The AGA Weblog

Systemic Risk and the Art of Listening

By: Sunil Datt, MBA, CGFM, PMP

Sunil Datt, MBA, CGFM, PMP, is Senior Managing Consultant, IBM Global Business Services.

New adage: A transmitter has no use if the receiver does not function.

Old adage: You can take a horse to the pond, but you cannot make him drink.

New version of old adage: You can take the pond to the horse, and still not make him drink.

If you ever sat in on a class or read a book on financial risk, or were a central banker, commercial/investment banker, financial regulator etc., the term ‘systemic risk’ was the one that gave you goosebumps or kept you awake at night, depending on your level of direct responsibility. And if you wanted someone’s attention, the mention of systemic risk was sure to stop them in their tracks; or in terms of the adages above, would make the horse drink immediately, and make the receiver very receptive!

And yet, no such thing happened when the GAO issued its October 2004 report titled, “Financial Regulation: Industry Changes Prompt Need to Reconsider U.S. Regulatory Structure.” In its very first paragraph the report pointed out that, “While the financial services industry and the international regulatory framework have changed, the regulatory structure for overseeing the U.S. financial services industry has not.” In addition, “no one agency or mechanism looks at risks that cross markets or industry segments or at the system and its risks as a whole.” The report was sent to the House Committee on Banking, Housing and Urban Affairs and the Committee on Financial Services; the Secretary of the Department of the Treasury; the Chairman of the Board of Governors of the Federal Reserve System; the Chairman of the Federal Deposit Insurance Corporation; the Comptroller of the Currency; the Director of the Office of Thrift Supervision; the Chairman of the Securities and Exchange Commission; the Chairman of the Commodity Futures Trading Commission; the President of the National Association of Insurance Commissioners; and other interested parties. Yet, it seems, no one was listening! Because listening, as opposed to hearing, has concomitant action inherent to it.

The only other weapon in GAO’s arsenal was the “High Risk” report. Surprisingly, the state of financial regulation did not move to that list in 2007 (the report is issued every two years), but now in 2009 when systemic collapse has already taken place, and a new administration has to deal with the crisis on a war footing. To continue with the analogies of the adages, it’s like trying to close the barn door after the horse has bolted.

Traditionally, the agency most concerned with systemic risk is the central bank, because the historically known systemic risks were banking collapses or runs on banks. But the risk of bank runs was largely contained by deposit insurance, and in the current crisis it was eliminated early by quickly raising the deposit insurance limit from $100,000 to $250,000 per depositor. In the current crisis, the risks arose from the excessive derivative securitization of all kinds of assets, the major being mortgage assets, and these risks then pervaded all sectors of the financial sector as the securities were traded worldwide. Surprisingly, even GAO did not cover housing finance, its institutions and possible systemic impacts in this report. It did mention another report where it had examined the issue of governance and oversight of Government Sponsored Enterprises (GAO-04-269T).

The issue was further complicated by the Gramm Leach Bliley Act of 1999 that blurred the distinctions among banking, securities and insurance activities. This further made the ‘functional’ model of regulation in the U.S. financial sector irrelevant as financial institutions now operated in multiple financial markets, but the regulators still stuck to their traditional roles—the Federal Reserve, OCC and FDIC for banks, the SEC for securities, and State Insurance Commissioners for the insurance industry.

All that being said, the point remains that once GAO pointed out the gaping hole in regulation of systemic risk, why was no action taken? There were discussions of which agency could fulfill that role, and there were fears expressed that such an agency would become super powerful. But those concerns were certainly not insurmountable.

The creators of the American method of government and regulation created a wonderful system of checks and balances to prevent the concentration of power in any one agency, and thus protect the freedoms so dear to us. But on the flip side, there appears to be no trigger that ensures action against red flags as prominent as systemic risk. Certainly, a conscientious public servant like David Walker can resign his position to draw attention to a massive red flag like our rising national debt, but can there be no better mechanisms? Suggestions invited.

Validation for Transparency and Accountability in Government

By: Rebekah Stephens

Rebekah Stephens in the Planning and Performance Coordinator, Metropolitan Government of Nashville and Davidson County.

In recent days we have heard President Obama commit his administration to ushering in a new era of transparency, accountability and accessibility in the federal government. 

