One of the audit committee’s most critical functions is the oversight and review of financial reporting which requires the critical review of voluminous documents filled with complex accounting and reporting matters. Whether or not you’re a financial expert, you should understand the basic components of the company’s financial close process and the key financial reporting matters and related judgments.
Ask management for help in better understanding what has changed in the current filing.
Have management prepare a summary memo highlighting areas of change (e.g., risk factors, disclosures, accounting policies, new events and developments) from the prior period. Consider having management highlight these areas within the draft filing document(s) as well. Request schedules quantifying the impact of both unusual transactions and significant changes in estimates impacting the current period.
Pay attention to “special items” and non-GAAP measures -- particularly in the earnings release.
Transparent disclosure of non-GAAP measures can be useful to investors. In particular, audit committees should ensure that both positive and negative adjustments are included. But recent focus and interpretive guidance by the SEC staff warrant additional focus to ensure management’s use of non-GAAP measures is appropriate.
If the company maintains a disclosure committee, understand how it functions and who attends the meetings.
Have management describe significant transactions or events that were discussed in the quarterly meeting.
Understand any nonstandard representations in management’s letter of representation to the external auditors.
In addition to normal ongoing representations, external auditors sometimes add nonstandard items to address unusual transactions or events that occurred during the period. Request that these special representations be highlighted and explained by management.
Discuss the status of the external auditors’ work before the earnings release.
External auditors may indicate that they are “comfortable” with the results the company is about to release, but the reality is that auditors cannot provide final approval until their work is completed—so understanding what work is left to be completed is important.
Assess the risk that some event or finding could come to light before the actual filing date that could impact the preliminary results to be reported in the earnings release.
Audit committees should consider the company’s history, management experience, and the facts and circumstances.