Audit Chapter 3 Review Questions and Exercises

Chapter 3: Review Questions and Exercises Multiple Choice Questions 1. Audit committee activities and responsibilities include which of the following? a. Selecting the external audit firm. b. Approving corporate strategy. c. Reviewing management performance and determining compensation. d. None of the above. 2. Which of the following audit committee responsibilities has the SEC mandated? a. Obtaining each year a report by the internal auditor that addresses the company’s internal control procedures, any quality control or regulatory problems, and any relationships that might threaten the independence of the internal auditor. b. Discussing in its meetings the company’s earnings press releases, as well as financial information and earnings guidance provided to analysts. c. Reviewing with the internal auditor any audit problems or difficulties that they have had with management d. All of the above. Exercises Exercise 1 Below is the summary of the SEC corporate governance requirements of companies publiclylisted in the stock exchange. For each requirement, state how it is intended to help to address the risk of fraud in publicly traded organizations. a. Boards need to consist of at least 3 independent directors or 1/3 of the board which is higher.  This is also practiced to ensure that no director or small group of directors can dominate the decision-making process. It helps cope with the possibility of fraud within publicly traded organization as it ensures the exercise of independent judgement on corporate affairs and proper oversight of managerial performance, including prevention of conflict of interests and balancing of competing demands of the corporation. b. Boards need to hold regular executive sessions of independent directors without management present.  It helps in ensuring that the independent directors can openly and freely communicate their opinions and suggestions to each other. Through these sessions, it is easier for them to deal with more sensitive or confidential matters without receiving possible deceiving opinions from other non-independent members or the management, which can sometimes be the basis for fraudulent acts. It helps address the risk of fraud in publicly traded organizations as it ensures that proper checks and balances are in place within the corporation. c. Boards must have a corporate governance committee composed at least 3 of independent directors.  Boards are tasked with ensuring compliance with and proper observance of corporate governance principles and practices. Corporate governance committee exists to assist the board in the performance of its corporate governance responsibilities. d. The corporate governance committee must have a written charter that addresses the committee’s purpose and responsibilities, and there must be annual performance evaluation of the committee.  It serves as the standards for evaluating performance of the committee. Corporate governance committee must have a written charter stating in plain terms their respective purposes, memberships, structures, operations, reporting processes, resources, and other relevant information. It exists to avoid any overlapping functions with other existing committees in a business organization. e. Boards must have an audit committee with a minimum of three independent members.  Audit committee exists to enhance the board’s oversight capability over the company’s financial reporting, internal control system, internal and external audit processes, and compliance with applicable laws and regulations. There must be a minimum of three independent members, including the chairman, to ensure that they are formally and properly doing their duties and responsibilities without bias. f. The audit committee must have a written charter that addresses the committee’s purpose and responsibilities, and the committee must produce an audit committee report; there must also be an annual performance evaluation of the committee.  The audit committee must have a written charter which formally defines the role of internal audit and the audit plan as well as oversees the implementation of the IA charter. It includes the audit committee’s responsibility on assessing the integrity and independence of external auditor and exercising oversight to review and monitor the external auditor’s independence and objectivity and the effectiveness of the audit process. There is also an annual performance evaluation of the committee to review and monitor the external auditor’s suitability and effectiveness on an annual basis. Exercise 2 Below is the summary of the SEC listing requirements for audit committee responsibilities of companies listed on this stock exchange. For each requirement, state how it is intended to help to address the risk of fraud in publicly traded organizations. a. Obtaining each year a report by the external auditor that addresses the company’s internal control procedures, any quality control or regulatory problems, and any relationships that might threaten the independence of the external auditor.  This helps address the risk of fraud in publicly traded organizations as the report by the external auditor addresses condition of the company’s internal control procedures as well as problems in regulations and quality control, this is done to deal with the potential conflict of interests.  b. Discuss the company’s financial statements with management and the external auditor.  This is done to monitor and facilitate compliance with applicable laws, rules and regulations. This helps address the risk of fraud in publicly traded organizations as it discusses if there are errors or misstatements in the company’s financial statements, as well as the assurances if the financial information stated are correct and unbiased. c. Discussing in its meetings the company’s earnings press releases, as well as financial information and earnings guidance provided to analysts.  . The information is provided to the company’s shareholders to show the financial results in a given period, as well as insights about the financial performance of the company. This helps address the risk of fraud in publicly traded organization as the financial analyst will be giving his professional analysis in the given financial information regarding the company’s earnings d. Discussing in its meetings policies with respect to risk assessment and risk management.  This helps address the risk of fraud in publicly traded organizations as it ensures proper risk assessment and risk management. There will be a discussion regarding policies which affects the profitability of the company, this is important in identifying possible risks, problems, or disasters before they happen and enables the company to set up procedures to avoid the risk or minimize its impact to the business organization. e. Meeting separately with management, internal auditors, and the external auditor on a periodic basis.  This is to ensure that the management discloses in the financial reports the correct financial information and the significant findings that has a significant impact to the company. This helps address the risk of fraud in publicly traded organization as the management, internal and external auditors will be discussing the company’s financial statements and all the financial information it comprises.  f. Reviewing with the internal auditor any audit problems or difficulties that they have had with management  This is done to ensure the independence of the external auditor ensuring that there are conflicts regarding his relationship with the company. This is done to ensure the integrity of the external auditor in his line of work in the company. This address concerns of audit problems or difficulties wherein the management may have an issue regarding cooperation or compliance with the applicable laws, rules and regulations. g. Setting clear hiring policies for employees or former employees of the external auditors.  This is required by all applicable laws to formally set hiring policies regarding employees of the external auditor. Employees must have a significant background in this line of work and must meet the requirements of applicable law and listing standards, to ensure that they are the right employees of the external auditor that can participate in the capacity of auditing work. h. Reporting regularly to the board of directors.  Audit committee reports regularly to the board of directors as it has a direct relationship with the board to discuss audit plans, audit findings and other items of audit which are held significant that has a direct impact in the business organization. The audit committee is responsible in overseeing financial reporting and related matters that will be reported to the board of directors to ensure the effectiveness of the entity’s internal control and risk management systems.