In a Jan. 21 memo to the heads of executive departments and agencies, President Obama outlined his administration’s three principles for transparency and accountability in the federal government. These principles will serve as the foundation upon which federal agencies will develop a plan of action with the goal of not only making the federal government more accountable, but also engaging citizens in a meaningful way by using communication mechanisms that allow instant access and opportunities for feedback about the issues that matter most to the citizens.  

Below are the principles President Obama outlined in his memo:

Government should be transparent. Transparency promotes accountability and provides information for citizens about what their government is doing. Information maintained by the federal government is a national asset. My administration will take appropriate action, consistent with law and policy, to disclose information rapidly in forms that the public can readily find and use. Executive departments and agencies should harness new technologies to put information about their operations and decisions online and readily available to the public. Executive departments and agencies should also solicit public feedback to identify information of greatest use to the public.

Government should be participatory. Public engagement enhances the government's effectiveness and improves the quality of its decisions. Knowledge is widely dispersed in society, and public officials benefit from having access to that dispersed knowledge. Executive departments and agencies should offer Americans increased opportunities to participate in policymaking and to provide their government with the benefits of their collective expertise and information. Executive departments and agencies should also solicit public input on how we can increase and improve opportunities for public participation in government.

Government should be collaborative.  Collaboration actively engages Americans in the work of their government. Executive departments and agencies should use innovative tools, methods, and systems to cooperate among themselves, across all levels of government, and with nonprofit organizations, businesses and individuals in the private sector.  Executive departments and agencies should solicit public feedback to assess and improve their level of collaboration and to identify new opportunities for cooperation.

The memorandum, in its entirety, can be found at www.whitehouse.gov

Many state and local governments are already making great strides toward the very principles that President Obama outlines in his memorandum. For those that are, the focus on these principles at the federal level should serve as a reminder of their importance, even during difficult economic times. Citizens, now more than ever, are demanding proof that the tax dollars they invest in their city, state and federal government will produce the right results.  

How is your government incorporating the principles of transparency, participation and collaboration into its decision-making processes and daily operations?  

Please feel free to contact me at 615.862.6539 or rebekah.stephens@nashville.gov

Think Big! Act Courageously! Make a Difference! Community Service—Yes We Can!

By: William Morehead, Ph.D., CGFM

William Morehead, Ph.D., CGFM, a member of AGA’s Jackson Chapter, is the chair of Accountancy, Computer Information Systems and Finance at Delta State University in Cleveland, MS. He is AGA’s National President-Elect.

What a spectacular week! Regardless of how we voted last November, we can only be filled with American patriotism with the events of this week. President Obama has asked each of us to work together to make a difference in the future of our country. It’s purely coincidence that part of my presidential theme asks that we act boldly to make a difference. (I’d like to say we planned it this way, but that would be stretching things quite a bit.) I recognize AGA cannot be all things to all people, but we can work together to continue moving our association and our country forward.

Let me suggest one way you can join me and others to be involved in AGA as we work to make a difference in our country and the City of New Orleans.

One of the core values and strategic themes of AGA is Service. Our objective of “service” is to “provide members and customers with quality programs, products and services” and we include four key strategies to achieve our objective:

• Attract and retain a diverse and growing membership.
• Promote leadership roles at the National and Chapter organizational level.
• Provide opportunities for networking.
• Use innovative technological approaches and methods to provide programs, products and services. (for a complete discussion of the strategic theme of service go to: http://www.agacgfm.org/about/governance/longrange/service.aspx)

As I have visited and talked with many of our chapters, I have discovered that part of networking within our chapters includes their involvement in community service. This goes beyond our professional networking where we gather to discuss business related subjects; chapter community service involves individual members and their families working in soup kitchens, collecting items for various relief or service organizations, supporting causes relating to cancer research, children’s issues, battered women, and much more. Nationally, AGA has been involved in providing funds for AGA members and their families who lost loved ones on Sept. 11, 2001 and who were affected by the devastation of Hurricane Katrina. And, many of us participate in contribution to the National Community Service Fund each year as AGA raises funds at our PDC. Each of these is a worthwhile cause.

