10 minute read 30 Jun 2022
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How audit committees can prepare for 2022 Q2 reporting

By Pat Niemann

EY Americas Audit Committee Forum Leader

Community champion. Family man. USC Trojan alum.

Contributors
10 minute read 30 Jun 2022

In this quarterly review of issues affecting audit committees, we summarize key developments for audit committees to consider.

In brief

  • Inflation, rising interest rates, supply chain disruptions, and market volatility continue to be a significant focus area for audit committees.
  • Audit committees should consider how to prepare for potential regulatory changes that may impact reporting requirements, disclosures and enforcement trends.
  • Audit committees are looking for more from the internal audit function on environmental, social and governance matters.

Presented by the EY Audit Committee Forum

The audit committee role grows more demanding and complex amid fast-paced change, and this report will assist audit committees as they proactively address recent and upcoming developments impacting Q1 reporting and beyond.

Risk management

Given the ongoing changes in the business environment, it remains critical for audit committees to stay on top of critical drivers of risk (e.g., political, economic, societal, technological, legal, and environmental) and changing macroeconomic conditions (e.g., impacts stemming from inflationary pressures, rising interest rates, recession risk) to better assess the near- and longer-term risk implications to companies. Additionally, after a protracted period of operating in survival and stabilization mode, organizations are starting to turn their attention to enhancing enterprise resiliency and investing boldly for optimal growth and transformation. As management teams balance near-term imperatives — geopolitics, talent, supply chains, security — with long-term endeavors such as digital strategy, global taxation or the focus on environmental, social and governance (ESG) matters, it is important to consider key actions. Read more.

Accounting and disclosures

Organizations continue to be affected by macroeconomic factors, such as inflation, rising interest rates, supply chain disruptions and market volatility, as well as the war in Ukraine and its ripple effects. We anticipate that audit committees will continue to evaluate these evolving impacts and changes in the business environment on their financial reporting processes.

Companies should continue to update their disclosures about the effects of the current market conditions (e.g., inflation, pandemic) and their expectations for the future. It will be important for audit committees not only to understand management’s view of future economic conditions, but also validate that the organization provides transparent disclosures regarding these views.

  • Highlights from conversations between the Public Company Accounting Oversight Board (PCAOB) and audit committee chairs

    In March 2022, the PCAOB released its 2021 Conversations with Audit Committee Chairs report, which summarizes the conversations the PCAOB inspection teams had with more than 240 audit committee chairs of US public companies. This PCAOB report provides insight into some of the key issues that audit committee chairs are focused on. Some key highlights and excerpts from this PCAOB report include:

    • The required communication areas that generated the most discussion with auditors in 2021 related to accounting policies and practices, with goodwill accounting and impairments, accounting implications of the COVID-19 crisis, revenue recognition, and recording credit losses being the top topics discussed.
    • Some audit committee chairs noted spending significant time with the auditors discussing matters related to controls – most notably in the context of cybersecurity incidents, implementation of information technology, and the impact of spinoffs and other transactions related to capital structure.
    • Beyond required communications, audit committee chairs are seeking the auditor’s perspectives on management/tone at the top, big-picture business trends, and the regulatory state of play in financial reporting and standard setting. 
    • When it comes to discussing auditor strengths, audit committee chairs cited appreciation for comprehensive, timely and focused communication (both formal and informal) from their auditors. Audit committees also expressed appreciation for the auditor’s ability to highlight and bring key issues to the forefront, including holding “deep dives” or educational sessions on noteworthy or emerging topics (such as mergers and acquisitions, cybersecurity, and the use of technology in the audit).
    • Areas of auditor improvement that were most frequently flagged included instances of poor communication, work left to the last minute, and turnover on the audit team.
    • Of the audit committee chairs who discussed information outside of the audited financial statements, approximately 70% of audit committee chairs cited ESG as a key discussion topic and issue that was gaining prominence on many audit committee agendas.

    Source: PCAOB’s Spotlight: 2021 Conversations with Audit Committee Chairs, March 2022

  • How can internal audit accelerate ESG strategy and performance?

    With environmental, social and governance (ESG) considerations growing in prominence, audit committees are revisiting internal audit’s audit scope and expecting more from their internal audit functions on ESG-related matters. Below are six ways that leading internal audit functions are incorporating ESG into their internal audit agenda:

    ESG risk and the role of internal audit

    SEC and other reporting considerations

    The SEC has continued to issue new rule proposals in Q2, although the pace of rulemaking slowed down somewhat compared to Q1. Its activities have included proposed new ESG-related disclosures for investment funds and advisors and rule changes relating to special purpose acquisition companies (SPACs). Still expected are SEC proposals to require disclosures on board diversity and human capital.

    The SEC has taken several actions relating to climate disclosures. In May, the SEC extended the comment period on its proposed new rules to enhance and standardize disclosures that public companies make about climate-related risks, their climate-related targets and goals, their greenhouse gas (GHG) emissions and how the board of directors and management oversee climate-related risks. The proposed rules would also require registrants to quantify the effects of certain climate-related events and transition activities in their audited financial statements. The extension of the comment period is intended to provide the public additional time to analyze the issues and prepare their comments, given the extensive interest in the proposals. Also in May, the SEC proposed rules to require investment advisors and investment funds to disclose information about ESG investment practices, including requiring certain environmentally focused funds to disclose the greenhouse gas emissions associated with their portfolio investments.

    The SEC also has proposed requiring new disclosures when a special purpose acquisition company (SPAC) conducts an initial public offering (IPO) and when it combines with a private operating company in what is known as a “de-SPAC transaction.” The proposal would also subject SPACs, underwriters and their private company targets to liability under the securities laws. The proposal is intended to more closely align the disclosure requirements and legal obligations of parties involved in de-SPAC transactions with those in traditional IPOs.

