Audit Committees

By: Gary A. Porter, CPA

Judge Samuel Putnam, in 1830, stated his now famous “Prudent Man Rule” by saying "Those with responsibility for the money of others, should act with prudence, discretion, intelligence, and regard for the safety of capital as well as income." If the world really operated this way, we would have little need for audits. But, since the world doesn’t operate this way, audits are here to stay. Most new guidelines come from either the American Institute of CPAs (AICPA) or the Financial Accounting Standards Board (FASB). In the public corporation arena, rules are also established by the Securities and Exchange Commission (SEC). While those rules are intended to apply only to public corporations, the requirements often filter down to nonpublic corporations, or are adopted by the AICPA and FASB.

The SEC has established new rules for audit committees that will be effective in June 2001. Many hail these changes as crucial developments in the effort to overhaul the often neglected procedure of internal auditing. The new guidelines are practical measures to ensure objective and organized audits, as well as to help clarify the financial wisdom of corporate decision making. 

At its best, a corporation's Audit Committee will help funnel financial information from corporate boards to their shareholders (members). It will be an open pipeline of facts and figures, a tool for the creation of a transparent business model. It will ensure thorough financial reporting, as well as the proper identification and management of corporate risk. It also adds an additional level of fiscal security. Thanks to an Audit Committee, investors/members sleep soundly at night, secure in the knowledge that a corporation's books are in order.

At its worst, however, an Audit Committee obscures the financial status of a corporation. It confuses or misleads investors/members, and prompts mismanagement lawsuits in the event of corporate failure.

The new SEC guidelines for audit committees include several major alterations:

  1. Audit Committees will consist of at least three independent directors, all of whom must be financially literate. At least one of these directors must have financial expertise, and none of them can be immediate family members of your corporation's past or current executive officers. This will limit conflicts of interest, and ensure that the audit process is an objective one from front to back.
  2. The independent auditors must review financial documents on a quarterly basis. This practice falls into line with the requirements of the "Big Five" accounting firms, which have long since implemented complete quarterly reviews. The frequency of these audits will ensure a constant flow of information to shareholders of publicly held corporations.
  3. Safe harbor  or the ability of a company to disclose certain facts about their operations in public domain documents  has been limited. The Securities and Exchange Commission (SEC) will now have expanded jurisdiction over the items that are contained in the communications between companies and investors. Ideally, this will expand the power of federal regulators, and allow them to ensure that fiscal transactions are free of all possible fraud.
  4. A corporation's proxy statement will be required to include a copy of the charter for the Audit Committee. This way, shareholders can vote on the members of the committee, and can have a voice in the process of securing the financial future of the enterprise.

While these guidelines apply only to public corporations at this time, they are common sense rules that should be applied by nonpublic corporations. Associations may want to consider these guidelines in establishing audit committees or revising the charter of existing audit committees. The association’s purpose is to serve its members, and financial activity is a significant matter in every association. Most association members can visually determine if their complex is being physically maintained by observing the condition of landscaping, buildings, streets, etc. But, they can’t tell the financial condition without doing a little digging. The existence of a strong audit committee provides assurance to the member that those things he can’t readily observe are also being carefully watched.