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Creating an effective
audit committee
z an inability among directors that are not audit committee members to grasp
fully major accounting or risk issues;
The audit committee mandate should only empower the committee to make
recommendations to the board and not to make decisions in its own right. As
the board must sign off the financial report, it needs to be comprehensively
informed by the audit committee of any issues relating to the financial report on
an ongoing basis.
2 Creating an effective audit committee
Composition
The size of the audit committee will vary depending upon the needs and culture
of the company and the extent of delegated responsibilities to the committee.
The objective is to allow the committee to function efficiently, all members to
participate, and an appropriate level of diversity of experience and knowledge.
Most companies have no set policies for rotating committee members but
depend on weighing a member’s experience against the risk of complacency.
Without a rotation policy, it is important for the board of directors to evaluate an
audit committee member’s performance to see that it meets both the board’s
and the committee’s expectations. Rotation of audit committee members can
provide a practical way to refresh and introduce new perspectives to audit
committee processes. It also enhances the opportunity for a greater number of
board members to gain an in-depth and first hand understanding of the function
of the audit committee.
The chief executive officer or managing director and the chief financial officer
should not be members of the audit committee but should be invited to meetings
to help resolve issues more efficiently.
Independence of members
Audit committees should comprise independent non-executive directors. To be
effective in their role, non-executive directors should display the following
characteristics:
Be given timely access to all relevant information, so that they can consider
and discuss it before important decisions are taken.
Be fully aware of the significant risks faced by the company and take an active
role in the board’s review of the effectiveness of the system of internal control,
including both regular reviews and an annual assessment exercise.
To the extent that they are members of the audit committee, be able to
understand the principles that underpin the preparation of financial statements.
To the extent that they are members of the remuneration committee, have
access to professional advice on remuneration matters from both inside and
outside the company, and be sensitive to the wider scene, including pay and
employment conditions elsewhere in the group and similar companies.
Recognise that ultimately they share responsibility for the leadership and
control of the company with the executive directors and, where things go wrong,
they may be held liable.
The chairman should also be independent and should not also be the board
chairman.
Qualifications of members
Due to the nature of the responsibilities of the audit committee, the board should
have regard to candidates that possess some or all of the following skills and
experience:
z Broad business experience.
z Familiarity with risk management identification and evaluation.
z An understanding of internal control systems.
z Experience of compliance systems.
z An understanding of major accounting and reporting issues.
z Familiarity with the Companies Act financial reporting provisions and
accounting standards.
z An understanding of the roles of the internal and external auditors.
z Familiarity with the fundamental concepts of professional auditing
standards.
z An understanding of the implications of technological change on the
processes of the organisation.
In addition to skills and practical experience, the board should also look for the
following personal qualities when selecting committee members:
z The ability to act independently and be pro-active in advising the full board of
any concerns.
z The ability to ask relevant questions, evaluate the answers and continue to
probe for information until completely satisfied with the answers provided.
z Independence of thought.
z An ability and desire to learn.
z Openness to new ideas and a tolerance for unconventional views.
z An appreciation of the organisation’s culture and values, and a
determination to uphold these organisational values coupled with a
thoughtful approach to the ethical issues that might arise.
z A professional approach to duties, including an appropriate commitment of
time and effort.
z The courage to take and stand by tough decisions.
z Loyalty to the interests of shareholders and other stakeholders.
z Encouragement of openness and transparency, which is demonstrated by
the ability to accept mistakes and not ascribe blame.
z To maintain personally the highest ethical standards.
z To demand the highest ethical standards of behaviour from the internal and
external auditors.
6 Creating an effective audit committee
The secretary has an important role in ensuring that there are structured
communication channels between the board and the audit committee and that
board members receive reports that keep them adequately informed on the
audit committee’s activities.
The secretary must also ensure that papers support audit committee
recommendations, which are provided to the board, including the minutes that
explain the rationale for the committee’s recommendations.
Creating an effective audit committee 7
The audit committee must convey any significant concerns that internal audit or
the external auditor has to the full board immediately.