    Other new SEC rule proposals address investment company names, security-based swap execution, and regulation and registration of security-based swap execution facilities.

    Given the number of SEC rule proposals that have been issued in recent months, audit committees should consider how their companies should be preparing for potential regulatory changes, which could impact reporting requirements, related disclosures and enforcement trends. Find out key actions for audit committees.

Questions for the audit committee to consider

In discussions with management, compliance personnel and auditors, audit committees should consider the following in addition to standard inquiries:

  • Risk management-related inquiries

    • How is the company seizing strategic opportunities to tap into larger talent pools? How is the organization nurturing its existing and future talent pools (e.g., reskilling and upskilling, educational alliances) to position the company to meet current requirements, address enterprise risks and prepare for continued strategic pivots?
    • What processes does management have in place to accelerate idea generation, trialing and assessment while also encouraging appropriate risk-taking? What more can be done to accelerate digital transformation efforts and foster a culture of innovation? 
    • How is management understanding and monitoring the effectiveness of risk management of critical third parties with respect to financial and operational resiliency; IT security; data privacy; culture; and environmental, social and governance factors? 
    • In the event of a ransomware attack, what protocols and criteria will be considered to determine whether/when/how ransom will be paid? For example, what are the insurance protocols? Should the organization have a ransom negotiator on retainer? Do system backups exist and what is the projected speed of deployment? If ransom is paid to an ill-defined attacker located in an unknown location, what regulatory and legal implications might inadvertently be triggered?
    • What, if anything, is management doing to plan for potential tax policy changes in response to the OECD Pillar 2 global minimum tax model to which 144 countries (including the US) have agreed thus far? In particular, is management monitoring proposed tax legislation to adopt the Pillar 2 rules in the US and elsewhere? What is being done to address the expected increase in worldwide corporate effective tax rates and the systems and control enhancements that will be required to track new tax regimes as they are legislated? Is management planning any internal restructuring transactions to mitigate the increased worldwide taxes that may occur once any country represented within the consolidated reporting entity legislates the Pillar 2 principles triggering the accounting for the entire group?   
    • Does management have the resources within the tax function to keep pace with, and evaluate the impacts to the company of, the OECD global minimum taxation and new environmental/carbon taxes being legislated globally on a quarterly basis?
    • Have the organization’s tax planning strategies been re-evaluated to address possible shifts in supply chain, workforce (including tax implications of continuing remote work) and capitalization?
    • What more can and should be done through technology, training and manager support to optimize connectivity, engagement, security, and productivity?
    • Has the organization revisited and updated its training programs to consider the current and changing business landscape, new controls, new systems, and revised regulations?
    • How is the organization monitoring compliance with federal, state and local regulations and health guidelines, employee/customer health and safety, privacy and confidentiality?
    • Have there been any meaningful changes to the company’s key policies, any material exceptions granted or any unusual allowances to any compliance provisions?

    Source: PCAOB’s Spotlight: 2021 Conversations with Audit Committee Chairs, March 2022

  • Accounting, disclosures and other financial reporting related inquiries

    • What are the nonrecurring events and circumstances that have transpired and what are the related financial reporting and disclosure implications? 
    • In light of the current environment (including the macro market conditions), has the company evaluated how current market developments may change the value of assets and whether there are impairment indicators for assets such as property, plant and equipment; definite and indefinite-lived intangibles; inventory; receivables; debt; and equity investments? Have the valuation technique(s), inputs and assumptions been appropriately revisited and updated?
    • Are the company’s nonfinancial disclosures fit for purpose given current investor stewardship priorities, investing trends and related investor data needs? 
    • Does the company have sufficient controls and procedures over nonfinancial data? Is internal audit providing any type of audit coverage on ESG-related data, or is the company obtaining any external assurance?
    • If ESG-related matters are being discussed in more than one place (e.g., SEC filings, earnings releases, analyst communications, annual report and shareholder letter, sustainability report), is there consistency in the disclosures? 
    • Has the company evaluated its disclosures in light of Institutional Shareholder Services’ addition of 11 cyber-specific inquiries related to cyber risk?
    • How is the organization proactively assessing the opportunity to enhance stakeholder communications, including corporate reporting to address changes in operations and strategies as well as changing stakeholder expectations? 
    • Have there been any material changes to internal controls over financial reporting or disclosure controls and procedures to address the changing operating environment? Have any cost-saving initiatives and related efforts impacted resources and/or processes that are key in internal controls over financial reporting? If so, has management identified mitigating controls to address any potential gaps?
  • Inquiries to auditors

    • Can financial reporting, compliance and auditing procedures (internal and external) continue to be adequately performed through a combination of physical and remote working procedures? What options are there to perform alternative procedures to facilitate timely collection, processing and reporting of information for internal use and to prepare regulatory filings?
    • External auditors: What changes are anticipated with materiality, scope, and additional procedures in light of changes in the current business environment? What are the potential impacts arising from the complete or partial transition back to the office on the audit? Has the engagement team identified any incremental risks and/or adjusted its audit response in light of the war in Ukraine? If so, what are the impacts to the engagement’s audit strategy and overall approach to the interim reviews? How has the engagement team considered changes to the incentive, opportunity and rationalization of the fraud triangle? 
    • Internal auditors: How should audit plans be adjusted to address changes in risk appetite and tolerances as identified from the company’s ERM program? Are there any audit plans that are not being executed, or has the scope of the work been changed?

Summary

As another quarter closes, audit committees stay focused on the issues most affecting financial reporting. They can consider taking key actions on areas of risk management, disclosures and reporting.

About this article

By Pat Niemann

EY Americas Audit Committee Forum Leader

Community champion. Family man. USC Trojan alum.

Contributors