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sions with the internal and external auditing executives and the senior repre-
sentatives of management, such as the chief financial officer.
• Their report not only contains an independent and objective appraisal of the
audit functions but also provides assurance to the board that management is
fulfilling its stewardship accountability to its outside constituencies, particu-
larly the stockholders.
• The report reflects the audit committee members™ responsibility to exercise the
legal duty of care in view of the fiduciary principle, discussed in Chapter 4.
The reader should reread this chapter prior to the preparation of the report.
Also, the reader should refer to Appendix H on this book™s website.
• It calls the board™s attention to nonfinancial accounting matters of significance,
such as conflicts of interest and other general business practices.

Audit committee members are in a unique position within the framework of
corporate accountability because they provide a constructive dimension to the
board in helping the directors discharge their fiduciary responsibility to the stock-
holders. Through a review of their functions (discussed in Chapter 2), it is clearly
evident that the scope of their position is broad based. Such a position enables
audit committee members to obtain a broad perspective of the entity™s business op-
erations and its industry. As a result of their knowledge and their exposure to the
subjects discussed in this text, they are in a position to recognize the auditing
needs of the entity as well as to understand compliance matters with corporate
policies. Although they are not directly involved in the day-to-day accounting and
auditing management activities, their seasoned business experience permits them
to monitor the changes in accounting and auditing standards that affect the finan-
cial reporting responsibilities of both the board of directors and the officers of the
corporation. Furthermore, because of their independent posture in the corporate
framework and their broad overview of the entity, they are not restricted to one
particular function in the organization. Equally important, they can anticipate po-
tential financial reporting problems as well as communicate management™s course
of action regarding the solutions to such problems.
In short, audit committee members have a critical role in developing their re-
port for the board because of their responsibility to formulate recommendations
based on their meetings with the auditors and senior financial officers. Such rec-
ommendations are a result of their review of the coordinated efforts of the above
executives and their discussions with those executives. Consequently, it is incum-
Guidelines for Preparing the Report 391

bent on the audit directors to develop a report that is responsive to the needs and
interests of the board of directors.
The New York Stock Exchange has issued this directive with respect to the
audit committee™s assistance with board oversight:
(viii) report regularly to the board of directors.
Commentary: The audit committee should review with the full board any issues that
arise with respect to the quality or integrity of the company™s financial statements,
the company™s compliance with legal or regulatory requirements, the performance
and independence of the company™s independent auditors, or the performance of the
internal audit function.
General Commentary to Section 303A(7)(d): While the fundamental responsibility
for the company™s financial statements and disclosures rests with management and
the independent auditor, the audit committee must review: (A) major issues regard-
ing accounting principles and financial statement presentations, including any sig-
nificant changes in the company™s selection or application of accounting principles,
and major issues as to the adequacy of the company™s internal controls and any spe-
cial audit steps adopted in light of material control deficiencies; (B) analyses pre-
pared by management and/or the independent auditor setting forth significant
financial reporting issues and judgments made in connection with the preparation of
the financial statements; (C) the effect of regulatory and accounting initiatives, as
well as off-balance sheet structures, on the financial statements of the company; and
(D) the type and presentation of information to be included in earnings press releases
(paying particular attention to any use of “pro forma,” or “adjusted” non-GAAP, in-
formation), as well as review any financial information and earnings guidance pro-
vided to analysts and rating agencies.
General Commentary to Section 303A(7): To avoid any confusion, note that the
audit committee functions specified in Section 303A(7) are the sole responsibility of
the audit committee and may not be allocated to a different committee.2

General Comments
In view of their oversight, monitoring, and advisory capacity, it is important to rec-
ognize that the audit directors™ report should convey this position to the other
board members. Moreover, the audit directors should communicate their findings
and recommendations and avoid any final decisions, since such decisions are not
within the province of the committee. Therefore, it is desirable to reexamine the
committee™s charge from the board and develop the report in response to this
charge. This particular charge has been discussed in Chapter 2, and it is suggested
that the reader review the committee™s functions at this time.

