The concept of Audit Committees (ACs) is not new and can be traced back to the 19th Century. What is notable, however, is the extent of their promotion and subsequent adoption by listed companies in several countries during the last quarter century.
ACs are now required by law in Canada and Singapore and are a condition of listing on the stock exchange in the US and Thailand.
In the UK, Australia, New Zealand and South Africa, companies listed on the stock exchange are required to state whether they have an AC on their annual report. In others, such as France, Hong Kong, Japan and the Netherlands, ACs are recommended as the best practice.
In Pakistan, under the code of corporate governance issued by the SECP in March 2002, it is mandatory for the listed companies to establish audit committee comprising not less than three members including the chairman.
During the last two decades, audit committees (ACs) have become a common mechanism of corporate governance in several countries.
More recently, numerous official professional and regulatory committees have recommended their more universal adoption by corporate enterprises.
This recent global recognition of the AC as a relevant governance structure in a wide variety of environments may be linked to claims about AC benefits on a number of aspects of corporate governance.
The arguments associated with the promotion of ACs emphasise their potential contribution to, for example, the relationships between directors, investors and auditors, the discharge of accountability and directors, execution of their responsibilities.
The purpose and rationale of the Audit Committee is to render assistance to the Board of Directors of the company in fulfilling its legal and fiduciary obligations and responsibilities to the shareholders, potential shareholders and the investment community with respect to matters involving the accounting, auditing, financial reporting, and internal control functions of the company and its subsidiaries.
In the fulfilment of the said general purposes, the ideal Audit Committee is expected to guide the Board to overview the integrity of the company's financial statements, company's compliance with legal and statutory and regulatory requirements, independent auditor's qualifications and independence, and the performance of the company's internal audit function and of the independent auditors.
The Audit Committee should fulfill these responsibilities and duties by carrying out the activities, which need to be enumerated in the company's charter.
There is no doubt that the audit committee can play a major role in bringing about greater accountability by companies and in resorting confidence in financial reporting. It helps directors meet their statutory and fiduciary responsibilities, especially as regards accounting records, annual accounts and the audit.
An audit committee is unique in that it provides a forum where directors, management and auditors can deal together with issues relating to the management of risk and with financial reporting obligations.
The independent function of the audit committee results in the internal audit department assuming a greater responsibility in the financial reporting process.
This role in turn promotes improvements in the internal control structure, resulting in heightened integrity in the financial reporting process. It has the potential to provide a framework within which the external auditor can assert his independence in the event of a dispute with management and strengthen the position of the internal audit function, by providing a greater degree of independence from management.
The audit committee offers added assurances to the shareholders that the auditors, who act on their behalf, are in a position to safeguard their interests.
Therefore, the committee has an important role to play in enhancing the perceived independence of an internal and external audit from operational management.
In fulfilment of the said general purpose, the ideal audit committee is expected to guide the Board to overview the integrity of the company's financial statements, company auditor's qualifications and independence, and the performance of the company's internal audit function and of the independent auditors.
The audit committee should fulfil these responsibilities and duties by carrying out the activities, which need to be enumerated in the company's charter.
COMPOSITION: The Audit Committee should comprise three or more directors or as determined by the Board. The members of the Audit Committee should be experienced and meet other requirements of the Stock Exchange and all other applicable rules, regulations and statutes.
Members must be free from any relationship that, in the opinion of the Board, would interfere with the exercise of his or her independent judgement as a member of the Audit Committee.
All members of the Audit Committee should be abreast of basic finance and accounting practices or should be competent and capable to acquire such familiarity within a reasonable period of time after his or her appointment to the Audit Committee.
At least one of the members should be a financial expert or as defined by applicable rules, regulations and statutes.
A member of the Audit Committee preferably, must not simultaneously serve on the audit committee of other companies unless it is approved by the Board ensuring that such service would not impair the ability of such members to effectively serve on the Company's Audit Committee.
A member of the Audit Committee must not accept any consulting, advisory, or other compensatory fee from the company, or any subsidiary thereof.
The Audit Committee members should be appointed for an one-year term at the annual meeting of the Board of Directors and may serve until a replacement for each such member is duly elected and qualified or until such member's resignation or removal from the Board of Directors or the Audit Committee.
The members of the Audit Committee may be removed from the Committee, with or without cause, by a majority vote of the Board of Directors.
The Chairman of the Audit Committee needs to be designated by the Board of Directors. The Audit Committee may form and delegate authority to subcommittees in compliance with applicable law when deemed appropriate by the Audit Committee.
AUDIT COMMITTEE CHARTER: The Audit Committee must have a formal written charter specifying the scope of the Audit Committee's responsibilities and how it implements them and the ultimate accountability of the auditor to the Board of Directors and the Audit Committee, requiring that the auditor periodically submit a written statement to the company delineating all relationships that may impact its independence, and requiring that the Audit Committee take appropriate action to satisfy itself of the auditor's independence.
