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of the internal control system. Also, the time associated with each audit plan
should be reasonable in relation to the size and complexity of the entity™s op-
erations and organizational structure.
• An analysis of the costs and benefits of the auditing resources should be made
(e.g., What is the desirability of allocating more financial auditing work to the
internal audit staff and reducing the audit time of the independent auditors?).

Postaudit Segment
In the preceding discussion, the committee reviewed and appraised the audit plan-
ning activities of the auditors and corporate accounting management officers. Such
a review related to the initial planning segment of the auditing cycle. However, this
final step should be accomplished during the postaudit segment of the auditing
cycle whereby the audit directors should reassess the corporate audit plan. On the
basis of their reassessments, the directors should assure themselves that the audit-
ing policy and preaudit plans were effective in order to provide the assurances re-
quired by the board of directors.

8
Ibid., par. 27.
9
This list is not all-inclusive and is not intended to preclude the insertion of additional criteria.
228 Audit Committee™s Role in Planning the Audit


To provide such assurances to the board, these three general comments are ap-
plicable for related auditing and attestation standards (see Chapter 5):

1. The audit committee should inquire into the degree of cooperation received
from the entity™s personnel who are involved in the auditing process. Also, it
should be satisfied that the audit examination was conducted in an impartial
and objective manner.
2. Based on a review of the preaudit plan criteria, the committee should assess the
results of the audit and inquire into the reasons for any differences (e.g., Are
there any problems that preclude the independent auditors from complying
with the generally accepted auditing standards?). Such inquiries should be
made in relation to the independent auditor™s management letter, which dis-
closes their reportable conditions and recommendations for improving the en-
tity™s system of internal control. Also, the committee should review progress
reports or correspondence regarding the results of the audit (e.g., internal audit
reports and financial management correspondence).
3. The committee should inquire into additional matters such as:
a. The qualitative aspects of the manpower resources allocated to the auditing
function (e.g., the quality of the internal auditing group).
b. The entity™s policy and programs concerning general business practices
(e.g., corporate conduct, sensitive payments, management perquisites, and
conflicts of interest).
c. The financial reporting disclosure practices of the entity (e.g., accounting
policies and SEC disclosure requirements).


RECOMMENDING THE APPOINTMENT
OF THE INDEPENDENT AUDITORS
A Synopsis
Based on a review of the independent auditors™ report in the annual report, the ad-
dressee of their report is ordinarily the board of directors and the shareholders,
since the board approves the selection or reappointment and recommends the firm
to the shareholders. Selection or reappointment of the auditors is within the
province of the audit committee and is required by the Sarbanes-Oxley Act of
2002, as discussed in Chapter 2. For example, the Wal-Mart audit committee:

• Reviews financial reporting, policies, procedures, and internal controls of
Wal-Mart
• Recommends appointment of outside auditors
• Reviews related party transactions
• The Board has determined that the members are “independent” as defined by
the current listing standards of the New York Stock Exchange and
The Board has adopted a written charter for the Audit Committee10


10
Wal-Mart Stores, Inc., Notice of 2003 Annual Meeting of Shareholders Proxy Statement, p. 4.
Recommending the Appointment of the Independent Auditors 229


Refer to the discussion in Appendix D on this book™s website regarding the Inde-
pendence Standards Board™s requirement that independent auditors issue an an-
nual independence confirmation. Thus the committee should address this question:
What criteria should be used in the selection and reappointment of the independent
auditors?
According to the American Institute of Certified Public Accountants, the com-
mittee should give consideration to these five points11:

1. Executive auditing personnel 12 What has been the company™s past experi-
ence with the personnel assigned to the audit? Do they convey the impression
that they value the company as a client? Do they seem able to work compati-
bly, but efficiently and independently, with management and the audit com-
mittee? Do they demonstrate an understanding of the company™s business
problems? Do they anticipate problems and advise the company of new ac-
counting tax or SEC developments?
2. Quality of professional services Can the firm supply the professional ser-
vices the company needs? For example, does the firm have access to individu-
als skilled in matters affecting the company (i.e., industry and SEC specialists
or specialists in the problems of smaller companies), and are their skills made
available to the company? Does the firm have the capability to serve the com-
pany efficiently?
3. Firm™s policies What are the firm™s quality control policies, including its
training policies? What is the firm™s policy on rotation of the personnel as-
signed to the audit? On acceptance of clients? On recruitment of personnel? On
growth?13
4. Audit fees Has the firm satisfactorily explained significant variances in ac-
tual fees from estimate? Have suggestions been made for management actions
that might reduce fees?
With respect to ways for reducing audit fees, management should:
a. Develop and maintain an accounting policies and procedures manual
b. Develop an internal auditing group if the costs and potential benefits war-
rant such a group
c. Ensure that significant and/or unusual transaction cycles are properly doc-
umented and approved
d. Discuss changes in the system of internal control with the independent au-
ditors prior to implementation to ensure cost-effectiveness
e. Follow up on the recommendations noted in the independent auditor™s man-
agement letter to correct deficiencies