Securities and Exchange Commission, Release No. 34-47673, Proposed Rule Change Relating to
Corporate Governance, April 11, 2003, www.sec.gov/ruls/SRO/34-47672.htm.
392 The Audit Committee™s Report and Concluding Observations

In developing their report, the audit directors should be particularly alert to
present or potential financial reporting and compliance problems. Such a charge is
a difficult task for a member of the committee. However, subsequent to their ori-
entation program as outlined in Chapter 7 along with their continuous committee
meetings, each member™s ability to recognize such problems will be enhanced.
Obviously, such a skill is not acquired as the result of only a few meetings. Nev-
ertheless, through an understanding of the entity™s business and other subjects
as discussed in this text, each member can assess his or her own strengths and
weaknesses and develop the necessary proficiency. Furthermore, the quality of
their report will be contingent on not only each member™s perceptiveness and in-
quisitiveness but also their creativity concerning appropriate recommendations to
the board. For example, during the committee™s preaudit planning segment of the
auditing cycle, discussed in Chapters 6 and 7, the committee should inquire and
discuss with auditors and management any particular matters they should be aware
of regarding the audit examination. Such inquiries will enable the committee to
identify potential areas for possible recommendations to the board. For example,
in Chapter 10 it was observed that the audit committee of Wal-Mart Stores, Inc. re-
views the changes in accounting policy. Thus it can be seen that the committee has
a key role in evaluating and understanding the accounting policies of the corpora-
tion. Clearly, audit committee members should plan their agenda to allow each
member sufficient time to study and review the subjects for the report. In sum-
mary, each member should keep the board™s expectations in proper perspective
during the report development period and realize that fellow board members will
be relying on the report regarding the board™s overall final decisions.

Sources of Information for the Report
Although the sources of information for the report will vary among different audit
committees, the following recapitulation of the common sources discussed in the
text is applicable:
1. Independent auditors
a. Engagement letter and independence confirmation letter
b. Management letter and audit committee reports
c. Interim financial audit reports
d. Annual auditors™ report in the corporate annual report
e. Special audit reports, if applicable
2. Corporate management
a. Lawyer™s letter for the outside auditors
b. Management™s letter of representation to the outside auditors
c. Minutes of meetings of the board and its other standing committees, such
as the audit and finance committees3

Obviously, the minutes of the audit committee™s meetings should be documented. Such a record of
the committee™s proceedings during the year facilitates the preparation of the report. The chairman of
the audit committee should be satisfied that the recorded minutes of each committee meeting are suf-
ficient and adequate in terms of the committee™s findings, conclusions, and recommendations.
Guidelines for Preparing the Report 393

d. Minutes of the annual stockholders meeting
e. The annual corporate report and proxy materials
f. Compliance reports with the regulatory agencies, particularly the SEC and
the IRS
g. Management report in the annual report
h. Releases to employees and the general report through the public relations
3. Internal auditors
Reports on the following:
a. Compliance audits
b. Operational audits
c. Financial audits
d. Internal control system
e. Risk management
f. Governance
g. Long-form internal audit report, if available
h. Special survey reports, such as conflicts of interest and fraud prevention
4. Other sources of information
a. Audit committee™s professional development program as discussed in
Chapter 7
b. Interviews with the chief executive officer, chief financial officer, and
legal counsel
c. Bulletins within the organization and outside the organization, such as the
newsletters from the professional accounting firms

Report Preparation
The audit committee™s report is essentially an informational report that contains its
overall assessment of the preceding sources of information along with its separate
or joint meetings with the auditors and the representatives of management. Ordi-
narily, such a report will be prepared by the chair of the committee prior to the is-
suance of the annual corporate report and subsequent to the committee™s postaudit
conference. However, it may be desirable to issue an interim committee report with
respect to special matters, such as interim financial information, so that such mat-
ters are communicated to the board in a timely manner. Thus it is highly probable
that the audit committee may issue more than one report during the fiscal period.
During the phases of the auditing cycle, discussed in Chapters 6 and 7, the
audit committee will have several review meetings concerning the auditing activ-
ities and compliance matters. Such review meetings along with the minutes of
those meetings assist the committee in the preparation of the report. Although the
content of the report may evolve from the transcripts of their meetings, it is im-
portant that audit committee members provide sufficient time to develop their re-
port. Moreover, they should be satisfied not only that the facts are properly
documented in the minutes but also that their proposal recommendations are prac-
tical and reasonable.
394 The Audit Committee™s Report and Concluding Observations

