This year will pose significant challenges for boards and their audit committees. When considering and carrying out their 2009 agendas, the following items should be high on the list:
1) Closely monitor the impact of the financial crisis/recession on the company; focus on financial forecasts and early warning indicators. Understand the recession's impact on the company's earnings, cash flow, liquidity, and compliance with debt covenants, and monitor key indicators of trouble. Recommend that management assemble a crisis-management team to monitor the impact of the crisis on a "realtime" basis, and to develop and stress-test worst-case scenarios. A strategic response to this crisis is critical.
2) Assess the company's exposure to third parties in financial distress. Ensure that management is monitoring the impact of the crisis on the company's key customers, suppliers, insurers, partners, banks, underwriters, counterparties, and other third parties that may be experiencing financial difficulty (or have filed for bankruptcy). An up-to-date inventory of potential exposure to third parties is essential.
3) Understand the impact of the financial crisis on the company's financials— particularly the balance sheet. Focus on the investment portfolio, including debt and equity securities, to identify declines in value or impairments that should be reflected in the financials. Help ensure that management has identified possible impairments of goodwill, deferred taxes, patents, and other intangibles, and that fair values determined by management and valuation experts are reasonable. Assess how changes in financial markets have impacted the valuation of pension plan assets and funding requirements.
4) Focus on fair value and liquidity disclosures. Understand the company's disclosure processes for fair value accounting and liquidity issues—and how the application and impact of fair value accounting is described in the MD&A and other periodic filings. Consider whether the description of the company's liquidity risks is sufficiently robust and specific to the company.
5) Make sure your risk discussions with management are healthy and productive. With the benefit of hindsight and possible "lessons" from the financial crisis, consider the adequacy and effectiveness of the company's governance processes for managing risk (management's processes and the board's). Be a catalyst in helping to pose the right questions, including: Can management provide a holistic view of the company's major risks—both on and off the balance sheet? Are the top risks facing the company understood and agreed upon? How rigorously does management stress-test key risk assumptions?
6) Help the company and the board prepare for change. With the financial crisis and globalization changing the world in dramatic ways, step back and consider what the emerging business environment will look like. Does management understand how this new environment will impact the company's risk profile, and the viability of its strategy and business model? And keep International Financial Reporting Standards (IFRS) on the radar, given the potential scope and scale of conversion.
7) Pay attention to the basics of effective oversight.Make sure the audit committee has the right mix of committee member experience and skill sets, committee independence and leadership, an understanding of the company's strategy and financial risks, and the adequacy of support for the audit committee.
8) Be sensitive to the strains on the CFO, internal auditor, and finance organization. The demands of the financial crisis on liquidity and cash flow, possible resource constraints, and pressures to meet performance expectations have all exacerbated the normal rigors of the CFO's and finance teams' jobs. Recognize their critical role by helping to maintain the focus on long-term financial performance, injecting objectivity into financial disclosures, and ensuring they have the right expertise and resources (including the budget) to do their jobs well.
9) Expand the audit committee's information sources. Consider whether the information the audit committee receives comes from a balanced variety of sources (versus relying too heavily on information from management), and whether the information flow promotes sufficient internal transparency (versus fragmented or partial views). Getting the right information is essential to providing effective oversight of the company's financial reports, its risks, internal controls, and finance team.
10) Monitor the tone from leadership and throughout the organization. In this environment, it is more important than ever to be acutely sensitive to the tone from—and the example set by—leadership, and to reinforce a culture of compliance and a commitment to financial reporting integrity throughout the organization.