Vanasco 1994

Managerial Auditing Journal
The Audit Committee: An International Perspective

Rocco R. Vanasco
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Rocco R. Vanasco, (1994),"The Audit Committee: An International Perspective", Managerial Auditing Journal, Vol. 9 Iss 8 pp.
18 - 42
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18
MANAGERIAL AUDITING JOURNAL 9,8
The role of the audit committee is expanding

owing to its value to the board of directors and
management.
The Audit
Committee: An
International
Perspective
Rocco R. Vanasco
Managerial Auditing Journal, Vol. 9 No. 8, 1994, pp. 18-42

MCB University Press, 0268-6902
During the 1970s, the collapse of the Penn Central

company, the Equity Funding case, and the startling
revelations of bribery of foreign officials by public firms
engaged in foreign trade, which led to the Foreign Corrupt
Practices Act, prompted the Securities and Exchanges
Commission (SEC) and the New York Stock Exchange
(NYSE) to recommend audit committees in order to secure
responsible corporate governance. Since then, almost all
publicly-held corporate entities in the US have established
audit committees of their board(s) of directors.
A survey on audit committee formation indicates that the
NYSE, SEC and the American Institute of Certified Public
Accountants (AICPA) influenced the directors decision to
form an audit committee. Although several respondents
questioned the usefulness of audit committees with
potential for real service to the companies and to the
public, still audit committees were recognized as playing a
limited role in the 1970s[3]. The Institute of Internal
Auditors has welcomed the initiatives of the SEC, AICPA,
and the Treadway Commission in recommending the
establishment of audit committees in the corporate
domain, and has taken a leadership role in addressing the
benefits that audit committees can provide to the board of
directors, management, investors and the public.
The professional literature and the various surveys
undertaken to assess the effectiveness of audit committees
show that the trend of audit committee formation
continues and has expanded worldwide.
The New York Stock Exchange
Introduction
We must continually broaden our vision and look for barriers
that may stand in the way of universal application of the IIA
Standards. We must not feel we have reached the ultimate
and that development is not needed[1].
Over the past decade, dramatic changes have occurred in

the roles of the boards of directors, audit committees,
management, internal auditors and independent auditors
and in the relationships among these groups. The
principal motivation of this changing dynamics is the
growing public pressure for greater corporate
accountability[2]. The role of the audit committee is
expanding due to its value to the board of directors and
management and because of the need to meet the
challenges of the constantly changing business, social and
economic environment.
This article won the International Chapter Research Contest
Award (First Place) at the International Meeting of the Institute
of Internal Auditors held in Toronto, Canada, 19-23 June 1994.
The Exchange believes that the idea no longer represents a

corporate luxury but has become a necessity, and we strongly
recommend that each listed company form an audit
committee[4].
Groups such as the New York Stock Exchange have

strongly supported, and more specifically required, the
creation and functioning of audit committees. On 23
August 1940, a report of the Subcommittee of the NYSE on
Independent Audits and Audit Procedures of the
Committee on Stock List stated: Where applicable the
selection of the (independent) auditors by a special
committee composed of directors who are not officers of
the company seem acceptable. In 1973, the NYSE claimed
in a White Paper that: The Exchange first suggested the
concept of an audit committee back in 1940. The SEC
Commission and the AICPA subsequently added their
support[4]. In 1974, the New York Stock Exchange issued
a strong statement asserting that a vigorous audit
committee can stimulate improvements in financial
reporting and control and strengthen the credibility of
corporate reports. In January 1977, the NYSE adopted an
Audit Committee Policy Statement which required the
establishment of audit committees: Each domestic
company with common stock listed on the Exchange, as a
condition of listing and continued listing of its securities
THE AUDIT COMMITTEE: AN INTERNATIONAL PERSPECTIVE
on the Exchange, shall establish no later than 30 June 1978

and maintain thereafter an Audit Committee comprised
solely of directors independent of management and free
from any relation that, in the opinion of the Board of
Directors, would interfere with the exercise of independent
judgment as a committee member[4]. Since 1978, audit
committees composed entirely of outside directors have
been required as a condition of listing by the NYSE.
Stock exchanges outside the US have also exercised great
influence in the formation of audit committees. In 1989, the
Company Act of Singapore required each company listed
on the Singapore Stock Exchange to have an audit
committee. In 1992, the London Stock Exchange adopted
the recommendation of the Cadbury Committee which
mandated that listed UK companies establish audit
committees composed of non-executive directors. Recently,
the chair of Kuala Lumpur Stock Exchange indicated that
he is considering imposing a requirement for all listed
companies to establish an audit committee. Even with no
such current requirement, a number of major corporations
there have already established audit committees.
The Role of the AICPA

Audit committees can assist their full board of directors in
matters involving financial statements and control over
financial operations[5].
On 20 July 1967, the AICPA Executive Committees

Statement recommended that publicly-owned corporations appoint committees composed of outside
directors to nominate the independent auditors and
to discuss the auditors work with them. The Statement
recognized the role of the audit committee in the review
process of financial statements and internal control
function. It highlighted the benefits of an independent
review of management policies and its operations by audit
committees: Audit committees can strengthen the
position of management by providing assurance that all
possible steps have been taken to provide independent
reviews of the managements financial policies and
operation. This is good for the company and good for the
public[5]. In 1979, AICPAs Special Committee on Audit
Committees encouraged public companies to establish
audit committees and suggested the following general
function for audit committees:
Approve the selection of the independent auditor.
Review the arrangement and scope of the audit.
Consider the comments from the independent
auditor with respect to weaknesses in internal
control and the consideration given or corrective
action taken by management.
Discuss matters of concern to the audit committee,
the auditor or management relating to the
companys financial statement or other results of
the audit.
19
Review internal accounting controls with the

companys financial and accounting staff.
Review the activities and recommendations of the
companys internal auditor.
The Committee also stated that:
It may also be appropriate for the audit committee to perform

additional duties as assigned by the board of directors. Such
duties might include review of financial statements and other
financial information distributed by the company to the
public, review of changes in accounting principles or
methods of applying them, review of nonaudit services
performed by the independent auditor, establishment and
monitoring of policies to prohibit unethical, questionable, or
illegal activities by company employees, or review of
executive perquisites[6].
In March 1993, the Public Oversight Board (POB) of the

SEC Practice section of the AICPA issued a report, In the
Public Interest: Issues Confronting the Accounting
Profession, in which several recommendations were
directed to the audit committees. The POB recommends
that audit committees should assume responsibilities
related to an SEC registrants preparation of annual
financial statements such as:
Review the annual financial statements.
Confer with management and the independent
auditor about them.
Receive from the independent auditor all
information that the auditor is required to
communicate under auditing standards.
Assess whether the financial statements are
complete and consistent with information known to
them.
Assess whether the financial statements reflect
appropriate accounting principles[7].
In a recent statement, Meeting the Financial Reporting
Needs of the Future, the AICPA is recommending that
audit committees be composed entirely of
independent directors, and
audit committees describe their responsibilities,
including how they have been carried out[8].
Professional accounting societies worldwide have
also considered enacting professional auditing standards
of audit committees. In 1986, the Institute of Chartered
Accountants in England and Wales recommended that
audit committees be responsible for the appointment and
remuneration of auditors, the approval of audit plans, and
review of management reports issued by auditors.
The Role of the US Securities and Exchange

Commission
The SEC should mandate the establishment of an audit
committee composed solely of independent directors in all
public companies[9].
20
As early as 1940, the Securities and Exchange Commission

(SEC) endorsed the concept of non-officer audit
committees which had been suggested by the New York
Stock Exchange[10]. In March 1972, the US Securities and
Exchange Commission (SEC) recommended that all
publicly-held companies have audit committees composed
of outside directors. Accordingly, no members of
management would be involved in the review of certain
matters which were once solely the prerogative of
management[11]. In the same year, the SEC required that
corporations disclose to shareholders whether they had an
audit committee[12]. In April 1977, in the case of SEC v.
Killearn Properties Inc., a United States District Court
judge handed down a final judgment and order which
decreed that:
the majority of the board of directors are not to be
employees of Killearn;
the board maintain an audit committee of outside
directors; and
the audit committee become involved in internal
control and improvements suggested both by
independent auditor and the internal staff.
On 5 July 1978 the SEC in its annual report to Congress
stressed the vital importance of an independent
audit committee to the proper functioning of the
corporation[13].
In 1978, newspapers reported that the audit committee of
National Telephone had never held a meeting before the
company was placed in the hands of a court-appointed
receiver[14]. In 1979, audit committees were cited as
needing oversight by a voluntary group to ensure
substance rather than merely a form of window
dressing[15]. On 18 July 1978 the SEC proposed stringent
rules for the three standing corporate committees
Nominating Committee, Compensation Committee, and
Audit Committee. It required reporting any director not
present at 75 per cent or more of directors meetings. The
SEC reaffirmed its belief that these three oversight
committees be formed with independent members. The
SEC set forth eight customary functions of the audit
committee:
(1) Recommend engagement or discharge of the
independent auditors.
(2) Direct and supervise investigations into matters
within the scope of its duties.
(3) Review with the independent auditors the plan and
results of the audit engagement.
(4) Review the scope and results of internal auditing
activities.
(5) Approve each professional service provided by the
independent auditors to its performance.
(6) Review the independence of the independent
auditors.
(7) Consider the range of audit and non-audit fees.
(8) Review the adequacy of the system of internal

controls[16].
The SEC has proposed a mandatory Report of
Management Responsibility (RMR) for disclosure that
closely follows the Treadway Commissions recommendations. The audit committee will be held responsible
for the accuracy of the entitys financial statements. More
recently the Treadway Commission recommended that the
SEC require all public companies to include in their annual
reports to stockholders management reports signed by the
chief financial officer and the chief accounting officer[17].
Securities exchange commissions can strongly influence
the establishment of audit committees in other countries.
In France, the Commission des Operations de Bourse, the
equivalent of SEC, has recommended that public
companies have audit committees.
National Association of Corporate Directors/

National Association of Securities Dealers/
US Federal Sentencing Commission
The primary thrust of the accounting provision was to
require public companies which lacked effective accounting
control or tolerated unreliable record keeping to comply with
the standards of their better managed peers[18].
Both the National Association of Corporate Directors and

the National Association of Securities Dealers have
recognized the benefits of corporate committees.
In November 1979, the National Association of Corporate
Directors and the Institute of Internal Auditors sponsored
a conference designed to address the shifting responsibilities of the audit committee and internal auditors[19].
In 1987, the National Association of Securities Dealers
required that all listed companies have an audit committee
with independent directors in the majority.
In November 1991, the US Federal Sentencing Commission
issued the Federal Sentencing Guidelines for
Organizations, targeting various white collar crime and
imposing mandatory fines. The imposition of penalties on
companies and their officers and directors has been
gaining momentum and has affected the responsibilities of
audit committees[20[.
The Legal Profession