The board should also accept the internal and external audit plans, have an
understanding of the processes of the audit committee and receive assurance
on an annual basis that those processes are adequate.
8 Creating an effective audit committee
Given the importance of the managing director or CEO’s role, and the roles of
other senior management, in respect of the risk and control framework, it is
critical that these senior executives have the respect and confidence of those
they lead and those to whom they report. This includes, but is not limited to,
demonstrating the organisation’s values in their day-to-day behaviour and in
their interactions with the audit committee and the board. These actions,
underpinned by appropriate policies, processes and reward systems, support a
“no surprises” environment.
The managing director or CEO and CFO usually have a standing invitation to
attend audit committee meetings.
Where the internal audit function resides in-house, it is preferable that the head
of internal audit report to the managing director or CEO on a functional basis
and to the CFO for administrative purposes only.
The internal auditor should also have unfettered access to the audit committee.
Where the internal audit function is outsourced, the head of internal audit usually
reports directly to the audit committee and a senior executive.
The committee should receive regular reports from internal audit on the results
of its activities including management’s responses to recommendations made
on controls and compliance. Internal audit should be pro-active in bringing
matters to the attention of the audit committee.
In reviewing the scope of external audit and the remuneration of the external
auditor, the members of the audit committee should undertake the necessary
steps to satisfy themselves that a comprehensive, complete and independent
audit can be and is undertaken.
There should be open and frank dialogue with the external auditor throughout
the year and not simply at the time of finalising the financial report.
Creating an effective audit committee 9
The right to receive independent professional advice is a policy that should apply
to all members of the board whether serving on board committees or only on the
board itself.
Continuing education
There is increasing and dynamic change not only in the area of financial
reporting but in regulatory compliance, technology and business risk. It is
essential that directors have sufficient training to enable them to keep
abreast of such developments. The committee chairman, in consultation with
the board, should monitor the needs and opportunities for further education.
Performance evaluation
A structured and formal performance evaluation of an audit committee’s
performance, both collectively and at an individual level can help to ensure
the committee delivers on its mandate and enable the committee to enhance
its contribution to the board continuously. The evaluation may be a self-
evaluation or involve facilitation or review by an external party.
Creating an effective audit committee 11
The evaluation should seek input from the board, management and the internal
and external auditors.
Key questions suggested in the Report of the NACD Blue Ribbon Commission
on Director Professionalism 2001 edition include:
z are committee meetings productive?
z does the agenda-setting process allow for appropriate issues to be raised
as necessary?
z is the agenda ordered with sufficient time to discuss the most complex and
critical issues?
z can and do the members influence the content of the agenda?
z do members receive sufficient information about agenda items in advance?
z how could the committee be improved in terms of meeting frequency,
duration, content, location and interests? and
z how well informed are non-committee members about the deliberations of
the committee - particularly other members of the board?
The full board should discuss the findings and recommendations and ensure
that appropriate action is taken to enhance the committee’s ability to perform
effectively. Evaluations that are well performed demonstrate the committee’s
intention to meet all its responsibilities.
SOx defines the audit committee as "a committee (or equivalent body)
established by and amongst the board of directors of an issuer for the purpose
of overseeing the accounting and financial reporting processes of the issuer
and audits of the financial statements of the issuer."
Audit committee members are faced with increased expectations from many
groups, including shareholders, shareholder and governance activists,
regulators, the media, and fellow board members. The New York Stock
Exchange, in its listing standards proposals, has suggested that a formal
evaluation process be established for the board as a whole and for each major
committee of the board.
Contact us:
Boris Lvov
Corporate Governance, Performance
and Compliance
This text is an unaccredited translation and adapted version of "Creating an effective audit committee" prepared by Audit © 2009 ZAO KPMG, a company incorporated under the Laws of
Committee Institute sponsored by KPMG. the Russian Federation and a member firm of the KPMG
network of independent member firms affiliated with KPMG
The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual
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without appropriate professional advice after a thorough examination of the particular situation. International, a Swiss cooperative.