How to organize and use audit committees.

• Author: Zetzman, Wayne
• Position: Implementation and use of independent audit committees

How to organize and use audit committees The author advises chief financial officers of small-and medium-sized companies how to get the most effective results from an independent audit committee. In the fall of 1987, the National Commission on Fraudulent Financial Reporting (the Treadway Commission) recommended that all publicly held companies be required to establish independent audit committees. According to the recommendation, this committee would be composed entirely of independent directors, i.e., members of the board of directors who are not members of the firm. Although it remains unclear how Congress and/or the SEC will respond to the Commission's recommendation, it is an excellent one.

There are, of course, some concerns. The Commission recognized that a smaller company may find it difficult to form such a committee, and a company of any size may be challenged by the committee to maximize effectiveness. In addition, the sponsoring group that is looking to the implementation of the Treadway recommendations, which includes FEI, is particularly concerned that small- and medium-sized companies receive all the assistance they need in forming an effective audit committee. This article may assist such companies in setting up their guidelines.

It is also this observer's view, however, that an independent audit committee offers significant advantages to all publicly held companies, whatever their size, and can play a vital role in helping them meet their statutory and fiduciary responsibilities to all their constituencies: customers, employees, society, owners, and lenders.

The problems that prompted the creation of the National Commission on Fraudulent Financial Reporting are well known to anyone who reads the business press. Revelations affecting earnings, stories about unscrupulous behavior, and major fluctuations in earnings continue to make the headlines every week. These unsavory disclosures frustrate the investment community and at the same time create public skepticism.

Some of these improprieties may indeed result from intentional fraud; however, wrongdoing is not always premeditated. The CFO has primary responsibility for evaluating the financial impact of corporate decisions and assuring that they are properly communicated. Although the CFO may take action independently, he or she is nevertheless a member of a management team intent on achieving corporate goals. Competitive pressures can cause even well-meaning individuals to make accounting decisions that are of questionable ethical merit. And some CFOs have to make decisions in a murky moral atmosphere. If they overstep the line, they may go to prison or lose their jobs; sometimes, because they will not overstep the line, they may also lose their jobs. What's more, the line is constantly moving!

Few individuals can be expected to have infallible judgment in any environment. Every CFO can therefore benefit from an evaluation of his actions from an informed but objective point of view. In other words...