A Change in Reporting Structure
 
Edited by Michael D. Marinaccio
 
 A chief audit executive's plan to alter his reporting relationship is potentially derailed.
 

Jim is the newly appointed chief audit executive (CAE) at a large, global manufacturer. The company is admired as an industry leader and prides itself on strong corporate governance practices. Its board consists of qualified, independent directors from outside the company, and the audit committee has its own charter and a chair with extensive industry experience. Moreover, the committee meets individually with both the CAE and the outside auditor in executive session on a regular basis, and its chair serves as the committee’s designated financial expert.

Jim was hired by, and reports to, the chief financial officer (CFO). The CFO prepares the audit committee agenda and presides over the meetings. During the hiring process, senior management — including the CEO and the CFO — expressed to Jim its support for the internal audit function. The company’s internal audit function is well established and consists of 10 employees.

Shortly after joining the company, Jim received a phone call from the audit committee chair welcoming him aboard and affirming the committee’s full support of him and the internal audit function. The chair suggested they meet to discuss Jim’s vision and intended future direction for the audit function. He also suggested they communicate regularly outside the formal committee meetings to allow for open dialogue.

Jim is preparing for the upcoming audit committee meeting, where he plans to present the next year’s internal audit plan and budget. He has also been reflecting on The IIA’s International Standards for the Professional Practice of Internal Auditing (Standards) as they relate to the CAE’s reporting responsibilities to management and the board. Accordingly, Jim is drafting a proposal and presentation for the CFO, CEO, and audit committee chair that would change his current reporting relationship.

As the company enters its fiscal year-end, the CFO stressed firmly at a recent staff meeting that he wants everyone to focus on completing the company’s annual close process and U.S. Securities and Exchange Commission filings. Furthermore, he announced that he was not interested in making any changes in reporting relationships or to the audit committee agenda at this time.

What are Jim’s reporting responsibilities to the audit committee? How should he proceed with the CFO and the audit committee chair?

 

Nancy Haig, CIA, CBA, CFE, CCSA, CFSA, CICA
Vice President, Internal Audit
Eisai Inc.

Although the trend of reporting to the CFO is declining, many CAEs continue to have this reporting relationship. Jim should keep in mind that he is working for a reputable company with strong governance practices. He knew the reporting structure when he accepted the position as CAE, and he will have the opportunity to meet individually with the audit committee chair. But discussing a reporting relationship change with his new boss, the CFO, during a year-end close would be unwise.

That said, Jim should accept the audit committee chair’s invitation for open dialogue, in part to cultivate this important relationship. According to The IIA’s Standards Jim, as the CAE, must communicate and interact directly with the board and report periodically to the board and senior management “on the internal audit activity's purpose, authority, responsibility, and performance relative to its plan.” The existing administrative reporting relationship may prove irrelevant if Jim develops an effective working relationship with the audit committee chair and the board and also participates in the committee’s executive sessions. If Jim has any future concerns regarding the CFO’s activities or the integrity of financial reporting, he will have established his credibility and the appropriate channel of communication will be available to him.

 
Michael A. Barry
Vice President, Internal Audit
Iron Mountain

Jim finds himself in a dilemma largely of his own making, having accepted a position without gaining clarification from his new manager on a key governance issue related to the CAE reporting structure. He must now decide how to discuss a concept with which his manager may not be comfortable and about which the Standards indicate a preference, but no firm requirement. Although Jim’s reporting structure is not prohibited, it is not preferred.

Jim’s manager, the CFO, controls the audit committee agenda and presides over committee meetings. Ownership of the agenda equals ownership of the information flow. Nonetheless, Jim’s company has adopted many effective practices. Management “takes pride in having strong corporate governance policies”; the audit committee comprises “qualified and independent” members; and structures are in place to ensure effective communication, including an executive session with the CAE. In addition, the audit committee has its own charter, and the committee chair has suggested communicating regularly with Jim outside of formal meetings.

Jim must exercise care to avoid adversely affecting his present relationship with the CFO. The CAE–CFO relationship is critical to sound corporate governance. He should inform the CFO of his invitation to meet the audit committee chair to discuss his departmental vision and explain that it will align with IIA Standards and other governance authorities. Jim should also explain that the meeting will provide an opportunity for him to present a balanced view of the proposed reporting structure, emphasizing the need for — and benefits of — transparency and independence.

 

Daniel DiTomasso, CPA, CIA, CISA
Consultant

Jim’s reporting responsibilities to the audit committee are covered in The IIA’s Attribute Standards 1000, 1010, 1100, 1110, and 1111 and in Performance Standard 2060 — he should consult each of these sections before proceeding. Jim should also review the current internal audit and audit committee charters and note any long established company practices. Additionally, he should review the time line and format of past years’ audit committee minutes and companywide presentations.

