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Sources and Suggested Readings 95

Fleming, John M., “Audit Committees: Roles, Responsibilities, and Performance.” Penn-
sylvania CPA Journal 73, No. 2 (Summer 2002), pp. 29“32.
Goodman, Amy L., and Michael J. Scanlon, “Survey of Audit Committee Charters and
Audit Committee Reports.” Insights: The Corporate & Securities Law Advisor 15, No. 8
(August 2001), pp. 13“18.
Hoffman, Ralph and Ray Bromark, “An Audit Committee for Dynamic Times.” Directors
& Boards, 16, No. 3 (Spring 1992), pp. 51“53, 60.
Institute of Internal Auditors, The Professional Practice Framework (Altamonte Springs,
FL: IIA, 2002).
Kalbers, Wayne P., “An Examination of the Relationship Between Audit Committees and
External Auditors.” The Ohio CPA Journal, 51, No. 6 (December 1992), pp. 19“27.
Katz, Eugene M., “Keys to an Effective Audit Committee.” Credit World 86, No. 4
(March/April 1998), pp. 21“23.
Korn/Ferry International, Twentieth Annual Board of Directors Study (New York:
Korn/Ferry International, 1993).
Korn/Ferry International, 25th Annual Board of Directors Study (New York: Korn/Ferry In-
ternational, 1998).
Leanby, Bruce A., Paul R. Grazina, and John D. Zook, “Improving the Effectiveness of Cor-
porate Audit Committees.” Pennsylvania CPA Journal 70, No. 2 (Summer 1999), pp.
Livingston, Philip, “Financial Experts on Audit Committees”An Overdue Implementa-
tion.” Financial Executive 19, No. 1 (January/February 2003), pp. 6“7.
Livingston, Philip, “Test From Financial Literacy.” Directors and Boards 26, No. 2 (Win-
ter 2002), pp. 21“23.
National Commission on Fraudulent Financial Reporting, Report of the National Commis-
sion on Fraudulent Financial Reporting (Washington, DC: NCFFR, 1987).
Olson, John F., “How to Really Make Audit Committees More Effective.” Business Lawyer
54, No. 3 (May 1999), pp. 1097“1111.
Price Waterhouse, Improving Audit Committee Performance: What Works Best (Altamonte
Springs, FL: IAA, 1993).
Quinn, Lawrence Richber, “Strengthening the Role of the Audit Committee.” Strategic Fi-
nance 84, No. 6 (December 2002), pp. 42“47.
Richardson, Robert C., and Charles P. Baril, “Can Your Audit Committee Withstand the
Market™s Scrutiny of Independence?” Financial Executive 19, No. 1 (January/February
2003), pp. 35“38.
Sarbanes-Oxley Act of 2002, H.R. Rep. No. 107-610, July 25, 2002.
Securities and Exchange Commission, Release No. 34-47672, File No. SR-NYSE-2002-33,
Proposed Rule Change Relating to Corporate Governance (April 11, 2003).
Spangler, William D. and Louis Braiotta, Jr., “Leadership and Audit Committee Effective-
ness.” Group and Organization Studies 15, No. 2 (June 1990), pp. 134“157.
Statement on Auditing Standards No. 58, “Reports on Audited Financial Statements” (New
York: AICPA, 1988).
Sweeney, Paul, and Cynthia Wallace Vallario, “NYSE Sets Audit Committees on New
Road.” Journal of Accountancy 194, No. 5 (November 2002), pp. 51“59.
Title 1 of Public Law No. 107-204, July 30, 2002.
96 Audit Committees: Basic Roles and Responsibilities

Verschoor, Curtis C., Michael Barry, and Larry E. Rittenberg, “Reflections on the Audit
Committee™s Role.” Internal Auditor 59, No. 2 (April 2002), pp. 26“35.
Vicknair, David, Kent Hickman, and Kay C. Carnes, “A Note on Audit Committee Inde-
pendence: Evidence from the NYSE on ˜Grey™Area Directors.” Accounting Horizons 7, No.
1 (March 1993), pp. 53“57.
Wal-Mart Stores, Inc. 2003 Annual Report.
Wal-Mart Stores, Inc., 2003 Notice of Annual Meeting of Shareholders.
Zetzman, Wayne, “How to Organize and Use the Audit Committee.” Financial Executive
15, No. 4 (July/August 1989), pp. 54“57.
Chapter 3
The External Users of
Accounting Information

The objective of this chapter is to provide a broad perspective on the importance
of the enterprise™s outside constituencies as well as their need for accounting in-
formation. In addition, this chapter will examine the role of audit committees and
the ways in which their work is affected by these external groups.

