Audit committee is a term which we are all familiar with though when it comes to the details and intricacies of it we all have a few questions unanswered. I am attempting here to remove the shroud of mystery surrounding the audit committees. In this article I am attempting to address why audit committees are formed, how are they structured, how they operate, become effective and support the business organizations. I am attempting to cover the Indian and the International aspects of Audit Committees in this article.
The sub-sections covered in this article are as follows;
- Legal requirement for formation of audit committee
- Structure and membership of audit committees
- Operations of audit committees
- Reporting to the audit committee
- Measuring effectiveness of audit committees
A. Legal requirement for formation of audit committee
Audit committees are now mandatory in most of the countries for public limited companies. A comparison of Company Law 1956 of India and USA the Sarbanes Oxley Act 2002 has been done. In USA prior to Sarbanes Oxley Act audit committees were required, it is just that in Sarbanes Oxley further provisions have been added which are applicable to date.
The Company Law of India, Section 292 A makes is mandatory for public companies having a paid-up capital of Rs 50 million or more to have an Audit Committee. According to the Sarbanes Oxley Act 2002 Section 301 all public companies should have an audit committee. The act has further in Section 204 and 407 defined the submission of Auditors report to the committee and participation of a financial expert in the committee respectively. The extracts of the sections are given below in a table for easier understanding of the requirements.
|Indian Company Law Section 292 A (1)Every public company having paid-up capital of not less than five crores of rupees shall constitute a committee of the Board knows as “Audit Committee” which shall consist of not less than three directors and such number of other directors as the Board may determine of which two thirds of the total number of members shall be directors, other than managing or whole-time directors.(2) Every Audit Committee constituted under sub-section (1) shall act in accordance with terms of reference to be specified in writing by the Board.
(3) The members of the Audit Committee shall elect a chairman from amongst themselves.
(4) The annual report of the company shall disclose the composition of the Audit Committee.
(5) The auditors, the internal auditor, if any, and the director-in-charge of finance shall attend and participate at meetings of the Audit Committee but shall not have the right to vote.
(6) The Audit Committee should have discussions with the auditors periodically about internal control systems, the scope of audit including the observations of the auditors and review the half-yearly and annual financial statements before submission to the Board and also ensure compliance of internal control systems.
(7) The Audit Committee shall have authority to investigate into any matter in relation to the items specified in this section or referred to it by the Board and for this purpose, shall have full access to information contained in the records of the company and external professional advice, if necessary.
(8) The recommendations of the Audit Committee on any matter relating to financial management, including the audit report, shall be binding on the Board.
(9) If the Board does not accept the recommendations of the Audit Committee, it shall record the reasons therefore and communicate such reasons to the shareholders.
(10) The chairman of the Audit Committee shall attend the annual general meetings of the company to provide any clarification on matters relating to audit.
(11) If a default is made in complying with the provisions of this section, the company, and every officer who is in default, shall be punishable with imprisonment for a term which may extend to one year, or with fine which may extend to fifty thousand rupees, or with both.
|Sarbanes Oxley Act Section 301: Public Company Audit Committees.Each member of the audit committee shall be a member of the board of directors of the issuer, and shall otherwise be independent.”Independent” is defined as not receiving, other than for service on the board, any consulting, advisory, or other compensatory fee from the issuer, and as not being an affiliated person of the issuer, or any subsidiary thereof.The SEC may make exemptions for certain individuals on a case-by-case basis.The audit committee of an issuer shall be directly responsible for the appointment, compensation, and oversight of the work of any registered public accounting firm employed by that issuer.
The audit committee shall establish procedures for the “receipt, retention, and treatment of complaints” received by the issuer regarding accounting, internal controls, and auditing.
Each audit committee shall have the authority to engage independent counsel or other advisors, as it determines necessary to carry out its duties.
Each issuer shall provide appropriate funding to the audit committee
Section 204: Auditor Reports to Audit Committees.
The accounting firm must report to the audit committee all “critical accounting policies and practices to be used; all alternative treatments of financial information within [GAAP] that have been discussed with management, ramifications of the use of such alternative disclosures and treatments, and the treatment preferred” by the firm.
Section 407: Disclosure of Audit Committee Financial Expert.
The SEC shall issue rules to require issuers to disclose whether at least 1 member of its audit committee is a “financial expert”.
The essence of requirement of audit committee of both the countries is the same, though Indian Company Law has defined the criteria and requirements clearly and the Sarbanes Oxley Act is covering it from the overall context.
As can be seen from the extracts of the Indian and US laws, audit committees are required to be constituted with independent directors, with some expertise in financial matters. The major role is to provide independent counsel on the financial statements including the accounting policies and auditors report. The audit committee is authorized to investigate discrepancies observed, and the board is required to give due attention to the recommendations of the audit committee.
Please do write in your comments and share insight on the requirements of Audit Committee in respect of your country laws.
Next section- to be continued.