The work done by attorneys for an audit committee may be
privileged, however, such a privilege is not absolute and may
be modified based on need[21].
In 1978, the American Bar Association endorsed

the concept of audit committees and made specific
recommendations regarding primary and other
responsibilities for potential legal liabilities of the audit
committees[22]. In 1985, the Delaware Supreme Court,
in the case of Smith v. Van Gortkum, narrowed the
business judgment rule which protected directors from
having their decisions second-guessed by the court as long

as directors followed standards of good faith and fairness.
In this particular case, the court required an independent
evaluation process by non-management directors such as
the audit committee and demanded that issues be
investigated in greater detail[23].
Judicial recognition of the internal audit function

has increased and so have the responsibilities placed on
the audit committee. It recommended from a legal
perspective that a charter of the audit committee be
adequately defined to establish the duties and
responsibilities of the members of the committee[21].
In March 1992, the American Law Institute (ALI), in its
Principles of Corporate Governance: Analysis and
Recommendations, has suggested dividing for-profit
organizations into three tiers. It would mandate the first
tier of large publicly held corporations (those with 2,000 or
more holders of equity securities and $100 million or more
of total assets) to establish audit committees. These
committees must comprise at least three members who are
not employed by the company. The document would
confer significant powers and duties to audit committees.
Extensive legal guidance from ALI consists of
recommended best corporate practices for audit
committees functions and powers, such as:
Recommend the firm to be employed as the

corporations external auditor and review the
proposed discharge of such firm.
Review the external auditors compensation, the
proposed terms of its engagement and its
independence.
Review the appointment and replacement of the
senior internal auditing executive, if any.
Serve as the channel of communication between the
external auditor and the board and between the
senior internal auditing executive, if any, and the
board.
Review the results of each external audit of the
corporation, the report of the audit, any related
management letter, managements responses to
recommendations made by the external audit in
connection with the audit and reports of the
internal auditing department, that are material to
the corporation as a whole and managements
responses to those reports.
Review the corporations annual financial
statements; any certification, report, opinion or
review rendered by the external auditor in
connection with those financial statements; and any
significant disputes between management and the
external auditor that arose in connection with the
preparation of those financial statements.
21
Consider, in consultation with the external auditor

and the senior internal auditing executive, if any,
the adequacy of the corporations internal control.
Consider major changes and other major questions
of choice respecting the appropriate auditing and
accounting principles and practices to be used in
preparation of the corporations financial
statements when presented by the external auditor,
principal senior executive or otherwise[24].
Foreign Corrupt Practices Act

From a cultural viewpoint, it is believed that commercial
modes and moral practices will not be changed to meet the
US standards unless revolutionary new social orders change
the patterns of centuries[25].
Audit committees are increasingly held responsible to the

Securities and Exchange Commission for illegal payments
to foreign officials and for assessing the existence of fraud.
This has been precipitated by the passage of the Foreign
Corrupt Practices Act (FCPA) in 1977, and the issuance of
the Treadway Commission Report in 1987. The SEC is also
proposing that companies expand their analysis and
documentation of internal control, which means a further
expansion of the audit committee agenda[26].
To comply with the FCPA, audit committees were given
the charge to investigate illegal payments to foreign
officials. In 1979, the Sun Oil Corporations audit
committee was put in charge of investigating various
allegations that some employees were making illegal
payments in connection with its foreign operations. After
all the investigatory work was complete, the audit
committee issued its final report, which cited some
questionable transactions. The audit committee recommended disclosing the questionable payments in the form
8-K with the Securities and Exchange Commission[21].
The AICPAs Statement on Auditing Standards No. 54,
Illegal Acts by Clients, and the IIAs Statement of
Internal Auditing Standards No. 2, Communicating
Results, require external and internal auditors to report
illegal acts to the audit committee.
The Treadway Commission Report

The Treadway Commission urged all participants in the
financial process management, audit committee, internal
auditors, and external auditors to consider several specific
risk factors when planning or reviewing proposed audit
activities[27].
Coincident with the hearing conducted by the House

subcommittee on Oversight and Investigations, the
AICPA, the American Accounting Association, the
Institute of Internal Auditors, the Financial Executives
Institute, and the Institute of Management Accountants
(formerly the National Association of Accountants)
22
reached agreement in 1985 to form an independent

National Commission on Fraudulent Financial Reporting,
chaired by James C. Treadway Jr, a former SEC commissioner. In 1987, the Treadway Report (officially known as
the Report of the National Commission on Fraudulent
Financial Reporting), offered 11 specific recommendations
designed to enhance the effectiveness of audit committees:
(1) Audit committees should have adequate resources
and authority to discharge their responsibilities.
(2) Audit committees should be informed, vigilant, and
effective overseers of the companys financial
reporting process and its internal control system.
(3) Audit committees should review managements
evaluation of the independence of the companys
public accountants.
(4) Audit committees should oversee the quarterly as
well as the annual reporting process.
(5) The SEC should mandate the establishment of an
audit committee composed solely of independent
directors in all public companies.
(6) The SEC should require audit committees to issue a
report describing their responsibilities and
activities during the year in the companys annual
report to shareholders.
(7) A written charter for the committee should be
developed. The full board should approve, review,
and revise it when necessary.
(8) Before the beginning of each year, audit committees
should review managements plans to engage the
companys independent public accountant to
perform management advisory services.
(9) Management should inform audit committees of
any second opinions sought on significant
accounting issues.
(10) Together with top management, the audit
committee should ensure that the internal auditing
involvement in the entire financial reporting
process is appropriate and properly co-ordinated
with the independent public accountant.
(11) Annually, audit committees should review the
programme that management establishes to
monitor compliance with the companys code of
ethics[9].
The issuance of the Treadway Report positioned the audit
committee as the keystone of corporate financial
governance[20]. The Treadway Commission suggested
that management and the audit committee should ensure
that the internal auditors involvement in the audit of the
entire financial reporting is appropriate. To provide
compliance with the Commissions recommendations, the
key references are the charter and the related scope of
audit activities reported to the audit committee. The
director of internal auditing communicates this
information for general direction by the board[28].
The Treadway Commission also urged the SEC to make
public audit committee reports a mandatory part of
corporate annual reports and recommended that a

separate audit committee chairmans letter be included as
a part of the corporate annual report. This separate audit
committee report should be signed by the chairman of the
audit committee and highlight the functions and major
work performed by the audit committee. A review of
annual reports of 100 companies for 1989 found that only
seven of the 100 companies presented a separate audit
committee report[29]. Companies did not include the audit
committees chairman letter in their annual reports
because the SEC does not believe such a letter would
provide any additional useful information since existing
corporate proxy statement disclosures currently include
information about the functions of the audit committee,
the number of meetings held, and the names of the
committee members[30].
A recent study of 13 Illinois corporations indicates that
most boards of directors were either already following or
implementing the Treadway Commissions recommendation to establish an audit committee. Most audit
committee chairpersons see the Treadway Commissions
recommendations as having exerted a positive influence
on corporate reporting and internal controls[31]. Chief
internal auditors were surveyed about whether they
thought the recommendations of the Treadway
Commission were being followed. The results indicate that
most audit committees are perceived as active and
relatively effective. In some circumstances, internal
auditors believe that reporting problems to the audit
committee could have negative consequences. The number
of private meetings reported ranges from zero to seven.
The absence of private meetings with the director of
internal auditing in some companies is of some concern. It
seems that the recommendation of the Treadway
Commission and The Institute of Internal Auditors as part
of professional internal auditing standards is not being
completely followed[32].
A sample of audit committee members were surveyed to
determine audit committee opinions about the importance
and necessity of the Treadway Reports recommendations.
The survey results indicate that most recommendations
for audit committees were already in effect. Results also
indicate that the financial community is building a strong
case for self-regulation, and has made significant progress
in improving the quality of financial reporting[33].
Committee of Sponsoring Organizations

Effective board members are objective, capable and
inquisitive[34].
In a 1992 response to a recommendation by the Treadway

Commission, a study and exposure draft was
commissioned by the Committee of Sponsoring
Organizations (COSO), which represents CPAs, internal
auditors, management accountants, financial executives
and accounting educators. The Committee issued a report
Internal Control Integrated Approach and restated the

importance of the internal audit function and its
relationship to the audit committee. Robert L. May, COSOs
chairman, asserted that the report does exactly what the
Treadway Commission called for:
It establishes a common definition that serves the
needs of all interested parties management, audit
committee, internal auditors, independent
accountants, legislators and regulators.
It provides a standard against which business and
other entities can assess their control systems and
determine how to improve them[8].
The COSO report is intended to help management better
control their organizations activities and to integrate
various internal control concepts into a framework in
which a common definition is established and control
components are defined[35].
If the existing UK reporting requirements are to be
extended to meet the COSOs guidelines, it was felt that it
would be helpful to have a framework against which the
audit committee, auditors and management can judge
their controls[36].
The Role of the Institute of Internal Auditors