To help foster a positive working relationship, Jim should first discuss his suggested reporting change with the CFO as a professional courtesy. He should then discuss the same details with the audit committee chair. His proposed changes and rationale should be consistent with The IIA’s Standards, and they should be presented to both individuals well in advance of formal meetings and discussion. Moreover, the CFO’s present focus on successful execution of the company’s annual close process is of paramount importance. If the parties agree on the merit of a reporting change, they could then plan a suitable time line for the transition, ensuring it does not interfere with the close or the execution of the next year’s internal audit plan and budget.

Lastly, Jim should use the audit committee chair’s invitation for open dialog as an opportunity to discuss the draft internal audit plan and budget as well as the current reporting protocol and potential repercussions of any changes. He should also be sure to gauge the current relationship between the audit committee chair and the CFO. Should the chair ask about the future direction and vision of the audit function, Jim should explain that he has not yet discussed it with company management. If the chair is open to continuing the discussion, Jim should present his rationale for the desired changes as part of his functional responsibilities to the audit committee.

 

How would you handle this scenario? Continue the discussion by sharing your comments below.

 


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Sharing of Audit Rating for Feedback Prior to Issuance of Audit Reports
Dear all, please guide in light of the international best practices that:- 1- Whether auditors should share audit ratings or not to auditee's Sr. management for their prior concurrence/feedback before issuance of final ratings in final audit reports? 2- Would this action will impair the independence of the auditors or not? As I don't find any solution in PG on Formulating and Expressing Internal Audit Opinions and PG on Independence and Objectivity.
Posted By: Ejaz Rasul
2012-06-20 1:09 AM
A Change in CAE Reporting Structure
I agree with what Mike Barry; Dan and others state namely the CAE ought to report to the Audit Committee as the CAE needs to be the "eyes" and “ears” of the Audit Committee and should enjoy full independence to do his/her job. Unfortunately many organizations do not follow what IIA recommended after various frauds perpetrated (that word was considered an "anathema" for audit community once!. This has become very conversant use today, after various frauds perpetrated by huge corporations like Enron (see the list http://www.corporatepredators.org/top100.html) that forced professional body of auditors to really focus on "independence" of auditors [including IIA’s recommendation] in corporate sector for the past 8 years. However, some corporations still follow the same "formula" to possibly cook books, with no one reporting it. SEC gets after them after many years, like they did with Bernard Madoff who defrauded billions of investor money. Probably the Audit Committee might want to watch over the CFO, because of that bitter investigation and bad publicity, and hence the CAE ought to meet with (with or with out the blessing of the CFO, which the CAE may never get; (redflag?)] to educate if the Audit Committee (if they did not know about the IIA recommendations) on CAE reporting structure. Since Jim received a call from the AC Chair affirming the committee’s full support of him and the internal audit function. The chair suggested they meet to discuss Jim’s vision and intended future direction for the audit function; also suggesting they communicate regularly outside the formal committee meetings to allow for open dialogue", Jim should respond over phone that he could accomplish the AC Chair's wishes, if the reporting structure is amended per IIA's recommended reporting lines and THEN prepare his proposal before surprising his CFO and CEO. I have done that successfully in my prior job and the Audit Chair changed the reporting structure to report directly to the Audit Committee at that same meeting for good!
Posted By: Sam Kulumani
2011-02-03 9:38 AM
A Change in the Reporting Structure
The healthy environment of internal auditor and functions is this ,his reporting requirement should be implicit and composite of checking company's fund management and employment to its objective and not personal or throw away uses. Jim as CAE should not be required to report CFO, rather he should be required to report managing director but preferably executive committee of board of directors of the company. Internal audit function should be the line-management and should not be under the finance function , whose work and activity have to be watched as supervisory authority,which will carry independence of object of audit to the end user of authority ,like, board of directors. Further internal audit function should not conflicting to become useless and timeless attitude in the organization, rather it should be independent departments responsibilty to perform their tasks and standards. Jim in his audit plan should outline the job tasks of 10 employees in the audit function of the company. Jim should report and show his expertise as executory approach of audit. He should review the existing system of internal controls and also he should suggest some improvement in the system , as accountable and acceptable aspects, to the audit committee. He should include in his report , outline and analyse certain points from internal audit standards; he can include areas to watch and report which was lying pending; he can draft in his report certain financial indicators with analytical approach and any reason come arrive; he can include in his plan to measure and analyse the company's financial budget , by this he can manage to his give understanding an executory approach to the audit committee. Regards Rashid Pervez ACIS,PFA, CA (finalist), ACMA (finalist) Member IIA - Karachi Chapter, Karachi, Pakistan. Tel: 9221-34821075 0333-2238406 Address : Flat#305, Block B-3, Savana City, Block 13-D-3, Gulshan-e-Iqbal, Karachi,Pakistan.
Posted By: Rashid Pervez
2010-06-30 4:31 PM


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