Financial oversight: A 'three-legged stool'.

• Author: TERRELL, MARK C.
• Position: Audit committees

Each leg -- the audit committee, management, and the external audit firm -- has a unique role that must be recognized and efficiently coordinated.

PROPOUND CHANGES are transforming the corporate financial reporting realm. Economic markets have increased pressure on companies to provide financial data faster and more frequently. Greater competition and consolidation have pushed companies to enhance their corporate governance procedures to satisfy mounting expectations by investors and stakeholders.

The increased focus on audit committees (which function on behalf of the board of directors) as the ultimate guardian of investors' interests and corporate accountability has only accelerated the rapid pace of change swirling through the corporate governance arena. The well-chronicled reforms designed to bolster the independence and effectiveness of audit committees have resulted in increased governance-level focus on companies' financial reporting.

Audit committee charters use a variety of terminologies to describe the roles and responsibilities of the audit committee. However, the key responsibility relates to oversight of a company's financial reporting. Effective oversight recognizes that "financial reporting" is the culmination of a process. Audit committees need, therefore, to focus on the key elements of the process as well as the participants who are integral to the process.

The key elements of the financial reporting process can be summarized as follows:

* Business and financial reporting risk-assessment process.

* Accounting systems to capture information.

* System of internal control, including "tone at the top."

* Evaluation and interpretation of data.

* External as well as internal reporting of financial information.

Foundation for integrity

The participants in the financial reporting process constitute a "three-legged stool" of responsible disclosure and active oversight, laying the foundation for financial integrity and greater accountability. The term "three-legged stool" is referenced in the "Report and Recommendations of the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees," commonly known as the Blue Ribbon Report.

The three legs are: management, including internal audit; the independent external auditor; and the audit committee. It is critical to recognize, maintain and coordinate the unique roles of each distinct leg of the financial reporting stool.

First, the financial reporting process is implemented, maintained and monitored by management, including internal audit. Management is responsible for the company's internal control structure and for understanding, assessing and implementing policies to mitigate risks. The internal auditor is in a position...