It should be clearly understood by the audit committee that
governance implies oversight, not management. Audit
committees that seek to interfere with management
prerogatives are courting two hazards. They are taking on
more than they can handle. They are relieving management
from responsibilities[11].
The Institute of Internal Auditors has long been a

proponent of audit committees and has published a
position statement on audit committee titled Internal
Auditing and the Audit Committee: Working Together
toward Common Goals. After examining the professional
literature of the AICPA, interviewing audit directors,
studying SEC legal activities, and examining related
projects by public accountants, the IIA concluded that
audit committees can play a critical role in detecting and
reporting fraud, and recommended that public-held
companies establish and maintain audit committees
comprising outside directors with financial and/or
business background[11]. The importance of the role
played by the audit committee is a central focus of the
Standards for the Professional Practice of Internal
Auditors (SPPIA), Statements of Internal Auditing
Standards (SIAS) and the Professional Standards Bulletins
(PSB).
In 1985, the IIA issued the Position Statement on Audit
Committees and recommended that every public company
have an audit committee organized as a standing
committee of the board of directors. The Institute also
encouraged the establishment of audit committees in other
23
organizations, including not-for-profit and government

bodies[37].
The International Arena

Auditing practices are influenced by the environment in
which they operate and hence reflect that environment[38].
Audit committees were virtually unheard of in the

international arena in 1970. Twenty years later, they are
required by statute for public companies in Canada, Israel
and Singapore; they are a normal feature of publiclyowned corporations in the United States; and they are
rapidly gaining acceptance in the UK, Australia, New
Zealand, South Africa and Malaysia. Audit committees are
not, however, a widespread practice in Malaysia, South
Africa and New Zealand. It is most probable that these
countries will demand more corporate accountability in
the future and will follow the footsteps of Australia,
Canada, Singapore, the UK and the US[39].
Although audit committees are not required by law in
South Africa, most major listed companies and many
smaller companies have audit committees. The role of the
audit committees is generally defined by the board of
directors. Generally, the responsibilities of the audit
committees in South Africa are similar to those of audit
committees in the US, the UK and Canada.
Audit committees are rare in South America. The audit
committees responsibilities are significantly less than
audit committees in Anglo-Saxon countries. There are
virtually no audit committees in Japanese companies.
Audit committees are also rare in Continental Europe.
France, where few companies have audit committees with
limited power, may be an exception; but even the use of
audit committees is not widespread.
A questionnaire was mailed to internal auditors of eight
countries: Australia, Canada, India, Israel, Japan, New
Zealand, USA, and the UK. The evidence shows that only
a little more than one-half of the firms have active audit
committees, and those that do have audit committees meet
with internal auditors either semi-annually or quarterly.
India, Japan, and the UK have national characteristics that
result in less use of the audit committee[38].
The British Experience

Cadbury has opened the door to better corporate governance.
It is a challenge to internal auditors to ensure that
shareholders in a company derive real confidence from the
new directors reports about issues important to the
organization[40].
Audit committees are not a recent phenomenon in the UK.

Tricker has provided a copy of the report of the Great
Railways audit committee dated 1872 (Table I). An
analysis of this report shows that the functions of the
committee are not dissimilar from those expected of audit
24
Table I. Audit Committee Report of Great Western Railway

(UK)
Great Western Railway
Report of the Audit Committee
The auditors and Mr Deloitte attended the committee and

explained the various matters connected with the Finances
and other departments of the railway, which explanations
were highly satisfactory.
The Committee consider the Auditors have performed
their arduous duties with great care and intelligence and
therefore confidently recommend that they be continued in
office.
Paddington Station
Benjamin Lancaster
22nd February, 1872
Chairman
Source: [41]
committees today[41]. However, the adoption of the audit

committee did not begin until the late 1980s. In 1987,
stimulated by the large and increasing size and incidence
of corporate fraud, the Bank of England, the Confederation
of British Industry, and other financial institutions urged
public companies to adopt audit committees[42].
In 1977, the UK Companies Bill proposed that public
companies have audit committees with non-executive
directors, and that these committees should be consulted
on major issues in internal control. In 1988, the same
Private Members Bill was reintroduced into Parliament
which would have required large publicly-held companies
in the UK to establish audit committees. Tom Smith,
commenting on the Bills defeat in the House of Lords,
observed: Both the government and regulatory bodies are
keen that the trend towards audit committees shall
continue. Eventually, new rules on audit committees will
become law hopefully before great companies crash and
investors lose out[43].
In 1982, a group known as Promotion of Non-Executive
Directors (PRO-NED) was formed to establish a new code
of practice for directors. In 1987, the group recommended
that public companies have audit committees comprising
non-executive directors, and that they be consulted on
major auditing issues.
The recent incident involving the Bank of Credit and
Commerce International (BCCI) and that of Maxwell
Communications led Gerald Vinten, editor of Managerial
Auditor Journal, to question the external auditors loyalty
to the public and proposed some reforms of corporate
governance that require the compulsory establishment of
audit committees and the filing of reports on internal
control and irregularities to the appropriate regulatory
body[44]. From 1985 to 1991, the establishment of audit
committees in the UK grew rapidly from 17 per cent to 53
per cent[45].
In December 1992, audit committees in the UK received a

boost from the Committee on the Financial Aspects of
Corporate Governance, known as the Cadbury Committee,
which recommended that all listed companies establish
audit committees within the next two years. Cadbury
requires that all listed companies establish an audit
committee with formal written terms of reference or
charter. It recommends audit committees meet privately
with external auditors at least annually without members
of management present. Specific responsibilities for the
audit committee are:
Make recommendations to the board on the
appointment of the external auditors, the audit fee,
and any questions of resignation or dismissal.
Review annual financial statements.
Discuss with the external auditor about the nature
and scope of the audit.
Review the external auditors management letter.
Review the companys statement on internal
control.
Review any significant findings of internal
investigations.
Review the internal audit programme[46].
The UKs Cadbury Committee report is the most
significant world-wide development on the subject of
corporate governance since the issuance of the Treadway
Commission Report in the US and the report of the
Canadian Macdonald Commission. The Report regards
audit committee oversight as a significant factor in
implementing appropriate corporate accountability.
The objective of the committee is to promote awareness of
the importance of the role of the non-executive or
independent outside director. One reform favoured by the
Cadbury Committee on corporate governance is the
compulsory appointment of audit committees, composed
of non-executive directors[47].
The Canadian Experience

What is expected of audit committees and internal auditors
has evolved into a much broader, more complex venue[48].
In Canada the impetus for the adoption of the audit

committee was precipitated by the collapse of Atlantic
Acceptance Corporation Ltd in the late 1960s. As a result
of the Royal Commission investigation, audit committees
became a legal requirement for public companies
incorporated in Ontario in 1971 and for those incorporated
in British Columbia in 1973. Section 182(1) of the 1970
Canadian Business Corporation Act prescribed that
directors of a corporation offering securities to the public
should establish audit committees composed of not less
than three directors. A majority must be external
directors. The Canada Business Corporation Act,
amended in 1975, requires all public companies to have an
audit committee whose duty is to approve the annual

financial statements before they are submitted to the
board of directors. Since that time, audit committees have
become a universally accepted feature of corporate life in
Canada[49].
In 1978, the Adams Report made some recommendations
about audit committee responsibility including statutory
and optional duties. The Canadian study group showed
that sufficient regulatory pressures are effective to ensure
that large public companies establish audit committees.
The report stresses, however, that a mandatory
requirement for establishing audit committees is
unnecessary. The analysis of the survey suggests that:
where the principal impetus for audit committees was
the legal requirement, chief executive officers were not as
directly supportive. Respondents oppose any extension of
the present legal requirement for audit committees[49].
In 1985, the Office of the Auditor General of Canada
outlined the responsibilities of the audit committee. The
legislated responsibilities of the audit committee include a
minimum of duties such as:
Review and advise the board of directors with
respect to the financial statements that are to be
included in the annual report of the corporation.
Oversee any internal audit of the corporation.
Review and advise the board of directors with
respect to the annual auditors report of the
corporation.
In case of a corporation undergoing a special
examination, review and advise the board of
directors with respect to the plans and reports.
Perform such other functions as are assigned to it
by the board of directors or the charter or by-laws
of the corporation.
Additional functions which may be assigned to the audit
committee may include:
Advising the board of directors with respect to the
appointment of external auditors.
Reviewing and advising the board of directors with
respect to the plan for the annual audit.
Reviewing plans and procedures to ensure
appropriate integration and inter-reliance among
internal audits, annual external audits and special
examinations.
Reviewing and advising the board of directors with
respect to any quantitative performance
information that is subject to audit and other
accountability-related information released by the
corporation.
Following up on the implementation of
recommendations made in internal audit, annual
external audit and special examination reports[50].
25
In 1988, the Canadian Institute of Chartered Accountants

(CICA) issued the Macdonald Report, which recommended
that:
All public companies should have audit committees
composed of outside directors.
Audit committees should report annually to
shareholders on how they have fulfilled their
responsibility.
Audit committees should review both interim and
annual financial statements before publication[51].
In October 1990, the Canadian Securities Administrators
issued a notice that described their views concerning the
role and responsibilities of an audit committee:
Audit committees should review interim financial
information before it is released.
The chair of an audit committee should be an
independent director.
The audit committee should normally consist of no
less than three persons.
The audit committee should meet in executive
session with internal audit, senior management and
the independent accountant.
The audit committee should periodically report the
results of reviews undertaken by it to the board of
directors.
The audit committee should review the
appointment of the independent accountant.
Audit committees should review all reportable
events, disagreements and unresolved issues on a
timely basis.
The audit committee is also charged with the review of
significant accounting policies, and many other auditing
oversight functions.
Recent securities commission proposals aim to shift the
auditors responsibility onto an audit committee made up
of outside members. It has been argued that if the full
weight of monitoring financial statements and related
reports is delegated to an audit committee of outsiders, the
overall management and monitoring quality of the
organizations would be reduced[52]. The functions of the
Canadian audit committees closely reflect the professional
pronouncements promulgated by the Institute of Internal
Auditors.
The Australian Experience

The primary impetus for establishing audit committees in
Australia was prompted by the large number of corporate
failures[53].
Since the change of the audit environment in the 1970s, the

concept of an audit committee was conceived as a way of
maintaining auditor independence. A total of 247 usable
questionnaires were mailed to Australian corporations to
assess their attitudes towards auditors independence.
26
Respondents disagreed that audit committees would

improve the quality of audit (66 per cent) and also
disagreed that it would enhance the auditors
independence (51.6 per cent). They also rejected the notion
that peer review would improve the perceived
independence and the validity of audits[54]. Surveys show
that from 1980 to 1990, the number of audit committees
rose from 27 per cent to 66 per cent[53,55].
In 1990, the Working Group on Corporate Practices and
Conduct recommended the establishment of audit
committees with the following guidelines:
an audit committee for each public company;
a majority of non-executive directors on the audit
committee;
audit committee membership published in the
annual report;
written terms of reference for audit committees.
In 1991, the Borsh Committee recommended that all
publicly-listed companies establish audit committees[56].
The Middle East Experience

In cultures where no tradition of external auditing exists, the
clients co-operation is unlikely to be readily forthcoming[57].
Audit Committees are prevalent only in Israel, where they

are required by law. The duties assigned to the audit
committee generally include:
Examining the financial position of the company.
Enquiring into matters concerning internal
controls.
Analysing significant audit findings and the
method for correcting them.
Approving of transactions with an officer of the
company or with an interested party.
Approving the terms of appointment of a member
of the company and other officers before requesting
the approval from the board of directors and
shareholders.
The New Zealand Experience

