Editor’s Note: This is the third in a series of articles by the author, Robert G. Hensley, on policies and procedures dealing with accounting and regulatory issues.

The origin of the modern audit committee dates back to 1939 when the New York Stock Exchange recommended that public companies have an audit committee. The role of the audit committee has evolved over time, and now the Sarbanes-Oxley Act of 2002 (“SOX Act”) requires public companies, including cooperatives that register their stock with the Securities and Exchange Commission (“SEC”), to have an audit committee. The SOX Act provides:

The audit committee of each issuer, in its capacity as a committee of the board of directors, shall be directly responsible for the appointment, compensation, and oversight of the work of any registered public accounting firm employed by that issuer (including resolution of disagreements between management and the auditor regarding financial reporting) for the purpose of preparing or issuing an audit report or related work, and each such registered public accounting firm shall report directly to the audit committee.

The SOX Act does not require that private cooperatives (those that do not register their stock) have an audit committee. However, a recent survey by the National Association of Corporate Directors found that 80% of private companies have an audit committee. Frequently, the bylaws of a cooperative will contain a provision requiring an audit committee, or it may be that your lender has required an audit committee. In addition, following the passage of the SOX Act, most auditing firms are strongly recommending that private companies, such as private cooperatives, have an audit committee. Likewise, most auditing firms are applying the same audit standards utilized for public companies to private cooperatives, further blurring the line of what is required by law and what is viewed to be a “best practice.”

In addition to federal requirements, there are state laws that have been recently adopted or are under consideration that would require an audit committee for a private cooperative. For example, a cooperative formed under Minnesota Statute 308B.445 is required to have an audit committee. California has adopted a state statute that mirrors some of the requirements of the SOX Act and has proposed legislation that would apply to private companies, including private cooperatives.

Once your cooperative has established an audit committee, the cooperative should adopt a charter or other policy outlining the function of the committee. Even if your cooperative does not have a separate audit committee, the Board as a whole is by default performing the function of the audit committee, and the Board should consider adopting an Audit Review Policy or other policy which essentially mirrors the charter that would be followed if the cooperative did have a separate audit committee.

The Audit Committee Charter

The audit committee of a private cooperative should probably meet two to four times a year, or more often if dictated by special circumstances. The purpose of an audit committee charter is to outline the responsibilities of the audit committee so that committee members are clear on the task they are supposed to perform. In general, the audit committee is appointed by the Board to assist the Board in monitoring (1) the integrity of the financial statements of the cooperative, (2) the compliance by the cooperative with legal and regulatory requirements, and (3) the independence and performance of the cooperative’s internal and external auditors. The audit committee charter should be written, and is usually 3 to 5 pages in length. The role of the audit committee can be broken down into several components, some of which are outlined below:

Hiring the Independent Auditor

  • Review the experience and qualifications of the auditing team
  • Hire/recommend to the Board the hiring of the auditor
  • Approve the retention of the auditor for any non-audit services
  • Approve the fees paid to the auditor
  • Consider/establish a policy rotating the lead audit partner

Planning and Supervising the Independent Audit

  • Meet with the auditor to review the planning and staffing of the audit
  • Review with the auditor any significant risk exposures
  • Inquire as to the auditor’s view about whether management’s choice and application of accounting principles is aggressive, moderate, or conservative
  •  Inquire as to the auditor’s view about the clarity of management’s financial disclosure practices
  • Meet periodically in separate sessions with management and the auditor to discuss any matters the committee believes should be discussed privately
  • Instruct the auditor that the auditors are ultimately accountable to the Board of Directors, through the audit committee
  • Review the results of the audit with the independent auditor and management
  • Review with the independent auditor any difficulties the auditor may have encountered and any management letter provided by the auditor (including the cooperative’s response to that letter)

Interaction with Management

  • Meet at least annually with the chief financial officer (or equivalent)
  • Obtain annual certifications from the CEO and CFO (or equivalent) that they have made appropriate financial disclosures to the auditor and the audit committee
  • Review the cooperative’s major financial risk exposures and the steps management has taken to monitor and control such exposures
  • Review the audited financial statements with management
  • Establish and periodically review a Whistleblower Policy
  • Establish and periodically review a Code of Ethics

Size and Composition of the Audit Committee

It is not unusual for a private cooperative to have the Board of Directors perform the function of the audit committee. However, the burden on the time of directors may require that the cooperative establish separate committees to divide the workload (e.g., compensation committee, member relations committee, audit committee). When a committee is created, the typical audit committee contains from three to five members. With respect to the composition of the audit committee, the SOX Act requires that a public company disclose whether or not the audit committee contains a financial expert. An audit committee for a private cooperative should be comprised of individuals with a range of talents, including members who:

  • Have a financial background and relevant accounting expertise
  • Are independent of management and are willing to ask probing questions
  • Have relevant business experience

Keeping Minutes and Reporting to the Board

It is important that the audit committee keep written minutes of its meetings. While the minutes do not need to be a verbatim transcript of every meeting, the minutes should reflect the identity of the people present, the nature of the items discussed, and the decisions reached by the committee. The audit committee, usually acting through the chair of the audit committee, may elect to make a verbal report at the periodic meetings of the Board of Directors. The verbal report should be recorded in the minutes of the Board meeting. Instead of verbal reports, many audit committees have elected to submit a written report to the Board of Directors so that the written report can be reviewed for completeness by all members of the audit committee prior to submission to the Board.

Summary

Most cooperatives conduct an annual independent audit of their financial statements. Even in situations where the Board as a whole is responsible for hiring and supervising the auditors, the cooperative should have a written policy in place that governs how the audit is conducted. If the cooperative has formed a separate audit committee, the Board should establish an Audit Committee Charter so that the functions and expectations of the committee are clear. The adoption of a written charter also serves as a type of checklist for the audit committee during the course of the year. Adopting a written charter should add a level of consistency from year-to-year with regard to the tasks performed by the audit committee, hopefully leading to more consistent accounting and audit review practices.