I want to bring your attention to one additional cause several AGA members have been involved in over the past two years and will again be involved in this coming April and June. I invite you to consider being involved as well. Past National President Jeff Hart has help coordinate a National Community Service project in New Orleans for each of the past two years where many AGA members have gathered in the Lower Ninth Ward to help rebuild New Orleans. I was able to join the group in 2008 for a day and what an awesome experience. I encourage you to join the effort in 2009. Here is information on how you can be involved:

Community service and helping those that are less fortunate than ourselves is an important part of what AGA is about. The dates for the Third Annual National Community Service project are April 27–May 1, 2009, dates that are again sandwiched between the two weekends of the New Orleans Jazz and Heritage Festival.

Tens of thousands of people in New Orleans still need new housing, so AGA volunteers are returning to the Crescent City to build a house with Habitat for Humanity. We will seek lodging for volunteers in the beautiful, new University of New Orleans dormitory (actually two bedroom furnished apartments) with a rate of only about $20 per night per person.

Due to popular demand, we have created a second opportunity this year to experience what it’s like to work with Habitat in New Orleans. Since AGA’s PDC is in New Orleans June 21–24, 2009, we will also have a one-day community service event with Habitat on Thursday, June 25, the day after the PDC ends. For this event, we will seek to extend AGA’s special hotel rate to include this extra night.

Last year, some chapters "sponsored" one or more of their members to participate, and some chapters have said they will do so again. If you are interested in participating, or have some questions before you can decide, please contact Past National President Jeff Hart, CGFM, CFE.

I encourage you to follow the link below to share in experience of the group from last year:

http://www.agacgfm.org/publications/topics/051208/neworleans.aspx

Again, AGA cannot be all things to all people. Some are very interested and are able to be involved in community service events and others are not. As we focus on others before ourselves, let’s seek out ways that we, AGA, can be involved in making our country and world a better place.  If you can join us in New Orleans in April or at the PDC in June, come on over to “Make A Difference” in someone’s life and help in our work with Habitat for Humanity—it will definitely make a difference in your life as well.

Outsourcing? How Much Do You Know About the Audit You Need?

By: Anna Miller, MA, MBA, CPA

Anna D. Gowans Miller, MA, MBA, CPA, is Director of Research for AGA. She was the researcher on a recent AGA study on the usefulness of SAS 70 audits. In a later weblog, James R. Merrill, Partner, AABS Advisory Services Ernst & Young, will discuss AICPA developments related to SAS 70. Merrill is a member of the AICPA Task Force on SAS 70 and helped Miller on the AGA research study.

In an era in which outsourcing has become an accepted and cost-conscious way to provide services such as payroll or IT support, the ability to ensure that the organization can rely on the information provided by the organization doing the servicing becomes ever more important. As long ago as 1992, the American Institute of Certified Public Accountants (AICPA) started to provide guidance for companies that outsourced their financial functions (user organizations) and companies that provided the services (service organizations) in the form of Statement on Auditing Standards (SAS) No. 70, Service Organizations. It is still the most commonly used guidance for preparing and using service organization reports and is also used in numerous countries outside the United States. 

The term “audits” in the title is a bit of a misnomer. The SAS 70 audits that service organizations contract for and that user organizations rely on are not audits as one generally understands them. The service organization decides those controls that are to be evaluated by the service organization’s auditor. Unless the organization using the services, known as the user organization, is proactive and takes an interest in the contract requirements in setting the scope of the SAS 70 audit before the SAS 70 audit is actually performed, the user organization(s) usually accepts the SAS 70 report even if it does not cover everything that may have been determined to be an important control by the user organization or its own financial auditor. Of course, the user organization could send its own auditors to the service organization to do additional work, but that costs money and time and usually the organization does not want to go that far.

Agencies of the federal government have for many years outsourced many functions. Therefore, the pace of outsourcing in the past decade has really taken off. An interesting twist is that many federal agencies provide services to other federal agencies, that is, they are the service organization for many other user organizations, which tend to be federal agencies. A service organization naturally wants to get just one SAS 70 report for its controls and hopes that all of its customer user organizations will accept the report as enough.

AGA and the Corporate Partner Advisory Group Research Program decided to look at how useful these reports are and what improvements would make them even more helpful to government entities. AGA Corporate Partner Ernst & Young LLP provided the support for the research. We interviewed many different entities and also conducted a written survey (administered online). Learn what we discovered by reading our report, SAS 70 Reports: Are They Useful and Can They Be Improved?