11
American Institute of Certified Public Accountants, Audit Committees, Answers to Typical Questions
about Their Organization and Operations (New York: AICPA, 1978), p. 15. For more information on
the relationship between the independent auditors and boards of directors, see the related sections of
the Sarbanes-Oxley Act in Chapter 2 and at the end of this chapter.
12
Visit the American Institute of Certified Public Accountants, Code of Professional Conduct, at
www.aicpa.org.
13
Cindy H. Nance and William W. Holder, “Planning for the Audit: Logical Steps Towards Cost Con-
tainment.” Financial Executive 45 (May 1977), pp. 48“49.
230 Audit Committee™s Role in Planning the Audit


f. Discuss with the auditors significant accounting transactions and their im-
plications during the preaudit planning segment of the auditing cycle (e.g.,
the impact of new accounting and auditing pronouncements on the audit)
g. Request a summary of auditing schedules to be prepared by the client™s staff
h. Decide on the desirability of an audit coordinator in order to expedite the
audit process14
5. Nonaudit fees Independent auditing firms of the AICPA/SEC Practice Sec-
tion are required to report to the audit committee or to the board of directors
total fees received for management advisory services and a description of the
services rendered during the year.15 In addition, the National Commission on
Fraudulent Financial Reporting recommended that the audit committee “re-
view management™s plan to engage the independent public accountant to per-
form management advisory services during the coming year.”16 Such reporting
requirements give assurance to the audit committee and the full board of di-
rectors that the independence of the auditing firm is not compromised. These
requirements became law under Sections 201, 202, and 301 of the Sarbanes-
Oxley Act of 2002.

In summary, as Adolph G. Lurie pointed out:

Management should review the company™s operations and determine what services
it needs from an independent certified public accountant.
In addition to contemplating its needs, management should consider the cost of an
auditor™s services in relation to its requirements. . . . All things being equal, the low-
est fee may not obtain the type and quality of service needed to meet the particular
situation.17

The Sarbanes-Oxley Act of 2002 provides certain sections related to audit
planning for all engagements. These sections were presented in detail in Chapter
2; Exhibit 7.3 shows only the titles of each section for convenience. Therefore,
audit committee members should revisit Chapter 2 during their review and dis-
cussion of the agenda for the audit committee meetings. Of course, the audit com-
mittee members also should review the provisions of the SEC final rules and
SRO™s listing standards, where appropriate.




14
The audit committee also may wish to consider other matters, such as the independent auditors™ pro-
fessional indemnity insurance and past and pending litigation.
15
American Institute of Certified Public Accountants, Membership Requirement Regarding Commu-
nications with Audit Committees or Boards of Directors of SEC Clients. In the Division for CPA
Firms, SEC Practice Section Peer Review Manual: Update 3-B (New York: AICPA, 1987).
16
National Commission on Fraudulent Financial Reporting, Report of the National Commission on
Fraudulent Financial Reporting (Washington, DC: National Commission on Fraudulent Financial Re-
porting, 1987), p. 44.
17
Adolph G. Lurie, Working with the Public Accountant (New York: McGraw-Hill, 1977), pp. 15“16.
Recommending the Appointment of the Independent Auditors 231



Exhibit 7.3 Sarbanes-Oxley Act of 2002: Checklist Reminder of Key Sections for
Audit Committees

