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  Audit Committees

Introduction to Audit committees

The UK Corporate Governance Code places audit committees at the heart of the financial reporting process and they are seen as vital to good corporate governance. The tasks of the audit committee have increased in recent years following the introduction of international financial reporting standards and tougher overseas corporate governance rules, such as the Sarbanes-Oxley Act in the US. This Act was introduced in the wake of accounting scandals and applies to a number of large UK listed companies that also list their shares in the US.

  • The role of the audit committee

There is a danger that the role of the directors as preparers of the financial statements and the role of external auditor as 'watchdog' will not be properly carried out. We saw in earlier that there have been several accounting scandals involving directors preparing financial statements that portray a company's financial health in a way that bears little resemblance to economic reality (creative accounting). External auditors have sometimes failed to spot irregular accounting practices used by directors to obscure the true position. This has cast doubt about the quality of the audit process and, in some cases, over the freedom of auditors. It has been disputed that where an accountancy firm carries out a large amount of non-audit work for a client company, its ability to audit the financial statements on behalf of the shareholders will be compromised.

Non-audit work is awarded through the directors and may involve tax advice, IT support, financial and management consultancy.

The UK (United Kingdom) Corporate Governance Code suggests that an audit committee should have delegated authority for trying to make sure that financial reporting and internal control principles are appropriately applied and for maintaining a suitable relationship with the external auditors. The committee should contain at least three, or in the case of smaller companies, two, independent, non-executive directors. The major role and responsibilities of the audit committee should be as follows:

  • to watch the integrity of the financial statements;
  • to review the internal controls of company;
  • to create recommendations regarding to the appointment and removal of the external auditor and to approve the terms of engagement;
  • to review and watch the independence, objectivity and effectiveness of the external auditor; and
  • to implement and establish policies concerning the supply of non-audit services by the external auditor.

Additionally to these duties, the audit committee might also take responsibility for reviewing the risk management systems of the company where the board, or a separate risk committee, does not address this issue.

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