Differing cultures and levels of economic development are
likely to cause professionals in many countries to find some
parts of international audit standards irrelevant to their
needs, and even for some, antithetical to the social and
economic environment in which they work[58].
In New Zealand, there appears to have been little interest

in audit committees. A 1989 survey showed that about 22
per cent of publicly listed companies had audit
committees. Considering the unexpected large number of
company failures after the October 1987 stockmarket
crash which occurred in New Zealand, an increase in audit
committees in the near future is expected[59].
The influence of the size of the board of directors and the

incentives of (Big 8) auditors to establish audit committees
were tested. Tests undertaken on 135 firms listed on the
New Zealand Stock Exchange indicate that voluntary
audit committees are unrelated to auditor incentive
variables or to agency cost variables arising from the
separation of (residual) ownership and the (decision)
control. A relationship is, however, discovered between
voluntary audit committee formation and directors
incentives. The number of directors of the board was
found the most important determinant of voluntary audit
committees[60].
In 1992, the Institute of Directors issued the draft of a Code
of Practice for boards of directors and recommended the
use of audit committees.
The Chinese Experience

A significant organisational consideration severely hampers
objective internal auditing in China[61].
There are no audit committees in China. The internal

auditing departments report to the person in charge of
that organization. This reporting function hampers not
only the auditors independence but also objective internal
auditing.
China did not begin to emphasize auditing in a
comprehensive way until the economic reforms and opento-the-outside-world policy adopted in 1979[61]. The word
auditing appeared in the 1982 edition of the Constitution
of the Peoples Republic of China. Article 109 of the
constitution states:
Auditing bodies are established by local peoples
governments at and above the county level. Local auditing
bodies at different levels independently exercise their power
to supervise through auditing in accordance with the law and
are responsible to the peoples government at the
corresponding level and to the auditing at the next higher
level[62].
In 1985, the State Auditing Office issued Regulations in

International Auditing which require the establishment of
independent auditing departments in government
bureaus, in state financial organizations, in large and
medium-level state enterprises, and in construction
units. However, changes in auditing regulations have not
kept pace with changes in the financial laws and
regulations[61].
Audit Committee Functions and Structure

An understanding of the expanding role of the audit
committee depends importantly on a better understanding of
the changing role of the larger board of directors of which the
committee is a part[63].
Audit committees are established by corporate boards of

directors to oversee the financial activities of the company
and to act as liaison between the board of directors and the

internal and external auditors. The audit committee of a
companys board of directors is a subcommittee made up
of external directors. The primary responsibilities of the
audit committee involve:
Assisting the board to fulfil its oversight duties
concerning financial reporting and internal control.
Maintaining, via regular meetings, direct lines of
communication among the board, financial
management, the independent auditors, and
internal auditors.
Additional responsibilities that some audit committees are
assuming include:
Reviewing corporate policies.
Conducting reviews of litigations or regulatory
proceedings.
Performing or supervising special investigations.
Reviewing executive expenses.
Reviewing policies on sensitive payments.
Reviewing transactions between the corporation
and members of management.
Assessing the performance of financial
management[64].
The IIA, in its Professional Standards Bulletins (PSB), has
further reiterated the oversight role of audit committees.
They generally perform an oversight and advisory role
for the board of directors or other designated governing
bodies. Their role includes a review and appraisal of the
overall audit resources available, objectives, and scope and
audit results of both the external and internal auditors
(PSB, 84-1). The IIA has also highlighted the primary
responsibility of the audit committee to assist the board of
directors in carrying out its duties as they relate to the
organizations accounting policies, internal control, and
internal reporting practices (IIA, 1987). The IIAs
Professional Standards Bulletins suggest that the main
purpose of the audit committee is twofold:
(1) To promote the independence of external and
internal auditors from management.
(2) To assure that the directors exercise due care.
Audit committees provide the boards of directors with
their evaluation and recommendation of the internal audit
departments operation and activities. This may include a
review of the internal auditing charter, qualifications,
organization structure, financial budget, long- and shortrange plans, audit work schedules, activity reports, and
the report on internal review audit department (PSB, 84-1).
In 1985, the IIA issued the Position Statement on Audit
Committees and reiterated that one of the primary
responsibilities of the audit committee is to assist the
board of directors in carrying out their responsibilities as
they relate to the organizations accounting policies,
internal control, and financial reporting practices[37].
27
Often a charter of the audit committee is included in the

bylaws of a corporation. Such a charter, approved by the
board of directors, describes the responsibilities of the
audit committee and may contain the following items:
Size and members of the audit committee. The audit
committee shall consist of no fewer than three, nor
more than five members of the board of directors,
none of whom shall be an employee of the
corporation.
The oversight role of the audit committee. The audit
committee shall review with the corporations
independent auditors the results of their
examination of the financial operations of the
corporation and shall make recommendation to the
board of directors with respect thereto. It shall also
review annually the corporations internal audit
function[65].
The functions of the audit committee vary with the size
and objectives of the company. The most frequently cited
functions of the audit committee are:
Assisting directors fulfil their legal responsibilities.
Strengthening the position of non-executive
directors.
Strengthening the internal and external audit
function.
Improving the quality of the accounting and
auditing function.
Co-ordinating the work of the external and internal
auditors.
Assessing audit risk.
Acceptance of the Charter

A careful drafting of the charter can promote and help
maintain a high level of expectation for the professional
integrity and performance within the department. It also can
promote the status of the internal auditing function[66].
The acceptance of the charter by the audit committee is

paramount in the audit function. The charter defines the
boundaries of the internal audit function, establishes the
internal auditing department within the organization,
delineates its status and the scope of internal auditing
authority and responsibility, authorizes access to records,
personnel, and property needed to conduct the audit, and
prescribes its various relationships to other units within
the organization and to those outside the organization.
The IIA Statement of Responsibilities of Internal Auditors
recommends that the purpose, authority and responsibility of the internal auditing department be defined in a
formal written document (charter). The director of internal
auditing is charged with seeking the approval of the
charter by senior management as well as acceptance by the
board[67].
28
To ensure that internal auditors carry out their

responsibilities, the IIAs Position Statement on Audit
Committees recommends that the audit committee should
approve and periodically review the internal audit charter,
a management approved document which states internal
audits purpose, authority and responsibility[37].
The importance of such acceptance by the audit
committee is reiterated twice in the Standards for
Professional Practice of Internal Auditors. In the General
Standard 110, the director of internal auditing is charged
to seek approval of the charter by management as well as
acceptance by the board since independence is enhanced
when the director seeks such approval (SPPIA, 110.04).
General Standard 500, Purpose, Authority, and
Responsibility, also states that the director of internal
auditing is responsible for seeking the approval of
management and the acceptance by the board of a formal
written document (charter) for the internal auditing
department (SPPIA 510.01).
SIAS No. 7, Communication with the Board of Directors,
stresses that the director of internal auditing should
periodically assess whether the purpose, authority and
responsibility, as defined in the charter, continue to be
adequate to enable the internal auditing department to
accomplish its objectives. The result of this periodic
assessment should be communicated to senior
management and the board. PSB 82-15 also suggests that
the purpose, authority and responsibility should be
defined and communicated to establish the role of the
department and to provide a basis for management and
the board to use in evaluating the operations of the
department. If a question should arise, the charter also
provides a formal, written agreement with management
and the board about the role and responsibilities of the
department within the organization.
A total of 100 internal auditors in the US and Japan were
surveyed to determine whether or not audit committees
had a formal audit charter. The survey shows that some 85
per cent of the US internal audit departments have a
formal audit charter, compared with 23 per cent for the
Japanese departments[68].
Assessing Audit Risk

Risk determines the level of control that is needed.
Consequently, risk is the driving force behind the audit
program[69].
One of the tasks assigned to the audit committee is the

periodic review of the companys risk assessment process
and managements responses to significant financial and
non-financial risks facing the organization. In assessing
audit risk, the audit committee must consider that:
The major risks facing the organization are
identified and analysed.
The auditor examines the companys efforts to

control these risks through contingency plans,
security measures and other means.
The auditor compares the risks and company
responses to determine adequacies.
The auditor recommends improvements in
company activities in the identification, control and
financing of critical risks[70].
Communicating with the Audit Committee

Internal audit communications are based, in part on each
organizations needs and unique culture. One measure of
any departments success is how well it explores and
exercises communications options to maximize
contributions[71].
In response to recommendations contained in the

Treadway Report, the Auditing Standards Board of the
AICPA issued Statement of Auditing Standards No. 61,
entitled Communication with Audit Committees, in 1988.
Given the increasing responsibility assumed by audit
committees as the sole intermediary between external
auditors, SAS No. 61 requires that auditors communicate
to the audit committee additional information not
specifically addressed otherwise in professional
pronouncements, but which may assist the committee in
overseeing the financial reporting and disclosure process
for which management is responsible. The statement
requires communication with the audit committee, but
does not preclude communication with management and
internal auditors. The matters to be communicated to the
audit committee include:
the auditors responsibility under generally
accepted auditing standards (GAAS);
significant accounting policies;
management judgements and accounting
estimates;
significant audit adjustments;
other information in documents containing audited
financial estimates;
disagreements with management;
consultation made by management with other
accountants about accounting and auditing
matters;
major issues discussed with management prior to
retaining the auditor for the next audit;
difficulties encountered in performing the audit.
The communications specified are typically incidental to
the audit and, therefore, need not be made before issuance
of the audit report[72].
As a sponsor of the Treadway Commission, the Institute of
Internal Auditors has responded to these recommendations by issuing Statement of Internal Auditing
Standards (SIAS) No. 7 Communicating with the Board of

Directors. This contains several interpretations related to
the Standards for Professional Practice for Internal
Auditors and the internal auditors communication
responsibility to the audit committee. It concerns:
direct communication between the director of
internal auditing and the board;
reassessment of the internal auditing charter;
annual communication of audit plans;
activity reports;
relationships with external auditors.
The objective of the Statement is to be helpful to audit
committees to better understand their oversight
responsibilities in areas of financial and operational
auditing.
The audit committee will interface with management,
external auditors and internal auditors. To achieve an
effective interface with these three groups Sawyer
suggests the following:
Providing committee members with an agenda for
meetings well in advance of those meetings.
Ensuring that the meetings of the audit committee
are informative.
Ensuring that all relevant financial reports and
SEC documents are regularly distributed to
committee members.
Making continued efforts to familiarize committee
members with company operations and financial
affairs that significantly affect financial and
operational reporting.
Obtaining objective information from external and
internal auditors[11].
The co-operation and co-ordination between the internal
and independent auditor will promote audit effectiveness,
reduce unnecessary duplicative procedures, and stabilize
audit fees. Since the publication of the Treadway
Commission recommendations, the working relationship
between external and internal auditors has assumed
increased importance. A survey of internal auditors shows
that the improved communication with the audit
committee may further improve the internal-external
auditor working relationships[73].
Interface with Management

