EY: Audit committees face key challenges in 2018

Dec 18, 2017
Changes may require audit committees to improve their effectiveness

Audit committees face a range of testing changes in the new year, ranging from revised revenue reporting and CEO pay disclosure to new regulatory leadership and US tax reforms.

‘As audit committees grapple with challenges and an evolving business landscape, many are seeking guidance to enhance their operating effectiveness to better serve as a strategic asset for the organization,’ according to an end of year review by EY’s Center for Board Matters.

The Financial Accounting Standards Board (FASB) is introducing its new revenue recognition standard in January 2018 and a new leasing standard in January 2019. The authors of the EY report say work should already be underway on implementing these standards, and that the audit committee will be crucial in evaluating whether additional disclosures are needed to explain the changes.

‘Once they adopt the new [revenue recognition] standard, registrants may need to make more disclosures about the judgements and assumptions underlying revenue recognition within their management’s discussion and analysts of critical accounting estimates,’ the EY authors note.

Microsoft has given a demonstration of how to tackle such changes well. The company adopted the revenue recognition standard early and produced a range of new disclosures and interactions with its investors – from restated financials and guidance, to hosting analyst days to explain how the new standard changes the way the company reports revenue (IRMagazine.com, 12/4). The company was recently given an award by Pace University, having been praised by investors and analysts for its handling of the new standard.

EY also points to the SEC’s looming CEO pay-ratio rule as demanding a new disclosure that audit committees will have to engage with in early 2018. The agency is requiring public companies to report its CEO pay relative to its median employee pay in its proxy statements for the first time.

‘While compensation committees have taken the lead on addressing the pay-ratio disclosure requirement, audit committees should work with the compensation committee to help establish the reasonableness of the estimates and methodologies used to calculate the pay ratio,’ the authors write.  

SEC DEVELOPMENTS

There will be significant changes next year in the top ranks of regulatory bodies with the greatest impact on audit committee. The SEC recently announced the appointment of five new directors, including a new chair, to the board of the PCAOB. Meanwhile the SEC, which oversees the PCAOB, is waiting for Senate approval of two commissioners – Hester Peirce and Robert Jackson – at which point it will have a full complement of members.

EY points out that one of SEC chair Jay Clayton’s stated priorities is capital formation. He has targeted streamlining financial reporting and can now move forward on that front in 2018.

The PCAOB in 2019 is implementing an updated standard requiring auditors to report on their own tenure with companies, which EY warns may prompt questions from investors. ‘While transparency has increased steadily over the past three years, several recent and upcoming regulatory developments, such as the PCAOB’s revised standard on the auditor’s report and the SEC’s ongoing disclosure effectiveness project, may contribute to further consideration of audit-related disclosures in the coming years,’ the EY authors note.

US TAX REFORM

With Republicans in Congress keen to pass a new tax bill before the end of the year, EY’s Center for Board Matters provides the following recommendations for audit committees:

  • Monitor tax policy changes and developments – both actual and potential – in key jurisdictions
  • Make certain that management models the potential impact of tax reforms that might affect any aspect of company tax strategy
  • Communicate and engage with local and global policymakers about the potential impact of tax policy changes to ensure that they understand the business implications of any legislation.
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