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 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, the 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 fulfil these responsibilities and duties by carrying out the activities as laid down in the company's Charter.
The concept of audit committees (ACs) is not new and can be traced back to the 19th century.
The Great Western Railway Company had an AC in 1872. 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 in their annual report. In others such as France, Hong Kong, Japan and the Netherlands, ACs are recommended as the best practice.
This recent global recognition of the AC as a relevant governance structure in a wide variety of environments is to be seen in the context of the AC's benefits on a number of aspects of corporate governance.
During the last few years audit committees 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. Early recommendations for ACs made in the US and Canada have been followed by proposals for extending their use in many countries.
Accompanying their widespread adoption, expanded roles for ACs have been advocated, stipulated and various rules have been adopted concerning their operation.
CONCERNS ABOUT ACS:
Concerns about the effectiveness of ACs in overcoming weaknesses in corporate governance have been expressed by regulators. Researchers have also questioned whether the potential contribution of ACs to governance has been overshadowed by intense scrutiny and criticism of the function and suggested that there is considerable anecdotal evidence that many, if not most, audit committees that fall short of doing what are generally perceived as their duties.
Concerns have been voiced that many AC members lack critical attributes such as expertise and experience in oversight that the level of interaction between the AC and auditors is variable, undermining the ACs value as an effective vehicle for pursuing shareholders interests and that whether ACs are actually discharging their important responsibilities is not sufficiently understood.
Some have argued that the adoption of ACs may be primarily symbolic, that although an AC fulfils the form of regulation in reality they often lack sufficient substance and that there is a need to evaluate more closely the possibility that the benefits associated with ACs are more theoretical than substantive.
The incidence of corporate failures involving fraud, poor accounting, inadequate internal control and apparently ineffective monitoring by ACs accentuate these concerns. Despite negative observations by critics and researchers, there is no denying the fact that ACs play a vital role in inculcating financial discipline and purifying the corporate environment by safeguarding the interest of various stakeholders ; some of these are discussed in the succeeding paragraphs.
STRUCTURAL INCENTIVES:
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 the directors execution of their responsibilities. There is no doubt that audit committees can play a major role in bringing about greater accountability by companies and in restoring confidence in financial reporting.
The audit committees can help directors meet their statutory and fiduciary responsibilities, especially as regards accounting records, annual accounts and the audit. The 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 observations which are echoed in the text of many reports, suggest that ACs influence the balance of power in accountability and audit relationships. Whether or not this interpretation is valid, not least in terms of perceived or implied benefits, may be revealed by the circumstances that are associated with adoption (and non-adoption) of AC structure.
Although voluntary formation of an AC does not in itself provide evidence of actual effects in practice, it can indicate something about the motivations associated with an AC in governance structures and the organisational circumstances in which accountability benefits are most strongly perceived. Studies of the factors associated with formation in non-mandatory settings can thus provide evidence on the justification for AC requirements.
Notwithstanding the claimed virtues of ACs and the prevalence of normative recommendations for their adoption, there remains the overriding question of what difference they make to organisational accountability in practice. In this context, issues of interest include the effects of ACs on the audit function, financial reporting and corporate performance.
EFFECTS ON THE AUDIT FUNCTION:
A second aspect of the case for ACs is their impact on corporate auditing. It has often been as a consequence of reviews of, inter alia, alleged weakness in audit effectiveness that recommendations for AC requirements have been made (eg Cadbury, 1992) , and actual outcomes in this area are therefore an important subject for evaluation. The potential for ACs to influence a number of factors concerning external and internal audit is illustrated by the following extracts. OK.
"The independent nature of the audit committee should result in the internal audit department assuming a greater responsibility in the financial reporting process. This role should, in turn, promote improvements in the internal control structure, resulting in heightened integrity in the financial reporting process" (Apostolou, 1990).
"Audit committees have 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. ACs offer added assurances to the shareholders that the auditors, who act on their behalf, are in a position to safeguard their interest" (Cadbury, 1992).
"Audit committees have an important role to play in enhancing the perceived independence of internal and external audit from operational management" (Price Waterhouse, 1997)
It is therefore appropriate to consider what evidence is available regarding the effects of ACs on the audit function in practice For example, ACs could be expected to have an impact on the appointment, removal and remuneration of auditors, the content and extent of audit work programmes, auditor independence and the resolution of disputes between auditors and executive management. Also the evidence of the effects of ACs on the internal audit function and on internal controls and risk management needs to be evaluated.
EFFECTS ON FINANCIAL REPORTING:
Many ACs comment upon and approve the choice of accounting policies, and they can be expected to influence a company's approach to financial reporting, levels of disclosure, adherence to standard practice etc. Over many years, the advocative literature has included various claims about the potential contribution of ACs to improving financial reporting.
ACs are expected to monitor the reliability of the company's accounting processes and compliance with corporate legality and ethical standards including the maintenance of preventive fraud controls. There is also a belief that ACs help ensure the maintenance of proper accounting records and the reliability of published financial information. Again, some extracts indicate the intended benefits of ACs in this area.
"The audit committee or a company's board of directors can play a crucial role in preventing and detecting fraudulent reporting (NCFFR 1987)
"The existence of an audit committee can strengthen the position of the finance director. He has a forum in which to explain certain policies or disclosures relating to external financial statements: (Marrian, 1988)
"Audit committees have the potential to improve the quality of financial reporting, by reviewing the financial statements on behalf of the board and to create a climate of discipline and control which will reduce the opportunity for fraud. Audit committees can also increase public confidence in the credibility and objectivity of financial statements: (Cadbury, 1992)
An interesting aspect of research on the financial reporting effects of ACs is the manner in which proxies for reporting quality are created, relying on both analysis of actual reported numbers and the more negative signals of poor quality, such as regulatory action against companies.
EFFECTS ON CORPORATE PERFORMANCE:
A fourth and final area of potential impact concerns whether the existence of an AC as a governance mechanism results in better corporate performance. It may seem tenuous to draw a direct link between the AC and company performance, but recommended management and government structures are intended to lead to improved control and better management practices, and this in turn could be associated with positive improvements in performance on behalf of investors.
Increasingly, companies will be expected to demonstrate good governance in order to access the world's capital markets. The fact that a company has an audit committee may boost investor confidence in its governance practice.