The audit committee can keep management staff on their
toes. They know they will be asked questions. And the
prospect of interface with the audit committee forces
management to take action on problems that it might have let
slide along[11].
The audit committee must interface with financial and

operational management about financial and operating
reports. The prospect of interface with the audit
29
committee forces management to take action on

unresolved problems. The Treadway Commission
recommended that management should inform the audit
committee of any second opinions sought on significant
accounting issues. Survey results from external auditors,
internal auditors, management, and the audit committee
chairpersons suggest the existence of agency conflicts
between management and audit committee chairs
regarding variables that constitute full accounting
procedures choices[74]. CEOs pointed out the various
benefits that can be reaped from having an audit
committee; they obtain information to help them be aware
of what is going on and warn them of problems[11].
Interface with External Auditors

Audit committees should review managements evaluation of
the independence of the companys public accountant[9].
Recent criticism of the external audit function has spurred

standard-setting bodies to adopt several measures to
strengthen the effectiveness of the independent auditors
role. Many of the new rules and regulations mandate
greater involvement of audit committees in the audit
process. The study suggests that audit committee
members perceive that the size of the auditing department
and the length of auditor tenure have a significant
influence on the quality of the audit service provided[75].
Common functions of the audit committee include
selecting external auditors, reviewing the plan for the
audit, and reviewing audit results and financial
statements. It has been suggested that the audit committee
should ask the independent auditors the following
questions:
What was the scope of your study and evaluation of
internal accounting controls, and what type of
report will be issued?
Do you believe that management has been
responsive to reported weaknesses in the system?
Have you performed a risk analysis to consider the
potential impact of new conditions?[76].
Among the many responsibilities of the audit committee is
the review of the audit plan and to see that external audit
fees are controlled by reducing external audit hours
through co-ordination of the work of the internal and
external auditors[77]. A survey, supplemented by
interviews, was used to examine the responsibilities,
attributes and effectiveness of audit committees in a
sample of US corporations as perceived by external
auditors. The study shows that external auditors often
rate audit committees significantly lower than do audit
committee members on the responsibilities and
effectiveness of audit committees. Over time, the audit
committee, management and the external auditor must
work towards the right balance of audit committee
involvement with audit fees, audit scope, audit results,
internal controls and related issues. It was suggested that
30
audit committee training on auditing, accounting and

internal control issues could play an important role in
helping audit committees meet their responsibilities[32].
Another recent study shows that audit committee
members do not give equal weight to input from external
auditors (EAs) and internal auditors (IAs). The Treadway
Commission recommended a series of steps to enhance the
quality of audits. One of the more important
recommendations is that the audit committee meet with
EAs to discuss the performance of IAs and vice versa.
External auditors tended to be more concerned about what
the CFO reported to the audit committee about their
performance than what the internal auditor reported[33].
Similar concerns were raised in the UK. The Cadbury
Committee recommended that the audit committee meet
privately with external auditors at least annually without
members of management present as in the US.
Interface with Internal Auditors

Lack of preparation by audit committee members can
obviously reduce the effectiveness of audit committees and
discourage quality interaction with internal auditors[32].
Corporate audit committees have assumed a significant

role in the financial reporting process. In fulfilling their
expanded oversight responsibilities, these committees
must rely on internal auditors for much of their
information concerning corporate activities. SIAS 7
provides explicit guidance for internal auditor-audit
committee communication. Its provision should increase
the independence of the internal auditing department
within the organization. The independent nature of the
audit committee should result in the internal audit
department assuming a greater responsibility in the
financial reporting process[78].
The IIAs Position Statement on Audit Committees views
internal auditing as a corporate resource, supporting the
audit committee. The IIA has recognized that the audit
committee and internal auditors have common goals. A
good working relationship with internal auditors can
assist the audit committee in fulfilling its responsibility to
the board of directors, shareholders and other outside
parties[37].
Reporting to the highest level of management and the
audit committee increases the stature of internal auditing
and confers greater independence to the auditor. Several
surveys in the last three decades show a steady trend for
audit departments reporting to the audit committee. In
1963, a Conference Board study reported that internal
auditors were reporting to higher levels of management
and were gaining access to the board of directors[79]. In
1984, another survey elicited responses from directors of
internal auditing about the people to whom they reported.
The survey showed that about 80 per cent of the auditing
department reported to the audit committee[80].
The relationship of internal auditors with the audit

committee in the 500 largest US publicly held corporations
was examined. The survey showed that the size of the
internal auditing function in large publicly-held firms
varies widely. The organization status of the internal
auditing function continues to improve. Nearly 20 per cent
of directors of internal auditing report to the board chair or
the CEO and 28 per cent to the corporate controller. The
audit committee in the 358 responding firms held an
average of four meetings per year. The director of internal
auditing attended each audit committee meeting in 89 per
cent of the responding firms[81].
A recent survey shows, however, that many chief internal
auditors do not believe there are strong incentives to report
problems to the audit committee. The chance of negative
consequences for reporting problems is not only in the
mind of some chief internal auditors. The reluctance of the
chief of internal auditors to report problems to the audit
committee reveals a serious weakness. In this control
environment, internal auditors cannot perform their jobs
in an independent manner[32].
Director of Internal Auditing

The director of Internal Auditing should be elevated in the
organization hierarchy to a level consistent with the CFO.
This would minimize board discounting of IA input, enhance
the quality of audits, and meet the spirit of the Treadway
recommendations[33].
The Institute of Internal Auditors has recognized the

importance of a close relationship between the audit
committee and the director of the auditing department and
has issued in 1989, the SIAS 7 Communication with the
Board of Directors. Following the recommendation of the
Treadway Commission, the IIA has reiterated the
importance that the chief auditor have direct and
unrestricted access to the audit committee. SIAS 7 gives
guidance to internal auditors in reporting to audit
committees and recommends that the director of internal
auditing should meet privately with the board, at least
annually. According to the Statement, direct
communication occurs when the director regularly attends
and participates in those meetings of the board which
relate to its oversight responsibilities for auditing,
financial reporting, organizational governance and
control. The directors attendance at these meetings and
the presentation of written and/or oral reports provides for
an exchange of information concerning the plans and
activities of the internal auditing department (SIAS,
110.2.1).
The Treadway Commission, SEC, AICPA and IIA seem to
concur that the major objective in establishing an audit
committee is fostering auditors independence. Such
independence is enhanced when the director has direct
communication with the board. SPPIA recommends that
the director of the internal auditing department ought to
communicate with the audit committee on a regular basis

since such interaction helps assure independence and
provides a means for the board and the director to keep
each other informed on matters of mutual interest (SPPIA,
110.02). Independence of the auditing department is also
enhanced when the audit committee concurs in the
appointment or removal of the director of the internal
audit department (SPPIA, 110.03).
The organizational reporting structure of the internal
audit department probably has the greatest impact on
both its actual and perceived independence. To foster
internal auditors independence, PSB 88-4 suggests that
the director communicates more frequently with the audit
committee and undertakes the following steps:
Establish an audit charter, outline the departments
responsibilities signed by the audit committee,
which precludes outside interferences or reprisals.
Meet periodically with the audit committee.
Balance audit scope and plan approved by the audit
committee.
The SPPIA encourages the director of the internal
auditing department to submit annually, to management
for approval and to the board for its information, a
summary of the departments audit work schedule,
staffing plan and financial budget. Audit work schedules,
staffing plans and financial budgets should inform
management and the board of the scope of the internal
audit work and of any limitations placed on that scope
(SPPIA, 110.05). Standard 500 also states that the director
of internal auditing should properly manage the internal
auditing department and should ensure that audit work
fulfils the general purposes and responsibilities approved
by management and accepted by the board (SPPIA,
500.01).
The director of internal auditing has the primary
responsibility for co-ordinating the audit of the external
and internal auditors. The audit committees function is to
oversee that external auditors seek to provide efficient
audit coverage jointly with internal auditors at minimal
cost and assess the benefits flowing from a well-coordinated audit coverage. Organizations paying for audit
services should be concerned with the level of total audit
coverage they receive from external and internal audits
and the cost of coverage[82].
In a survey of American and Japanese corporations, when
asked whether their organization had an active board of
directors audit committee, 16 (90 per cent) of the US
respondents and two (15 per cent) of the Japanese
respondents replied yes. Ten of the US firms audit
committees meet with internal auditors four or more
times, two meet twice, and one meets once. The two
Japanese Auditing Committees meet with the auditors
twice a year[68].
31
Fostering Auditors Independence

The enforcement of the independence standards has been
difficult because of different perceptions of independence
among countries and the various attitudes toward
enforcement. It would appear that consensus needs to be
reached as to what constitutes independence[83].
The first general standard of the SPPIA states that

auditors independence is enhanced when the internal
auditors have the support of the board of directors, so that
they can gain the co-operation of auditees and perform
their work free from interference (SPPIA, 110.01).
In the US, Canada, and the UK, internal auditors are
making progress in attaining independence from
management. Many believe that the ideal situation is for
them to report to an active audit committee. Internal
auditors within Japanese firms appear much less
independent. They report to high-level management and
do not have an audience with the board of directors[68].
Formal Audit Plan

Successful audit managers often juggle many variables,
seeking the magic formula for their audit plans. The objective
is to make the overall audit plan a vital, cost-effective service
to the organization, and each audit a standout effort[84].
Among the many functions assigned to the audit

committee is the review of the audit plan. Both the SPPIA
and PSB emphasize the importance of a formal audit plan
for consideration by the audit committee. A formal audit
plan should be consistent with the internal audit
departments charter and with the goals of the
organization (PSB, 83-10). The director of internal auditing
should provide the audit committee with a copy of the
formal plan, staff make-up, activity reports highlighting
significant findings and recommendations; major variance
against departmental goals, work schedules, and financial
budgets; any other information requested by the audit
committee and considered appropriate by the director of
internal auditing (PSB, 84-1). A written copy of the formal
plan should be presented annually by the director of
internal auditing to the audit committee. The formal plan
should include, among other relative matters, internal
auditings overall objectives, audit work schedules,
staffing requirements, financial budgets, and a description
of any limitations placed on internal auditings scope of
work (PSB, 84-1).
Activity Reports
The auditor can provide management with significant
information on trends, problem areas, and the causes of the
problems. Such information elevates the auditor from a
finger-pointer to a source of constructive information as a
member of the problem-solving team[11].
Activity reports are often prepared to make the audit

committee and management aware of the audit
32
departments accomplishments over a period of time.