Work on making the SAS 70 audit product more useful has not stopped. Both the International Federation of Accountants and the AICPA have issued proposed new guidance in the form of drafts exposed for comment. One thing both have in common is that they split the overall guidance into two segments, one for the user auditor and one for the service organization and their auditor. The proposed guidance for the service organization and their auditor is slated to be under the AICPA attestation standards, which does make more sense, in my opinion. The proposed guidance for the user organization’s auditor is still under auditing standards. They can be found by going to the AICPA website.

If you have had experience with SAS 70 reports, either as a user or user auditor or as a service organization or its auditor, please tell me what you think and what improvements you would suggest.

Reporting on Internal Control: How Much is Too Much?

By: Harold I. Steinberg, CGFM, CPA

Harold I. Steinberg, CGFM, CPA, is the technical consultant for AGA’s Certificate of Excellence in Accountability Reporting Program.

AGA recently evaluated a pilot program by the U.S. Office of Management and Budget (OMB) that gave agencies the opportunity to present financial and performance information in a different way. Rather than a lengthy Performance and Accountability Report, or PAR, OMB offered an alternative: an Agency Financial Report, Annual Performance Report and Highlights Report. These three reports would replace the agency PARs, which are usually quite lengthy and take up considerable time and resources.

During that process, AGA looked at the pilot program’s emphasis on reporting on internal control, and concluded that it might be time for a change. Is it time to rescind the requirement for the separate evaluation and report on internal control over financial reporting, and instead emphasize internal control over program and administrative activities?

Agencies’ management has been required since 1983 to evaluate and report on the agency’s internal control. This work has been performed with varying degrees of quality. Following the enactment of the Sarbanes-Oxley Act in 2002, OMB overlaid the existing requirement with an additional requirement for a separate report on internal control over financial reporting. Since agencies’ managements were, to at least some degree, already evaluating and reporting on internal control over financial reporting as part of their reports on internal control, plus the auditors were evaluating internal control over financial reporting in order to conduct the financial audits, agencies were reporting twice, and sometimes thrice, the same weaknesses in internal control.

The resulting confusion was perhaps one of the reasons a requirement was added to include tables that listed by name the material weaknesses reported under the three separate evaluations, and to assure that the name for each weakness was short and consistent. These tables were to be included in the PARs and the FY 2007 pilot program’s Annual Financial Reports.

The duplication inherent in requiring a separate evaluation and report on internal control over financial reporting appears to be not worth the effort, particularly when the financial management community is faced with other emerging requirements and shrinking personnel resources. In other words, the goal of requiring a separate evaluation and report of internal control over financial reporting apparently has been achieved. Management has documented the systems plus the manner in which they are evaluated.

Also, the need to focus on internal control over financial reporting detracts from the attention the agencies should be devoting to internal control over other areas that are likely to be more significant to Congress and the public, for example, benefit payment systems, procurement and grants data systems, and potential conflicts of interest.

Do we need a separate report on internal control over financial information? If OMB removed the requirement, I believe OMB should advise the agencies not to reduce the intensity of the financial reporting portions of the evaluation of internal control conducted pursuant to the requirements of the Federal Financial Management Improvement Act. OMB would be sending a signal that although internal control is important for financial processes and reporting, it is equally important for program operations.

What’s your opinion?

AGA Tackles Intergovernmental Cooperation on Tuesday Radio Show

By: Relmond Van Daniker, DBA, CPA

AGA Executive Director Relmond Van Daniker, DBA, CPA, hosts the "Your Government, Your Money," radio show.

Happy New Year to everyone. I hope that you had a chance to listen to AGA’s first ‘Your Government, Your Money’ radio show that discussed the government transition featuring a joint interview with two former U.S. Office of Management and Budget (OMB) controllers, Linda M. Springer and Linda Combs, in December. Our next show will air tomorrow, Jan. 13, at noon EST on WFED AM 1500. Our conversation involves the ever-important subject of intergovernmental cooperation. Even if you are not in the Washington D.C. area, you can tune in online. The shows are also archived on this same Web page.

Why discuss intergovernmental cooperation?

