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Audit Committee

Audit Committee

Audit Committees

Audit Committee plays a critical role by ensuring the independence of an audit process. Auditing the operations of a modern corporation is an intricate and complex process that would require the understanding of the rules and judgements taken by the management while preparing financial statements. Audit Committee is formed to act as a conduit of information supplied by the management to the auditors and to insulate an auditor from the pressures of the management. Therefore, such committees are to be independent of management and has the responsibilities of deciding the work or scope, including the fixation of audit fees and the determination of the extent of non-audit services.

Formation of Audit Committee

In India, the constitution of audit committees is deemed mandatory for listed companies as stated under the Companies Bill, 2009 and the SEBI Act. The Companies Bill requires every listed company to have an audit committee that comprises a minimum of three directors with independent directors forming a majority with at least one of them with expertise and knowledge in financial management, audit or accounts. The norms to be followed while forming an audit committee according to SEBI has been given below.

  1. An audit committee must comprise a minimum of three directors as its members.
  2. Two-thirds of the total number of an audit committee’s members must comprise of independent directors.
  3. Every member of an audit committee must be financially knowledgeable with at least one of the members having accounting or related financial management expertise.
  4. An independent director must be appointed as the Chairman of an audit committee.
  5. The Chairman of an audit committee must be present at all Annual General Meetings with the purpose of answering shareholder queries.
  6. The audit committee may invite executives, as it considers appropriate, to be present at the meetings held by the committee. The invitees for the meetings of the audit committee may also include the finance director, head of the internal audit and a representative of the statutory audit.
  7. The Company Secretary must take up the role of being the secretary of the audit committee.

Note: The term “financially knowledgeable” refers to the ability to read and understand fundamental financial statements such as balance sheets, statement of cash flows, and profit and loss accounts.

Powers of Audit Committee

Under Clause 49 (II)(C) of the Listing Agreement, an audit committee would have the following powers.

  • To investigate any activity under the scope of its terms of reference.
  • To search or seek information from any employee.
  • To obtain any outside professional or legal advice.
  • To secure the attendance of outsiders with any relevant expertise.

It should be noted that the powers mentioned above are only illustrative and not exhaustive. The auditor is required to review the terms of reference of the audit committee and check if it has been framed with inclusion to the above powers. It is mandatory and of utmost importance that the mentioned powers to be vested in an audit committee. The Board has the authority to further delegate or vest more powers to the audit committee.

Role of Audit Committee

Under Clause 49 (II)(D) of the Listing Agreement, an audit committee would have the following roles to play.

  1. To have continuous oversight of the financial reporting process of the company and the disclosure of its financial information to ascertain that the financial statement is accurate, sufficient and credible.
  2. To recommend the appointment and removal of external auditors, the fixation of audit fee and also, approve the payment of any other services.
  3. To review the annual financial statements with the management before the submission of the same to the Board. The audit committee must primarily focus on the following:
  4. To review the annual financial statements with the management before the submission of the same to the Board. The audit committee must primarily focus on the following:
    • Any changes made to the accounting policies or practices;
    • Any significant accounting entries concerning the exercise of judgements by the management;
    • Qualification in the draft audit report;
    • Major adjustments arising out the audit;
    • The going concern assumption;
    • Compliance with the accounting standards;
    • Compliance with stock exchanges and the legal requirement regarding financial statements.
    • Any related party transactions.
  5. To review the adequacy of the internal control system with the management, internal and external auditors.
  6. To review the adequacy of the internal audit function. This includes the review of the structure of the internal audit department, staffs and the seniority of the official who heads the department as well as reporting the structure coverage and the frequency of the internal audit.
  7. To discuss any significant findings and follow-ups with the internal auditors.
  8. To review the findings of all the internal investigations conducted by the internal auditors concerning matters where fraud has been suspected or in irregularity of internal control systems of material nature and informing the Board.
  9. To discuss the nature and the scope of the audit with the external auditors before the commencement of the audit. This could include a discussion to ascertain any area of concern.
  10. To review the financial and risk management policies of the company.
  11. To review the reasons for substantial defaults in the payment to depositors, shareholders, debenture holders and creditors.
  12. To carry out any other function as mentioned regarding reference of the Audit Committee.

Mandatory Review of Information by Audit Committee

The Audit Committee must mandatorily review the following information according to Clause 49 II (E).

  • The management discussion and analysis of the financial condition of the company and the result of the operations.
  • The statement of significantly related party transactions as defined by the audit committee and submitted by the management.
  • The letters of the management and internal control weaknesses issued by the statutory auditors.
  • The reports of internal audits related to internal control weaknesses.
  • The review of the appointment, removal and terms of remuneration of the Chief internal auditor.

The auditor must ascertain from the minutes’ book of the audit committee and other reliable sources such as agenda papers, whether the audit committee has been reviewing the previously mentioned information. The auditor must also ensure if, as a part of the directors’ report or an addition to the same, a management discussion and analysis report is included in the annual report submitted to the shareholders. Along with this, the auditor must ascertain whether the management discussion and analysis also includes discussion on matters stipulated in this sub-clause. The auditor is required to check that certain deficiencies and adverse findings noted by the audit committee, is suitably dealt with by the management in the report concerning Corporate Governance. The auditor must also ensure that the information reviewed by an audit committee is consistent with the reports in the financial statements. This would also include those reports that were made for giving segment-wise break-up for compliance of the Accounting Standards 17 related to Segment Reporting.

Meeting of Audit Committee

Under Clause 49 (II)(B) of the Listing Agreement, an audit committee is required to meet three times in a year at the least. An audit committee is also expected to have these meeting with not more than four months of a lapse between two consecutive meetings. If a meeting is considered necessary by the external auditors, they may request for one.

The Finance Director, the Head of Internal Audit, and a representative of the external auditors shall generally attend the audit committee meetings. Other Board members may also have the right of attendance. However, the audit committee should meet with the external auditors without the Executive Board members at least once a year.