Audit Committee's charter should be reassessed at least annually to determine the scope of appropriate Audit Committees functions.
The Audit Committee should have direct access to the company's finance and auditing staff (and vice versa), the company's auditors, as well as outside consultants and analysts. It should promptly review SEC and other regulatory correspondence relating to financial and accounting matters, and analysts' reports that consider financial and accounting matters at the company. The Audit Committee should have the ability when it believes it necessary to retain separate counsel and advisors.
AUDIT COMMITTEE'S INDEPENDENCE: The NYSE places the following three restrictions on Audit Committee members for purposes of determining independence:
EMPLOYEES: A director who is an employee of the company or its affiliates may not serve on the Audit Committee until three years following the termination of such employment, unless the Board of Directors determines under exceptional and limited circumstances to appoint such a director to the Audit Committee prior to the end of the three year period if the disabling relationship no longer exists and the Board of Directors determines in its business judgement that the best interests of the company and its shareholders require the director's membership.
BUSINESS RELATIONSHIPS: A director who is a partner, controlling shareholder or executive officer of an entity that has a direct business relationship with the company or has a direct business relationship with the company (eg, consultant), may not serve on the Audit Committee until three years after the termination of such a relationship, unless the Board of Directors determines in its business judgement that the relationship does not interfere with the director's exercise of independent judgement.
IMMEDIATE FAMILY RELATIONSHIPS: A director, who is an immediate family member of an executive officer of the company (or an affiliate), cannot serve on the Audit Committee until three years following the termination of the employment relationship, unless the Board of Directors determines under exceptional and limited circumstances to appoint such director to the Audit Committee prior to the end of the three-year period if the disabling relationship no longer exists and the board of directors determines in its business judgement that the best interests of the company and its shareholders require the director's membership.
IMPORTANT FUNCTIONS OF AC'S: The audit committee should be ideally empowered to obligate the following tasks/functions:
-- The responsibility to oversee the work of an accounting firm employed by the company, including the resolution of any disagreement between management and the auditor regarding financial reporting.
-- At least annually, to obtain and review a report by the independent auditor describing: the firm's internal quality-control procedures.
-- At least annually, to evaluate the independent auditor's performance. The Audit Committee may further ensure the rotation of the auditing firm as per laws of the SEC. It is also for the Audit Committee to determine as to whether the company is obtaining high-quality audits. The Audit Committee may present its findings with respect to the independent auditor to the full Board.
-- To discuss the annual audited financial statements and quarterly financial statements prior to dissemination, with management and the independent auditors.
-- To review in consultation with the independent auditors, management and the internal auditors, the integrity of the company's financial reporting process, both internal and external.
-- The Committee should obtain and discuss with the management and the independent auditor, reports from the management and the independent auditor regarding:
(i) critical accounting policies and practices to be used by the company;
(ii) analyses prepared by the management and/or the independent auditor setting forth significant financial reporting issues and judgements made in connection with the preparation of the financial statements;
(iii) major issues regarding accounting principles and financial statements;
(iv) major issues as to the adequacy of the company's internal controls and any specific audit steps adopted in the light of material control deficiencies; and
(v) any other material written communications between the independent auditor and the company's management.
-- To review periodically the effect of regulatory and accounting initiatives or the amendments in laws introduced by the regulatory authorities.
-- To discuss policies with respect to risk assessment and risk management and to discuss the company's major financial risk exposures and the steps management has taken to monitor and control such exposures.
-- To review and discuss with the independent auditor any audit problems or difficulties and the management's response, including, but not limited to, any restrictions on the scope of the independent auditor's activities or on access to requested information.
-- To review and approve, if appropriate, the operations and responsibilities of the Internal Audit Department and any changes thereto.
-- To report regularly to the Board including, but not limited to, any issues that may arise with respect to the quality or integrity of the company's financial statements, the company's compliance with legal or regulatory requirements, the performance and independence of the company's independent auditors or the performance of the internal audit function.
-- To direct preparation of and approve the Audit Committee Report required by the rules of the Securities and Exchange Commission.
-- To perform such additional activities and consider such other matters within the scope of its responsibilities as the Audit Committee or the Board deems necessary or appropriate.
PERFORMANCE EVALUATION: The Audit Committee may conduct a review and evaluation, at least annually, of the functioning of the Audit Committee and its compliance with the company's charter.
The obligations it is required to discharge in accordance with the requirements of the Security and Exchange Commission or any regulatory authorities.
The Audit Committee may also conduct special assignments such as evaluations and reviews, as and when desired by the Board, to strengthen the financial discipline of the company.
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