Few people understand just how much money flows from the federal government to the states and individual cities and towns, and how inextricably linked government finances really are. Every year, the U.S. government sends hundreds of billions of dollars to the states. Local governments receive tens of billions of dollars, and state and local governments hold hundreds of billions in federal Treasury obligations.

The federal government is rushing to turn around a battered economy while facing its own internal financial challenges. States and local governments are caught in a fiscal trap: Unlike the federal government, they must balance their budgets. With most states five months into the 2009 fiscal year, 18 have already cut services. Sales tax revenues—the largest single source of state and local revenue—are eroding dramatically and retail sales are expected to remain sluggish as the country weathers an economic downturn that Economist magazine projects will be long and severe.

Tomorrow’s show will explore how a cohesive, intergovernmental response can be developed for dealing with the current economic downturn and other challenges.

Let me introduce the top leaders for our discussion tomorrow.

Taking the state perspective is Martin Benison, CGFM, Comptroller of the Commonwealth of Massachusetts. The local government perspective is brought to light by David Bennett, CGFM, Assistant County Mayor and Director of Accounts and Budgets for Blount County, TN.  Thomas Cooley, Chief Financial Officer and Director, Office of Budget, Finance and Award Administration (BFA), National Science Foundation and Jeanette Franzel, CGFM, Director of Financial Management and Assurance at the U.S. Government Accountability Office, take the federal perspective. 

I had a very dynamic discussion with these professionals about their position within the state, local, federal government framework and also listened to their ideas for better connectivity. We also talked about why we need an Intergovernmental Partnership, whether recent intergovernmental revenue flows will be sustainable and why it is important for the various levels of government to have a joint strategy for dealing with the current financial strains.

As we see and hear on the news, our world and concept of government is constantly changing. From your perspective, do you have any examples of intergovernmental issues or strategies to offer to our intergovernmental partnership panel?

Our hope is that this AGA show will provide a forum to discuss and offer common-sense examples, definitions and successful government financial management strategies. We’ll cover timely subjects with the top leaders in the government accountability profession.

AGA will be hosting a total of seven shows between now and mid-2009. Our third show will air on Jan. 27 and will feature a panel of leaders discussing performance reporting. Be sure to tune in!

Cheering on Obama as He Cuts Spending, Stimulates Economy

By: Anna Lafferre

Anna Lafferre is the director of the Center for Government Performance at the Performance Institute.

Much like Jefferson Smith in Frank Capra’s Mr. Smith Goes to Washington, President-elect Barack Obama quit his life in his hometown to move to Washington this week. One can only imagine what was running through his mind when he landed at Andrews Air Force Base, prepared to begin his life as the world’s most powerful man.

Even though he is not president yet, we’ve heard a lot of his opinions: everything from the government needing to use technology more effectively to college football needing to change to a playoff system.

Arguably one of his most important decisions is the budget cuts and program reviews he has promised to make to improve the federal government by rooting out wasteful programs. Obama named Nancy Killefer as Chief Performance Officer (CPO) Wednesday, a new position he outlined in his performance plan, which he released last fall. The CPO will report directly to the president and will also be responsible for leading a White House “SWAT Team” composed of top-performing and highly trained government professionals to set tough performance targets and hold managers responsible for progress. However, complicating the matter is the fact that many things in the federal budget just cannot be cut—either because it is a necessity (Homeland Security) or because cutting it would mean political suicide (health care).

Simply put, cutting spending from the federal budget is not as easy as clipping coupons for Saturday’s trip to Super Wal-Mart.

The Associated Press reported that a member of the transition team, speaking on condition of anonymity, said that nothing will be considered off the table, at least for discussion, when considering budget cuts.

The annual federal budget is $3 trillion, and it will take a lot of work to discover which programs funded by this budget can go. But it’s a necessary step in curbing federal spending and making government more efficient.

As Obama said, “We will go though our federal budget—page by page, line by line—eliminating those programs we don’t need and insisting that those we do operate in a sensible, cost-effective way.”

Like Jefferson Smith’s plan to introduce a bill in his first month in Congress, Obama has been preparing his economic stimulus plan that will soon become a bill before Congress. The plan, which is expected to cost at least $775 billion, is intended to boost America’s troubled economy, the Associated Press reports. Not only will this plan help turn the economy around, but Obama also promises it will set a "new higher standard of accountability, transparency and oversight.” It is likely that Congress will approve a version of this bill within the next few weeks, as Democrats control both the House and Senate. With this promise of an economic stimulus, Obama also warns, however, that the nation is facing a deficit (currently at around $1 trillion) for years to come.