Several items that often appear in the activity reports are:
number and diversity of audit assignments;
comparison of work programmed with work
accomplished;
number and kinds of reports issued;
number of other communications to management;
cost of operating the audit department;
amounts of recoveries and savings;
number of suggestions adopted;
co-ordination activity with external auditor;
number and types of special management studies.
The general standards stress the importance of submitting
activity reports to the audit committee. Activity reports
tell the extent to which internal auditing managed to meet
the goals it set for itself. The director of internal auditing
should submit activity reports to management and to the
board annually or more frequently as necessary (SPPIA,
110.06). Activity reports should be submitted periodically
to management and the board. These reports should
compare:
Performance with departments goals and audit
work schedules.
Expenditures with financial budgets. They should
explain the reasons for major variances and
indicate any action taken or needed (SPPIA,
520.06).
Significant Audit Findings

Improving the quality of financial audits may be directly tied
to elevating the status of internal audit[33].
The board should be informed of senior managements

decision on all significant audit findings. Such significant
audit findings ought to be reported to the audit committee.
Activity reports should highlight significant audit
findings and recommendations and should inform
management and the board of any significant deviations
from approved work schedules, staffing plans, and
financial budgets, and the reasons for them (SPPIA,
110.06). SIAS 7 also recommends that significant audit
findings be reported to the audit committee. Significant
audit findings are those conditions which, in the
judgement of the director of internal auditing, could
adversely affect the organization. Significant audit
findings may include conditions dealing with
irregularities, illegal acts, errors, inefficiency, waste,
ineffectiveness, conflict of interest and control weaknesses.
After reviewing such findings with senior management,
the director of the internal auditing should communicate
these significant audit findings to the audit committee,
whether or not they have been satisfactorily resolved
(SIAS 7 110.06.2).
The audit committee should be notified if substantial

doubts exist over the clients ability to continue as a going
concern, or if a noncompliance with environmental laws
exists. In this situation, the auditor should use the audit
procedures discussed in SIAS 12[85].
The AICPAs SAS No. 60, Communication of Internal
Control Related to Matters Noted in an Audit requires the
external auditor to communicate to the audit committee
any reportable conditions identified while performing
the financial statement audit. Reportable conditions
are defined in SAS No. 60 as: significant deficiencies in
the design or operation of the internal control
structure that could adversely affect the organizations
ability to record, process, summarize, and report financial
data consistent with the assertions of management in
the financial statement. Reportable conditions may
involve deficiencies in the control environment, such
as managements override of control procedures.
A deficiency may be of such a magnitude as to be
considered a material weakness in the internal control
system[72].
Scope Limitations
Not only must auditors make certain that they arent part of
the problem; they must also be among the leaders in finding
solutions[86].
Internal auditors may experience an adverse audit

environment which may inhibit the unrestricted access to
information. After assessing the impact of such an adverse
relationship, internal auditors should inform the director
of the internal auditing department. If the adverse
environment persists, the director of the auditing
department should seek advice from the audit
committee[87]. SIAS 7 recommends that any scope
limitation along with its potential effect should be
communicated, preferably in writing, to the audit
committee. The statement defines the scope limitation
as a restriction placed upon the internal auditing
department that precludes the department from
accomplishing its objectives and plans. A scope limitation
may restrict:
scope defined in the charter;
departments access to records, personnel, and
physical properties relevant to the performance of
audits;
approved audit work schedule;
performance of necessary auditing procedures;
approved staffing plan and financial budget.
The director should also consider whether it is appropriate
to inform the board regarding scope limitations which
were previously communicated to and accepted by the
board. This may be necessary particularly when there
have been organization, board, senior management, or
other changes (SIAS 7 110.05.4).
Reporting Fraud
An auditor is not bound to be a detective, or, as was said, to

approach his work with suspicion or with a foregone
conclusion that there is something wrong. He is a watchdog,
but not a bloodhound[88].
New guidelines issued by the Treadway Commission, the

AICPA, IIA, and other institutions require the reporting of
fraud to audit committees. The Treadway Commission
considered the extent to which management fraud
undermines the integrity of financial reporting, the extent
to which fraud can be prevented, the role of the
independent auditor in detecting management fraud, and
whether the changes in auditing standards are necessary.
AICPAs Statement on Auditing Standards No. 53, The
Auditors Responsibility to Detect and Report Errors and
Irregularities (AU Sec 316), issued in 1988, provides
guidance about an external auditors responsibility for
detecting management fraud.
According to professional auditing standards,
independent CPAs have the responsibility to plan and
perform their examination to search for irregularities that
would have a material effect on their clients
financial statements. Possible fraudulent acts can be
attributed to the potential serious implications that may
derive from:
inadequate internal auditing scope or a
management-imposed limitation on that scope;
limited communication between audit department
and the audit committee;
insufficient audit committee participation in
internal auditing matters;
lack of audit committee independence.
The case of Sunstrand Corporation is an example of
deceptive devices used to defraud the government by
rendering the oversight function of the audit committee
ineffective[89].
In many parts of the English-speaking world, additional
corporate watchdog duties have already been imposed on
auditors through legislation. For example, under the
Financial Services Act of 1986 in Britain, and the Reserve
Bank of New Zealand Act of 1964, auditors are required to
report certain matters of concern arising from their audits
to regulatory authorities. This is reflected in the
promulgation on auditors duties with respect to fraud,
illegal acts and going concern considerations published in
the USA, Britain, and New Zealand[90].
Compliance with Professional Standards

Since internal auditors play a large role in evaluating the
system of internal accounting control, management and the
board will want assurances that the internal auditors the
33
evaluators are performing in accordance with established

professional standards[91].
SIAS No. 4, Quality Assurance, suggests that the director

should discuss with the audit committee the nature of the
external review with the audit committee, the nature of an
external review in the context of the overall quality
assurance programme, and should involve them in the
selection of an external reviewer (SIAS 4 540.04).
Section 110.06.6(c) of the Professional Standards for the
Practice of Internal Auditing states that senior
management may decide to assume the risk of not
correcting the reported condition because of cost or other
considerations. The techniques used to accomplish followup effectively include reporting to senior management or
the audit committee on the status of the responses to audit
findings (SIAS 3 440.13).
Surveys
Very often, the objective of internal audit reports is not
only to inform, but to mobilize follow-up action raising
noticeable flags where waste or inefficiencies can be
avoided or the possibilities of improving operations are
identified[71].
In the last two decades, audit committees have undergone

a closer scrutiny and have been subject to several
empirical studies to assess their effectiveness and
usefulness in the corporate, bank, and governmental
sectors. The objectives of the audit committee in a local
government may differ from those of a corporation where
the internal control system seems to be the overriding
factor. Surveys on audit committees for banks,
government, and other non-profit organizations will
explore this matter in the following paragraphs.
Bank Audit Committees

Particularly in periods of runaway change and uncertainty,
internal auditors in the banking industry must be aware of
their unique insights and strengths and utilize them for the
benefit of their organizations[92].
An audit committee is essential to the board of directors

fulfilment of its responsibility to oversee the banks
financial reporting process. Recent reports have cited
fraud and negligence as a catalyst to financial institutions
failures. Effective internal audit and the work of audit
committees in the banking industry can significantly
strengthen the internal control structure, contributing to
the early detection of deficiencies in internal control and
other areas. A recent study on the bank industry suggests
that the internal auditing department should communicate to the audit committee a great deal of
information, including:
its schedule and scope and manner in which its
procedures are planned;
an analysis of open audit findings;
34
an assessment of regulatory reports issued[93].

In October 1991, the General Accounting Office (GAO)
issued a report entitled Audit Committee: Legislation
Needed to Strengthen Bank Oversight that analyses the
extent to which audit committees of large banks (assets of
$10 billion or more) have the information, expertise and
independence for appropriately discharging their function.
In the GAOs view, members of bank audit committees
who have large customer relationships with their
respective banks may lack independence and may have
impaired objectivity. Many of the audit committees
surveyed had members with little or no experience in
banking, auditing or accounting. Many audit committee
chairpersons reported that they rely heavily on the banks
annual independent financial audit to help them identify
problem situations[94]. The GAO Report recommended
that more sophisticated individuals serve on bank audit
committees and that the committee focus more attention
on internal controls and on the oversight of both internal
and independent auditors. The study suggests that bank
audit committees should comprise a wide spectrum of
individuals, including independent directors with no
significant ties to the bank and with significant financial
experience. In addition, bank audit committees need to
review accounting principles to determine that financial
statements reflect appropriate consideration of changes in
the banks operating conditions or reporting requirements.
Bank audit committees also have a fiduciary responsibility
to co-ordinate the work of internal and external
auditors[95].
In 1991, the Federal Deposit Insurance Corporation

Improvement Act (FDICIA) required that banks with
assets of more than $500 million have audit committees
consisting solely of external directors. Other FDICIA
requirements for audit committees include:
Audit committees of large institutions ($3 billion or
more in assets) are required to include two
members with financial accounting, audit or
banking experience, have the specific ability to
engage their own legal counsel, and must not
include any large customer of the institution.
Audit committees are required to review, with
management, the independent accountant and the
director of internal audit, the basis for the newly
mandated reports on the effectiveness of the
institutions internal control structure and
procedures and other reports required by the Act,
as well as to review the basis for the independent
accountants report on the annual financial
statements.
In 1993, audit committee requirements for bank and
saving institutions, mandated by the FDICIA, went into
effect that are likely to increase the personal and
professional exposure of committee members subject to
the act[96]. Of the FDICIA provisions, the oversight
responsibilities for an audit committee (members of
institutions with over $500 million in assets) are organized

in five categories:
(1) Relationship with external auditors:
Discuss the selection or termination of the
external audit firm and any significant
disagreement with it.
Review the scope of external audit services,
significant accounting policies and audit
conclusions regarding significant accounting
estimates.
(2) Financial reporting: Review financial statements
and other financial reports before filing them with
regulators.
(3) Internal control over financial reporting:
Review required management assertion and
external auditor attestation reports before
filing with regulators.
Review the adequacy of the internal control
structure as well as managements resolution of
identified weaknesses.
(4) Compliance with designated laws and regulations:
Review required management assertion and
external auditor attestation reports before filing
them with regulators.
(5) Relationship with internal auditors: Oversee the
internal audit function.
Foreign banks are taking the initiative of establishing
audit committees. In 1987, the Bank of England formally
encouraged the formation of audit committees in banks,
and the Chair of the London Stock Exchange
recommended that listed companies follow the code of the
Promotion of Non-Executive Directors (PRO-NED) group.
Speaking at the September 1991 Canadian Risk
Management Conference, Hal Wyatt, retired vice-chairman
of the Royal Bank of Canada, suggested that business
insurances audit committee should comprehensively
examine the companys insurance programme at least
once a year. Risk managers should have the opportunity to
discuss companies risks directly with the audit committee
without their bosses being present[97].
On 1 June 1992 the Canadian Bank Act, Trust and Loan
Companies Act and the Insurance Companies Act set out
specific duties for audit committees which encompass:
Reviewing the annual statement before the
approval by the directors.
Reviewing any returns specified by the
superintendent.
Ensuring that appropriate internal controls are in
place.
Reviewing investments and transactions that could
affect the wellbeing of the institution.
Meeting with the external auditors to discuss the

statement of matters affecting the institutions wellbeing.
Meeting with the chief internal auditor and
management to discuss the effectiveness of control
procedures.
The Banque de France has considered requiring audit
committees for banks and other financial institutions, but
has not issued final regulations.
Government Audit Committees
If governmental auditing is to be an effective resource, it will

have to go beyond financial accountability and focus more on
performance accountability[98].
In 1986, the Presidents Blue Ribbon Commission on