Since the board of directors, through the audit committee, is responsible for as-
suring that management fulfills its financial reporting obligations, audit commit-
tees have an indirect accountability to the external users of accounting information.
According to the Financial Accounting Standards Board (FASB):
Members and potential members of some groups”such as owners, creditors, and em-
ployees”have or contemplate having direct economic interests in particular business
enterprises. . . . Members of other groups”such as financial analysts and advisors,
regulatory authorities, and labor unions”have derived or indirect interests because
they advise or represent those who have or contemplate having direct interests.1

To respond to the needs of these groups as well as to formulate a basis for fi-
nancial accounting and reporting standards, the FASB has developed a conceptual
framework that consists of six Statements of Financial Accounting Concepts
(SFAC) relative to financial reporting for business enterprises:

SFAC No. 1 “Objectives of Financial Reporting by Business Enterprises” (No-
vember 1978)
SFAC No. 2 “Qualitative Characteristics of Accounting Information” (May 1980)
SFAC No. 3 “Elements of Financial Statements of Business Enterprises” (De-
cember 1980)
SFAC No. 5 “Recognition and Measurement in Financial Statements of Busi-
ness Enterprises” (December 1984)
“Elements of Financial Statements” (December 1985)2
SFAC No. 6

Financial Accounting Standards Board, Statement of Financial Accounting Concepts, No. 1 (Stam-
ford, CT.: FASB, 1978), p. 11.
SFAC No. 4, “Objectives of Financial Reporting by Nonbusiness Organizations,” December 1980. It
should be noted that SFACs No. 2 and No. 6 apply to nonbusiness enterprises.

98 The External Users of Accounting Information

SFAC No. 7 “Using cash flow Information and Present Value in Accounting
Measurements” (February 2000)

The accounting profession has developed and continues to promulgate ac-
counting standards based on a prescribed set of objectives, definitions, and prin-
ciples, as set forth in the conceptual framework that is discussed in Chapter 5.3
Notwithstanding the objectives of complete and accurate information in the fi-
nancial accounting process, it should be noted that both internal accountants and
external auditors exercise judgment in the selection of accounting standards for a
fair presentation of the financial statements. Thus, if management has presented
the financial statements in conformity with generally accepted accounting princi-
ples, then such statements are fairly presented. However, the Auditing Standards
Board states in part:

11. In connection with each SEC engagement . . . , the auditor should discuss with
the audit committee the auditor™s judgments about the quality, not just the accept-
ability, of the entity™s accounting principles as applied in its financial reporting.
Since the primary responsibility for establishing an entity™s accounting principles
rests with management, the discussion generally would include management as an
active participant. The discussion should be open and frank and generally should in-
clude such matters as the consistency of the entity™s accounting policies and their ap-
plication, and the clarity and completeness of the entity™s financial statements, which
include related disclosures. The discussion should also include items that have a sig-
nificant impact on the representational faithfulness, verifiability, and neutrality of the
accounting information included in the financial statements.6 Examples of items that
may have such an impact are the following:
• Selection of new or changes to accounting policies
• Estimates, judgments, and uncertainties
• Unusual transactions
• Accounting policies relating to significant financial statement items, including
the timing of transactions and the period in which they are recorded
Objective criteria have not been developed to aid in the consistent evaluation of
the quality of an entity™s accounting principles as applied in its financial statements.
The discussion should be tailored to the entity™s specific circumstances, including ac-
counting applications and practices not explicitly addressed in the accounting liter-
ature, for example, those that may be unique to an industry.4

These characteristics of accounting information are discussed in the Financial Ac-
counting Standards Board (FASB) Statement of Financial Accounting Concepts No.
2, Qualitative characteristics of Accounting Information. FASB Concepts Statement
No. 2 notes that consistently understating results or overly optimistic estimates of re-
alization are inconsistent with these characteristics.

The terms standards and principles are used interchangeably in practice and throughout this book.
Statement on Auditing Standards, No. 90, “Audit Committee Communications” (New York: AICPA,
1999), par. 1.
The Investors 99

Moreover, in the absence of more authoritative accounting literature concern-
ing the accounting treatment of a particular item, account, or transaction, practi-
tioners can use the conceptual framework to solve the problem.5 In an article
dealing with the subjects of minority interest, stock issues, and legally enforceable
contracts, Steven Rubin indicated how the conceptual framework could be used
for the appropriate accounting treatment, and he concluded that:

Concepts statements can provide helpful guidance in resolving knotty practice prob-
lems involving liabilities and other matters. Consult them as you would other sources
of established accounting principles. You may be surprised to find that these basic
statements will provide the help you need.6

One way of classifying the external users is to divide them into groups of in-
vestors, credit grantors, regulatory agencies, and other outside constituencies.
Such classification is useful from the audit committee™s point of view, because
each constituent has different informational needs and objectives. Thus, the four-
way classification of the users is a useful framework for discharging the board of
directors™ financial accountability. To the extent that the audit committee can mon-
itor the accounting information as well as understand the perceived needs of the
outside constituencies, it can provide a balance in the corporate financial report-
ing process.

