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periodically, both with and without management present.
H. Lee Scott Thomas M. Schoewe
President and Chief Executive Officer Executive Vice President and Chief
Financial Officer 58
58
Wal-Mart Stores, Inc., 2003 Annual Report, p. 52.
82 Audit Committees: Basic Roles and Responsibilities


The audit opinion is presented in the independent auditors™ or accountants™ re-
port. Such a report may be addressed to the board of directors, to the stockholders,
or to both the board and the stockholders. For example, if the independent auditors
were employed by the stockholders, then the report would be addressed to them. It
should be noted that the report is included in the corporate annual report.
The report consists of three paragraphs. The first is the introductory paragraph,
which sets forth the responsibilities of management and the auditors. The second is
the scope paragraph, which describes the nature of the audit, and the third paragraph
states the opinion. The standard form of an unqualified audit report is as follows:

(Introductory paragraph)
We have audited the accompanying balance sheets of X Company as of December
31, 19X2 and 19X1, and the related statements of income, retained earnings, and
cash flows for the years then ended. These financial statements are the responsibil-
ity of the Company™s management. Our responsibility is to express an opinion on
these financial statements based on our audits.
(Scope paragraph)
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit also in-
cludes assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
(Opinion paragraph)
In our opinion, the financial statements referred to above present fairly, in all material
respects, the financial position of X Company as of [at] December 31, 19X2 and 19X1,
and the results of its operations and its cash flows for the years then ended in confor-
mity with accounting principles generally accepted in the United States of America.59

In the introductory paragraph, the auditors indicate that they are responsible for
their audit report and that management has primary responsibility for the financial
statements. In regard to the scope of the examination, the auditors state that they
have performed not only certain auditing procedures based on their professional
judgment but have also conducted their examination within the general guidelines
or standards set forth by the AICPA. This scope paragraph communicates to the
reader of the financial statements that the auditors™ compliance with auditing stan-
dards provides reasonable assurance that such statements are free of material mis-
statements and/or omitted material facts. Furthermore, in the opinion paragraph,
the auditors state that the financial statements have been prepared in accordance
with accounting principles that are widely accepted in the practice of accounting
and, therefore, that such statements are fairly presented. An illustration of the au-
ditors™ report follows.
59
“Reports on Audited Financial Statements,” Statement on Auditing Standards No. 58 (New York:
AICPA, 1988), par. 8, as amended by ASB interpretation.
The External and Internal Auditing Process 83


Report of Independent Auditors
The Board of Directors and Shareholders,
Wal-Mart Stores, Inc.
We have audited the accompanying consolidated balance sheets of Wal-Mart Stores,
Inc. as of January 31, 2003 and 2002, and the related consolidated statements of in-
come, shareholders™ equity and cash flows for each of the three years in the period
ended January 31, 2003. These financial statements are the responsibility of the
Company™s management. Our responsibility is to express an opinion on these finan-
cial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of mate-
rial misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes as-
sessing the accounting principles used and significant estimates made by manage-
ment, as well as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all mate-
rial respects, the consolidated financial position of Wal-Mart Stores, Inc. at January
31, 2003 and 2002, and the consolidated results of its operations and its cash flows
for each of the three years in the period ended January 31, 2003, in conformity with
accounting principles generally accepted in the United States.
As discussed in Note 1 to the consolidated financial statements, effective February
1, 2002, the Company adopted the provisions of Statement of Financial Accounting
Standards No. 142, Goodwill and Other Intangible Assets.60
Ernst & Young LLP
Tulsa, Oklahoma
March 19, 2003

The work of the audit committee and the inde-
Role of the Audit Committee
pendent auditors is very closely related because both groups have common objec-
tives regarding the financial affairs. The audit committee members are responsible
for overseeing the independent audit examination as well as the recommendations of
the independent auditors. The audit committee members must assure themselves that
the financial statements and the system of internal accounting controls are based on
acceptable accounting principles and procedures. Moreover, they need assurance
that the executives and their staff are reasonably competent and trustworthy.
Although the extent of the audit committee™s activities has led to some contro-
versy, it is clearly evident that its effectiveness has been increased by the U.S.
Securities and Exchange Commission, the U.S. Congress (FDICIA) (Sarbanes-
Oxley Act of 2002), and other private-sector initiatives (National Commission on
Fraudulent Financial Reporting, the MacDonald Commission (Canada), and the
Cadbury Committee, Hampel Committee, and Committee on Corporate Gover-
nance (UK) as well as self-regulatory organizations. The reality of the situation is
that the Foreign Corrupt Practices Act, the Private Securities Litigation Reform

60
Ibid., p. 51.
84 Audit Committees: Basic Roles and Responsibilities


Act, and the aforementioned initiatives place greater responsibilities on the audit
committee. Thus, it is critically important that the committee keep a perspective
and focus on its oversight role for the system of internal control and financial re-
porting areas of the company. If the audit committee becomes too deeply involved
in management™s operational activities, its effectiveness will be diluted. As Ray
Groves, E&Y former managing partner, has indicated:
This does not mean a committee cannot rely on management and the internal and ex-
ternal auditors to see that controls are in good order. The committee™s responsibility
is to satisfy itself that these groups are performing and the necessary documentation
exists.61

