The company board of directors is responsible for stewardship and should monitor the company’s governance, planning, direction, and all other crucial matters. Effective boards function best when dividing responsibilities with members only populating a few committees.
Like a company with different departments to manage everyday work, the board also has various committees focusing on their primary tasks.
Different committees on the board ensure that everyone knows their area of authority and duty. A board may have different types of committees like governance committees, managing committees, advisory committees, and more.
One of the most crucial board committees is the Risk & Audit Committee. The audit committee ensures that the company’s financial strategy aligns with its goals and business plan. It analyses the financial reports and confirms no discrepancy in the financial disclosures. A qualified audit committee is essential for a company to be listed on the stock exchange.
In this article, we will focus on the roles and responsibilities of the audit committee. We will also explore what one needs to become an audit committee member. Further, the article discusses how an audit committee is essential for a company’s seamless functioning.
What is Audit Committee?
An audit committee is a standing committee appointed by the board of directors. Its members are independent outside directors and hold financial expertise in the corporate sector.
Independent outside directors are the individuals who the board has brought in. They do not have direct relations or any external business connection with the company. As they are independent or outside the company, they have not worked with the company as managers or in some other post.
Independent directors bring new insights and give a fresh perspective to the company’s vision. Having a fresh pair of eyes, especially coming from outside of the organization, can be illuminating.
The audit committee analyzes and monitors the company’s financial health and reporting. They have the authority to carry out independent audits of the company. Though they do not indulge in everyday accounting, they oversee the independent audit process.
An audit committee is also responsible for independent auditors’ hiring and work assignments. The committee also shares its recommendations and reports to the board of directors.
The audit committee’s responsibility spans the company’s financial disclosures, audits, and expense management. They ensure that all the financial details, including investments, expenses, and revenue are in sync and there is no discrepancy or cases of money laundering or financial mismanagement.
Audit Committee Regulations
Companies seeking a public listing on major stock exchanges must fulfill specific criteria. It is the function of the audit committee to oversee the listing process. In the Sarbanes-Oxley Act of 2002, the U.S. Securities and Exchange Commission (SEC) made these criteria compulsory for listed companies.
- The audit committee will be comprised of independent directors.
- The audit committee will appoint the independent auditors of the company.
- The audit committee will oversee the independent audit process, including audit report analysis and recommendations.
- The company shall compensate the independent auditor hired by the audit committee.
- The audit committee has the authority to appoint financial advisors or seek the advice of any financial expert.
- The audit committee should have a proper financial mismanagement complaint redressal system.
Qualifications For The Audit Committee Members
The board should not appoint just any member of the audit committee.
The audit committee members should possess the necessary skills and educational qualifications.
Audit committee members should ideally have academic qualifications or work experience in a few of the following areas:
- Finance
- Economics
- Law
- Corporate governance
- Accounting
- Commerce public affairs
- HR management
- Company’s related industries
The members of the audit committee should also be familiar with the following areas:
The external and internal audit process
- Internal financial controls
- Corporate law and regulations
- Risk management policies
- Integrated reporting, especially financial reporting
- The general process of governance within an organization
- Information and technology governance
- Education qualifications
4 Major Functions Of the Audit Committee
Oversight of Financial Reporting
1.1 Review of Audit Reports and Internal Controls
The audit committee’s primary responsibility is to oversee the financial reporting process, including reviewing audit reports, examining internal controls, and ensuring that accounting policies comply with GAAP. The committee also ensures legal compliance before filing the company’s annual report with the SEC.
1.2 Regular Meetings and Quarterly Conference Calls
The committee should meet regularly, at least four times a year, and may hold special meetings as needed. Having at least one quarterly conference call with management outside regular meetings is also required. During these calls, members discuss audit results and address any issues or concerns regarding internal controls over financial reporting. The committee reviews audit reports and focuses on material weaknesses and significant deficiencies in management’s internal controls related to audit reports, including the audited financial report.
1.3 Review of Independent Auditor’s Work
The audit committee reviews the scope of management’s work with the company’s independent auditor. They examine all working papers supporting the auditors’ findings and conclusions. The committee also approves all independent auditors’ auditing services, including engagement letters and fee arrangements. Additionally, the committee monitors the company’s financial reporting processes to ensure the effective implementation and testing of new accounting policies.
Oversight of Risk and Compliance
2.1 Guidelines for Risk Management
The committee is responsible for overseeing the company’s risk and compliance functions, including establishing guidelines for risk management and assessing the effectiveness of the company’s risk management policies. They also ensure compliance with relevant laws and regulations.
2.2 Internal Control Issues and Regulatory Compliance
The committee establishes or approves procedures to identify, mitigate, monitor, and report on internal control issues related to legal compliance risks. They also establish and approve internal policies for regulatory compliance.
