Audit Committee & its Importance

There are few words more reassuring to the investors and shareholders than accountability. A system of good corporate governance promotes relationships of accountability between the principal actors of sound financial reporting - the board, the management and the auditor. It holds the management accountable to the board and the board accountable to the shareholders. The audit committee's role flows directly from the board's oversight function. It acts as a catalyst for effective financial reporting.

The Committee is of the view that the need for having an audit committee grows from the recognition of the audit committee's position in the larger mosaic of the governance process, as it relates to the oversight of financial reporting.

A proper and well functioning system exists, therefore when the three main groups responsible for financial reporting - the board, those responsible for the financial management including the internal auditor and the outside auditors - form the three-legged stool that supports responsible financial disclosure and active and participatory oversight. The audit committee has an important role to play in this process, since audit committee is a sub-group of the full board and hence the monitor of the process. Certainly, it is not the role of the audit committee to prepare financial statements or engage in the myriad of decisions relating to the preparation of those statements. The committee's job is clearly one of oversight and monitoring and in carrying out this job it relies on senior financial management and the outside auditors. However it is important to ensure that the boards function efficiently for if the boards are dysfunctional, the audit committees will do no better. The Committee believes that the progressive standards of governance applicable to the full board should also be applicable to the audit committee.

1. The Committee therefore recommends that a qualified and independent audit committee should be set up by the board of a company. This would go a long way in enhancing the credibility of the financial disclosures of a company and promoting transparency.
   [ This is a mandatory recommendation. ]

2. The following recommendations of the Committee, regarding the constitution, functions and procedures of audit committee would have to be viewed in the above context. But just as there is no "one size fits all" for the board when it comes to corporate governance, same is with audit committees. The Committee can thus lay down some broad parameters, within which each audit committee has to evolve its own guidelines.

The composition of the audit committee is based on the fundamental premise of independence and expertise.
The Committee therefore recommends that

• the audit committee should have minimum three non executive directors, majority being independent, with at least one director having financial and accounting knowledge;

• the chairman of the committee should be an independent director;

• the chairman should be present at Annual General Meeting to answer shareholder queries;

• the finance director, head of internal audit and a representative of external auditor should be present as invitees for the meetings of the audit committee;

• the Company Secretary should act as the secretary of the committee.
  [These are mandatory recommendations. ]

• The Committee recommends that to begin with the audit committee should meet at least thrice a year. One meeting must be held before finalisation of annual accounts and one necessarily every six months.

• The quorum should be either two members or one-third of the members of the audit committee, whichever is higher.
  [The recommendations in paragraphs 6.8 and 6.9 are mandatory]

Being a committee of the board, the audit committee derives its powers from the authorisation of the board. The Committee recommends that such powers should include:

• To investigate any activity within its terms of reference.

• To seek information from any employee

• To obtain outside legal or other professional advice.

• To secure attendance of outsiders with relevant expertise, if it considers necessary.
  This is a mandatory recommendation.

As the audit committee acts as the bridge between the board, the statutory auditors and internal auditors, the Committee recommends that its role should include the following

• Oversight of the company's financial reporting process and the disclosure of its financial information to ensure that the financial statement is correct, sufficient and credible.

• Recommending the appointment and removal of external auditor, fixation of audit fee and also approve payment for any other services.

• Reviewing with management the annual financial statements before submission to the board, focussing primarily on

• Any changes in accounting policies and practices.

• Major accounting entries based on exercise of judgement by management.

• Qualifications in draft audit report.

• Significant adjustments arising out of audit.

• The going concern assumption

• Compliance with accounting standards

• Compliance with stock exchange and legal requirements concerning financial statements.

• Any related party transactions i.e. transactions of the company of material nature, with promoters or the management, their subsidiaries or relatives etc. that may have potential conflict with the interests of company at large.

• Reviewing with the management, external and internal auditors, the adequacy of internal control systems.

• Reviewing the adequacy of internal audit function, including the structure of the internal audit department, staffing and seniority of the official heading the department, reporting structure, coverage and frequency of internal audit.

• To discuss with internal auditors any significant findings and follow-up thereon.

• Reviewing the findings of any internal investigations by the internal auditors into matters where there is suspected fraud or irregularity or a failure of internal control systems of a material nature and reporting the matter to the board.

• To discuss with external auditors before the audit commences, the nature and scope of audit. Also have post-audit discussion to ascertain any area of concern

• Reviewing the company's financial and risk management policies.

• To look into the reasons for substantial defaults in the payments to the depositors, debenture holders, share holders (in case of non-payment of declared dividends) and creditors.
  [This is a mandatory recommendation]