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2000 December Report of the Auditor General of Canada

December 2000 Report—Chapter 18

Appendix D—Best Practices Applicable to Federal Crown Corporation Audit Committees

In this appendix, we present a comprehensive list of suggested best practices that are applicable to federal Crown corporations and are complementary to the statutory requirements of audit committees under Part X of the Financial Administration Act. These best practices were taken from recent studies and publications in Canada and the U.S., including the Report and Recommendations of the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees, sponsored by the New York Stock Exchange and the National Association of Securities Dealers (1999), as well as various accounting and auditing publications.

We do not suggest that this template of best practices applies equally to all audit committees. Each audit committee should develop and observe guidelines suited to itself and its corporation. Some of these responsibilities may also be assigned to other board committees. However, as part of the audit committee's periodic self-assessment, it should ensure that key oversight responsibilities outlined in the best practices are assumed by it or another board committee.

Audit Committee Best Practices

(Those in bold were selected for comparison with current Crown corporation practices, as described in the chapter.)

Audit Committee Responsibilities

The audit committee should:

ensure oversight of compliance matters by monitoring the corporation's compliance with applicable laws and regulations.
ensure financial oversight by:

critically reviewing the operational and capital budgets, interim and annual financial statements, the auditor's report and the management discussion and analysis section of the annual report; and
reviewing the external auditor's audit plans and actively soliciting his/her judgments about the quality, not just the acceptability, of the corporation's accounting principles as applied in its financial reporting. This discussion should include such issues as the clarity of financial disclosures and the degree of aggressiveness or conservatism of the corporation's accounting principles and estimates.

ensure oversight of corporate books, records, financial and management control and information systems and management practices by:

reviewing the special examination plan and report prepared by the external examiner;
actively soliciting information about significant risks and exposures and reviewing the adequacy of internal controls to manage those risks;
reviewing the integrity and effectiveness of the management information systems;
reviewing internal audit plans and reports and management's subsequent actions; and
reviewing significant findings and recommendations made by the external auditor and follow up on management's subsequent actions.

confirm the external auditor's independence through the receipt of a formal written statement from the external auditor and through subsequent dialogue about any issues that may impact the objectivity and independence of the auditor.
ensure ethical oversight through the annual review of management's compliance with the corporate code of conduct.
actively solicit all sensitive information (for example, senior management expenses, significant litigation, non-compliance with laws and regulations, misuse of corporate assets, illegal activities).

The audit committee should, where warranted, advise the board of directors about any of these matters.

Membership and Competencies

The audit committee should be composed of at least three directors, the majority of whom should not be officers or employees of the corporation. Audit committee members must have a significant degree of commitment to the corporation that they take adequate time for meeting preparation, near-perfect meeting attendance, and ongoing education about the corporation's business and environment and topical issues.

Good governance dictates that the board be composed of individuals with certain personal characteristics such as integrity, strategic thinking, and the ability to ask probing questions. Ideally, audit committee members would be the most qualified and experienced directors on the board.

Although a variety of skills and experience is beneficial to an effective and balanced audit committee, all members should be financially literate and at least one member should have accounting or related financial management expertise. Financial "literacy" signifies the ability to read and understand fundamental financial statements, including a balance sheet, income statement and cash flow statement, and the ability to ask probing questions about the corporation's financial risks and accounting. "Expertise" signifies past employment experience in finance or accounting, requisite professional certification in accounting, or any other comparable experience or background that results in the individual's financial sophistication (such as CEO or other senior officer with financial oversight responsibilities).

Operating Procedures

Terms of Reference. Audit Committees should have clear, written terms of reference and operating procedures that specify the scope of the committee's responsibilities, and how it carries out those responsibilities, including structure, processes, and membership requirements. This charter should be approved and reassessed periodically by the board of directors.

Authority. The audit committee should have explicit authority to investigate any matters within its terms of reference, should be provided with the resources it needs, and should have full access to information and the organization's personnel. The committee should also be able to obtain independent professional advice.

Member Orientation. The audit committee should consider training and education programs for its members to ensure that they have current knowledge of the following:

the committee's responsibilities and the methods of discharging them;
the roles of the internal and external auditors;
the corporation's business, including products, systems, risks and opportunities; and
basic elements of technical areas such as accounting principles and policies, internal control systems, and auditing.

Meetings. The frequency of audit committee meetings should be tailored to the responsibilities assigned, but should be at least quarterly. The audit committee agendas are set with sufficient input from the chair of the committee, the CEO, the chief financial officer and the internal and external auditors. Detailed minutes of the meetings should be prepared. The external auditor should be invited to every meeting. The audit committee should also periodically meet with management, the external auditor and the director of internal auditing in separate private sessions.

Reporting and Self-Assessment. The audit committee should periodically report the results of its activities to the board of directors. Its charter should be disclosed at least triennially in the corporation's annual report. The committee should also provide a general disclosure letter in the corporation's annual report stating whether the audit committee has satisfied its responsibilities during the prior year in compliance with its charter. The disclosure should also state that the audit committee:

has reviewed the financial statements with management and has discussed the quality of the accounting principles and significant judgements;
has discussed the audited financial statements, accounting principles and significant judgements with the external auditor;
has discussed the information provided by management and the external auditor; and
believes, in reliance on the review and discussions with management and the auditors, that the corporation's financial statements are fairly presented in conformity with generally accepted accounting principles in all material respects.