Ch 2 Prob 2 -44 Essay

Audit committees are mandatory for all public companies. The AICPA and IIA have endorsed the formation of audit committees (or their equivalent) for most organizations, including governmental entities and larger privately-held companies.

Required
a. Define the term audit committee. Indicate its composition.
b. What are the responsibilities of the external auditor to communicate information to the audit committee? Identify all required information that must be communicated to the audit committee and briefly indicate the likely rationale for requiring the communication.
c. Explain why non-public entities might want to have audit committees.
Consider the following entities in formulating your answer:
• Governmental unit, e.g. a school that must be audited
• A charity, e.g., United Way
• A larger, privately-held company

SOLUTION

a. An audit committee is a subcommittee of the board of directors; it is responsible for monitoring audit activities and serves as a surrogate for the interests of shareholders. Audit committees should preferably be composed of outside members of the board, that is, members who do not hold company management positions or are closely associated with management.

b. The following information should be discussed with the audit committee:

• A summary of the auditor's responsibilities under GAAS. Auditor responsibilities change over time as new standards are issued. The audit committee should always be aware of the nature of the audit function within the organization. • Initial selection or major changes in significant accounting policies that could have a material effect on financial statement presentation. The audit committee needs to know how the choice may affect both current reports and future financial reports as well as the rationale for the choice because it is presumed that companies select the accounting principles that best reflect the economic substance of their transactions and are thus changed only when dictated by standard-setting bodies or when the economics of the situation change. • The process utilized by management to make significant estimates and other management judgments such as loan loss reserves in banks and savings and loans and insurance reserves in insurance companies. • Significant audit adjustments that may reflect on the stewardship and accountability of management, even if management agreed to make the adjustments. • The auditor's review of and responsibility for other information contained in an annual report (outside of the audited financial statements). • All major accounting disagreements with management, even if such disagreements are eventually resolved to the auditor's satisfaction. • The auditor's knowledge of management's consultation with other auditors regarding accounting or auditing issues. • Any significant accounting or auditing issues discussed with management prior to the acceptance of the

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