Definition of Audit Committee
Audit committee, a committee required to be created under the federal law to get and remain listed in the stock exchanges, is a committee of various directors where a majority of the directors are required to be independent to undertake major business work processes such as communication to the Auditors, the appointment of the auditors, approval of the financial reports, other financial reporting and disclosure requirements, etc.
The audit committee is created by the Board of Directors alongside other directors which are independent of the company. in the layman language, the independent director indicates a person who is unrelated to the senior management and does not hold a major relationship with the company. The primary work of the audit committee is to oversee the financial process, and other ancillary work such as financial reporting, disclosures, handling audit and auditors, providing recommendations to the board, and other ancillary work, etc. The audit committee is also responsible for communicating the financial information to the external auditors besides handling the matters related to the Generally Accepted Accounting Standards as well. Other relevant measures absorbed by the committee are related to information technology, security, and other operational matters also.
How does it Work?
The audit committee is created by the board of directors and sometimes it is formed under the respective law or regulation. For instance, listed companies or companies must be listed in the stock exchange to have a working audit committee. The committee is made up of various directors of different backgrounds where most of them should be literate in financial terms. Once the committee is constituted, it starts working on various processes related to accounts, finance, auditor, shareholder grievances, Corporate Social Responsibility, etc. The committee reports to the directors and becomes one-point contact for communication related to the external auditor and other ancillary parties. The committee is also allowed to hire experts if it deems fit and to approve their remuneration or emoluments as well.
The Audit Committee, as we see it today, has come into existence from the inspiration of the Sarbanes Oxley Act, 2002. The Sarbanes Oxley Act has come into the picture since the debacle of Enron in the United States. Due to a couple of liquidations arising from the issues related to corporate governance, SOX has come into the picture. As per the Sarbanes Oxley Act to resolve the issues related to corporate governance there needs to be a committee that takes care of primary functions related to finance and the auditors. Again, there need to be directors who do not work under the orders from the board of directors. So, the concept of the independent director has been evolved.
Role and Responsibilities of Audit Committee
There are various roles and responsibilities to exercise due care and the diligence and skill in multiple areas:
- Assisting the board to cater to the responsibilities to due care, skill in the relation related to the users of the financial reports.
- To manage the policies regarding the accounting estimates and policies, financial management, Internal control system, risk management system, Business practices, Protection of an entity’s assets, compliance with regulations, the board of directors and senior financial management, etc.
- It facilities communication between the board of directors and the internal and external auditors.
- Facilitating communication between the board of directors and senior financial management, and senior management.
- Facilitating communication and internal and external auditors. Facilitating the maintenance of independent external auditor.
- Making a recommendation to the board regarding whether the rotation of the external audit engagement partner.
- Consideration of significant matters that were raised during the process.
Requirements of Audit Committee
Since 2003, the Securities and Exchange Commission has adopted the rules that required the companies to be listed in the national securities exchanges to follow the compliance and requirements of the Audit Committee and in the absence of that, the securities should not be allowed to be listed. The requirements of the Audit committee demands the independence of the audit committee members, to oversee and select the independent accountant, handling issues related to the accounting practices of the issuer company, to have any authority to hire and take opinions of the advisors or subject matter experts and to fund the independent auditor and the advisors engaged by the audit committee.
There are various benefits of the constitution and its existence. Few of the pertinent ones are as follows:
- It is being created by the independent auditor besides the members of the board which helps in taking unbiased opinions.
- The Audit Committee has been involved in multiple works such as overseeing financial statement, handling queries of auditors, the appointment of the auditors, etc. Resultantly, a major burden of the official word has been shifted from the board of directors to the Audit Committee.
- The Audit committee enhances the morale and faith of the investors and other stakeholders of the company due to its independent nature.
- The company helps in providing the oversight of the board and helps in the financial reporting, internal control, handling of auditors, and compliances with relevant laws and regulations.
Some of the disadvantages are:
Despite multiple benefits entailed by the audit committee, there are some disadvantages as well. The foremost shortcoming of the audit committee is the increase in the cost of the company. As it requires members from board and these people are highly paid employees which increases the cost of the company. Another disadvantage turns out to be the dearth of independent directors. As independent directors are quite rare to find because of the requirement of multiple qualifications such as non -pecuniary relationship, no relation with the senior management, etc.
Despite having certain shortcomings such as increased expenditure, difficulties in hiring quality personnel, lack of availability of independent directors, etc., the audit committee, is one of the greatest tools to maintain transparency in the corporate world and enhances the faith of the stakeholders in the company.
This is a guide to Audit Committee. Here we also discuss the definition and role and responsibilities along with advantages and disadvantages. You may also have a look at the following articles to learn more –