February 2002


By Timothy J. Zanni and Mark C. Terrell

Boards of directors' audit committees are expected to serve as the guardian of investors' interests and corporate accountability. Shareholders rely on the audit committee to embrace new government rules and provide independent, effective oversight of the financial reporting process.

Equally important, however, are the expectations the audit committee places on the other participants in the financial reporting process. Regulatory reforms will prompt audit committees to heighten their expectations of management, including CFOs, and external auditors. These reciprocal expectations are indispensable to an efficient financial reporting process.

The Blue Ribbon Report

Audit committees of the board of directors were first recommended by the New York Stock Exchange in 1939. In early 1999, scrutiny of audit committees intensified with the release of the Report and Recommendations of the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees. The Blue Ribbon Report was intended to effect pragmatic, progressive changes in the functions and expectations placed on corporate boards, audit committees, senior and financial management, internal auditors, and external auditors.

The resulting reforms adopted by the stock exchanges, the SEC, and the auditing profession have focused on the role and independence of audit committees and raised expectations of their effectiveness. These increased expectations are sparking more demanding audit committee meetings and processes. The Blue Ribbon Report recognized that audit committees neither prepare financial statements nor make the numerous decisions required to prepare them. In carrying out its oversight of the financial reporting process and internal controls, the audit committee relies on what the Blue Ribbon Report describes as a three-legged stool that supports responsible financial disclosure and active and participatory oversight. The three legs of the stool represent-

An Open and Candid Dialogue

The role of the audit committee is one of oversight, oversight of the elements and participants in the financial reporting process. This monitoring role encompasses the activities and responsibilities of the CFO. Effective and diligent CFOs should recognize the regulators and investors' expectations of audit committees, and CFOs should be prepared to respond to the expectations that audit committees will appropriately place on a company's financial management.

A more focused and informed audit committee is a more effective audit committee. The audit committee should expect the CFO to be an integral part of expanding the committee's awareness of the company's financial reporting process, identifying risks and understanding the controls surrounding those risks. CFOs should ask themselves the following questions:

The audit committee's expectation of support from financial management is matched by a similar expectation on the part of management. The committee should expect help from management in understanding the key elements of the company's internal controls over financial information flow. Similarly, management should expect the committee's support in developing strong financial controls and creating an environment of accurate financial reporting.

A number of factors have placed pressure on financial management to stay current and effective: increasingly complex financial reporting standards; newly designed transaction structures; increased regulatory demands on financial reporting; and market expectations for rapid reporting of financial results that meet or exceed market estimates. The CFO should expect the audit committee to ensure that appropriate financial and human capital is allocated to the financial reporting processes and controls of the company.

An open and candid dialogue between the CFO and the audit committee is imperative in order for each to meet the other's expectations. Most audit committees routinely meet in executive sessions with the internal and external auditors. More audit committees are beginning to expand these executive sessions to include the CFO, according to surveys conducted at KPMG's audit committee roundtable series, which in 2001 involved more than 2,000 board members in 24 U.S. locations.

In the current environment of corporate governance, audit committees have attracted increasing scrutiny. That focus should not obscure the pivotal position that financial management must assume in providing information and candid assessments to the audit committee. The full support of financial management can result in a more focused audit committee and, just as important, in smoother interplay and greater coordination among all parties in the financial reporting process.

Timothy J. Zanni, CPA, is a partner in KPMG's assurance practice, and Mark C. Terrell, CPA, is the partner in charge of KPMG's audit committee institute, a national resource for corporate board members and senior management. The institute can be reached at (877) KPMG-ACI,, or

Robert H. Colson, PhD, CPA

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