In contrast to the independent auditors™ report, discussed in Chapter 13, the
audit committee™s report is not standardized by a professionally recognized ac-
counting organization, such as the AICPA. Nonetheless, the committee™s report
should describe the activities of their meetings, which consist primarily of their
reviews, discussions, findings, and recommendations. In developing the content
of the report, the committee™s comments should not contradict the audit report
opinion of the external auditors or the conclusions of the director of internal au-
diting. Therefore, subsequent to the preparation of the first draft of the report, the
report content should be checked against the sources of information, primarily
the audit reports, to avoid potential misunderstandings among the other board
While there are no definitive rules on the subjects, length, and format for the
internal report to the board of directors, the committee should give consideration
to these points4:

1. The title of the report should be Audit Committee™s Report.
2. The report should be addressed to the board of directors and dated.
3. The charge of the audit committee should be stated in the beginning of the re-
port. Such information should be taken from the corporate bylaws or from a
formal resolution passed by the board.
4. The report should contain a statement of the scope of the committee™s review.
For example, the scope of the report may include the following statement:
We have made a review of the corporate audit policy statement and related in-
ternal and external auditing plans and results for the (period of review) in order
to determine whether such functions were being performed in an effective
manner. Our review included a discussion of the following: (1) a summary of
the entity™s financial reporting requirements and the annual report and proxy
materials; (2) the system of internal accounting control and the scope of the
audit; (3) the coordinated activities between the internal and external auditors
regarding the scope of the audit; (4) management™s judgment in the selection
and application of accounting principles in the preparation of the financial
statements; and (5) the entity™s compliance with the applicable laws and regu-
lations, particularly the federal securities laws and income tax laws, with the
independent auditors and legal counsel.
5. A summary of the committee™s review activities and a general discussion of
such activities for the current fiscal period. The report should contain a chrono-
logical account of the committee™s meeting activities. The subjects for the re-
port will consist of the committee™s reviews during the phases of the auditing
cycle. For example, the committee should describe all significant accounting

The author believes it may be desirable to prepare a formal report (as illustrated) in view of not only
the potential legal liability of the committee but also the professionalism of the audit committee
Guidelines for Preparing the Report 395

changes and related accounting policy disclosure matters that were approved
during the postaudit review segment of the auditing cycle. For additional guid-
ance on the subjects for the report, the reader should review the check list and
other guidelines as discussed in the preceding chapters.
6. A summary of the committee™s recommendations regarding such matters as the
selection of the public accounting firm and changes in the internal auditing
policies. Such recommendations may be incorporated with the preceding step.
The reader should review the salient points in Chapter 7 regarding the selection
or reappointment of the public accounting firm. Also, the committee will ap-
prove certain matters, such as financial statement disclosure matters (e.g.,
changes in accounting policies) as well as the audit and nonaudit fees.
7. The report should be signed by the chair, and names of other committee mem-
bers should be disclosed in the report.
8. The committee may wish to provide attachments of principles™s reports, such
as the independent auditors™ management letter, management™s letter of repre-
sentation to the auditors, and other special reports based on its discretion.

A suggested format for the report is presented in Exhibit 14.1. Subsequent to
their recommendations, audit committee members may wish to use this paragraph:

Based on our reviews, we are confident that management has fulfilled its reporting
stewardship accountability in connection with the financial statements, and we are
assured that both the internal and external auditors have properly discharged their ap-
propriate auditing responsibilities.

Finally, publicly held corporations are required by the SEC and self-regulatory
organizations to disclose a report of the audit committee™s activities in their annual

Exhibit 14.1 Illustrative Audit Committee Internal Report

(To Board of Directors) (Date of Report)
(Charge of the audit committee)


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