The audit committee members are in an excellent position to contribute to the ex-
ternal auditing process. For example, the independence of the auditing firm is en-
hanced because the independent auditors establish a line of communication to the
board of directors through the audit committee. In addition, since the audit commit-
tee members nominate and select the auditing firm, they are in a position to examine
the qualifications of this firm as well as to assess the results of the audit examination.62
In a survey of 34 publicly held companies dealing with the effectiveness of
audit committees as perceived by both external auditors and audit committee
members of those companies, Lawrence P. Kalbers found that practicing audit
committees are not uniformly effective and that the auditors rate committee mem-
bers significantly lower than do members on responsibilities, attributes, and ef-
fectiveness. He concludes that the audit committee, management, and auditors
need to work toward the right balance of the committee™s involvement with audit
fees, audit scope, audit results, and internal controls. He believes that training and
educating the committee members can help them meet their responsibilities.63

The Nature of Internal Auditing
As defined by the Institute of Internal Auditors:
Internal auditing is an independent, objective assurance and consulting activity designed
to add value and improve an organization™s operations. It helps an organization accom-
plish its objectives by bringing a systematic, disciplined approach to evaluate and im-
prove the effectiveness of risk management, control, and governance processes.64

For example, internal auditors may evaluate the internal control of a company
as well as review management™s adherence to the company™s policies. They can
also help the audit committee with special investigations and compliance audits.

61
Ernst & Whinney, E&W People, p. 7.
62
For further discussion on communication with audit committees, see Chapter 5.
63
Lawrence P. Kalbers, “An Examination of the Relationship Between Audit Committees and External
Auditors,” Ohio CPA Journal 51, No. 6 (December 1992), p. 27. Similarly, Price Waterhouse noted
that: “The single most important findings, and the key to audit committee effectiveness, is: back-
ground information and training.” See Price Waterhouse, Improving Audit Committee Performance:
What Works Best (Altamonte Springs, FL: IIA, 1993), p. 2. For further discussion on training and ed-
ucating audit committee members, see Chapter 5 and Chapter 7 of the second edition, 2000.
64
Institute of Internal Auditors, The Professional Practice Framework (Altamonte Springs, FL: IIA,
2002), p. 3.
The External and Internal Auditing Process 85


However, it is important to recognize that the internal auditing group is not
completely independent from corporate management, because the members of the
group are employees of the company. To enhance their independence and objec-
tivity, the Institute of Internal Auditors recommends that the chief audit executive
should be responsible to an individual whose authority is sufficient to promote in-
dependence and provide the necessary internal auditing coverage.65 Thus, the chief
audit executive should report not only to a senior executive, such as the chief fi-
nancial officer with access to the chief executive officer, but also to the indepen-
dent audit committee. To ensure the independence of the internal auditing group,
the chief audit executive must have free access to meeting regularly with the com-
mittee. The internal audit function is discussed more extensively in Chapter 9.

The interface between the audit committee and
Role of the Audit Committee
the internal auditing group provides a logical relationship because these groups
have common goals.66 It is important that both groups establish a working rela-
tionship which is not counterproductive. More specifically, to maximize the pro-
ductivity of the internal auditing group, the audit committee should:

• Assist in the overall internal auditing policy determination and approve such
policies to ensure that the internal auditing group has authority that is com-
mensurate with its responsibilities
• Review the coordination of the work and schedules of the internal and exter-
nal auditing groups
• Review not only the qualifications of the chief audit executive and his or her
support staff but also the professional development activities of the group
• Review the copies of the internal auditing reports and critically evaluate find-
ings, recommendations, and management™s response

As noted in Chapter 1, audit committees have become a key institution in the
corporate accountability process. Given the congressional enactment of the Sar-
banes-Oxley Act of 2002, many of the past guidelines of the professional and reg-
ulatory organizations regarding audit committees have become law. Thus the role
and responsibilities of audit committees have become a federal statute by which
such committees measure their performance.
To assist audit committees with their new roles and responsibilities, Exhibit 2.4
contains a summary of the sections of the Sarbanes-Oxley Act, and SRO™s listing
standards, and SEC final rules on audit committee disclosures. Clearly, boards of
directors and their audit committees need to reexamine and update their charters
to reflect the laws and regulations. Exhibit 2.5 discusses an approach to continu-
ous improvement for audit committees.

65
Institute of Internal Auditors, The Professional Practice Framework, p. 7.
66
For further discussion of the audit committee™s role, see Internal Auditing and the Audit Committee:
Working Together Toward Common Goals (Altamonte Springs, FL: IIA, 1987); and Barbara A. Apos-
tolou and Raymond Jeffords, Working with the Audit Committee (Altamonte Springs, FL: IIA, 1990).
Also see the video, Audit Committees and Internal Auditing: An Essential Alliance for Effective Gov-
ernance (Altamonte Springs, Fla.: IIA, 1994).
Exhibit 2.4 Audit Committees: Roles and Responsibilities under the Sarbanes-
Oxley Act of 2002, SROs, and SEC
Applicability
Sectiona SOAa SROsb SECc
Audit Committee Practice Area
Organization of the Audit Committee
” ”
• Charter
” ”
• Membership

• Meetings
” ” ”
• Independence 301
” ” ”f
f
• Financial Literacy/Expertise 407
Activities
” ”d ”
Internal Control 404
Annual and Interim Financial Statements,
” ”d ”
CEO/CFO Certification 302/906

Loans to Directors or Offices 402

Corporate Code of Conduct

Code of Ethics for CFOs 406
Auditors
”d
Internal Auditors
External Auditors
” ”
• Retention and Fees 301
” ”d
• Hiring 206
” ”
• Non-Audit Services 202
” ”d
• Auditor Rotation 203/207
” ”d
• Disagreements 301
• Critical Accounting Policies and
” ”
Disclosures 204, 401, 409
Communication
• Opinions from Legal Counsel and
” ”
Other Advisers 301, 307
” ”e
• Whistleblowing Protection 301, 307, 806
• Stock Exchange Listing Requirements
”d

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