Role of the Audit Committee in Corporate Governance

Nicholas J Price
5 min read

The role of the audit committee forms the cornerstone for effective corporate governance. Boards rely on their audit committees to offer effective oversight of the annual auditing process. Members of the audit committee do their best quality work when the majority of the members are independent and objective. Regardless of their experience, nearly all audit committees have room to improve the financial reporting process. Effective audit committee oversight is a vital process for protecting investors and the health of the capital markets.

Audit committees also oversee the system of internal controls and ensure that the company is compliant with laws and regulations. Audit committee oversight extends to IT security and operational matters. Certified public accountants report directly to the audit committee, as opposed to reporting to management. The role of the audit committee includes such responsibilities as appointing and overseeing the work of the auditor and managing the auditor’s compensation.

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Role of the Audit Committee in Corporate Governance

Audit committees should have at least one individual on the committee who is considered a financial expert. It’s not necessary for all members of the committee to be financial experts, but they should be individuals who are knowledgeable about financial issues and who have a solid understanding of accounting principles and audit and finance terms and definitions.

Senior managers and independent auditors also have distinct roles in the financial reporting process. Managers are responsible for preparing the financial statements and establishing internal controls over the financial reporting. Management must also maintain the internal controls and ensure that the financial reporting process is accurate and effective. The independent auditor bears the responsibility for expressing an opinion on the fairness of the financial statements, the company’s financial position, operational results and cash flows and helping to ensure that those issues conform with generally accepted accounting principles.

Before the audit committee begins its work, committee members will need to understand how management develops and reports internal financial information. Reviewing internal information gives audit committees an opportunity to ask questions about the completeness, accuracy and timeliness of audit reports. Having a good understanding of audit reports ensures that audit committee members will know the potential impact of financial statements. All audit committee members must also be up to speed on recent professional and regulatory changes and announcements.

The audit process is an interactive process between the audit committee, auditors and management. Audit committees review the results of the audit with senior managers and external auditors, including matters that managers generally share with the audit committee under general auditing standards. One of the primary responsibilities of the audit committee is to review significant accounting and reporting issues.

Working With External Auditors

Audit committees are uniquely different from other committees in that they have more authority than most other types of committees. Because of their unique relationship with external auditors and the importance of their duties, it’s necessary for audit committees to have authority over their budgets and for managing external auditors.

For companies that have an internal audit department, the audit committee reviews and approves the audit plan, reviews staffing and provides insight over the organization of the audit plan. The audit committee also meets with internal auditors and management to touch base for periodic review. During these reviews, the audit committee may propose alternative audit approaches and coordinate the audit with internal audit staff.

During the annual audit, the audit committee meets separately with external auditors to discuss matters that need to be discussed privately. It’s important for audit committees to work toward preventing fraud. Auditors with forensic audit expertise are adept at detecting willful accounting errors and anomalies.

The audit process is designed to protect investors, and the hope is that shareholders will have trust in the financial reports that the company releases.

Understanding Regulations

Members of the audit committee should be familiar with the Sarbanes-Oxley Act of 2002 (SOX). The Securities and Exchange Commission (SEC) adopted a rule in 2003 that mandates the national securities exchanges and national securities associations to disallow listings that aren’t in compliance with the audit committee requirements of SOX.

SOX contains several rules that are specific to the role of the audit committees of publicly listed companies. The law says that all committee members must be independent to preserve the integrity of the auditing process. By virtue of ensuring that all audit committee members are independent, shareholders gain assurance that the company is doing its best to prevent inside employees from manipulating the work of the committee and the external auditors.

Audit committees are responsible to choose and oversee the issuer’s independent accountant. The board must have procedures in place to manage complaints about the issuer’s accounting practices. The audit committee’s charter gives the committee the authority to enlist the help of independent advisors and to budget accordingly for them. Audit committees also have the authority for the budget for funding the independent auditor.

In addition to SOX regulations, NYSE listing standards involve having audit committees review major issues related to accounting principles and how the company presents financial statements. The standards also require audit committees to explain significant changes in the company’s application of accounting principles, internal controls and other material control deficiencies. NYSE recommends that audit committees review these issues with management on a quarterly basis.

NASDAQ requires companies to disclose the purpose of the audit committee as it is described in its charter and the role of the committee in overseeing the financial and accounting reporting processes of the company and the audit reports of the financial statements.

Some of a board’s most crucial duties are performed by the role of the audit committee. It’s vital for the audit process to remain confidential until financial reports are thoroughly reviewed and ready for public release. A board portal system by Diligent is a highly secure platform in which audit committees can record and store updates on regulations where audit committee members can access them at any time. A secure board portal also provides an online place where committee members can meet remotely and exchange documents confidentially. Diligent Messenger is a software communication tool that integrates seamlessly with Diligent Boards so that audit committee members can communicate electronically without the fear of being hacked.

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