Do We Really Need More Audit Committee Disclosure?

Disclosure is a good thing, and more is even better, right? Not always.

Information about what the board does and how it does it has expanded significantly in recent years. Now there's a call for more disclosure, this time on the activities of boards' audit committees. Where to draw the line on how much reporting is enough can be a difficult decision.

It's true that financial statements are a lifeline to investors for making critical decisions, and it's imperative that the information provided by corporate America is reliable, relevant, and useful. It's also true that a main player ensuring that financial information meets those criteria—along with management and the independent auditor—is the audit committee. Being at the center of the tri-party process, there are calls for more information about the committee's responsibilities and how it carries them out. Whether or not they are warranted is a debate worth having.

Central to this is a new call to action by the Audit Committee Collaboration—a consortium of governance and policy organizations including the National Association of Corporate Directors, the Center for Audit Quality, and others—outlining how audit committees can enhance communication with investors to provide a clearer picture of the committee's activities.

Underlying Financial Reporting Quality

Before diving into the Collaboration's report, let me first provide some context by looking at what happens behind the scenes to help ensure the quality of financial information, since that's really the ultimate objective: high-quality information about a company's financial position, results of operation, and cash flows that reflect how it has performed with indications about its future prospects. While neither new nor exciting, it's worth a few moments to review what's already behind quality reporting.

We begin with management, with the CFO usually leading the financial reporting process. In the vast majority of public companies, this leader is highly experienced and qualified, surrounded by a team of professionals with broad backgrounds and expertise in the financial reporting process. There are checks and balances within that process, including a system of internal control over financial reporting. This encompasses the culture of the organization, integrity and ethical values, human resources, risk management, information flows, control activities, monitoring, and a host of related functions. Of course there's the Securities and Exchange Commission and other regulators that establish rules and investigate as necessary.

Then there's the independent auditing firm. At the larger firms, the audit teams have broad-based experience in accounting, financial reporting, auditing, and securities filings. The team is led by a partner who has risen through the ranks and proven to have the outstanding qualifications, knowledge, skills, and attributes to lead the team in conducting the audit. Partners are assigned to clients by carefully matching skills and expertise to the needs of the engagement, including experience in the client's industry. There's also another partner assigned to provide a second set of eyes and judgment on the accounting, reporting, auditing procedures, and conclusions. Further experts are available and called upon to help the team deal with more complex issues. There's also an internal quality control program that reviews engagements and provides opportunity for continuous improvement.

The call to action does not suggest that the audit committee take on any more responsibility—but simply to make clear what its responsibilities are, and how they are carried out. It's about transparency and enhancing communication with investors.

Relatively new to the entire system is a regulator established by the Sarbanes-Oxley Act—the Public Company Accounting Oversight Board—which conducts audits of the auditing firms, including reviews of selected audit engagements. The PCAOB also has responsibility for establishing generally accepted auditing standards.

The CEO and CFO are required to certify the propriety of the company's financial statements with a signature, as well as its system of internal control.

The point here is that there are independently established rules for reporting and auditing, with well-developed processes and skilled and experienced professionals motivated to ensure that high-quality information is provided to investors.

The Audit Committee Report

Within this context, the audit committee has a number of important responsibilities, including monitoring what management is doing in developing the financial statements, reviewing draft reports, and discussing a range of issues to gain a level of comfort about the quality of the process and financial information. Responsibilities also include overseeing matters related to the independent auditor, such as engaging the auditing firm and monitoring how the firm staffs the audit team, maintains its independence, and conducts the audit.

With this backdrop, some observers have been seeking more information from audit committees on how they carry out these responsibilities. Proxy statements already include an audit committee report providing useful information—but the Audit Committee Collaboration's “Call to Action” suggests that the disclosure should be enhanced to better meet the needs of investors.

Here are some of the items the Collaboration suggests audit committees should provide more information on:

The financial reporting process and committee's oversight. This calls for a clear sight line to the audit committee charter and information around its key provisions. Disclosures might include descriptions of the committee's role for such areas as risk management and cyber-security, and responsibilities regarding the independent auditor and financial reporting risk, which could serve as a foundation for understanding other information in the committee's report.

Selection of the independent auditor. Factors considered in selecting the external auditor and the lead engagement partner, such as the qualifications of the firm, it's ability to staff the engagement, geographical reach, and industry expertise.

Oversight of the independent auditor's independence. Information going beyond already required information that sheds additional light on how independence is supported. Also suggested is information on the frequency of meetings with the independent auditor without management present.  

Determination of the auditor's compensation. Information related to how audit fees are determined, ensuring the amount is reasonable and consistent with delivery of a high-quality audit.

Evaluation of the independent auditor. Called for is information about the committee's process for evaluating the auditor, including key conclusions from the evaluation.

This is just an overview of what the Collaboration suggests, with more in the report itself. A particularly insightful analysis with more specificity of what disclosures might be provided can be found in PwC's The Audit Committee Report—An Opportunity to Enhance Communication With Stakeholders.

The End Result

Theoretically there's little downside in providing this type of additional information to the marketplace. The call to action does not suggest that the audit committee take on any more responsibility—but simply to make clear what its responsibilities are, and how they are carried out. It's about transparency and enhancing communication with investors.

Still, I wonder how many investors—even sophisticated ones—will really find their analyses for making investment decisions swayed by this additional information. Will decisions be changed based on whether risk management is overseen by the audit committee, by a separate risk committee, or the full board? Will they be swayed by knowing what factors the committee considered in selecting the independent auditor or its lead partner? Or by being informed of how the committee looks at the auditing firm's independence?

Many believe more information is always good. But in the context of the entirety of the financial reporting process, and in light of the costs associated with still more disclosure, and the potential use of this information, one might readily reach a different conclusion.