TITLE II”AUDITOR INDEPENDENCE
Sec. 201. Services outside the scope of practice of auditors.
Sec. 202. Preapproval requirements.
Sec. 203. Audit partner rotation.
Sec. 204. Auditor reports to audit committees.
Sec. 205. Conforming amendments.
Sec. 206. Conflicts of interest.
Sec. 207. Study of mandatory rotation of registered public accounting firms.
Sec. 208. Commission authority.
Sec. 209. Considerations by appropriate State regulatory authorities.
TITLE III”CORPORATE RESPONSIBILITY
Sec. 301. Public company audit committees.
Sec. 302. Corporate responsibility for financial reports.
Sec. 303. Improper influence on conduct of audits.
Sec. 304. Forfeiture of certain bonuses and profits.
Sec. 305. Officer and director bars and penalties.
Sec. 306. Insider trades during pension fund blackout periods.
Sec. 307. Rules of professional responsibility for attorneys.
Sec. 308. Fair funds for investors.
TITLE IV”ENHANCED FINANCIAL DISCLOSURES
Sec. 401. Disclosures in periodic reports.
Sec. 402. Enhanced conflict of interest provisions.
Sec. 403. Disclosures of transactions involving management and principal stockholders.
Sec. 404. Management assessment of internal controls.
Sec. 405. Exemption.
Sec. 406. Code of ethics for senior financial officers.
Sec. 407. Disclosure of audit committee financial expert.
Sec. 408. Enhanced review of periodic disclosures by issuers.
Sec. 409. Real time issuer disclosures.
TITLE VIII”CORPORATE AND CRIMINAL FRAUD ACCOUNTABILITY
Sec. 801. Short title.
Sec. 802. Criminal penalties for altering documents.
Sec. 803. Debts nondischargeable if incurred in violation of securities fraud laws.
Sec. 804. Statute of limitations for securities fraud.
Sec. 805. Review of Federal Sentencing Guidelines for obstruction of justice and
extensive criminal fraud.
Sec. 806. Protection for employees of publicly traded companies who provide evidence
of fraud.
Sec. 807. Criminal penalties for defrauding shareholders of publicly traded companies.
TITLE IX”WHITE-COLLAR CRIME PENALTY ENHANCEMENTS
Sec. 901. Short title.
Sec. 902. Attempts and conspiracies to commit criminal fraud offenses.
Sec. 903. Criminal penalties for mail and wire fraud.
Sec. 904. Criminal penalties for violations of the Employee Retirement Income
Security Act of 1974.
Sec. 905. Amendment to sentencing guidelines relation to certain white-collar offenses.
Sec. 906. Corporate responsibility for financial reports.


Source: Sarbanes-Oxley Act of 2002, H.R. Rep. 107-610 (2002). The material contained in this text
excludes Section 1, Titles I, V, VI, VII, X, and XI, and Sections 2 and 3.
232 Audit Committee™s Role in Planning the Audit


SOURCES AND SUGGESTED READINGS
American Institute of Certified Public Accountants, Audit Committees, Answers to Typical
Questions About Their Organization and Operations (New York: AICPA, 1978).
American Institute of Certified Public Accountants, Membership Requirement Regarding
Communication with Audit Committees or Boards of Directors of SEC Clients. In the Di-
vision for CPA Firms SEC Practice Section Peer Review Manual: Update 3-B (New York:
AICPA, 1987).
Korn/Ferry International, Twentieth Annual Boards 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).
Lurie, Adolph G., Working with the Public Accountant (New York: McGraw-Hill, 1977).
McKesson Corporation, 1992 Annual Report.
Nance, Cindy H., and William W. Holder, “Planning for the Audit: Logical Steps Towards
Cost Containment.” Financial Executive 45 (May 1977), pp. 46“50.
National Commission on Fraudulent Financial Reporting, Report of the National Commis-
sion on Fraudulent Financial Reporting (Washington, DC: NCFFR, 1987).
Sarbanes-Oxley Act of 2002, H. R., Rep 107-610 (2002).
Statement on Auditing Standards No. 22, “Planning and Supervision” (New York: AICPA,
1978).
Statement on Auditing Standards No. 65, “The Auditor™s Consideration of the Internal Audit
Function of Financial Statements” (New York: AICPA, 1991).
Wal-Mart Stores, Inc., Notice of 2003 Annual Meeting of Shareholders Proxy Statement.
Part Three
The Monitoring and
Reviewing Functions
of the Audit
Committee
Chapter 8
Monitoring the System

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