Audit committees get new responsibility in financial reporting.

• Author: Cooper, W. Scott
• Position: Brief Article

New stock-market listing requirements and new regulations from the Securities and Exchange Commission have dealt greater responsibility to audit committees of public companies. Audit committees traditionally have been the advisory link between the board of directors and the public company's outside auditors. Now, with increased responsibilities, audit committees must take an active role in the production of financial statements. Those who serve on audit committees will receive greater public scrutiny and must meet qualifications of independence and financial literacy. These recent developments have changed the role of audit committees and, to a significant degree, the functioning of boards of directors of public companies.

Earnings management

Stock-market organizations and the SEC have been concerned about the potential for abuse when management of a public company places too much emphasis on short-term demands for steady earnings growth. The practice is known as "earnings management" and often result in management pushing the envelope when it comes to financial reporting. Under SEC scrutiny or the pressure of private litigation, many public companies have restated their prior earnings and the prices of their publicly traded securities have fallen dramatically. The common refrain has been "where were the auditors?"

Out of this environment has come a call for independence of the audit committee from management. The first initiative came in February 1998 when the accounting profession established the Independence Standards Board. In 1999, the ISB promulgated Standard No. 1, which requires an independent auditor to discuss with an audit committee issues bearing on independence as defined under the securities laws. Another initiative shifted the spotlight from the auditor to the audit committee. In September 1998, the SEC, the New York Stock Exchange and the National Association of Securities Dealers sponsored a "blue-ribbon" panel to make recommendations on strengthening the role of audit committees in over- seeing the corporate financial reporting process. In February 1999, the blue ribbon panel announced a 10-point plan to improve the quality of corporate financial reporting. The NYSE and the NASD used parts of the plan as the basis for an enhancement of the listing standards. The SEC included panel recommendations in new regulations for expanded disclosure requirements regarding audit committees.

New listing standards

The new listing...