Defence Management, also known as the Packard
Commission, recommended an effective oversight of the
entire process by an independent committee, such as the
audit committee of the board of directors[99]. Government
leaders are being forced to look at government spending in
new ways. Because there are limited resources and
unlimited need, leaders must decide which programmes to
fund and which to cut[98]. Audit committees could provide
impartial and objective oversight of the financial reporting
process of governmental units. It has been suggested that
audit committees for governmental units consist solely of
independent directors to ensure an objective assessment of
the activities of the governmental units. Audit committees
must comprise diligent members who are cognizant of the
needs of governmental units and the public to be optimally
effective[100].
The governmental sector has, however, shown to have
been slow in establishing audit committees despite the
vast literature concerning the objectives and benefits of
audit committees and criteria for establishing these
committees. In a survey of 118 internal auditors identified
as being employed by public sector organizations not
using audit committees in 1987, only 13 of the total 38
respondents reported that an audit committee was now
in existence and operating in their organization. Only
five reported that their audit committee comprises
individuals not involved in the management of the
entity[73].
The US General Accounting Office (GAO) has issued an
exposure draft of Government Auditing Standards,
commonly known as the yellow book. The exposure
draft (ED) proposes extensive changes to both financial
standards and the performance audit standards. The GAO
Standards require auditors to communicate their
responsibilities to audit committees or others who oversee
financial reporting. The ED would extend the applicability
of SAS No. 61, Communications with Audit Committees, to
all entities having yellow book audits of their financial
statements. Auditors would have to communicate all
35
matters included in SAS No. 61, plus information about

additional yellow book responsibilities[101].
In several countries, governments have enacted new
regulations to strengthen their internal control system.
In China, government auditing was established either
under the control of the Ministry of Finance or part of
the judicial system. It is now under the direct supervision
of the Premier of the State Council and is recognized as
an independent department. As a result of the new
regulation, auditing independence is being improved and
strengthened[102].
City Government Audit Committees

The objective of performance auditing is not to second-guess
the policy makers who determine the purpose of specific
programmes, but to identify and reduce or eliminate
waste[103].
City government officers are not interested in establishing

audit committees for the main purpose of serving as a
watchdog. Their main interest in forming audit
committees is the achievement of greater efficiency in their
operations. A survey of municipal officers of 164 cities
shows that the driving force for establishing audit
committees for local government is achieving efficiency
and effectiveness in city government. The audit committee
is believed to be the most logical method for local
governments to satisfy the growing demand for services
with limited resources[104].
Hospitals and Health Care Audit Committees

The Audit Committee should assume a leadership role in
assuring that the internal audit department has the resources
and status to objectively pursue its responsibility in a
professional manner and, at the same time, demand a high
quality and professional product from the audit
department[105].
A recent study shows that the establishment of audit

committees in the health care setting has been slow and
only partially embraced. The cause of this slow process is
due to the current environment of declining occupancy
levels, decreasing profit margins, and continued rising
costs. There seems to be an urgent need for establishing
audit committees in the health care sector to ensure the
integrity of the financial information on which the board
relies. It has been suggested that an audit committee in the
health care sector should be charged with monitoring all
aspects of internal and external auditing, including
reviewing the organizations relationship with the external
audit firm and reporting to the board on the audit[106].
A survey of 141 hospitals revealed that 60.5 per cent of the
audit committees have written charters setting forth their
objectives, responsibilities, and duties. Although an audit
committee should function more effectively when the
36
members are independent of management, an average of

1.5 inside directors serve on 47.4 per cent of the audit
committee. The results of the survey suggest that one of
the most important steps in creating an audit committee is
the development of a written charter[107]. A third survey
of 174 hospitals shows that audit committees have the
highest frequency of interaction (about 87 per cent) with
the members of the internal audit department. The audit
committee has, however, the lowest number of meetings
per year, approximately four[105].
Small Business
Audit Committees should have adequate resources and

authority to discharge their responsibilities[9].
No matter how small the organization, its leadership has

responsibility to check regularly on management and its
finances. The usefulness of the audit committee is not
limited to a company which needs or is required to have an
audit. Even the non-public company needs someone whose
job is to oversee and protect the interests of all owners. It
has been suggested that for small business enterprises, the
accountant and the business owner can create a functional
equivalent of the audit committee[108].
Concerns have been expressed that a mandatory
requirement to establish audit committees would impose
an intolerable burden on small companies, that it might
create the impression that audit committees constitute a
supervisory body with the board of directors, and that the
duties imposed on them as a part of the mandatory
requirement might be inappropriate[39]. Another option is
for the board of directors to appoint an annual audit
committee, consisting of two or more board members who
are willing to review the treasurers records. After the audit
committee finishes its review, a report should be prepared
for the board. The purpose of the audit committee is to
protect the organization, assure that financial matters have
been handled properly, and give the treasurer a sense of
completion of a years work and protection from
criticism[109].
Audit Committees in the Voluntary Sector

The work of the audit committee has been fruitful, both from
the charitys internal viewpoint and from the external
auditors viewpoint[110].
Surveys on the structure and effectiveness of audit

committees have been undertaken to assess the
effectiveness of the provisions enacted by the SEC,
the Treadway Commission, and other professional
organizations. Effectiveness of an audit committee in
carrying out its responsibilities depends mostly on the
power conferred on the board members and the latitude in
exercising their judgment on matters related to internal
control issues. A survey of 90 US corporations aimed at
assessing audit committees effectiveness shows that

organizational power and authority coupled with
observable support from top management play the most
important role in the audit committees effectiveness.
Power is unquestionably related to its effectiveness[111].
The precise authority and structure of an audit committee
will vary depending on the companys circumstances. It
has been suggested that for an audit committee to be truly
effective, a number of attributes are essential such as:
The audit committee should be invested with
sufficient authority to act with independence and
integrity as a basis for an effective oversight of the
financial reporting process.
The committees terms of reference should be set
out in writing and should detail clearly its authority
and responsibility.
The committee needs should be large enough to
provide a mix of skills and experience to permit
fruitful discussion encompassing different
viewpoints, but small enough to make effective
decisions with reasonable speed.
The committee members must exercise soundness
of judgement and a healthy dose of scepticism[112].
In view of the Treadway Commissions recommendations,
it has also been suggested that in order for an audit
committee to be effective, it should perform eight essential
activities:
(1) Maintain independence.
(2) Combine a balance of skills.
(3) Make the necessary time commitment.
(4) Be tough minded.
(5) Develop a clear charter.
(6) Develop a list of specific issues.
(7) Plan the years agenda.
(8) Document the committees work[113].
Survey data were used to examine audit committee
effectiveness in regard to the leadership styles of audit
committee chairpersons. The results suggest that
transformational leadership and active management by
exception have a substantial impact on the performance of
audit committees. The correlations of transformational
leadership, contigency rewards, and active management
by exception with effectiveness were significant in the
predicted positive directions[114]. A survey of 200 audit
committee members revealed that, regardless of the
composition of the audit committee, it takes some time for
committee members to feel confident about their jobs and
begin contributing to the committees activities[115].
An effective audit committee must be part of an
integrative approach where all the components of the
control system interface in order to keep the board and top
management informed about the state of internal control
in the corporation. Gulf Canada Resources Ltd seems to
have developed and implemented such an integrative

control system which has resulted in better informed
management and more effective controls. A high
correlation between the results of control assessments by
managers and staff and the overall control effectiveness led
Gulf to define internal control as a combination of several
controls[116].
The Price Waterhouse survey shows that the single most
important finding and the key to audit committee
effectiveness is the information and training provided to
audit committees by internal auditors. Other areas to
improve the effectiveness of audit committees may include:
the definition of an independent director, for
purposes of service on an audit committee;
Audit Committee self-assessment;
Audit Committee oversight of interim reporting;
Audit committee reporting to shareholders (Price
Waterhouse, 1993).
Inefficient Audit Committees

Over time, the role of an effective audit committee as overseer
of the financial reporting process, the internal control system,
and codes of corporate conduct has been heightened. This
stems from vesting the audit committee with the authority to
question top management regarding its responsibilities and
to ensure that corrective action is taken[117].
During the 1970s, audit committees were thought to

improve the financial accountability of public
corporations. However, several spectacular audit failures
in Canada in the 1980s, including Canadian Commercial
Banks, Northland Banks, Calgroup Graphics, National
Business Systems, and Principal Group, have cast doubts
on the quality of corporate financial reporting. To prevent
such audit failures, three structural reforms have been
suggested:
(1) mandatory audit committees;
(2) independent directors;
(3) strengthened audit committee-auditor relationships.
To enhance the audit committee performance, it is also
recommended that legislation is needed to:
Eliminate insiders from audit committees.
Allow individual firms the discretion of audit

committee involvement.
Treat the audit committee as a standard board

committee rather than an independent entity.
Force the visibility of audit committees by

requiring boards to report annually on
activities[118].
37
There is considerable anecdotal evidence that many

audit committees are not adequately performing their
duties. It has been suggested that auditors should advise
the board of directors on the optimum size of the audit
committees, their most desirable composition, duties to
perform and ways to maximize their effectiveness[119].
The MiniScribe case is an excellent example of the
result of an inefficient audit committee. The MiniScribe
Corporation continues to feel the repercussions from its
fraudulent financial reporting. The greatest threats to
MiniScribes efforts to continue are the growing number of
lawsuits against it. In addition to MiniScribe, other
defendants include the officers and directors individually,
the certified public accounting firm, and the firms
employing two audit committee members. The Securities
and Exchange Commission and the Justice Department
are also investigating the company. The audit committee
of MiniScribe Corp. failed to insist that the company
establish and maintain an effective internal auditing
function, a crucial indicator of its failure to oversee
the matters of financial reporting, auditing, and
internal control. The audit committee also did not
effectively discharge the responsibility it assumed, to
evaluate properly the scope of the annual auditors
examination[120].
Conclusion
Internal auditors must accept the challenge of providing
relevant information and training to audit committee
members. This information and training should enable
audit committees to address the full range of issues related to
internal control, organizational governance, and
management reporting[121].
Although audit committees have been in existence in the