Whether you voted for Obama or not, it is clear that the United States is facing some large issues: defense, the economy and homeland security to name a few. While it may be easier to cheer on fictional Jefferson Smith as he navigates his way through the Capitol, it is just as necessary to cheer Obama on as well, in hopes that he and his appointees can cross party lines and get things done.

Do you think this economic stimulus package will succeed in fulfilling its mission to set a "new higher standard of accountability, transparency and oversight” in the federal government?

Accounting for Social Security, Medicare and Other Social Insurance

By: Richard Fontenrose, CGFM

Richard Fontenrose, CGFM, a member of AGA's Washington, D.C. Chapter, is the assistant director of the Federal Accounting Standards Advisory Board.

On Nov. 17, 2008, the Federal Accounting Standards Advisory Board (FASAB) issued an exposure draft (ED) regarding accounting for Social Security, Medicare and other “social insurance” programs titled Social Insurance Accounting, Revised. Social insurance comprises five programs but two—Social Security and Medicare—are of special significance because of the high rate of participation among citizens, the fiscal challenges related to the programs, and the challenges associated with incorporating estimates of future cash flows of this magnitude in financial statements. 

Fundamental questions about social insurance programs can be addressed by financial reporting. The information provided as a result of this proposed standard should help users answer questions about social insurance commitments and the reasons these commitments change over time. 

From the outset of the social insurance project, members have agreed on the objectives of financial reporting for social insurance programs but have had different views about how best to achieve the objectives. Members have agreed that social insurance information should be included in the basic financial statements, should be audited, and should be “transparent”—that is, readily understandable to an interested, non-expert reader. Members also have agreed that the financial report should highlight any long-range fiscal imbalances anticipated in social insurance programs. Moreover, all members have supported several innovations. They have supported a new basic statement presenting changes in the amounts presented on the statement of social insurance. All members have supported new reporting on fiscal sustainability in the consolidated Financial Report of the United States Government (CFR). However, they have had different views about the timing of the recognition of expense and liability for social insurance programs and about what should be reported on certain financial statements.

Some members believe that an expense is incurred and a liability arises for social insurance programs during the working lives of participants, and that some portion of the benefits accumulated at the balance sheet date should be recognized as a liability. Other members agree with Statement of Federal Financial Accounting Standards 17, Accounting for Social Insurance that an expense is incurred and a liability arises for social insurance programs when the participants have met all eligibility requirements and the amount is “due and payable.”  

The exposure draft represents a compromise. The proposed standard does not change the liability and expense recognition and measurement from SFFAS 17. It proposes enhanced reporting but does not resolve the two strongly held views regarding when the obligating event occurs for social insurance programs and, thus, when the liability and expense definitions are met within those programs.

The proposed standard requires the addition of the following information:

• Critical information about costs, assets and liabilities, social insurance commitments, budget flows, and the “fiscal gap” in a section in management’s discussion and analysis devoted to financial statement analysis.

• A new line item representing the closed group measure that would be presented on the balance sheet below assets, liabilities, and net position and that would not be included in the totals for these classifications.

• A new summary section for the statement of social insurance presenting the closed and open group summary totals.

• A new basic financial statement to present the reasons for changes during the reporting period in the closed group measure reported on the statement of social insurance.

• Other information. 

Thus, the standard proposes additional key information not currently provided and would link information from the statement of social insurance to other basic financial statements. 

Six members have endorsed the proposal presented in the ED. As with all compromises, members have diverse views. Five members are seeking comments on an alternative view regarding when the liability definition is met.  Three members oppose certain aspects of the proposal. They seek comments on their alternative view.  

What are your views? How should Social Security, Medicare and other social insurance be accounted for? Does the compromise provide additional useful information? What should the balance sheet present as a liability? Should there be a new, supplementary balance sheet line item as described in the exposure draft?     

The ED requests comments by Feb. 9, 2009. The ED is available at the FASAB website.

