Six common mistakes of audit committees: from failing to fully understand complex accounting concepts to failing to interview key sales personnel, a repeating pattern emerges of shortcomings in the work of the audit committee.

AuthorLipman, Frederick D.
PositionAUDIT COMMITTEES

AUDIT COMMITTEES of public companies are trying their best to adjust to the Sarbanes-Oxley Act of 2002, related SEC rules, and the increased focus by shareholders, corporate governance rating groups, and others on audit committee oversight. This has resulted in longer, more intense and more frequent meetings of audit committees.

Despite their best efforts, I have observed the six common mistakes made by audit committees:

  1. Failure to fully understand complex accounting concepts

    It is the duty of audit committee members to fully understand the accounting used by the company. Accounting concepts can be very complex. Anyone who has read any of the recent opinions of the Financial Accounting Standards Board is aware of this complexity. The accounting in certain companies is extremely complex even for trained accountants, let alone the average audit committee member. SEC accounting pronouncements (such as SAB 101 and 104) further compound the problem.

    It is difficult to ask incisive questions of the auditor or management if the audit committee does not fully understand the accounting used by the company. A number of auditors and CFOs have privately advised me that they do not consider anyone on their audit committees to have the necessary accounting expertise to fully understand the financial statements.

    The audit committee should schedule special education sessions with the CFO, the auditor, and possibly a consultant to the audit committee (e.g., an accounting professor) to make certain that they fully understand the company's accounting policies. It may be necessary to have continuing education sessions over a period of time to enhance the audit committee's expertise.

  2. Failure to interview sales personnel and the tax manager

    Many of the revenue recognition problems of public companies have resulted from side deals with customers made by sales personnel that are not correctly reflected in the financial statements. Most audit committees do a good job of interviewing the auditor, company accounting personnel, corporate governance officers (if any), inside and outside counsel, head of the disclosure committee, internal auditor (if any), and top management as part of their oversight function.

    Few audit committees consider it necessary to go beyond these groups to sales personnel, particularly the head of sales. This is a mistake, since the accounting for a transaction is no better than the quality of the information provided by the sales...

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