USA since 1870, it is only during the last two decades that
their value of enhancing corporate governance has been
fully recognized. The broad role that audit committees
play is reflected in the wide range of duties they are
expected to perform. They include overseeing the external
financial reporting process, the co-ordination of the
internal and external auditor functions, and the
assessment of the environmental and legal risks the
company may be exposed to on the effectiveness of
business controls installed to limit their potential effect.
External auditor independence has been one of the focuses
of the provisions for establishing audit committees. Audit
committees facilitate for the board a better understanding
of internal controls, auditing functions, and managements
effectiveness.
The consensus is that board members in general, and audit
committee members in particular, consist of executives of
other entities and leaders from various community
organizations. The audit committee composition may vary
from industry to industry. The number of the members on
38
the audit committee is determined by the size of the board

of directors and the size of the organization. Usually, three
to five members is considered ideal. The board of
directors/trustees plays a major role in determining
whether the institution/organization will have an internal
audit function and the status of that function. The size of
the audit committee may vary from industry to industry
and even within the same industry.
The development of audit committees has varied from
country to country. Its rise is mostly attributed to the large
number of business failures and corporate malpractice.
Strong support for mandatory audit committees has come
from politicians such as Moss, Metcalf and Dingell in the
US, and Rhys Williams in the UK, and also from bodies
such as the Treadway Commission, the Cadbury
Committee, the Macdonald Commission, and the Borsch
Committee. There is, however, an equally strong support
for them to remain voluntary. The Canadian Study Group
suggests that there may be sufficient regulatory pressures
to ensure that large public companies establish audit
committees and that a mandatory requirement is
unnecessary[49].
There seems to be a consensus among researchers in the
field and the various national and international
organizations that audit committees provide significant
benefits to the corporation, public, investors and
regulatory agencies. The most cited functions of the audit
committee are:
Strengthening the internal and external audit
functions.
Co-ordinating the work of the external and internal
auditors.
Strengthening the position of non-executive
directors.
Assisting the board of directors to fulfil their legal
responsibilities.
The specific duties of audit committees vary from
corporation to corporation, although there seems to be the
trend to expand its oversight function.
The IIA embraced wholeheartedly the establishment of
the audit committee and helped sponsor the Treadway
Commission which helped establish itself in the public eye
in the US. The task of the Institute of Internal Auditors is
to set guidelines for audit committees which meet the
specific needs of each particular industry but also consider
the cultural differences, the economic environment, and the
political factors that affect auditing in a multicultural
setting. Considering the cultural, political, and economic
diversity among countries, an international auditing
forum is needed to deal with sensitive issues such as
voluntary and compulsory requirements for audit
committees, harmonization of internal auditing standards,
and the need for flexibility and compromise when the

situation warrants it.
References
1. Mills, O.W., An Interview with Orville W. Mills,
Chairman of the Board, Internal Auditor, Vol. 48,
October 1991, pp. 20-8.
2. OMalley, S.F., Auditing, Directors, and Management:
Promoting Accountability, Internal Auditing, Vol. 5,
Winter 1990, pp. 3-9.
3. Mautz, R.K. and Newman, F.L., Corporate Audit
Committees: Policies and Practices, Ernst & Ernst, New
York, NY, 1977.
4. New York Stock Exchange (NYSE), White Papers, New
York Stock Exchange, New York, NY, 1973.
5. AICPA, Executive Committees Statement, Journal of
Accountancy, September 1967.
6. AICPA, Report of the Special Committee on Audit
Committees, AICPA, New York, NY, 1979.
7. AICPA, In the Public Interest: Issues Confronting the
Accounting Profession, Report of the Public Oversight
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New York, NY, 1993.
8. AICPA, Committee of Sponsoring Organizations
(COSO), Journal of Accountancy, February 1993,
pp. 10-18.
9. Treadway, J.C., Report of the National Commission on
Fraudulent Financial Reporting, National Commission
on Fraudulent Financial Reporting, Washington, DC,
1987.
10. SEC, Accounting Series Release No. 19, 1940.
11. Sawyer, L.B., Internal Auditing, The Institute of Internal
Auditors, Altamonte Springs, FL, 1988.
12. SEC, Accounting Series Release No. 165, 1972.
13. SEC, SEC Annual Report to Congress, 5 July, 1978.
14. Schorr, B., Board Breakup: Corporate Directors
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41
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Further Reading
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Auditor, CPA Journal, June 1974, p. 7.
American Law Institute (ALI), Principles of Corporate
Governance: Analysis and Recommendations, American Law
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Auditor, August 1993, p. 10.
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Committee, The Institute of Internal Auditors, Altamonte
Springs, FL, 1992.
Berry, L.E., Co-ordinating Total Audit Coverage: Trends and
Practices, IIA Research Foundation, Altamonte Springs, FL,
1992.
Bolton, W.B., Auditing Financial Compliance, The Internal
Auditor, April 1976, p. 80.
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Study of the Independence and Scope of Work of Internal
Auditors, Proceedings of the First Asian-Pacific Conference
on International Accounting Issues, California State
University, Fresno, CA, 1989.
Castellano, J.F., Roehm, H.A. and Walker, J.P., Status and
Quality, Internal Auditor, June 1992, pp. 49-52.
Charlton, M.A., Audit Committees, Accountants Weekly, (UK),
3 October 1976.
Christofi, M., Audit Committees: What Are They? Should They
Be Introduced in Australia?, The Chartered Accountants in
Australia, April 1977, p. 5.
Colegrove, R.L, The Functions and Responsibilities of the
Corporate Audit Committee, The Internal Auditor, 11 June
1976, p. 16.
Coopers & Lybrand, Good Audit Committee and Internal Audit
Communications Are Essential, Journal of Accountancy,
April 1978, p. 77.
Corey, G.R., The Directors Audit Committee and the Audit
Function, The Internal Auditor, January-February 1975,
p. 29.
Corey, G.R., Some New Comments on the Directors Audit
Committee and the Audit Function, The Internal Auditor,
October 1977, p. 25.
De Marco, V.F., The Board of Directors: Policy Maker or Rubber
Stamp?, The Internal Auditor, September-October 1974,
p. 18.
42
De Marco, V.F., The Board of Directors: The Rubber Stamp Is

Cracking!, The Internal Auditor, June 1976, p. 22.
De Marco, V.F., How Internal Auditors Can Help CPAs Stamp
Out Illegal Acts, The Internal Auditor, February 1978,
p. 60.
Foster, A.P. and Lacey, A., Auditors and the Law Now and in
the Decade Ahead, The Australian Accountant, May 1971, p.
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Fram, E.H., An Insiders View of Audit Committees, The
Internal Auditor, April 1978, p. 40.
Institute of Internal Auditors, Internal Auditing and the Audit
Committee: Working Together toward Common Goals, The
Institute of Internal Auditors, Inc., Altamonte Springs, FL,
April 1987.
Institute of Internal Auditors, The Interaction of Audit
Committee with Internal Auditing, IIA (Chicago Chapter),
Chicago, IL, 1991.
Institute of Internal Auditors, Codification of Standards for
Professional Practice of Internal Auditors, The Institute of
Internal Auditors, Inc., Altamonte Springs, FL, 1992.
Kalbers, L.P., An Examination of the Relationship between
Audit Committees and External Auditors, Ohio CPA
Journal, December 1992, pp. 19-27.
Mautz, R.K. and Neumann, F.L., The Effective Corporate Audit
Committee, The Internal Auditor, July-August 1973, p. 28.
Pelfrey, S. and Peacock, E., How Internal Auditors View
External Auditors, Internal Auditing, Vol. 6, Fall 1990,
pp. 12-21.
Perry, W.E., Effective Audit Committees, The Internal Auditor,
August 1977, p. 9.
Pomeranz, F., How the Audit Committee Should Work, Journal
of Accounting, Auditing and Finance, Fall 1977, p. 19.
Price Waterhouse, Improving Audit Committee Performance

What Works Best, The Institute of Internal Auditors
Research Foundation, Maitland, FL, 1993.
Professional Standards Committee, Statement on Internal
Auditing Standard No. 7., Communicating with the Board of
Directors, Institute of Internal Auditors, Altamonte Springs,
FL, 1989.
Schiff, M., Sorter, G.H. and Wiesen, J.L., The Evolving Role of
the Audit Committee, Journal of Accounting, Auditing and
Finance, Fall 1977, p. 19.
Securing Responsible Corporate Governance and Reliable
External Financial Reporting, Proceedings of Fourth AsianPacific Conference on International Accounting Issues,
California State University, Fresno, CA, 1922, pp. 100-6.
Stamp, E. and Moonitz, M., International Auditing Standards,
CPA Journal, June-July 1982, pp. 24-32.
Urbancic, F., Auditor Communications with the Board of
Directors, Internal Auditing, Vol. 6, Winter 1991, pp. 11-16.
Verschoor, C.C., Building a More Effective Audit Committee,
National Association of Corporate Directors, Washington,
DC, 1989.
Verschoor, C.C., The Aftermath of Audit Committee
Ineffectiveness at MiniScribe, Internal Auditing, Vol. 6,
Summer 1990, pp. 25-8.
Verschoor, C.C., Cadbury Committee Report Has Value for US,
manuscript submitted for the Faculty Research Award,
Institute of Internal Auditors, (Chicago Chapter), Chicago, IL,
1993.
Verschoor, C.C. and Liotta, J.P., Communicating with Audit
Committees, Internal Auditor, Vol. 47, April 1990, pp. 42-7.
Wallace, W.A., Auditing, Macmillan., New York, NY, 1992.
Williams, H.M., The Emerging Responsibility of the Internal
Auditor, The Internal Auditor, October 1978, p. 45.
Rocco R. Vanasco is Chair of the Research Committee of the Institute of Internal Auditors Chicago Chapter, Chicago,
Illinois, USA.

Vanasco 1994

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The Audit Committee: An International Perspective

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