Importance of the Investors
Investors are the largest users of accounting information. As a group, investors in-
clude not only potential investors but also the stockholders. As the American As-
sembly indicates:

Shareholders are among the major groups in the community to which the corporation
must respond. As the undisputed owners of the corporation, they possess great po-
tential influence. Vocal shareholders, even if a minority, should be heard. Share-
holders can sensitize management and directors to social as well as economic issues
and should exercise this power.7

Statement on Auditing Standards, No. 69, “The Meaning of Present Fairly in Conformity with Gener-
ally Accepted Accounting Principles in the Independent Auditor™s Report” (New York: AICPA, 1992),
par. 11.
Steven Rubin, “How Concepts Statements Can Solve Practice Problems,” Journal of Accountancy
166, No. 4 (October 1988), p. 126. Two authors have developed a flow chart, “An Overview of FASB™s
Concepts Statements.” See Gwen Richardson Pate and Keith G. Stanga, “A Guide to the FASB™s Con-
cepts Statements,” Journal of Accountancy 168, No. 2 (August 1989), pp. 28“31.
The American Assembly, Corporate Governance in America, Pamphlet 56 (New York: Columbia
University, April 1978), p. 5. The American Assembly convenes annually and has a national session at
the Arden House in Harriman, New York. The Assembly conducts forums on national and multina-
tional issues. See The American Assembly Report 1991“1992 (New York: Columbia University, 1992).
100 The External Users of Accounting Information

The New York Stock Exchange Fact Book in 2001 reported that institutional in-
vestors held 46.7 percent, or $6.4 trillion, which represents the market value of
13.6 trillion of all New York Stock Exchange (NYSE) listed stock at the end of the
third quarter 2001.8 In addition, the American Stock Exchange Fact Book reported
that institutional activity was 74.7 percent of $162.2 billion, which is the value of
all stock listed on the American Stock Exchange (AMEX) in 1997.9 Although the
individual investors held 40 percent and others held 13.3 percent of the dollar
value of the NYSE stock and 25.3 percent of the dollar value of the AMEX stock
for the respective years, the equity investments of institutional investors cannot be
overlooked because of their market impact on the volume of trading. These in-
vestors represent a dominant force in daily stock trading. Their influential role is
important, because they can concentrate their investments in large corporations
and, thus, increase their market power.
Furthermore, the SEC reported that “the total dollar amount of securities filed
for registration with the SEC during 2002 reached a record of 2.0 trillion”10 Thus,
the investing public is of paramount importance to the nation™s capital market as
well as to the international marketplace, and corporate management must appraise
its position regarding the investor™s interests.
The Business Roundtable concluded that:

Corporations are chartered to serve both their shareholders and society as a whole.
The interests of the shareholders are primarily measured in terms of economic return
over time. The interests of others in society (other stakeholders) are defined by their
relationship to the corporation.
The other stakeholders in the corporation are its employees, customers, suppliers,
creditors, the communities where the corporation does business, and society as a
whole. The duties and responsibilities of the corporation to the stakeholders are ex-
pressed in various laws, regulations, contracts, and custom and practice.11

In addition to their significance concerning capital markets, investors have an
impact on corporate policies. For example, stockholders can influence corporate
policies through their votes at the annual stockholders™ meeting. They can vote on
such issues as:

• The election and removal of the board of directors
• Amendments to the corporate charter and bylaws
• Proposals of the stockholders to corporate management

New York Stock Exchange, New York Stock Exchange Fact Book 2001 (New York: NYSE, 2001), p.
61. Visit the web site at www.nyse.com/marketinfo/shareownersurvey.html.
American Stock Exchange, American Stock Exchange Fact Book 1998 (New York: ASE, 1998), p. 15,
and Security Industry Automation Corporation database, 1998. More recent information was not
available at the time of this writing.
Securities and Exchange Commission, 2002 Annual Report (Washington, DC: U.S. Government
Printing Office, 2002), p. 80.
The Business Roundtable, Corporate Governance and American Competitiveness (New York: The
Business Roundtable, 1990), p. 4.
The Investors 101


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