2.3 Clear Guidelines for Oversight
Audit committees develop clear guidelines for their oversight efforts, covering internal controls and risk management policies. These guidelines specify the types of transactions that must be reported and their reporting frequency. They also outline the methods for monitoring risk management.
Oversight of External Communications
3.1 Monitoring External Communications
The audit committee monitors the company’s external communications to the public and shareholders, including reviewing press releases, conference calls with analysts, and all official statements made to investors. Committee members work closely with management to ensure accurate information is communicated to the general public. They adhere to ethical guidelines set by the SEC and disclose any potential conflicts that may hinder ethical conduct.
3.2 Collaboration with Stakeholders
Audit committees collaborate with management, internal auditors, regulators, and proxy advisors to make financial disclosures. They hold the C-suite administration accountable for accurate communications about company performance. The committee also provides ongoing assessments of potential risks related to external communications.
Approval of Audit and Non-Audit Services
4.1 Approval Process
Audit committees are responsible for approving both audit and non-audit services provided by independent auditors. They work with management to identify the necessary services and oversee the engagement process.
4.2 Monitoring Fees and Identifying Costs
The committee monitors the fees charged by independent auditing firms to ensure they are appropriate for specific tasks or engagements. They verify that no unnecessary or duplicate charges exist and identify costs outlined in client contracts, such as travel and out-of-pocket expenses. Understanding these processes helps prevent conflicts of interest between companies and auditors.
What Makes Audit Committees Effective?
Strong Audit Committee Chairperson
Having a strong chairperson who can facilitate productive meetings and communicate effectively is essential for the effectiveness of an audit committee.
Training for Committee Members
Providing training to audit committee members through adjunct meetings, retreats, or courses offered by governance organizations helps them carry out their responsibilities effectively.
Self-Assessment
Performing a self-assessment allows the audit committee to identify areas for improvement in its oversight activities and take necessary steps to address them.
Transparency
Ensuring transparency in its activities allows the audit committee to share important information with stakeholders, promoting trust and confidence in its work.
Effective Communication
Establishing effective communication channels, including internally among committee members and externally with management, auditors, and non-audit board members, helps the audit committee demonstrate how it is fulfilling its responsibilities.
Diversity
Ensuring diversity among committee members regarding experience and knowledge enhances their capabilities and proficiency in carrying out their duties.
Strong Relationship with Auditors
One of the crucial aspects of an effective audit committee is maintaining a strong relationship with both external and internal auditors, including facilitating open communication and effective oversight of auditors while promoting proper internal controls.
By incorporating these elements, audit committees can enhance their effectiveness in carrying out their responsibilities and providing valuable oversight to the organization.
Key Factors to Enhance Audit Committee Effectiveness
Audit Committee Transparency
Transparency is crucial for enhancing the effectiveness of an audit committee. The committee should provide meaningful disclosures regarding its work and operations, focusing on issues related to financial statements and reports. By disclosing how it addresses these issues, the committee enables the board of directors to assess its performance and effectiveness.
Effective Communication
Effective communication is essential for an audit committee’s effectiveness. It should have open and regular contact with the company’s management, CFO, and board of directors discussing critical aspects of the audit process, highlighting issues that may require the board’s input, and ensuring a smooth flow of information.
Committee Composition
The composition of the audit committee plays a vital role in enhancing its effectiveness. The committee should consist of individuals with the necessary finance and financial reporting oversight skills and competence. Having diverse experience and a commitment to continuous learning helps members stay updated on emerging issues in the field.
Efficient and Effective Working Methods
Considering the increasing risks and complexity, the audit committee should establish efficient and effective methods for executing its work. Clear terms of reference that outline the committee’s duties and responsibilities can provide a solid foundation for best work practices.
By focusing on these critical factors, an audit committee can strengthen its effectiveness in providing oversight and contributing to the organization’s financial reporting integrity.
Key Takeaways:
Oversight of Financial Reporting: The audit committee is responsible for overseeing the financial reporting process, ensuring compliance with accounting principles, and reviewing audit reports. They work closely with management and auditors to ensure accuracy and adherence to internal controls.
Risk and Compliance Oversight: The committee oversees the company’s risk management and compliance functions. They establish risk management and internal controls guidelines, monitor legal compliance, and establish procedures for identifying and reporting internal control issues.
External Communications: The audit committee monitors external communications, including press releases and investor statements, to ensure accuracy and compliance. They collaborate with management to communicate information effectively and follow ethical guidelines set by regulatory bodies.
Approval of Audit and Non-Audit Services: The committee approves audit and non-audit services provided by external auditors, ensuring appropriate engagement, fee arrangements, and monitoring of charges. They may also oversee the performance and compensation of internal auditors.
Overall, the audit committee plays a vital role in ensuring the integrity of financial reporting, managing risks, and promoting organizational compliance. They work closely with various stakeholders to fulfill their responsibilities effectively.