An article in the January 21, 2002 issue of Business Week entitled How Governance Rules Failed at Enron questions the effectiveness of today’s audit committees. “The ideal audit committee envisioned by the rules governing independence and financial literacy,” concludes the author, “is to some extent a mythical beast.”
The article draws three lessons from the Enron collapse in an effort to help guide future regulation: (1) Audit committees should be required to disclose all financial ties, (2) Audit committees should be required to meet more often, review internal audits and get industry-specific finance training, and (3) Audit committee members who are compensated in stock should be banned from selling their stock for as long as they remain on the board.
In the meantime, PricewaterhouseCoopers (PwC) offers help for audit committees still trying to comply with the existing rules. John O’Connor, a senior audit partner at PwC finds that, “Audit committee members are taking their responsibilities more seriously than ever.” To provide a resource for directors serving in this difficult role, PwC has compiled a handbook of briefings and advice entitled Current Developments for Audit Committees 2002.
PwC’s Advice: Stay Alert to Risks and Rules
Among other things, PwC’s report recommends that audit committees familiarize themselves with risks and rules likely to affect financial reporting this year. Examples:
- Premature earnings releases. Issuance of press releases that announce earnings too far in advance of quarterly SEC filings can increase the likelihood of future restatements that can be both costly and embarrassing. PwC suggests a prudent approach to managing these risks might involve two steps; (1) Ask the independent accountant to review the earnings stated in the press release and associated 8-K filing, and (2) Ask management to file the 10-Q as soon as possible after the press release.
- Misleading pro forma information. While investors may find pro forma information helpful in some respects, there are also risks associated with the inclusion of this information in corporate press releases. PwC suggests that audit committees be aware of the types of pro forma information released and satisfy themselves that the pro forma information is meaningful, not misleading, and that pro forma earnings reconcile to earnings reported under generally accepted accounting principles (GAAP).
- Accounting for acquisitions, derivatives and revenues. Several recently released accounting standards take effect for the first time with 2001 and 2002 reports. These standards include the statements issued during the past year by the Financial Accounting Standards Board (FASB) on business combinations (FAS 141) and goodwill and other intangible assets (FAS 142). In addition, complex accounting guidance issued in past years may require special attention in developing 2001 financial reports. Examples include the FASB’s standard on derivatives and hedging (FAS 133), along with guidance from the Securities and Exchange Commission and FASB’s Emerging Issues Task Force on matters related to the recognition of revenues.
PricewaterhouseCoopers also makes available a separate publication entitled Audit Committee Effectiveness — What Works Best.