Government Audit Committees

By: Irwin T. (Ted) David, CGFM, CPA

Irwin T. (Ted) David, CGFM, CPA, a member of AGA's Washington, D.C. Chapter,  is a retired partner with Deloitte and Touche (now Deloitte.) as well as a retired federal official. Most  recently he was Chief Financial Officer of NOAA’s National Weather Service and Acting Chief Financial Officer of NOAA. 

The private sector financial debacles of the early 21^st century resulted in sweeping corporate governance legislation known as the Sarbanes-Oxley Act of 2002 (SOX). One requirement of SOX is the expansion of audit committee responsibilities of publicly held companies.

Governments are not subject to SOX. Even so, many governments have effectively implemented audit committees. Since little is known of government audit committees, AGA has just completed a research project on the “Characteristics of Effective Audit Committee in Federal, State and Local Governments” (available from AGA).

Several organizations have published guidance useful to governments in establishing audit committees—the American Institute of Certified Public Accountants (AICPA) (for all government entities), Deloitte & Touche, LLP (for state and local governments), the Department of Defense Inspector General (for DoD entities), the Government Finance Officers Association (GFOA) (for local entities) and KPMG, LLP (one publication for state and local governments and one for federal entities). These publications reflect the diverse characteristics of government audit committees in practice.

Governments establish audit committees for many reasons, such as improved accountability and transparency, quality advice, “clout,” an independent forum for resolving issues, extension of the governing board, “a third set of eyes,” insulating the internal auditor from undue pressure, increased credibility for the internal audit and finance departments, and improved communications of financial information.

The diversity of practice provides a number of best practices and good ideas, transferrable to other governments. Perhaps the most important best practice is that governments adopt a well-thought out, complete charter for its audit committee. The most important elements of a charter relate to a clearly defined committee mission, committee responsibilities and committee membership: 

·       Generally, the mission of government audit committees falls into one or more of the following categories—Responsibility for, oversight of or advice relating to the external audit; responsibility for, oversight of or advice relating to the internal auditor; and/or advice for ensuring and/or maintaining auditable financial statements. Each potential mission includes some responsibility for internal controls and risk management.

·       The charter must also define the responsibilities or activities that the audit committee should undertake. Such articulation provides guidance for committee activities and a basis for self-evaluation.

·      Recommended committee membership and structure varies among the guidance documents and in practice. Each committee should include at least one financial expert and at least one individual who understands the audit process. Other skills may relate to particular industry or technical skills, understanding of the entity and/or presence in the community. In the government, independence of committee members is less critical than in the private sector, as demonstrated by the number of committees that include members of entity management among committee members.

Audit committee members must receive orientation and education as they assume their responsibilities. While relatively few committees provide sufficient initial orientation, several committees provide ongoing education for committee members.

Top management support is critical to the success of the audit committee. The CEO can demonstrate support by his or her presence (or that of a key aide) on the committee or as an invited guest at each meeting, by the qualifications and expertise of personnel appointed to the committee, by providing the committee with adequate resources and by implementing its recommendations.

Audit committees vary in their relationship with the external and internal auditors. Irrespective of the relationship, the committee should meet at least three times a year with the external auditor—at audit planning time, while the audit is being performed and at the conclusion of the audit. The committee should also assure continued independence of and review the external auditor’s peer review report.

The committee should review the annual audit plan of the internal audit department and may participate in the internal audit department’s risk assessment evaluation. The audit committee should review audit reports with each, or selected, auditees. Several audit committees have innovative techniques to ensure that corrective action plans are accomplished.

Some committees rely on the annual external audit and internal audits to test the adequacy of internal controls. Other committees require specific internal control reviews by entity staff and may participate in annual internal control, fraud or risk management workshops for the entity.

The research identified many other best practices, including member and chairperson recruitment, committee self-evaluation, a committee annual report, member compensation, committee letter in the entity’s annual report, fraud and ethics hot lines, enterprise risk management, access to people and data, outside consultants, executive sessions, the Annual Financial Report, the Federal Advisory Committee Act for federal executive agencies, visibility for the committee and committee meetings, among others.

Government audit committees provide valuable contributions to improving a government’s financial management and overall governance. Not all best practices or good ideas are applicable to or useful to every audit committee. Each government should evaluate the potential role of an audit committee in its environment and determine which practices and ideas may apply.

Read more about the research in AGA's Journal of Government Financial Management, Spring 2009.