Audit Committee Responsibilities and the Risk of Restatement

Accounting judgments about revenue recognition, accruing losses and assessing fair value are principally the responsibility of management. A company’s audit committee functions in an oversight role over financial reporting and must assure itself that the financial statements are reasonably accurate, complete and fair. Ultimately, some accounting judgments will be subjected to audit. The audit committee has the primary oversight role and is the agency of communication with the company’s independent auditors.

As a result, it is important that management and the audit committee understand the areas in which the company makes significant accounting judgments. A best-practices approach should be developed to apply in those situations.

The exercise of accounting judgment can lead to a restatement – an admission that a company’s past financial statements were materially inaccurate – which may expose the company to considerable risk. The authors suggest that members of the audit committee spend time with C-suite management on at least a quarterly basis, to understand the accounting judgments being made and management’s approach to them.

Questions to ask include: Do the critical accounting policies and judgments described in the notes to financial statements accurately reflect current realities? Have there been significant changes in business that impact accounting? Have there been any unique or significant transactions during the period?

The authors describe the areas of accounting in which most restatements originate, and provide a list of best practices to avoid material inaccuracies.