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Informational Memorandum
Subject:Audit Committees and Farm Credit System Institutions
Date of Memorandum:05/09/2000
Expiration Date:
Signed By:Smith, Roland
FCA Contact Person:Holland, Tom
Contact Phone:703-883-4484
List of Attachments:none


May 9, 2000

To: The Chairman of the Board
The Chief Executive Officer
All Farm Credit System Institutions

From: Roland E. Smith, Director /s/
Office of Examination

Subject: Audit Committees and Farm Credit System Institutions

Farm Credit Administration (FCA) Regulation 12 CFR 630.6(b) requires each Farm Credit bank to establish and maintain an audit committee. Although this regulation is applicable only to banks, the benefits to be achieved by using an audit committee could strengthen the internal control environment in all institutions, including associations. Effective internal control is a foundation for the safe and sound operation of institutions. Therefore, we believe it is a sound business practice for all Farm Credit System (FCS) institution boards to establish and maintain a board audit committee with the responsibility to ensure that the system of internal control operates effectively.

The regulation that requires banks to maintain audit committees provides the broad framework that we believe would also assist each association board in establishing an audit committee. This regulation prescribes that members of the audit committee shall be independent of management and free from any relationship that, in the opinion of the board of directors, would interfere with the exercise of independent judgment as a committee member. In addition, the regulation prescribes that audit committee members shall be knowledgeable in public and corporate finance, and financial reporting and disclosure. The audit committee may be comprised of the full board, or at least three members thereof. If the audit committee does not include all board members, a process should be established for the committee to report the results of its oversight to the full board. The audit committee or the full board should meet periodically in executive session with internal and external auditors to discuss the results of audits performed.

The principal responsibilities of the audit committee in supervising the internal control environment are to:

Monitor internal controls, including those relating to compliance with laws and regulations;
Review the institution's financial statements and significant accounting policies;
Monitor the levels of risks in the institution;
Oversee the institution's financial reporting regarding disclosure to shareholders and others; and
Oversee the audit activities of the internal and external auditors.

Institutions have made significant progress over the years in establishing workable, preventive and detective internal control systems. Recently, we conducted a survey of FCS institutions to determine the extent to which audit committees are being used. Survey results showed that 79 out of 178 (44%) associations had formal audit committees that either consisted of all board members or were a separate component of the board. Fifty-eight of the 79 associations had separate audit committees. Most of the associations without formal audit committees had boards that fulfilled many of the typical functions of an audit committee.

The results of the survey are encouraging. However, as the financial services industry continues to evolve and the operating environment of the System becomes more complex, greater emphasis should be placed on the use of board audit committees to address the responsibilities identified above. A separate formal audit committee, independent of management, that provides oversight of the financial reporting process and the institution’s internal control environment is the ideal structure. We recognize that in small institutions, a separate audit committee might not be practical or cost effective. The boards of directors of these institutions should still ensure that audit committee functions are administered by the board.

As you are aware, our examinations are risk-based and the quality of an institution’s internal controls weighs heavily in setting the scope of examinations. All things being equal, the examination scope is less at an institution that has an effective system of internal controls. A critical part of each examination includes sufficient tests of internal control programs to ensure that the internal control environment and processes provide for both the prevention, and timely detection and correction of material weaknesses. In addition to helping an FCS institution prevent or detect fraud and mismanagement, an effective internal control system aids the institution in accomplishing board established goals and objectives, safeguarding assets, complying with laws and regulations, ensuring accurate and complete financial reporting, and providing a self-assessment of the institution’s performance.

If you have any questions about this memorandum, please call Thomas J. Holland, Director, Special Examination and Supervision Division, Office of Examination, at (703) 883-4483 or me at (703) 883-4160. You may also write to us on the Internet at e-mail addresses or