Audit committee


An audit committee is a committee of an organisation's board of directors which is responsible for oversight of the financial reporting process, selection of the independent auditor, and receipt of audit results both internal and external.
In a U.S. publicly traded company, an audit committee is an operating committee of the board of directors charged with oversight of financial reporting and disclosure. Committee members are drawn from members of the company's board of directors, with a Chairperson selected from among the committee members. A qualifying audit committee is required for a U.S. publicly traded company to be listed on a stock exchange. Audit committees are typically empowered to acquire the consulting resources and expertise deemed necessary to perform their responsibilities. The role of audit committees continues to evolve as a result of the passage of the Sarbanes-Oxley Act of 2002. Many audit committees also have oversight of regulatory compliance and risk management activities.
Not for profit entities may also have an audit committee.
Internationally, an audit committee assists a board of directors to fulfil its corporate governance and overseeing responsibilities in relation to an entity's financial reporting, internal control system, risk management system and internal and external audit functions. Its role is to provide advice and recommendations to the board within the scope of its terms of reference / charter. Terms of reference and requirements for an audit committee vary by country, but may be influenced by economic and political unions capable of passing legislation. The European Union directives are applied across Europe through legislation at the country level. Although specific legal requirements may vary by country in Europe, the source of legislation on corporate governance issues is often found at the European Union level and within the non-mandatory corporate governance codes that cross national boundaries.

Definitions

  • Institute of Internal Auditors definition: "The Audit committee refers to the governance body that is charged with oversight of the organization’s audit and control functions. Although these fiduciary duties are often delegated to an audit committee of the board of directors, the Practice Advisory is also intended to apply to other oversight groups with equivalent authority and responsibility, such as trustees, legislative bodies, owners of an owner-managed entity, internal control committees, or full boards of directors".
  • In Nigeria, the Audit Committee is defined as a “Committee of Directors and the enterprises shareholders representatives whose specific responsibility is to review the annual financial statements before submission to the Board of Directors”.
  • In Uzbekistan, audit committee — a committee, consisting of the members of the supervisory board of an economic entity, as a rule, including at least one independent member, responsible for establishing control over the correctness of financial reporting, selection of an independent auditing organization, overseeing audit processes, as well as obtaining and reviewing the results of internal and external audits.
  • The above definitions are focused on the private sector. A similar definition has been developed by the government auditors in the INTOSAI’s Internal Control Standards: ''"A committee of the Board of Directors whose role typically focuses on aspects of financial reporting and on the entity's processes to manage business and financial risk, and for compliance with significant applicable legal, ethical, and regulatory requirements. The Audit Committee typically assists the Board with the oversight of the integrity of the entity's financial statements, the entity's compliance with legal and regulatory requirements, the independent auditors' qualifications and independence, the performance of the entity's internal audit function and that of the independent auditors and compensation of company executives..
In India, according to Section 177 of the Companies Act 2013, the Board of Directors of every listed company and such other class or classes of companies, as may be prescribed, shall constitute an Audit Committee.
As per Rule 6 of the Companies Rules, 2014, the Board of directors of every listed companies and the following classes of companies shall constitute an Audit Committee and a Nomination and Remuneration Committee of the Board:
All public companies having:
  • Paid-up Capital ≥ ₹10 Crore;
  • Turnover ≥ ₹100 Crore;
  • Loans + Borrowings + Debentures + Deposits ≥ ₹50 Crore.

    Composition

Usually, membership of the committee is subject to the maximum number of 6 persons.
  • In the US, a qualifying audit committee is required for listed publicly traded companies. To qualify, the committee must be composed of independent outside directors with at least one qualifying as a financial expert.
  • The European Union's 8th Directive on company law 2006/43/EC states that “Each public-interest entity shall have an audit committee. The Member State shall determine whether audit committees are to be composed of non-executive members of the administrative body and/or members of the supervisory body of the audited entity and/or members appointed by the general meeting of shareholders of the audited entity. At least one member of the audit committee shall be independent and shall have competence in accounting and/or auditing.”
  • Institute of Internal Auditors best practice: “The audit committee will consist of at least three and no more than six members of the board of directors... Each committee member will be both independent and financially literate. At least one member shall be designated as the "financial expert" as defined by applicable legislation and regulation”.

    Responsibilities

Boards of Directors and their committees rely on management to run the daily operations of the business. The Board's role is better described as oversight or monitoring, rather than execution. Responsibilities of the audit committee typically include:
The duties of an audit committee are typically described in a committee charter, often available on the entity's website.×
  • European Union: Directive 2006/43/EC, article 41.2: the audit committee shall, inter alia: Monitor the financial reporting process; Monitor the effectiveness of the company's internal control, internal audit where applicable, and risk management systems; Monitor the statutory audit of the annual and consolidated accounts; Review and monitor the independence of the statutory auditor or audit firm, and in particular the provision of additional services to the audited entity.
  • Public sector: Cf. Standard INTOSAI GOV #9100

    Role in oversight of financial reporting and accounting

Audit committees typically review financial statements quarterly and annually in public companies. In addition, members will often discuss complex accounting estimates and judgments made by management and the implementation of new accounting principles or regulations. Audit committees interact regularly with senior financial management such as the CFO and Controller and are in a position to comment on the capabilities of these managers. Should significant problems with accounting practices or personnel be identified or alleged, a special investigation may be directed by the audit committee, using outside consulting resources as deemed necessary.
External auditors are also required to report to the committee on a variety of matters, such as their views on management's selection of accounting principles, accounting adjustments arising from their audits, any disagreement or difficulties encountered in working with management, and any identified fraud or illegal acts.

Role in oversight of the external auditor

Audit committees typically approve selection of the external auditor. The external auditor reviews the entity's financial statements quarterly, audits the entity's financial statements annually, and issues an opinion providing assurance on the entity's annual financial statements. Changing an external auditor typically also requires audit committee approval. Audit committees also help ensure the external auditor is independent, meaning no conflicts of interest exist that might interfere with the auditor's ability to issue its opinion on the financial statements.
  • European Union: Directive 2006/43/EC, article 41.3 and 41.4: "In a public-interest entity, the proposal of the administrative or supervisory body for the appointment of a statutory auditor or audit firm shall be based on a recommendation made by the audit committee. The statutory auditor or audit firm shall report to the audit committee on key matters arising from the statutory audit, and in particular on material weaknesses in internal control in relation to the financial reporting process."

    Role in oversight of regulatory compliance

Audit committees discuss litigation or regulatory compliance risks with management, generally via briefings or reports of the General Counsel, the top lawyer in the organisation. Larger corporations may also have a Chief Compliance Officer or Ethics Officer that report incidents or risks related to the entity's code of conduct.

Role in monitoring the effectiveness of the internal control process and of the internal audit

includes the policies and practices used to control the operations, accounting, and regulatory compliance of the entity. Management and both the internal auditing function and external auditors provide reporting to the audit committee regarding the effectiveness and efficiency of internal control.
  • IIA Practice Advisory: Cf. PA1110-1 paragraphs 2 and 3
  • European best practice for the role of the Audit Committee in overseeing internal audit.