicknair, Kent Hickman, and Kay C. Carnes, “A Note on Audit Committee Independence: Evi-
dence from the NYSE on ˜Grey™Area Directors,” Accounting Horizons 7, No. 1 (March 1993), pp. 55“56.
56 Audit Committees: Basic Roles and Responsibilities


In short, the membership of the committee should consist of both financial and
nonfinancial people so that the board can draw on members from various profes-
sions, such as accounting, economics, education, psychology, and sociology. As
Richard T. Baker, retired managing partner of E&W (now E&Y) and now a mem-
ber of several audit committees, points out:

Having one or two nonfinancial people can make a committee more effective. They
bring a different and useful perspective. Over the years I have come to greatly respect

<<

. 12
( 82 .)



>>