Ten best practices for audit committees: the public company audit committee now has an enhanced role and needs to revise some of its practices. Here are some key areas to focus on.

• Author: Lipman, Frederick D.
• Position: Audit committee

One result of the accounting scandals of recent years is the enormous attention given to audit committees of public companies and the subsequent change in the committee's role and practices. The Sarbanes-Oxley Act of 2002 effectively transferred certain powers from the CEO and the CFO to the audit committee. The enhanced role requires audit committee members with more expertise to devote substantially more time and effort to their task. Indeed, in many cases, time spent on audit committee work has increased as much as 100 percent.

In light of these changes, spurred not only by the scandals but the new rules and regulations that followed the scandals, there are some key areas to focus on. The following discusses 10 best practices for audit committees summarized from a list of 30 that are included in a new book on the subject by this author.

1 Establish an effective internal audit function that reports to the audit committee. Establishing such an internal audit function is probably the most important thing the audit committee can do. The internal auditor must be hired and compensated by the audit committee of the board of directors. The primary responsibility of the internal auditor should be to assist the board in performing its fiduciary duty to monitor management--or, in other words, act as the eyes and ears of the audit committee.

Other operational duties may be assigned to the internal auditor by management, but these other duties should not interfere with the primary responsibility of the internal auditor.

It is clear from the WorldCom Inc. fiasco that the audit committee must control the operations of the internal audit department to the extent that those functions deal with the audit of financial reporting. WorldCom's audit committee allowed management to control the internal audit department and created an incentive structure that required the internal audit group to emphasize operational audits, which saved money for WorldCom or otherwise produced "value." This resulted in an internal audit group that had neither the staffing nor funding to provide adequate information to the audit committee on financial reporting issues.

Serious consideration should be given to structuring the compensation of the head of the internal audit to avoid excessive reliance on compensation driven by accounting results. To properly maintain the watchdog function of the internal auditor, he or she should not receive significant incentives based on profitability.

Some companies prefer to outsource all or part (so-called "co-sourcing") of the internal audit function. Under these circumstances, the audit committee should control not only the selection and retention of the outside internal auditor, but also the...